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The Daily Market Brief keeps investors and traders abreast of the latest market critical technical and macro developments as well as market directional strategy.

We are making some past Daily Market Briefs public so you can get a sense of how we approach markets analytically. This particular brief below was published on August 16, 2022 following an aggressive bear market rally we had suggested to come on June 17, 2022.

Our outlook here was for a coming pullback and filling of the open gaps left in the wake of this rally.

For context here’s a chart of $SPX with the time frame circled:

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While markets are still celebrating the apparent rollover in headline inflation there is a bit of a sinister truth lurking beneath it all that nobody is really talking about. For one the widening cliff I’ve highlighted before. Fed speakers talking about a 4% Fed funds rate and markets ignoring them all pivoting off of Powell’ s boneheaded “neutral comment” in July instead. Mohammed El-Erian imploring the Fed to stick to the course and not flip flop to a “quick and easy” solution again. The Fed didn’t listen to him last year when he warned them about staying too loose and easy for too long and I think it’s fair to assume the Fed will again not listen to him now, so markets, trained after many years of a Fed caving to markets, is for now assuming the Fed will cave again. Hence the continued rush into stocks.

But let’s just take a moment and look at what the Fed has actually done to combat inflation. Frankly, historically speaking, virtually nothing.

Take a look at the Fed’s balance sheet on a log scale and it’s very apparent they’ve done nothing to remove liquidity:

Based on GDP the balance sheet is as large as ever:

The liquidity remains in the system.

But oh all those rate hikes this year? How does these match up to the Fed’s efforts in the 70’s & 80’s? It doesn’t:

Not even close. In this context a 4% Fed funds rate would be a bare minimum to beat structural inflation.

In other words: They have done nothing serious and frankly it’s apparent when looking at financial conditions as published by the Fed itself:

We’re not even in restrictive territory, never mind neutral. In the 70’s and 80’s the Fed went into restrictive territory. Now we’re not even there yet. In summary: The Fed is still running loose monetary policy in context of 40 year highs in inflation. And I submit, while headline numbers are rolling over this policy, if continued, will not bring inflation back down to 2%. It can’t.

So all the Fed has accomplished here is preside over another mad FOMO rally in asset prices which is brought about by even looser financial conditions since the summer:

If the mission is to contain structural inflation this is just dumb.

So the Fed has a problem. How to get the market to take it seriously for clearly they aren’t. Is the Fed even serious? The data above suggests it is not, and hence Jackson Hole will be an important opportunity for the Fed to get its policy credibility taken seriously. If they are serious.

Especially now that markets have jammed to the max on most indicators:

$NYSI back in aggressive overbought territory both in terms of the stochastic as well as the actual print above 90.

$BPSPX RSI the most overbought since before the Covid crash:

And components above their 50MAs like its back to QE days with the market presuming the lows are in:

And yes, looking at the monthly 40MA action there is that nagging feeling that this was all it again:

But the 2 year yield doesn’t really show any new age of easing around the corner:

The cost of carry remains much higher than last year and if the Fed is serious it will move higher still.

No, markets are totally ignoring the fundamental backdrop at the moment, one of which is the Baltic Dry Index which continues to sink:

This rally having gone completely counter to the historical relationship.

And markets, like in 2000, are ignoring the steepest yield curve inversion since then:

It was during 2000 or course we had a powerful counter rally that ended on September 6 when reality began to sink in. Markets have a well established history of ignoring reality for a while after all.

No, my premise is that, if the Fed sticks to its mission, then a recession is coming as it’s the only way to beat structural inflation and that this rally will end up have been a selling opportunity.

But of course I can be wrong and the Fed will not be serious and indeed go back to quick and easy. Which then presents a rather binary outcome to the rest of the year, meaning that the next pullback will get bought and we run off to the races for year end.

So, conceptually, I can envision the binary route to look something like this:

Don’t hold me to timing or exact levels, but in either scenario a sizable pullback makes sense followed by a big bounce. It is then this bounce that will determine the outcome. The bear roll over history suggests that any pullback bounce produces a lower high before rolling over hard. If the lows are in then the bounce will just bust through the downtrend and race back to the highs.

Signs are mounting that a pullback is coming, mainly all the negative divergences that are now mounting, see CCI:

Also notable how weak the new highs/new lows remain to this day. There is virtually no expansion.

So markets are approaching key breakdown zones, resistance zones and 200MAs massively overbought:

Without a confirmed reversal risk remains higher until this move exhausts itself. So we must be cognizant that the 200MA or the down trend line above remain upside risk. To get there markets would simply become ever more overbought. Not a good set up to force a sustained breakthrough.

The weekly 50MAs also remain risk:

All this remains part of our original bear market rally risk profile. Hence maintaining $RUT long scales for now.

`There is another divergence of note building, that of Bitcoin. While it has rallied along with the market we can note that the correlation has begun to veer off:

Bitcoin has not rallied as much as the rest of the market in terms of the correlation. I can’t say who is leading who here, but it seems to me that Bitcoin is perhaps a leading indicator in terms of the coming liquidity equation. Indeed I can point to a still existing potential weekly bear flag:

And if this plays as one there is a lot more pain to come, including a potential up trend break.

To believe the lows are in you have to believe that in this cycle structural inflation can be beaten with non restrictive monetary policy, that inflation can be beaten without a recession, that the structural low can sit on top of the extreme market cap to GDP top of the year 2000 at 155%, that the steepest yield curve inversion since 2000 doesn’t matter and that all the economic rollovers we’ve have continued to see don’t matter either and that house prices still at historic levels represent a low in the economic cycle. You have to believe it. I’m not buying it.

But apparently the market, for now, is buying it:

Hook, line and sinker. At the time of this writing we have some slight overnight weakness. But the trend in recent days is that any slight weakness makes way to relentless buying during the day which results in closes at new highs by the end of the day. We saw this on Friday and we saw this yesterday. Until that we see an intraday reversal to break the up trend risk remains higher.

My view is this trend will break and many of the lower gaps will get filled into September hence sticking with sell attempts into the daily 200 and weekly 50MA if we get there. So you’re looking at a structural risk range of 4323-4365. Doesn’t mean we get there, but it’s clearly risk. For now our flat stops on $SPX and $NDX shorts are holding.

More Fed speak today, Fed minutes tomorrow and retail sales as well. Data for now doesn’t seem to matter as long as the gamma squeeze program and automated buying continues. But don’t let the calm fool you. It can switch on a dime. In mid June we would’ve killed to be able to sell into these levels. Now that these levels are here in context of this vertical overbought rally we’re definitely keen to aim to stick to plan and process and work to fade the strength.

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