Punch-Drunk Investors Will Keep Ignoring Reality...Until It's Too Late

Chinese spy balloons floating over the United States. Interest rates at 5%. The economy in full collapse. Inflation at 6%. We'll send you a postcard - everything's fine!

Back in January 2020, I was pointing out that the coronavirus was going to wreak havoc on markets weeks before it ever happened.

As I’ve noted many times on this blog, those days were immensely frustrating.

I waited for a collective market ethos that only viewed the news through a backward looking rearview mirror, with the attention span of a fruitfly and the collective IQ of a wooden ping-pong paddle, to catch up to a news story that was unfolding and evolving, by the second, right in front of their eyes. The news - and the ensuing chaos it would create - couldn’t have been more obvious if it was bludgeoning the market over the head with a wooden club, Bamm-Bamm Rubble style.

Ultimately, I was proven right in my prognostication when the market crashed in March, before the Fed came in and launched unlimited quantitative easing and the public started to wrap their head around the fact that Covid wasn’t necessarily a death sentence.

Current markets seem hell-bent not just on once again ignoring the obvious right now, but spitting the obvious back in the faces of those who use reality as a guide to their decision making. And the real kick in the nuts is that the Fed, the broadest influencer of our economy and market sentiment, isn’t even a tailwind this time. On the contrary, it is a massive headwind.

The market is simply still hanging around - like a Mortal Kombat character stunned, but still on his feet, waiting for the Fed to deliver the final blow.

Old habits die hard. As I pointed out many times just over the last several weeks, it is difficult to break the psychology of market participants who have been conditioned to buy the dip without consequence for the last 15 years. So, in that respect, I’m not surprised the market is rallying despite economic reality. But to say that the market has been grasping for straws when it comes to reasons to rally would be a vast understatement.

Take this week for instance. The market is rallying based on nebulous words Jerome Powell used or omitted from his presser on Wednesday despite the fact that he very clearly stated that more rate hikes were on their way. Its tea leaf reading on top of tea leaf reading, ignoring the very stark reality that interest rates are nearing 5%. There’s nothing to guess or speculate about with rates - they’re most certainly at their highest levels in decades.

But instead of the market swallowing that pill in advance, we have seen short term whiplash higher in the form of a short squeeze, because there’s too many people that can’t believe the market isn’t responding to the obvious reality that our economy is slowing down and monetary policy isn’t going to help. In other words, these people got caught flat-footed by clearly seeing reality and being short the market as a result. Then, the market does the “wrong thing” by squeezing higher and all of a sudden these people have a crisis of confidence and are mired in FOMO, seduced by the idea that buying the dip is once again the comfort of investing strategy home that we can all return to, akin to a warm blanket and a fireplace on a wintry New England day.

And as I said earlier this week in a portfolio/macro update, perhaps, for the very long term, buying the dip is the right plan. Will markets be decidedly higher 10 years from now? Probably. It doesn’t mean that the currency is going to hold up though, but that’s another discussion for another day. I talk about how I invest for this anyways here.

But taking a mid-term view, I still believe that this week’s move is nonsensical.

Market behavior today centers around ignoring reality. This is a product of 40 years of Fed intervention in markets. When you constantly have somebody at the ready to bail out the market the first half second one person feels discomfort, it creates a foundation of irrational expectations from investors, namely that things are always better than they seem.

In my time in markets, I’ve listened to a decade of stories about how “king dollar will never die”, how the market will always go up and how the United States will continue to be the world’s super power, no matter what.  Those statements are made with certainty despite the fact that, mathematically, none of these things are certainties. In fact, just the opposite is true.

And so the only way we can try to gauge how close we are to something eventually “breaking” and sending markets lower is to continue to follow the news, objectively, and think critically about it on our own.

Perhaps you are looking at the same group of facts that I am looking at and you have come to starkly different conclusions. If that’s the case, you likely made a lot of money over the last few weeks and I salute you – that’s what makes a market. However, the reality behind the scenes that the market continues to ignore doesn’t look as though it’s going to get any better anytime soon.

I’ll spare you guys the lecture about how 5% interest rates are eventually going to cause the economy to implode. I’ve prattled on about this way too much and continue to believe that it’ll be the case, and that it’s only a matter of time.

Let’s only take a look at what’s new. On Thursday night, Apple - the bellweather for tech stocks - reported awful earnings that missed expectations, a rarity for them. Google and Amazon did the same. As far as a gauge for technology stocks goes, that’s about as clear of an indication that we are going to get of an economy that’s slowing down and a technology sector where things are not OK.

These reports stand at extremely stark odds with the 16% rally in the NASDAQ that has taken place to start 2023. For a restrictive monetary policy environment, these moves simply don’t make sense.

Perhaps it is my fault for expecting that the market would understand and process this and act rationally – after all, the market never acts rationally.

And I don’t want to prattle on again about the geopolitical risk I see heading into this year, either. But, for fuck’s sake, yesterday we found a goddamn Chinese spy balloon flying over Montana.

