Historically, a rebound of this magnitude has almost always indicated that the bear market is over and that we've entered a new bull market. And there's plenty of reason to be optimistic right now. With the US dollar down, US manufacturing numbers have been coming in above expectations (PMI of 49 in July, vs. 46.7 estimate). Consumer confidence and home prices were also stronger than expected this week. The liquidity crisis for regional banks seems to have resolved itself, and the uptick in continuing jobless claims (USCJC) seems to have stabilized, at least for now. The ECRI weekly leading index is forecasting positive US growth. Yesterday, the Fed said it's no longer forecasting a recession. Preliminarily, it kinda seems like the magnitude of stimulus and interest rate hikes were in the right ballpark to actually stick a soft landing this cycle (with a big assist from the AI productivity boom).
But as the market pushes toward new highs, let's consider what might be the bear case. Because markets love to surprise, and I do think there are some worrying signs.
1. Inflation could come roaring back, forcing the Fed to keep interest rates high.
A few weeks ago, interest rate futures were forecasting a 99% probability that rates would be lower by this time next year. But now it's only 87%, with a 2% chance that rates will actually be higher next July. Why are rate futures getting more hawkish? Basically because housing costs have been slow to correct and commodities prices have been climbing since May, which points to the possibility that inflation may continue to run hot.
Why might housing prices and commodities stay hot? Well, for housing, it's basically because there's a shortage. We've got more real estate agents than houses for sale, by a wide margin. I do think housing prices will gradually come down, but it may take quite a while to normalize without a supply-side fix.
And for commodities? Well, there are basically two problems.
First, geopolitics are extremely ugly right now. You've got active insurgencies in huge swaths of Africa and the Middle East, and you've got Russia threatening to blockade food shipments on the Black Sea. That all drives commodity prices up.
And second, you've got a six-sigma temperature anomaly that's destroying crops. Global warming seems to be running ahead of forecasts, which raises the worrying possibility that we've hit some kind of climate change tipping point and the North Atlantic Current might collapse sooner rather than later. That would be not only very inflationary for food prices, but also very bearish for equities in Europe and the US. Something to keep an eye on, for sure.
2. Expectations may be too high, especially for tech.
Investors have been throwing money at tech companies because of the AI boom, on the assumption that these companies will be the main beneficiaries of it. But the reality, in my opinion, is that AI greatly erodes the value of their intellectual properties. For instance, ChatGPT has dramatically reduced the cost for me spin up a competitor product or even an open-source version of any major enterprise SaaS. The big software firms are going to have to throw a lot of money and people at AI in order to keep their edge. So far, only Microsoft is doing a really good job.
And what about semiconductors? The AI boom is good for semis, because all that AI requires a lot of GPUs. But you know what? With rapid advances in the field, the compute demands have come down a lot. I can train a LLaMa model on a Colab notebook now, which is insane. Meanwhile, there's a semiconductor inventory glut on a scale not seen since 2001. Chips have been an extremely good bet for decades, and investors have rightly thrown a lot of money at them. But it's possible that we may now be late-cycle for the industry.
Overall, I think the expectations for the S&P 500, and especially for Big Tech, may just be too high. We've got P/E above 26 at a time when profit margins are in a slide. My models point to a P/E in the 21–23 range as more appropriate for the current rates of interest and inflation. So it may be that there's not much room left for multiple expansion to lift the market higher here, so productivity gains will have to do a lot of work.
3. Liquidity remains a concern.
In addition to raising interest rates, the Fed is continuing to shrink its balance sheet. Liquidity from the Fed has driven a lot of the market gains over the last decade, so a shrinking balance sheet is a headwind for stocks. There's also some reason to think consumers and small businesses have some cash flow issues right now. Last month, the Fed published a report showing an unusually high level of commercial financial distress. Auto loan delinquencies also hit a high last month. As long as money and jobs don't get any tighter than they already are, we probably won't see anything break. But if inflation rises again and we see more interest rate hikes, then there may still be some systemic risk.
Conclusion
I'm definitely not betting on a major bear market here. But this close to a major resistance level, it's worth looking parking some money in cash or bonds or putting on a hedge. S&P 500 puts are somewhat cheap right now, so it's not a terrible time to buy protection. And long-term bonds are on the cheap end of the range they've been trading in since last November, so it's also not a terrible time to put on bonds. I'm basically just thinking in terms of modest rotation and rebalancing here.
