Ignorance Is Bliss

This past week culminated with the passing of the Trump tax cut. But this coming week features the re-escalation of the trade war that already collapsed markets back in April. This back-to-back sequence of bullish and bearish events led to the global melt-up in 2017 that collapsed in early 2018. And yet, pundits are nearly universally bullish, which leaves us to ask, "what could go wrong"?

This week, Powell admitted that Trump's trade war is the reason the Fed is not already cutting rates. Now they can add this massive tax cut mega budget to the list of reasons not to cut rates this year. This new deficit-driven tax cut is a gargantuan fiscal stimulus that will keep interest rates higher for longer. Bullish pundits constantly tell us that recession is nowhere on the horizon. However, they forget that had the U.S. deficit been 6% all along, then there would have been NO recessions since WWII i.e. the largest annualized GDP recession post-depression was less than -6%. In a 6% deficit with a growth rate of 2%, the term "recession" has lost all meaning. This interest rate paradigm of holding rates longer and longer, is by far the biggest risk to the economy and markets. Trump complains constantly that the Fed is being political, but they are operating off of the exact SAME economic models that saw them raise rates 21 quarter pts (5.25%) under Biden. Trump forgets that the Fed collapsed stocks into bear market in 2022.

On the topic of the casino, one thing I read all the time is that "valuations don't matter" because AI will have unlimited profits long into the future. We heard the same thing back in Y2K and the internet DID continue to grow into the future, but the stock market crashed regardless. Why? Because it was massively overbought and the rally had become very narrow in breadth. Back in Y2K, first small cap momentum stocks rolled over and imploded but the large cap "Four Horsemen" (MSFT, CSCO, INTC, DELL) kept on making new highs. However at the second Nasdaq market high, those mega caps imploded. Similarly we see the gap between large cap momentum and small cap momentum that attends this second high:

Here we see the price to sales ratio is now at the highest level in 25 years and higher than in 2021 when the Fed's rate hikes imploded stocks. So how can we be bullish now when Powell just said they are going to keep rates higher for longer?

On the topic of mass complacency, Barron's this weekend made only passing mention of the re-escalating trade war. Their lead story was the total Casinofication of the stock market via leveraged ETFs:

"The 2x Coinbase ETF which uses leverage to amplify its exposure to cryptocurrency exchange Coinbase Global, soared 233% in three months, while the more pedestrian $1.4 trillion behemoth Vanguard S&P 500 ETF (VOO) gained a mere 10.9%."

Wall Street traders embraced the acronym TACO, for Trump Always Chickens Out, for playing this phenomenon. Buy after he announces a tariff and the market falls, sell after the market recovers when he backs down. Rinse and repeat."

The problem with the TACO theory, is that THIS TIME investors didn't wait for the pullback, they piled into stocks AHEAD of this new round of tariffs. In other words, what began the second quarter as "buy the dip", turned into front-run the tariffs by the end of the quarter.