The Bear Flashes Its Teeth

This post will be slightly more speculative and long-term looking than before. More thought experiment laying out some scenarios than a hard prediction. Three weeks ago I posted What's Next for Markets. I laid out a few scenarios. At the outset, I wrote:

Many traders are looking for a low around the 3500. Some are short-term oriented, but others have that as a long-term target. The 3500 level is only 5 percent away. I will ride a position down to 3500 and might take very short-term trades, but overall I wouldn't be looking to short here if I thought 3500 would be the final low. There would be more to be made by buying at 3500 and riding the subsequent rally.

My mistake this week was not trading the 3500 level. I took some profits, but I didn't put on any long trades as I did back in January and that would have proven very profitable over one day.

To summarize the rest of that post, a low here is a double-bottom. Hindsight being 20/20, I'd label that June low as the end of wave 1 of the bear market. An A-B-C correction has started with A into August, then both B ending and C starting on Thursday. An alternative was this is Wave 3 and a decline down towards the 3000 to 3300 area. Something probably breaks on this wave such as a shock yuan depreciation, high profile bankruptcy and so on, that triggers intervention. Not necessarily a Fed pivot, but something more substantial that the Bank of England's actions. Looking at events, the Asian Crisis of 1997-1998 can serve as a guide. The Thai bath starts breaking in summer 1997, but it isn't until late summer 1998 that Russia defaults on its debt and Long Term Capital Management goes bust. In this scenario, we get something of a climax in the U.S. dollar rally for now before the final fireworks later next year.

As I read over the post, now I think it is possible a new low here could be more like an overthrow of Wave 1 because I believe this bear market is far larger than understood by the mainstream. I don't think a new low has been made yet. I made this chart yesterday showing how the market behavior since June is like a complex double bottom.  Attempt at a new low at one triggered a big short squeeze. Another attempt at two triggered a huge short squeeze. The market has only spend about 4 hours below the 3580 level, and that level is only 1.6 percent from the June low. Bulls will love hearing that because it means the market is way too bearish. This market is actually very strong because it hasn't really broken lower since June. The bear reading is lots of stocks are at meaningfully lower levels and they're leading the indexes. 

Using Elliot Waves as a guide here, a move to say 3000 is not a Wave 3 considering it would be only 600 points as compared to the 1200 points lost into June. It would be a 25 percent drop from the August top, matching the decline into June. To the point: if this was somehow a Wave 3, then this bear market is getting long in the tooth and likely to end sometime in early 2023. I don't like that timeframe right now, hence my thought that this is probably still Wave 1.

I don't want to go into the weeds with this because what's more important is where I expect the market will go in the days and weeks ahead. I still think a new low is incoming. If I'm wrong I'm wrong, but right now that's all the matters. The target is still 3000-3300.

Doomed Markets

If you're an active investor or trader, or enjoy following the markets, then you no doubt see a pronounced bearish shift in the sentiment. There are sentiment indicators showing bearishness. In my opinion, most of these people are not bearish or are not bearish enough. Example: I'm a little surprised at how many bears own stocks. Many people are trading with a small portion of their assets and hedging their long exposure. I own almost no stocks. I sold most of my holdings before this top was made. The only things I retain are natural resources stocks such as gold, copper and zinc mining (and a few remaining DRIPs that aren't worth the paperwork). I've sold down many of those miners, but in my opinion, they are more likely anti-stock trades because they will do best under stagflation or high inflation that will devastate the broader stock market. Most of my money is traded at the moment and most of it is bearish.

To explain the scale of what I think is coming, I think stocks are like Beanie Babies. It's the go-to investment idea for most people. The 401k and IRA are always put into financial assets unless an individual takes personal ownership and does something different with the money. I expect a lot of people currently working in finance will be unemployed in the coming years. Advisers and managers who ride this bear down will see the asset value under their care fall 40 percent to 60 percent from losses, and then add on all the clients that leave. In 2008, bonds rallied strongly. An investor who sat in a 60/40 portfolio from the top in 2007 to the bottom in 2009 saw bonds rise as stocks fell. SPY fell 54 percent and TLT rose 22 percent, making for a net loss of 23.60 percent. Not fun to see, but not world ending. If cash instead of bonds, 32.40 percent loss. 

An investor who was 60/40 in SPY and TLT this year is down 27.20 percent. If they were in cash, they're down 14.40 percent. TLT isn't the best comparison because it has underperformed the S&P 500 Index this year, instead of outperforming by more than 70 percentage points. Most conservatively invested portfolios are down more like 15 to 20 percent this year. Still, from my perspective of this being the end of round one, the potential losses will be much greater. Moreover, time is a factor. Most people in 2008 didn't start dumping stocks until the market started panicking in 2008. There hasn't really been a panic yet. Most investors have been trained to sit in stocks. If there is a panic now, redemptions and sales among retail investors and 401k holders will start. If not, then it might be well into 2023 and during the next wave down, which might mean close to 40 or 50 percent losses from the 2022 top before real selling kicks in.

