Rotation to Recession
The stakes are high - a new bull market or headfake rally prior to collapse?
When looking around at the various clues as to where this rollercoaster is heading, pundits have a choice to cite bullish indicators or bearish indicators. In what follows I will attempt to show both sides prior to conclusion.
First off, the bull case. As of yesterday this was the longest rally since last November 2023 which was the mid-point of the lows from 2022.
Monday August 19th, 2024:
"Stocks kept pushing higher, adding to a rally from August lows that’s already topped $3 trillion amid bets the Federal Reserve will signal it’s ready to start cutting interest rates."
All major groups in the S&P 500 rose, with the gauge up for an eighth straight day — the longest winning streak since November"
"Momentum traders and a surge in corporate buybacks promise to drive a US stock rally over the next four weeks, according to Goldman Sachs Group"
“Stocks just need a nod that growth is going to be supported”
Here we see the bull case in a nutshell: This has been the longest winning streak since last November which preceded a breakout to new highs. The Fed is about to cut rates to support the economy, momentum traders will take care of the rest. I read a similar story on Seeking Alpha yesterday - "No Second Chances" to get onboard this rally.
If you don't dig too deep below the surface of this Goldilocks fairy tale everything looks fantastic.
Enter the bear case.
First of all on the global macro environment, Last night we learned in China that the government is finally going to allow the housing market to final implode.
"A price war is spreading across China’s new-home market, as local governments dial back on intervention and developers race to recoup cash"
Since you need a subscription to read the entire article, what it says is that up until now the Chinese government has restricted how much prices could be reduced on new homes, in order to prevent a price war. However, those restrictions have now been lifted. Which means that bankrupt property developers can now dump homes onto the market en masse.
I have said many times that what is happening in China is coming to the rest of the world. China's financial markets have been stable recently solely because the government has been stepping in to support markets EVERY DAY. I am referring to the stock market, the bond market and the currency market. This is giving everyone the illusion of stability while the economic implosion accelerates.
While Powell is giving his speech in Jackson Hole, BOJ Governor Ueda will be held back from that conference in order to testify to Japanese Congress as to why he raised rates two weeks ago. Recall that back in July, the BOJ was under tremendous political pressure to support the Yen via higher rates. But since stocks crashed, on Friday Ueda will be asked by politicians as to why he listened to politicians in the first place. He can't win, because recent Japanese economic data is accelerating driving even further divergence with the rest of the world which is cutting rates. Which means that the entire bull case for U.S. investors is predicated upon a further unwinding of the Yen carry trade.
Therefore it's only fitting that we learned that hedge funds are piling back into the carry trade like nothing happened:
"A popular yen-centered carry trade that blew up spectacularly two weeks ago is staging a comeback"
The move back into carry trades highlights the allure of the strategy even after the volatility seen in recent weeks
“People have pretty short memories...There’s so many momentum traders in that sort of space.”
Here we see in this chart that as of this writing, the $USDJPY (Dollar/Yen) carry pair is going further risk off. Note that the Nikkei is rolling over at the 50 dma (blue line) which is where it imploded last time.
Which gets us back to the U.S. casino. Notwithstanding a rush back to near all time highs on the S&P 500, it's the leadership in the market that poses the greatest threat to U.S. investors. Recall that since the AI peak in July AI-related stocks imploded and have been clawing their way back from the lows. Then, in early August the cyclicals imploded as well. Which means that subsequently the "low volatility" recession stocks have been leading this market.
We have seen this movie three times in recent years where Min Vol stocks are leading the market - at the 2020 pre-COVID crash. The second time was in late 2021 prior to bear market. And now this time. Each time, new S&P 100 (mega cap) highs have diverged with this time having the largest divergence of new highs. And yet we are told this time will be when Procter & Gamble leads the market higher.
A bull market in toothpaste and fabric softener.
From a speculative standpoint, we see that the most speculative momentum stocks are back near all time highs which in theory is bullish. Momentum begets momentum.
However, when we compare this current melt-up to past melt-ups what we notice is that they all ended LOWER, not higher. These types of vertical melt-ups do NOT last.
In summary, what we are witnessing in real-time are pundits watching China final implode while cheering on rate cuts from the Fed even as recession stocks are leading the market.
Total Idiocracy.
