Powell Lays Down the Gauntlet

Inflation is enemy #1 equities tumble

In our subscriber only article on Feb. 14th entitled “Regime Change” this year we aptly stated this,

We keep hearing the FED can’t raise rates, well they will and they have too and its not going to be pretty, buckle up because the trains already left the station!

We removed the paywall and you can read it in full here, REGIME CHANGE

Yesterday saw the markets finally “get the picture” as Powell delivered some very chilling words at the Jackson Hole Symposium,

We are taking forceful and rapid steps to moderate demand so that it comes into better alignment with supply, and to keep inflation expectations anchored. We will keep at it until we are confident the job is done. (Powell JHSymposium speech 8/26/22)

We have been warning our readers for months and two weeks ago we sent out our chart on the Nasdaq here:

We pointed out our downward channel and the respect it should garner as well as the 13622 fib 0.786 retrace level backing it up. Well the 0.786 did work like a charm and after a bit of stop hunt above the channel, both the Fib and the channel held up:

Now that the cat is out of the bag and all the drone like alpha hunting conditioned managers of the buy the dip crowd are about to get a taught a very tough lesson in modern monetary mechanics, we can only tell you, PAIN IS COMING.

We often hear “timing markets is a fools game”, well this is not about timing, this is about value and value is not subjective here. Yes equities have historically risen, however they have also historically taken decades to regain prior highs (1937-1954, 1968-1992, 2000-2014, 2021-?) Where are you at now???

Now here is the rub, if you are in the equities market and are up pretty decent over the years, there’s no reason not to take chips off the table, EVEN IF YOU ARE IN FOR THE LONG HAUL.

Our rational can be simply be explained in the following example:

Let say you started at $10k in 2005 by 2021 the account = $40k.

If you don’t sell and equities lose 50% which is a garden variety average pull back over the last few decades then your account will be $20k.

Now ask yourself, how much of a return do I need to get back to $40k?

That’s right a 100% return…that is a simple mathematical construct nearly nobody realizes. So when someone tells you they are in for the long haul, you know the data, you know the truth. BTW everyone’s time frames are different, don’t forget that, but no matter what the math never changes!

So lets look at it this way, let’s change our strategy and instead take 40% of your position off:

$40k x 40% = $16k

Now you lock in $16k or you monetize $16k, make it a realized gain not unrealized. (BIG DIFFERENCE between the two) Now your account value is $24k

Now if the market drops 50% your position falls to $12k

Its not really $12k the account is actually the positions worth $12k plus the $16k in cash that you sold out of, so a total account value of $28k

So in order now to get back to even you only need a 42% return not a 100% buy and hold return! That is the real power of taking chips off. OK that lesson is over back to reality and back to what Powell did yesterday!

Hiking rates in the path that Powell has taken at a time where inflation is running 8% and an economy only held up by CBank balance sheets, is a recipe for disaster. We also have to mention the fact that the CBank balance sheet is about to accelerate its run off and this coupled with the rate hikes, is going to put a massive strain on corporate treasurers. We hope their swap desks did their jobs but we doubt any of them saw this coming. With all that corporate debt out there and the specter of a full blown recession, the words margin compression is going to be a massive understatement. BTW non financial corporate debt is up a staggering 90.6% over the last decade lets just hope a lot of this is fixed and not floating rate…but we doubt it we are sure the Goldman and JPM swap desks sold them down the river:

We also know that the biggest canary in the coal mine is the Federal Reserve balance sheet. September is here and the runoff max doubles to $95 billion a month! Let’s just see how the markets react if $60 Billion in USTs and $35 Billion in MBS start tumbling off, all in all not a good outlook anyway you spin it. We know they have been slow to reduce their balance sheet, but those days are over and we expect more than last weeks $18.87 billion in the coming months on the weekly FED H4 reports:

With MBS starting to roll off and with these rate hikes going parabolic, its no wonder the months supply of new single family homes is rising toward 2008-09 recession levels, @Charliebilello posted a great chart on this:

Alright now that we have painted the picture for you in regards to our present reality and what is to come, let’s take a look at what is expected next month from the Federal Reserves meeting on the 21st as the CME watch tool shows a 75bp hike still in the works:

We can’t understate the significance of the Fed Funds rising above the US Govt 10yr rate, but it is a massive warning sign for asset prices. Don’t take this lightly it is a very big deal when it comes to leverage and funding. A negative 10Y/FF curve is a death nail in short term funding because its a negative carry situation and the game of free money is over. When leverage gets purged assets get sold and we are just at the beginning stages, that’s for damn sure. We suspect 9/21/22 will usher in this negative carry scenario and here is our chart of what is coming:

Asset prices will not do well in this environment and with that let’s take a look at a few charts, first up let’s look at our SP/NQ futures spread where it seems the Tech crowd may have to diversify and we suspect broader SP outperformance to continue here:

Staying on that note let’s look at the QQQs where the value area sits some 22.8% below which is nothing more than the 2020 top:

Finally we just want to remind everyone how a fractional reserve central bank system works. When the central bank buys assets (QE) it expands its balance sheet and money is created to be levered 9 to 1. Well the exact opposite thing occurs when it destroys money (debt) and enacts QT quantitative tightening. We haven’t really seen an environment of QT, meaningful QT coupled with sharply higher Fed Funds. This is what made Powell’s speech yesterday so powerful, he’s not messing around and if the market hasn’t figured that out yet, well yesterday was just a wake up call!

We bring you this information to expand your horizons, to open your thought processes in hopes that you do your own research. In hopes that you start looking at our reality in a different way. All to often we neglect the things that truly matter and when we see something as powerful as a global economic shift or change, we want you aware of it. We want you to explore and research on your own and come up with your own plan, your own path, what works for you. We hope this inspired you to evaluate your plans and your time frames as we do feel that the regime change is real and its here to stay!

Till next time.

BONUS CHART:

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