The Market That Wasn’t There

3,600 (or Worse) S&P 500 Bottom Still Likely in 2024

Before (Hopefully) Resuming 15-Year Bull Market in 2025

DISCLAIMER: Comments below are not a recommendation to buy, hold, or sell any security.? Investing is inherently risky.? PAST PERFORMANCE IS NOT NECESSARILY INDICATIVE OF FUTURE RESULTS.

This article is an update of 2 bullish articles – one written June 2020 calling for 4,000 S&P500 and one written February 2021 calling for 5,000 S&P500 – and 3 bearish articles – one written February 2022 calling for 4,000 S&P500, one written May 2022 calling for 3,600 S&P500, and one written November 2022 extending call for 3,600 in 2023.? 4 of 5 since 2020 isn’t too bad, but last call isn’t yet complete.

Our government is a lie.? Our economy is a lie.? It logically follows that our stock market is also a lie.? Not much we can do about government until later 2024.? Until then, the actual economy is shrinking, and the stock market (outside of the Magnificent 7) is stultifying too.? Tack on renewed bubble valuation – slated to worsen even if we now go sideways – onto a weak economy, and you get a crash.

VIRTUALLY EVERYONE IS BULLISH (e.g., very low VIX), but there is a price for every asset.? Exceed and you’re toast.? Question is not if a crash will occur, but when.? While cash and Fed do counterbalance, those things matter little until AFTER a crash happens.? S&P500 will still likely at least touch 3,600 in 2024, thereafter resuming the 15-year bull.? Look under the hood.? There is currently no there there.

Government Partied, but All We Got Was 17% Inflation and $11 Trillion More Debt

The 2010s / early 2020s dream is over, but everyone acts as if they want to fall back asleep.? Reality is re-asserting, and 2023 return to bubble valuation (amid horrid breadth) didn’t change that.? That said, despite 2022 stock valuation decline, expected subsequent 2023 recession did not appear.? What if the economy was actually NOT resilient in 2023 though?? What if we have been and still are in a recession?

Annual real GDP growth excluding government debt borrowing has been just +1% since 2019 (+0.5% if you also exclude population growth).? That’s applying an understated official inflation rate!? Basically, no organic economic growth for past 4 years.? Think current corporate “earnings” are sustainable?? Without government over-spending (reported as growth like you reporting credit cards as income), not a chance.

Real GDP excluding government debt borrowing is estimated to shortly report at -5% for 2023.? Without the government over-spending (yet again), the current recession would be obvious.? Think the bond market (which tends to be smarter than the stock market) doesn’t know what it’s doing, betting on the historically 2nd longest-ever inverted yield curve signal (closing in on becoming the longest ever)?

Government continues to pull a fast one.? 17% inflation and $11tn more debt (+$3tn in 2023 alone) for nothing since 2019 with a ballooning Debt/GDP which is now higher than that of peak WWII spending!?

Statistics are also now adjusted (beyond norms) and almost entirely restated unfavorably in months following.? China has become the US role model!? If a company did this, it would be called WorldCom.?

Nonetheless, we keep looking at the shiny object of government debt-financed “growth.”? As long as the party continues though, why shouldn’t we?? Because we are careening toward 2000 – 2002 collapse repeat (or worse).? Soft landing?? Recovery (narrative pending)?? No.? Hard landing without government over-spending.? And it won’t be “confined” to housing, CRE, and transportation.? Pain will hit everyone.

The Feds will not stop over-spending in an election year, but stock market looks ahead.? It’s dicey to predict elections, but a second Trump administration is increasingly possible to become a “come to Jesus” moment.? Will Republicans potentially sweep federal control and then cut government over-spending, revealing our farce?? Enough of a chance to fear it, and stock market operates on greed/fear.

We Are All Macro Traders Now

S&P 500 is up ~+50% since end-2019 (though flat over last 2 volatile years), despite basically NO organic economic growth.? That’s a boatload of effective multiple expansion.? Government MUST continue to over-spend to keep earnings at elevated level in valuation models. ?However, earnings-based models can be misleading and even useless in earnings recessions (or worse).? There is a better way.

