WEEKLY MACRO NOTE - Catching a falling knife

Reading Time: 7min

TABLE OF CONTENT:

• WEEKLY WRAP UP

• FED TALK

• THE BIG PICTURE

• SENTIMENT

• ECONOMIC CALENDAR

WEEKLY WRAP UP

Know what you know, and know what you don’t know, or you shall not survive in this business.

A stronger and stronger inverse correlation has been building between the US dollar, Equities, and Commodities all year.Coming into this week we knew that Dollar Down likely meant Equities & Commodities Up, and vice versa.

Now while the relationship above, as simple as it is, may not have been obvious to all, the fact that the dollar strength or weakness is driven “almost exclusively” by Fed policy is taken to be a certainty.

As investors it would be wise for us to never forget that things change, time is nonlinear, correlations break down and the only certainty we have is that “in the end, we shall all be dead.”

I want to start this week's newsletter by bringing your attention to a couple of things you should have noticed.

After closing last week at a new low for the year, Mon & Tue we saw an almost -2% decline in the Dollar Index, which resulted in a +6% squeeze in most equity indexes.The down Dollar also drove Oil higher by +7% in the first two sessions.

Now you can ascribe the above to an oversold bounce or the once again revived Pivot narrative, but it doesn’t change what happened, nor what you should have done last Friday.

But in the background, there was another situation bubbling, the tightness of Supply in the Energy market and the OPEC+ output cut.After OPEC+ confirmed the 2M barrel per day production cut, despite the Dollar gaining +2.5% in the last three days of the week OIL continued to climb higher and closed the week with a total gain of +16%.The CRB index closed up +6.5% for the week and average US Gasoline price +15%, so not a promising start for the Oct inflation print.

For the last few weeks as Oil declined I had been highlighting the supply situation and that sooner or later the probabilities greatly favoured a rise in Energy despite the slowing demand dynamics and the stronger dollar.

Turning back to equities despite a stellar start to the week, by Friday most gains had been given back

WoWSPX +1.51%NDX +0.62%DJI +1.99%

The fact of the matter is that most investors keep on anchoring on to the past and many Bears are still scared senseless of another July Squeeze, while Bulls keep on endlessly and aimlessly buying every dip as the bottom keeps on falling out from under them.

This has lead to a market which is constantly hoping for a slightly lower inflation print or a disappointing jobs report to lead to a Fed Pivot and a rally to new all-time highs.

Investors continue to chase noise over fundamental reality.

As long as such narratives are rife I think it is highly unlikely we are anywhere near a bottom for equities.

By Wednesday after a 2-day rally from what was a very obviously oversold market (remember I mentioned this in last week's Newsletter) everyone must have already been thinking about another 20% plus rally, otherwise, how do you explain that Put/Call ratios were back as some of the lowest levels of the year; Bitcoin was at the top end of its 8-week range; the NAIIM index showed investors had taken up their exposure to equities to the highest level in 6 weeks or the Fear & Greed Index going from 15 to 30 in 2 days?

The Answer: many had gone long.

Sure enough, they were set up to be disappointed, and as soon as the thin threads upon which they were hanging did not come through, things unwound pretty quickly.

Now the reality is that none of us knows what is going to happen tomorrow, next week, next month or let alone next year. The best we can do is deal in probabilities and make bets based on our assessment of these.

I do think that at some point this quarter, the market is going to get so oversold that a multi-week rally will take place. But in the meantime how willing are you to catch a falling knife?

At the end of the day, it’s all about risk and reward. If you are managing your portfolio actively then you want to increase or reduce your exposure based on how promising the risk/reward set up is.

Now we have discussed the Fed Balance sheet a lot here and so it is only fair we point out when the Fed is truly following through with its stated goals.

Last week the B/S shrunk by a major -35B

This means that in Sept it was reduced by a total -65B, not far off from their stated goal of -95B, given their previous track record.Now the result of this was the biggest monthly decline in Equities since March 2022 with S&P500 posting a -9.3% return in Sept.

We all knew the inverse correlation between asset prices and the balance sheet right?Remember, as of now, the Fed intends to shrink the balance sheet well into 2023.

