What do 1929, 1973, 2000 and 2023 have in common? They are and were all home to a specific type of market environment, that eerily resembles each other: Tightening system liquidity along a severely thinning high-market-cap equity rallies, while broader markets stagnate, drifting sideways.
In 1929, it was utilities, 1973 the Nifty Fifty, 2000 the dot.com tech stocks, and 2023 American Mega-Caps with chip and AI exposure.
In 2000, the market topped out in March, followed by a severe correction, but succeeded by one of the biggest bull traps in history. Markets again put in a seemingly very strong rally in August … but already the late 1999/early 2000 run-up was thin as a rake, while this August rally would’ve put an anorexic to shame.
Crowded stocks like Juniper Networks were bought eagerly by euphoric money managers, driving it 240% from the correction bottom into new high prices for the next half a year, only to collapse into oblivion soon after.
This August rally and divergence is reminiscent of the one we’re seeing now, driven by crowded bets such as Nvidia, Broadcom or Apple.
Now, in 2023, we’re seeing monetary tightening, narrowing lending standards, and a market rally mainly driven by 7-9 mega-cap blue-chips while the rest of the market drifts sideways. Due to the extreme bias of the cap-weighted indices NASDAQ Composite and S&P500 (the top 10 stocks i.e. 2% of the S&P500 determine 32% of its movement !!!), they are swinging up, and consensus is swaying towards everybody believing we’re in a new bull market, from amateurs to even ‘reputable’ professionals.
Where we are now is not necessarily the end of this move. Unsustainable stock rallies are not a question of ‘valuations‘; they’re a question of sentiment, which is bubbling up immensely due to continued better-than-expected lagging economic numbers (e.g. labor and inflation) leading to an expectation of a soft landing, the AI stock craze, a flight into Big Tech “safe” havens due to their lower sensitivity to interest rates, a massive amount of institutional bears whose covering purchases add fuel to the rally, and some liquidity injected by the new Fed lending facility after the recent banking debacle (similar to the ‘TARP’ in 2008/9).
Bob Farrell warned of such thin “blue-chip-only” markets, but history shows they can carry on for longer than most think, so don’t go in shorting anything. However, the lack of actionable high-quality stocks should be a red flag to any stock speculator out there.
Although individual stocks are disconnected from fundamentals and the economy, the asset class of equities (which unwitty stock buyers often mistake with “blue-chip” stocks) sure serves as a discounting mechanism. The question is – is consensus right, way too early, or way too late?
Let’s have a brief look.
At the moment, there are two camps of strategists – those that look at leading economic indicators and history of the Fed’s actions and conclude that a recession is unavoidable, and those that look at lagging indicators and equity markets and conclude that a soft landing is being discounted.
I believe in looking at what’s right in front of us.
Equity markets are rallying seemingly, while under the surface, really only a couple of crowded mega-cap stocks are bid up while the rest of the market is lacklustre.
A deeply inverted yield curve, leading economic indicators nosediving, and potential massaging of labor data to make the economy more appealing for political reasons foretell anything but an impending soft landing.
The unprecedented rate hiking cycle, continued liquidity tightening by the Fed despite pausing rate hikes, and money supply crashing the hardest in more than half a century has already caused a slew of bank insolvencies in March, which are only getting worse by the day. If liquidity isn’t eased, it is only a question of time until something else breaks, e.g. the commercial real estate market. The Fed’s recent big bank stress test seems to be challenged left and right – and even if it is reliable, too-big-to-fail banks were never the problem. The Fed’s extreme actions still leave the many thousands of smaller banks liable to systemic failure that have a much higher exposure to the small businesses that drive the economy.
In my opinion, cracks have shown but the Fed eagerly stepped in to bail out banks in March, and real problems have not bubbled to the surface … yet. But logic dictates that they will in the next 6-12 months or so.
Ray Dalio argues that the current fire-sale of government debt will either lead to much higher rates or the Fed engaging in QE again in the (not too distant) future. I’d say, it’s not either/or – rather one, and then the other. Higher rates will follow (treasury yields are creeping up ever so slightly), and central bankers will at some point jump back into the old money printer mode.
But cutting rates, and even monetary stimulus does not always translate into a rising market, at least not immediately. Only the market will tell whether it is rising, and at the moment only very limited parts of it are.