Over the last 60+ years, one method stood the test of time that does not depend on earnings inputs: regression.? It too requires inputs, but they are sometimes more discernible than traditional measures.? To wit, just 4 inputs rationally predict S&P 500 fair value: Gross Domestic Product (GDP), Money Stock (M2), corporate bond spread, and CPI.? And everyone still thinks the stock market discounts earnings?

Regressing just these four factors against the monthly level of S&P 500 since 1960 yields a model with exceptional fit (i.e. 0.95 R2), credibility across factors/model itself (i.e. high t-stats and F-factor significance), and correlation/coefficient alignment.? In other words, the explanatory fit is not coincidence and includes a range capturing trading history (i.e. proxy 3x standard deviation of residuals):

Given causation implied in this model, we can extrapolate in 2024 to determine S&P 500 fair value.? S&P 500 currently is 20% overvalued (2024 “no landing” assumptions: 4.5% nominal GDP growth, $21tn M2, 2.20% bond spread, 2.5% CPI).? It’s worse for NASDAQ index at 25% overvalued.? Indeed, the only time periods in the last 60+ years with such overvaluation were 2021 and later 1990s!? AI better kick in fast!

We are all macro traders now.? When was the last time you really heard much about earnings or PE valuation, Nvidia aside?? No, the market now trades schizophrenic based on what Biden, Powell, and Yellen had for breakfast, fiscal/monetary moves, treasury auction results, and of course (manipulated) economic statistic releases.? It’s risk-on/risk-off.? Heaven help you if you’re on wrong side of the trade.

This reality will not likely go away any time soon, thus stock/bond/other asset markets’ correlations will likely remain high.? But the party is coming to an end, as the lies, now-truly unsustainable federal debt load (e.g., est. >$1tn interest-only 2024 annual expense), and lag of higher-for-longer Fed Funds rates impact the entire economy (even if the Fed cuts in 2024).? Reality is re-asserting.? Are you ready??

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Party’s Over

Everything now hinges on whether the fiscal policy of the US government can and will remain reckless.? It’s not a matter of if a recession will come.? Recession is already here in reality and will likely continue through 2024.? Fed cuts and cash do not change that.? It’s time to wake up…or continue to party like it’s 1999 (e.g., 2024 New Debt/GDP was 12% while NOT during a crisis).? And that turned out really well!

“This time is different” came true in 2020, 2021, and 2022, but not so much in 2023 (e.g., Magnificent 7/narrow market breadth rebound).? We all lived it.? The Everything Bubble.? Reason?? Government.? Traditional measures fail when government becomes backstop.? Punch bowl has already been taken away by the Fed.? A Trump Administration will likely limit fiscal recklessness – lethal to market narrative.

S&P 500 could fall to 3,600 (-25% from current level), and the 15-year bull market would remain intact.? Think the market cannot return to Fair Value (or worse)?? During 2020/2021 bull market, market habitually rallied off of then-Fair Value, and it actually fell below Fair Value in later 2022.? It is now very far above Fair Value.? All you need is a catalyst.? Cue (fear of) Republican sweep in later 2024 elections.

Bear markets rarely proceed in a predictable fashion.? If S&P500 falls convincingly below 3,600, the 15-year bull market will end.? If that level fails, it could then fall as far as 2,500 (about -50%) or unusual but precedented 7 standard deviations below Fair Value (though inputs would then likely change reducing true undervaluation).? That could finally set up a new structural bull market in stocks starting in 2025.

In the short-term, bulls argue for reversal of unprecedented low valuation and performance of small cap and value stock vs. tech stocks (especially Magnificent 7).? They fail to appreciate that there are 2 ways to rectify this historic anomaly.? Small cap and value stocks can rise…or tech and mega caps can fall.? Being in an actual and looking toward possibly even reported recession, which outcome is more likely?

Investment party of last decade – accelerated in recent years – is soon over.? The government simply cannot kick the can down the road further without serious top-line ramifications (e.g., reduced spending or increased taxation) – both of which will kill reported economic/earnings growth and market narrative.? Lies are about to reveal.? And Fed/cash won’t save stocks until after a crash.? Not if; when.? Be prepared.

DISCLAIMER: Comments above are not a recommendation to buy, hold, or sell any security.? Investing is inherently risky.? PAST PERFORMANCE IS NOT NECESSARILY INDICATIVE OF FUTURE RESULTS.