Intro and Performance Tracker Update

I’ve done a lousy job of updating the indicators since my last post on November 14th, and for that I apologize, but I will be back next week with a resumption of the weekly posts.

In the meantime, just a quick update about the site format going forward and some thoughts on tomorrow’s CPI print. Last year I began updating a performance tracker the intent of which was to track my site’s performance against the S&P 500. I have decided to discontinue that for two reasons. First, because every week’s assessment can be readily viewed it can be compared over any timeframe anyway.

Second, I have found the metrics too complex to maintain for my liking as I prefer to keep this site as simple as possible. Buying some when it’s somewhat bullish or selling it all when it’s very bearish, etc. These decisions seem arbitrary and calculating them to me is not worth any value that it may add.

Okay, onward and upward.

CPI

I also just want to say a few words about the current state of the market ahead of tomorrow morning’s widely anticipated CPI print.

I am very cautious into this data release and have reduced my own exposure and hedged the rest with some put positions in SPY and AMZN.

Earlier this week Jeffrey Gundlach made headlines by proclaiming that the bond market is in control and because across the entire yield curve yields are sub 5%, the Fed is never going to get above 5% and those predicting otherwise are wrong. The implication being that the bond market knows something that the rest of us don’t and is predicting that for whatever reason the Fed won’t hike more than another 25-50 bps despite its tough talk.

I disagree with this analysis because I believe Gundlach is oversimplifying as well as giving too much predictive power to the bond market. In my view what the bond market currently represents is a market all-in on the peak CPI narrative. If we are indeed past the point of the highest inflation in this cycle then the bond market is almost certainly correct and the Fed will pause after the next hike or two.

BUT and this is a major but- what Gundlach is missing here is that the bond market is simply making its best guess based on available evidence that inflation has peaked. But if CPI comes in hotter than expected tomorrow morning, it’s a near certainty that the bond market will have to adjust which I believe would send fed funds futures as well as 6 month treasury yields well into the 5-6% range and likely causing massive turmoil in the stock market in the process.

This CPI print is especially dangerous in my mind because it’s been just long enough that the market has seen enough evidence of peak CPI to be convinced of its reality and unsurprisingly has seen a major rebound particularly in the hardest hit stuff like big tech and more speculative growthy stuff.

I also believe there is enough evidence that inflation has not necessarily peaked at least to the point of underperforming expectations to cast a reasonable doubt on the peak CPI theory, the most major contributors being housing and the job market. Housing is still showing massive shortages in inventory with transactions nearly grinding to a halt in most markets. In the job market you are seeing very low unemployment currently which supports higher costs especially in housing. It certainly seems we could be somewhere in the early stages of a reckoning on both fronts with housing coming down very marginally and layoffs being limited to high earning tech employees.

Let me be clear, though. I am not predicting CPI one way or the other. It would be impossible for me to know. The preponderance of evidence would suggest CPI on the decline. But again, I believe that to be largely priced into the bond market and thus giving comfort to the stock market that may be misplaced. Consequently, I believe tomorrow’s print to present asymmetric risk to the downside. Something like getting even money to bet on the Bills to win the Super Bowl at the end of the season. Sure, they may be the favorite, but you aren’t being compensated for the risk that they don’t end up winning.

By the way, there is precedent for the bond market getting this wrong. Back in May the peak inflation narrative was widely accepted and the bond market priced this in by staying in a very narrow range in the weeks leading up to the June release. But the June release came in much hotter than expected and stocks sold off and have been in a volatile range ever since.

This print is more dangerous than that one. The nominal level of rates now is much higher than it was then and I believe that while the very strong economy could easily absorb hikes from 0 to 4% as they were largely symbolic and not all that restrictive in most areas in reality, when you start hiking above 4-5% things start to break and tech stocks will look very expensive.

Because the Fed has a major credibility problem and has tied itself to CPI, every time the CPI print comes in hot the further out the goal posts are moved for an eventual pause and it seems most are banking on a pause coming after the next hike.

If CPI comes in light or as expected I think stocks will continue to perform well and I will quickly sell the puts and buy back my positions but taking off some exposure here seemed right. This is all about managing risk into a fairly binary event.