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Go mode – that’s where we are in the markets. It feels like things are about to get moving. We have been of the thought process that we either begin a bear market rally here or the stronger dollar and Fed policies break something and the selloff continues into year-end. The year-end selloff, while painful, may be the easier of the two paths. Here is what is going on.
Bear market rally scenario – the corporate earnings peak this week. They haven’t been all that bad. The corporate buybacks blackout period is now ending. That will bring back $5 billion a day worth of price-agnostic buyers. The systematic strategies are short. If we get some movement above 3800 on the S&P, they will be back in size. That is another price-agnostic buyer. Remember, back in our July quarterly letter, we let you know that a head-scratching rally was coming and markets ran higher for a month. That head-scratcher may be back.
Our preferred scenario is the year-end selloff. It would be painful but much more straightforward, and would signal the end of this bear market. The year-end selloff scenario depends on the Fed breaking something with their interest rate policy, which is creating a very strong dollar. Everyone around the world transacts in dollars and is effectively short of dollars. Year-end regulations and funding should put even more pressure on banks and liquidity. The Fed will need to provide them with dollars to prevent something from breaking. The Fed has lent billions through their swap lines to the Swiss Central Bank in the last few weeks. That is not normal. When you hear talk of swap lines, it’s never good. There are several experts on the esoteric world of liquidity and interbank lending. They are putting up bright red warning flags. The bond market is struggling, and that is what the Fed is most worried about. Keep an eye on the bond market and the dollar.
Rampant speculation is going on in the options market, and most of it is betting that we will go up from here. The market has the potential to turn hard either way here. If the Fed breaks something (and they eventually will), things turn lower fast. If nothing breaks, investors are going to get antsy that they are missing out on a year-end rally and may produce a head-scratching rally into Christmas. If that occurs, we expect one last major move down in early 2023.
If we don’t head lower early next week, then I suspect the bear market rally is on. The corporate buybacks are in blackout but will start back late this week. The G-20 conference is November 16th. That should begin the turnaround in bonds and the US dollar. The end of the year brings funding challenges. The end-of-the-year selloff might be painful but it is easier. It would be a lot like 2018 when we bought on Christmas Eve. The more difficult journey has us headed higher for the next couple of months into the beginning of 2023. We are nimble but looking to nibble more on stocks. It usually isn’t the easy answer.
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