1929 Redux for SP:SPX by acatwithcharts

I have been waiting for the moment where my confidence was high enough to say the top was in for most of 2021. The relentless grind upwards has kept providing moments that “could be the one”, but all have been quickly bounced before any real technical damage could be done. Hence, we went almost a year from the last 5% SPX correction until now. This will be long-winded, because, well, this is as much a high timeframe macro fundamentals call as it is a technical one.

I called for the intergenerational top in January 2020 on SPX and NDX. The short trades I drew on those charts stayed below their stops heading into the pandemic crash, and that crash brought them to my 2nd TP target (of 3). I had not expected this crash to happen in a one-month straight-line crash, expecting instead a normal bear market for US equities lasting 1-2 years, but the pandemic was a genuine black swan catalyst.

My logic on that call was fairly straightforward – my indicators showed us looking like the 2000 top, a repo crisis in 2019 had the Fed pouring money into a what seemed like a leaking bucket, and valuations relative to GDP had matched 2000 levels almost precisely. TSLA and AAPL had gone parabolic out of nothing in a way that was deeply disconnected from fundamentals since that October 2019 intervention. It seems quaint now, but the “stonks only go up” meme had become prominent and fear-euphoria metrics were showing the most euphoric market since 2000.

…and then I’ve been wrong ever since and missed the longest, fastest bull rally in the history of US equities. Mea culpa. It turns out that it was actually possible for monetary and fiscal stimulus to plug the dam. The amounts involved were historically unprecedented, and they successfully stabilized the system. I’d argue that this is for the better of humanity too, given that an economic crash inside of the pandemic likely means immensely more death and suffering than if we timeshift the brunt of economic carnage until we’re past COVID-19; though there’s plenty of reason to be aghast at how little shared sacrifice was asked of and is still not being asked of elites relative to everyone else.

With hindsight, it was a substantial disadvantage that my background before ever touching trading was in graduate-level bioscience, meaning I actually understood how the pandemic was playing out, that it would likely last much longer than anyone but pretty much the scientists themselves was saying, and that governments were failing to get it under control by reopening too early. Thus, I was broadly correct about what happened in the real world while the market continued to trade a parallel universe consensus that everything was sunshine and rainbows.

I am too young to have my own memories of trading in 1998-2000 was like, and that’s the only thing that appears comparable to the post-pandemic market structure. Fundamentals, at least at the macro level, completely stopped mattering, or really, they became inversely correlated as anyone who traded their disbelief on that basis got squeezed. Bears, and with them, all tethering to reality itself, have gotten drowned in liquidity. Leverage via the options market has gone frank parabolic. US equities inflows in the past year have totaled more than the net inflow of everything from the 2009 bottom to before that window combined. Meme stocks have gotten bid up purely because they can be, and then the inflows from index ETFs have sustained those bubbles. NKLA, a company where the CEO is outright indicted for fraud at this point, retains a $5B market cap because it’s in the Russel 2000. The percentage increase in NDX bottom to top from 2009 to now is now a larger parabola in percentage terms than the one which led to the 2000 crash. Valuations have run well past 2000 levels and are now at 1929 levels.

We took a 2000-level tech bubble… and ran it up into a 1929-level total market bubble.

Meanwhile, the engine of growth for the past 30 years or so, essentially since the Nikkei topped out in 1989, has been the modernization of China. A country of 1.2B people has gone from being a mostly poverty-stricken agricultural society to the standard of living of Mexico – part of the global middle class but not a “high-income”, “developed” country, a bimodal country with cities of developed-world wealth alongside rural areas that are very very poor, and a country whose further progress is heavily restrained by corrupt governance.

…and the China bubble is now popping right now in front of our eyes. That has become the probable catalyst for the end of this “supercycle” – its real estate sector is 30% of its GDP, amounts to a giant piggybank of unfinished, unlivable, ghost city buildings so poorly-constructed that they frequently just topple over. Its high-yield bond market is comprised primarily of debt from that sector. If this was going to stop at Evergrande, the system would absorb it just fine, but it’s already not stopping there. China has been in a slow-motion financial crisis for several years now if you’ve been paying attention to the thinly-covered news about it, and the dam has finally broken. Much of this junk real estate debt is USD-denominated and ultimately, the CCP can’t keep the party going any longer if it wants to, so it’s now setting precedents whereby foreign bondholders get stiffed while domestic bondholders get the breadcrumbs that can be salvaged.

Defaults on this massive pool of USD-denominated debt is where the system is now finally breaking, since we’ve managed to defer the pain from the pandemic. Being the global reserve currency means that your money supply is, well, global – however safe US domestic debt may be, there’s more USD-denominated bond debt being issued abroad than there is domestically and it is of far more dubious quality.

Google Trends for the keyword “inflation” blew up earlier this year. As per usual, the crowd is wrong, or at best, late to the party. Inflation has been running modestly hot in the US and EU by the standards of post-2008, and people appear to have completely forgotten what “normal” was before then. Over the past 2 years, it hasn’t done much more cumulatively than make up for the weakness in first few months of the pandemic. If you’ve read this far and this paragraph seems wrong to you, then what I’ll say to that is that the way most complaints about “inflation” miss the boat is by misunderstanding what the word is actually measuring and either cherrypicking things that have clearly gone up in what is a broad index with many things that change little and some that are quietly going down, or they’re looking at “asset price inflation” and missing the point that this is specifically not something that conventional “inflation” measures at all. That low inflation has slowly juiced all asset prices which feels like “inflation” of asset prices is a difference between a technical and colloquial definition.

Thus, I’m calling for a deflationary bust at a time when this appears to be contrarian to, well, most everyone.

I’ve listed several targets on SPX and NDX taken from weekly and monthly charts using my ACAT indicator. I think the top is in, given the action of the past few weeks, but I’ve included a bit of wiggle-room for double-top if consolidation drags out a couple more months. I’d like to think I’ve patiently waited long enough and found a serious change in character in this market, but if I haven’t, risk of further parabolic blowoff means macro bears would need to cut the loss quickly to live to try again another day.

The effect of passive flows on this market has been to accelerate the moves, so I’ve drawn this as a shorter duration bear market than might otherwise be the historical expectation, but if I’m correct, and this is 1929 / 1989 Nikkei, then basically people will get eaten buying the dip several times and this will end only when sentiment that the market is a guaranteed thing so long as you buy-and-hold is no longer church doctrine. Crashes on this scale have typically taken decades to retake the highs.

You should expect regulation to curb excesses and that will cap the insanity – because markets like this get this insane due to clear examples of fraud and abuse. So we’ll respond to things like whatever the hell games TSLA has been playing with its accounting after it blows up Enron-style, and it will be the correct thing to do because the fundamental problem with “stonks only go up” is that a lot of why the economy feels perpetually poor to so many ordinary people is that we’re allocating capital to Ponzi schemes instead of actual not-fraud, real world mathematically-sound and often not-sexy businesses that can sustainably employ people with steadily rising wages over decades.

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