A Contrarian 2022 View 2.0

This analysis builds on our previous “A Contrarian 2022 View” published a week or two ago and includes analysis built around the Mauldin piece published last Saturday.

First, here is the background setup for the earlier analysis in “A Contrarian View’ of March 24, 2022

Forty years of Voodo economics..

This is a core concept, a Fed that is trying to deal with an embedded structural inflation that is the result of 40+ years of voodo economics. These are the compounding effects of supply side inefficiencies and resulting QE and Fed Balance sheet growth, plus government debt issued in attempts to paper over mis-management.

Current market view …

Currently in early 2022 the Markets seem to be succumbing to the story of tail risk inflation based around supply chain and war related energy issues. The Fed says it will fix everything with 3 fifty point hikes or maybe 7 twenty five point hikes. In that regards the market showed its allegiance to not fighting the Fed by front running the hikes over the recent weeks.

Market Interest rate hikes appear to be already in the market…

As of today the anticipated hikes are reflected in the market and the yield curve is sitting ass-backwards to the long term problems that are really at issue, the government debt and 9.0 T Fed Balance sheet issues. What changed today was an interview with FED governor Brainard who said the FED was going to aggressively tackle the Balance Sheet issue. Interestingly, and correctly, indication she is on the right track, the yield curve started steepening after her remarks

Tomorrow, we get the FED minutes from the March meeting and we might see what she is really talking about. You will recall recently we discussed the balance sheet issue and that at the February 24th low it appeared that the market was pricing in an aggressive monthly 90 billion dollar reduction in the balance sheet. So lets see what the minutes say and what the FED actually does next week at its meeting. Maybe the all talk little-action operation may be changing, but call me skeptical.

Analysis: A Contrarian View 2022 2.0

This analysis will dig deeper into the “Possible Outcomes” of dealing with the artificial economics part of the problem, i.e. the last eleven years of the 40 year problem, the period after FED Chair Bernanke put QE2 in play and started the build of the 9.0 Trillion dollar balance sheet..

  1. First it would seem appropriate to state that one of the big issues in the media and for the markets at the moment is whether or not the 10-2 yield curve is forecasting a recession.
  2. The FED Notes study that Jim Bianco mentions in the Mauldin piece of last Friday, and can be accessed therein in our blog post of Saturday; states that the main thing that the market should be focused on is the first 2 years of the 2-10 yield curve because it is just a reflection of what the FED is saying it is going to do for the next 2 years, and that the next 8 years of the curve are unknowable.
  3. If you believe the prior paragraph here, and it is difficult to refute, one comes away with the knowledge that this is all about current FED action, and does not reflect the unknowables, like the economy reaction or inflation reaction.
  4. Then moving another step forward in the analysis, one has to come to the conclusion that the two factors the markets will be trading going forward are: A) FED Action vs Economy Reaction, and B) FED Action vs Inflation Reaction.
  5. And then digging deeper you have the following interactions:
  6. FED Action and Economy Reaction vs FED Reaction to Market Reaction.
  7. Then we have to add in: FED Action and Inflation Reaction vs FED Reaction to Market Reaction
  8. That leaves us with: Reduction Bottom Line, i.e. we end up with FED Actions and Reactions are what we will be trading. The economy and inflation are only chess pieces in this big game.

Bigger Conclusions and Factors:

  1. Trading ones portfolio in 2022 will require Flexibility. I don’t think one can have a strong bearish or bullish outlook in the short-term, there are two many crosscurrents, and in reality you are, as said above, primarily trading the FED.
  2. The 9.0 Trillion dollar FED Balance sheet is in the background and is in reality the FED’s insurance policy against doing something wrong with their rate manipulation. If the FED does, in a panic, actually do something drastic with the Balance Sheet, like anything over 90 Billion reduction per month, all bets are off.
  3. With the Funny money in the background and investor sentiment still having a memory of higher markets, I do believe that stock market reactions to both bullish and bearish FED reactions will be of a large magnitude if it sees the FED lose its nerve or panics.
  4. As mentioned in the prior analysis, watching economic activity will be essential as a backdrop.
  5. The real economy is kind of in the background. Rising interest rates will put pressure on activity. The Atlanta Fed’s GDPNOW forecast as of today is at 0.9 % GDP growth estimate for the first quarter, down dramatically from prior quarters. One will need to follow the regular monthly reports on consumer confidence, industrial production, retail sales, along with CPI and PPI to see possible FED reactions.
  6. Commodities and Oil are really a supply story in my analysis. They have been on an upward run for the past few months as many traders have used them and the stocks related to them, the energy and AG areas as places to hide and push around during this period since last November when stocks started declining and consolidating. My view is that this commodity area, while in a long-term bull run, is probably going to run into some severe demand headwinds over the next few months.

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