The balloon was discovered right about the same time U.S. Central Intelligence Agency Director William Burns was talking about China’s ambitions towards Taiwan:

Burns said that the United States knew "as a matter of intelligence" that Xi had ordered his military to be ready to conduct an invasion of self-governed Taiwan by 2027.

"Now, that does not mean that he's decided to conduct an invasion in 2027, or any other year, but it's a reminder of the seriousness of his focus and his ambition," Burns told an event at Georgetown University in Washington.

"Our assessment at CIA is that I wouldn't underestimate President Xi's ambitions with regard to Taiwan," he said, adding that the Chinese leader was likely "surprised and unsettled" and trying to draw lessons by the "very poor performance" of the Russian military and its weapons systems in Ukraine.

His concluding remarks were notable: “Competition with China is unique in its scale, and that it really, you know, unfolds over just about every domain, not just military, and ideological, but economic, technological, everything from cyberspace, to space itself as well. It's a global competition in ways that could be even more intense than competition with the Soviets was.”

If you haven’t read my 2023 outlook, here it is summarized in two pieces: first is my 23 Stocks To Watch in 2023 which explains my macro view and what stocks I’m buying heading into the new year. The second is a piece I wrote a couple weeks ago about several catalysts unfolding that continue to act as waypoints, dictating to me that my thesis is on point - and a piece I wrote last Friday reaffirming additional waypoints.

As I have said in many of my pieces, I strongly believe markets in 2023 are going to be driven by both a residual crash coming from this year’s rate hikes and then an eventual Fed pivot, with a fair amount of geopolitical risk on the side.

When I put together the 23 Stocks To Watch In 2023 (Part 1 here, Part 2 here), I tried to keep all of this in mind - I wanted to create a somewhat diversified, risk adverse, plan for myself heading into the new year. Whether or not I’m right, we’ll know in about 12 months.

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So, anyways, I digress. I guess we can just add both balloons (the Chinese spy one, and the stock market bubble) to the long list of things that markets will continue to ignore until they cross the line from prophecies into action.

Only at that point (when it’s too late) will the market be able to understand reality, and only because it is literally being forced into not ignoring it anymore. After all, how are you going to make the argument that China isn’t going to invade Taiwan while China is actually invading Taiwan?

When it’s too late, the market will finally get it. This is what happened with Covid in February 2020, this is what happened when Lehman Brothers went under and the housing market crashed and this is what happened leading up to the tech bubble crash in the 2000s. 

Markets never crash as warning beacons are making their way out. In the case of the housing market, the market didn’t crash when delinquencies started to tick higher, it just ignored it. In the case of the Covid crash, the market didn’t crash based on the news that Covid cases were spreading in the U.S., it just ignored it. In both cases, the market crashed once the the public was forced to confront the reality of what was happening, and I don’t expect 2023 to be any different.

Bulls can have their last couple of weeks and their great start to 2023 and celebrate. If you’ve been a short term trader and have made money off this move, I commend you – it’s part of the reason why I like having long exposure in certain select names and sectors. But I still hold firmly in the camp that we are in unprecedented monetary territory and, most importantly, we are there without the backing of the central bank.

We could argue over whether or not the next rate hike is going to be 25 basis points, 50 basis points or nothing at all, but it’s immaterial. Stocks are expensive on a PE and market cap/GDP bases, rates are already near 5%, and that’s that. Even cutting rates to zero tomorrow wouldn’t reverse a lot of the trends that have already started economically at this point - they would still have to play their way out of the system before the cut took hold of the economy.

Like I said, if you’ve been a bull while I’ve been a bear over the last couple of months, you’ve made money. Congratulations. There’s two ways to look at what the market is doing over the last couple of weeks: either we have firmly shifted into a new era, where we are at the beginning stages of a bull market once again and the fundamentals have changed (this, obviously, I don’t think is the case), or we are drifting further and further off the path of reality, which will eventually only lead to a bigger snap back when the time comes and the market can no longer turn its a blind eye to the obvious, wretched financial reality our country faces.

QTR’s Disclaimer: I am an idiot and often get things wrong and lose money. I may own or transact in any names mentioned in this piece at any time without warning. This is not a recommendation to buy or sell any stocks or securities, just my opinions. I often lose money on positions I trade/invest in. I may add any name mentioned in this article and sell any name mentioned in this piece at any time, without further warning. None of this is a solicitation to buy or sell securities. These positions can change immediately as soon as I publish this, with or without notice. You are on your own. Do not make decisions based on my blog. I exist on the fringe. The publisher does not guarantee the accuracy or completeness of the information provided in this page. These are not the opinions of any of my employers, partners, or associates. I did my best to be honest about my disclosures but can’t guarantee I am right; I write these posts after a couple beers sometimes. Also, I just straight up get shit wrong a lot. I mention it twice because it’s that important.