But as the market pushes toward new highs, let's consider what might be the bear case. Because markets love to surprise, and I do think there are some worrying signs.
1. Inflation could come roaring back, forcing the Fed to keep interest rates high.
A few weeks ago, interest rate futures were forecasting a 99% probability that rates would be lower by this time next year. But now it's only 87%, with a 2% chance that rates will actually be higher next July. Why are rate futures getting more hawkish? Basically because housing costs have been slow to correct and commodities prices have been climbing since May, which points to the possibility that inflation may continue to run hot.
Why might housing prices and commodities stay hot? Well, for housing, it's basically because there's a shortage. We've got more real estate agents than houses for sale, by a wide margin. I do think housing prices will gradually come down, but it may take quite a while to normalize without a supply-side fix.
And for commodities? Well, there are basically two problems.
First, geopolitics are extremely ugly right now. You've got active insurgencies in huge swaths of Africa and the Middle East, and you've got Russia threatening to blockade food shipments on the Black Sea. That all drives commodity prices up.
And second, you've got a six-sigma temperature anomaly that's destroying crops. Global warming seems to be running ahead of forecasts, which raises the worrying possibility that we've hit some kind of climate change tipping point and the North Atlantic Current might collapse sooner rather than later. That would be not only very inflationary for food prices, but also very bearish for equities in Europe and the US. Something to keep an eye on, for sure.
2. Expectations may be too high, especially for tech.
Investors have been throwing money at tech companies because of the AI boom, on the assumption that these companies will be the main beneficiaries of it. But the reality, in my opinion, is that AI greatly erodes the value of their intellectual properties. For instance, ChatGPT has dramatically reduced the cost for me spin up a competitor product or even an open-source version of any major enterprise SaaS. The big software firms are going to have to throw a lot of money and people at AI in order to keep their edge. So far, only Microsoft is doing a really good job.
And what about semiconductors? The AI boom is good for semis, because all that AI requires a lot of GPUs. But you know what? With rapid advances in the field, the compute demands have come down a lot. I can train a LLaMa model on a Colab notebook now, which is insane. Meanwhile, there's a semiconductor inventory glut on a scale not seen since 2001. Chips have been an extremely good bet for decades, and investors have rightly thrown a lot of money at them. But it's possible that we may now be late-cycle for the industry.
Overall, I think the expectations for the S&P 500, and especially for Big Tech, may just be too high. We've got P/E above 26 at a time when profit margins are in a slide. My models point to a P/E in the 21–23 range as more appropriate for the current rates of interest and inflation. So it may be that there's not much room left for multiple expansion to lift the market higher here, so productivity gains will have to do a lot of work.
3. Liquidity remains a concern.
In addition to raising interest rates, the Fed is continuing to shrink its balance sheet. Liquidity from the Fed has driven a lot of the market gains over the last decade, so a shrinking balance sheet is a headwind for stocks. There's also some reason to think consumers and small businesses have some cash flow issues right now. Last month, the Fed published a report showing an unusually high level of commercial financial distress. Auto loan delinquencies also hit a high last month. As long as money and jobs don't get any tighter than they already are, we probably won't see anything break. But if inflation rises again and we see more interest rate hikes, then there may still be some systemic risk.
Conclusion
I'm definitely not betting on a major bear market here. But this close to a major resistance level, it's worth looking parking some money in cash or bonds or putting on a hedge. S&P 500 puts are somewhat cheap right now, so it's not a terrible time to buy protection. And long-term bonds are on the cheap end of the range they've been trading in since last November, so it's also not a terrible time to put on bonds. I'm basically just thinking in terms of modest rotation and rebalancing here.
注释
The market outlook has weakened considerably, and the bear case looks increasingly likely to be realized. Economic data are bad, and energy and housing prices are sharply rising again. However, it's been an abnormally warm year and will likely be an abnormally warm winter, which may take some of the pressure off the energy crunch. Not a lot of places to hide in this market if a stagflation scenario materializes, but the yield on money markets is hard not to like, and the 
FLBR Brazil ETF is an inexpensive energy play.
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