Key Drivers of the Market - A Deep Dive

6 thg 7, 2023

Hello everyone! Today we will talk about five different important concepts. Many things are happening in markets, so I will create similar reports to help people understand why things are how they are. This will be my first report, so it might be a bit harder to go through, especially because on Tradingview, I can't easily share economic data or random non-Tradingview charts, so I will try to make each concept as simple as possible.

Positioning
1) Positioning in markets appears to be quite extreme. Looking at the CoT long/short data for hedge fund positioning, we can get a pretty good sense of whether speculators are long or short. Overall, the market remains short on stocks and bonds.

Regarding bond data, it is possible that the positioning is like this for other reasons, which doesn't mean they are bullish. As contrarians, we usually want to go against most speculators, but sometimes the speculators take one position for reasons other than making a directional bet (maybe they are hedged).

Another significant market to look at is the energy market, and more specifically, oil, which in my opinion, is very close to transitioning back into a bull market. I am expecting one more shakeout here, with a dip toward 55-60$. I think one more shakeout for oil to take out all the lows (hunt stop loss), and speculators will fully turn short. Speculators have been cutting their longs for a year and are almost about to turn short for the first time in many years.

Inflation
2) Expected inflation in the next CPI print is around 3% YoY and 0.3% MoM, potentially influenced by recent commodity spikes. These short-lived spikes could affect June's print, as some food-related commodities had a little rally. I believe inflation could come back with a vengeance, as there are too many potential issues with producing several materials and products. These issues could be exacerbated due to deglobalization and climate change (not the climate getting hotter, but colder).

Truflation shows 2.3% YoY inflation, inflation expectations are at 2.3%, and interest rates are between 3.7% and 5.25% across the yield curve. My main view is that inflation will trend lower for a little longer, and its downtrend could end with a deflationary spike, as current real rates are substantially positive. It's even possible that we will get negative CPI MoM prints in Q3-Q4, but inflationary pressures will probably resume once we are done with that. Many argue that core inflation is sticky and too high, and I believe it might stay elevated for a while, but eventually, I think it will start falling.

My view on inflation mainly has to do with outright shortages and not with money printing. The current disinflationary trend seen across most countries will probably continue for a little longer as we haven't seen substantial money printing for a while, while interest rate hikes are starting to affect consumers negatively. The biggest issue I see is that commodity producers are struggling and face severe problems due to green policies, deglobalization, and climate change. Another important point is that OPEC+ is about to cut 1-2m barrels/day of production, which means oil could spike as demand remains relatively strong.

One of the reasons I think the biggest inflationary threat comes from the supply side (goods/services) is that Japan has had lower inflation than the US, despite keeping rates at 0. China didn't raise rates either and has been pumping liquidity into the system, as well as cutting rates, and yet inflation there is almost 0%. It shows that inflation has come down independently, with markets slowly shorting through various imbalances, not because interest rates increased. At this stage, higher rates might actually have the opposite effect than the one intended. Why? Because of the massive debts at the government level, which are being inflated even further as governments borrow at higher rates.

Housing
3) The housing market remains strong, and a deficit exists. More supply will be coming online over time, but there are no signs of weakness or that the supply won't be able to be absorbed by the market. Many people are still waiting for rates and prices to drop in order to buy a house, while those with a mortgage are not selling their houses because they don't want to get a more expensive loan. Therefore we essentially have a balance in the market, with new houses and defaults being absorbed by those with cash and those willing to get an expensive mortgage.

Rents have not gone up YoY but seem to be about to trend higher again. As there is still a lot of cash in the market and the US government keeps spending, it's reasonable to expect rents to stay flat or slowly tick higher, even if interest rate hikes are starting to affect the economy. Some countries are really suffering from higher interest rates, as most people have variable-rate mortgages; however, the US is in a better situation as most had their mortgages fixed at low rates. So far, it looks like banks and central banks are taking a loss on all the mortgages issued or refinanced during 2020 and 2021, and this effect won't be reverted any time soon.

GDP
4) Q1 GDP growth was revised higher at 2% (from 1.4%), showing resilience in the US economy amidst recession fears. Despite growth in the US markets, concerns over a recession remain. As the US government keeps spending at a high pace, a recession will probably be delayed; without that meaning, it will never arrive. Interest rates have been rising, and the Fed wants to hike rates once or twice again.

The Fed will likely intervene to support the economy in 1-2 years. As the deficit grows and rates increase, within the next few years, the government will have absorbed all excess liquidity trapped in the RRP or banks. That means that the Fed will then be forced to start buying bonds. The Fed is currently losing over 50B annually because it has to pay high rates to those that deposit at the Fed, which is effectively direct money printing. With so much government debt, the Fed can't raise rates much higher without adding this inflationary component.

Although unemployment and bankruptcies are trending higher, the market is showing resilience. As stated above, the US economy is the most resilient, while many other countries are suffering heavily. What has been very helpful is that so far, we had strong oil production despite the war in Ukraine, while the US was releasing a lot of barrels from SPR. This strengthened consumption and boosted the economy. One important data point that proves that the US hasn't been in a recession is that the Travel Numbers of people flying in the US are at ATHs. How could someone call for a recession with these numbers? It's possible that interest rate hikes and all the printing in the US, along with a strong dollar, helped the US consumer to stay in relatively good shape.

How bad do bankruptcies and unemployment get, and when? I don't know. I believe that the yield curve will eventually be right, and we will get a recession, but it's hard to call for one. Although lots of data points to the US being in a recession or close to getting into one, we haven't had proper confirmation for a downturn. Maybe we have been in a mild recession, and that's why the market is rallying so much, as people feared something awful, and this hasn't played out.

Stocks
5) Stocks seem to remain in a bull market. After hitting the targets that I mentioned in some of my previous ideas, they had a mini-correction. I never turned fully bearish, but I thought at once, the SPX got at 4450 and the NDX at 15200, the market might have topped. This hasn't played out, and I must admit that the market looks bullish here. I can't say anything with certainty yet, but I'd avoid shorting or being all out.

There are still many signals that point to higher stock prices. Apple just had a massive breakout and looks strong. Now at a 3T valuation, which seems too much, but when someone thinks that Apple is one of those companies that are essentially powering a 500T financial system, along with its growth potential with AI, then 3T doesn't seem that much. Although stocks seem expensive relative to the current GDP, let's not forget that AI will boost global GDP massively over the next few years. That means that tech companies like Microsoft and Google will keep expanding.

Also, let's not forget that unprofitable tech deflated last year and hasn't recovered yet, so a lot of garbage got washed out and isn't a drag on the market. Finally, many people are missing something important: leverage didn't fuel this rally. The market deleveraged massively in 2022 and is now free from excess leverage. If this rally was driven by leverage, it would be fragile, and a reversal could occur at any moment.

Summary
To sum things up and add a few final touches... The main things leading the market are: NDX is a monopoly, AI, stock buybacks, passive investing, and government spending. It's improbable that these factors will cease to exist, and things will turn ugly immediately after the best first half the Nasdaq 100 has ever had.

Sentiment might be changing and leaning toward bullish, but I am not seeing anything that's seriously worth paying attention to. Sure, maybe we get another little correction, but nothing more than that. The market looks very strong. Some leading indicators even show that liquidity and financial conditions will improve from here. I believe that too many people are stuck looking at interest rates but forget how bad the government deficits are and that the only way to keep moving forward is to print more money and accelerate growth and consumption.

The NDX (Nasdaq 100) has broken above its double top in Q1 2022 and could easily sweep its Q4 2021 double top next. The index is just 11% away from new ATHs, which it could achieve in 2023.