FED TALK

I want to share with you a few quotes from the barrage of Fed Governors who spoke this week, for they may have gotten lost among all the Pivot headlines.

FED'S MESTER: I HAVE NOT SEEN ANY EVIDENCE THAT MARKETS AREN'T WORKING IN THE US

FED'S MESTER: I SEE MORE PERSISTENCE IN INFLATION AND SEE RATES RISING HIGHER THAN THE MEDIAN OF FED POLICYMAKERS

FED'S WALLER: IT'S NOT CLEAR WHY YOU WOULD WANT TO PAUSE

FED'S WALLER: I THINK THERE'S A CHANCE WE CAN PULL OFF A SOFT LANDING

WALLER: NOT CONSIDERING SLOWING RATE INCREASES OR HALTING THEM DUE TO FINANCIAL STABILITY CONCERNS

FED'S EVANS: AT THE END OF THE DAY EVERY CENTRAL BANK HAS TO MAKE ITS OWN DECISIONS

FED'S BOSTIC ADVISES PATIENCE TO THOSE CONSIDERING THEIR INVESTMENTS

FED'S DALY: FED MANDATE REQUIRES TO FOCUS ON DOMESTIC ECONOMY

Enough said, let us look at the big picture.

THE BIG PICTURE

Lest you should forget:

In 2008 the S&P declined -38% and peak to trough declined -57%.After the DotCom bubble, the S&P declined -10% in 2000, -13% in 2001 and -23% in 2002, peak to trough it lost 50% of it’s value.In 1972 it lost -17% and in 1973 it lost -30%, peak to trough it was down -50%

The current decline still pales in comparison.

Many think that when the Fed pauses this will mark the end of the bear market.Historically this has not been the case.

The Fed has staked much of its current reputation and credibility on keeping interest rates high and getting inflation down, so why they would start cutting rates just because stocks are taking a beating is beyond me.

But even if they were to do so what would be the result?

The Fed started cutting interest rates in 2001 and the market did not bottom until 2003

The Fed started cutting rates in late 2007, the market did not bottom until 2009.

Instead, we are currently witnessing a very unusual situation where the Fed is raising rates into a decline

It’s often very easy to get caught up in the here and now and forget to zoom out and remember the big picture.

QE infinity over the past decade has inflated one of the largest bubbles in History, and despite the S&P having corrected some -25% the US Total Market Cap to GDP is still at the level it was at the peak of the DotCom bubble.

With the Fed having stated its determination to go ahead with QT, I want you to consider what could happen to the price of the S&P should it mean revert to a more historically “normal” level.

This is largely the product of QE and low rates inflating asset prices.

Consider that the interest rates we have known over the past 15 years are some of the lowest mankind has ever known.

On Thursday I have an article coming out in which I will discuss the distortions created by QE and low rates over the past few decades.

I firmly believe that many of today's malaises rise from this policy and look forward to sharing this article with you.

SENTIMENT

The move higher in exposure here is quite evident.

Slight improvement in the AAII sentiment report, but nothing major.

Fear and greed index closed the week back in Extreme Fear territory

Short Interest on the Indicies increased again but then so did long bets on the EUR.

Traders have also gotten quite long the Precious Metals again, it remains to be seen how wise a move this may be.

ECONOMIC CALENDAR

LOOKING AHEAD

The only question I want you to think about going into next week is this:

Why shouldn't the market make a new low?

Thank you for reading,Antonio C. Nobile

I am not a Financial Advisor & this is not financial adviceNone of the information or content shared via the Strictly Macro Newsletter constitutes investment, trading or other advice, nor an endorsement or recommendation of any financial instrument whatsoever. Investing and trading of any kind involves risk with no guarantee of return. This newsletter is for general information purposes only and is not tailored to any individuals’ personal needs or risk parameters. Reference to a security’s past performance should not be construed as guarantee of future returns. Unless otherwise stated all views are those of the author at the time of writing and can be subject to change without notice. Reasonable care has been taken to ensure that all information provided is true and reliable, however Strictly Macro does not assume responsibility for any error or omission. None of the authors of this newsletter are registered as securities broker-dealers or investment advisors either with the FCA, the SEC, CFTC or with any other regulatory authority. Do your own research and seek professional consultation before making any investment decision.