Casino Players

Most of what's been going on this year is casino action. Broken markets 2.0

This market is becoming more and more broken by the day. A month ago we referred to Goldman's latest observation on just how extreme short term options trading had become. We wrote: "Close to 50% of options volumes are in contracts with a maturity of less than 24 hours. The greeks that arise from such short term options are very hard to hedge given the current liquidity in the underlying market. Erratic markets at its best..." This is a massive problem for any market, but especially for a market where underlying liquidity is evaporating (chart 2). The options monster has become huge and you can't tame it....

Let's make this as simple as possible. Squeezes like we saw on Thursday are "happy" events with a nearby terminal point because eventually all the bears are gone. They are a minority of the market and lack asset scale. It doesn't take long to blow them all out. The flipside of Thursday is a crash. On a short timeframe, there is really no bottom for a crash because bulls are all in. They are the market. Everyone is watching their account values implode. The market has circuit breakers, but only if the market falls 20 percent will it close.

The above article also says things such as "investors are cashed up." Investors who sell stocks and leave cash in their account are wannabe bulls. When this bear market is done, investors won't be cashed up. They will have cashed out.

End Games

Everyone knows the endgames of the dollar imploding. They may not believe it possible, but they understand how deflationary panic can collapse asset values. Another less discussed scenario is the Fed pivot to destruction. During a twin panic in stocks and bonds, the Federal Reserve does something like a restart of QE. Except commodities haven't collapsed much. Stocks and bonds rally immediately, but so does oil, copper, wheat and so on. Then something like what happened on Friday begins in bonds. They start selling off hard. The rally in commodities picks up steam. Suddenly bonds are back to crashing. The market has decided it doesn't like QE anymore. It knows where it leads. What does the Federal Reserve do now? It immediately reverses like the UK government did with its budget this week.

The deflationary panic that most investors believe impossible will arrive for stocks. Or a bond market panic that devastates financial asset valuations will unfold. People who lose in this collapse will never buy stocks again because as with the Great Depression, the markets won't recover for a couple of decades. They're already be old by the time younger investors are wading back into the market.

Almost everyone I see is some form of bull. The majority of "bears" are buying up precious metals, cryptocurrency and commodities. Many stock bears have a minority of their assets in bearish positions. Many people say they are bearish in sentiment surveys, but they haven't done much with their portfolios. They think stocks will recover because they "always do." Those who have sold a little have raised cash and probably already dip bought some stocks. "Netflix is so cheap!" they think, because they can't comprehend companies of that size losing 90 percent of their value from the top. 

Stepping away from markets, look at the society. Americans feed children "puberty blockers" which are very powerful hormone pills used for people with cancer. They are not approved for children. Puberty blocking is a thing in history. You may be familiar with the castrati and the Chinese eunuchs. These pills permanently destroy children's' bodies. 

This same society punished doctors and banned anyone who spoke about using a safe drug, ivermectin, for treating coronavirus. Whether the drug worked or not, people were censored on social media because drug companies would lose their legal immunity if there were other treatments. Government vaccine mandates would be illegal if there were effective treatments. Many people probably would not have taken the shots if they thought there was an alternative, costing pharma companies billions in profits. The shots were said to prevent transmission, but this was an obvious lie because early tests showed the "vaccinated" were spreading it. Now it is revealed there was no evidence that the shots stop the spread. 

The masses of the West are mindless robots who flip political opinions based on whatever the television and social media tell them. They are simultaneously screaming for shutting down the Western economies to fight climate change while agitating for nuclear war that will glass the West and Russia, maybe China too. Perhaps they are consistent in seeking mass death to lower CO2 emissions, but is this a society you want to be long of?

Extend this corrupt and irrational thinking into markets. Look at this item from Yahoo Finance's Twitter account: 

Chipotle was given an ‘outperform’ rating by Bernstein based on the company's social media strategy on TikTok.

We can debate how deeply this stupidity has infected the investing public, but I am 100 percent certain the vast majority of people don't realize current market valuations are supported by morons. If I'm allowed to count people such as Cathy Wood among the idiots, then I'm 100 percent certain there is more money managed by morons than by bears.

When thinking of financial asset valuations, I'm reminded of the Seinfeld episode where Kramer pumps up Elaine by telling her how he's gone on to dominate his karate class. Later she learns the truth:When people realize how badly they've been hoodwinked by Wall Street, central banks, their own governments and their own stupidity, then the market will reach a bottom low enough to put long-term capital to work. We're a long way from there.