The Santa Claus Rally is About to Get Its Bell Rung 🎅🏼 🔔

In mid November I told you the odds of a melt-up end of year rally were high.

There's an old market adage that they don’t ring a bell at the top.

But I’m ringing one 🔔.

IMHO, there's a much higher likelihood the next 10-20% is down, rather than up. Here's why.

It's never a layup to be short (high time preference vs. madness of crowds or  to paraphrase Galbraith's famous quote - market irrationality > your solvency)....

But this is a slam-dunk time to raise cash or trim longs.

Although the S&P and Nasdaq are making new all-time highs today, gun to head I'd say it's very likely sometime in the next 3 days will be the highs of not only 2023, but quite possibly 2024 as well.

Am I talking 'on the nose' exact print highs?  No, but who cares.

I'm talking about the incremental risk of additional market returns vs. the very real likelihood of future declines.

Here are my Top Reasons the Bull Market Ends this Week (with a whimper, not a bang):

Valuations are stretched.

P/Es are trading back at historically stretched valuations nearly a standard deviation above the norm. While not quite at the post-Covid $6T+ injection levels, they're high by any metric.

The Shiller PE is at 32.5 which is 23.7% higher than the recent 20-year average of 26.3 (which itself is much higher than historical standards).

The Shiller PE, named after economist Robert Shiller who famously called the housing bubble, gives you a longer-term view that corrects for short-term volatility.

The formula for the Shiller P/E ratio is simple: current price divided by average inflation-adjusted 10-year EPS.

Today’s market trades at a Shiller PE above the levels it was at during both Black Tuesday and far above its levels during Black Monday. It’s also about 10% higher than its level during the 2008 crisis.

For comparison, the Shiller PE of 32.5 is about twice its median of 15.93x and almost twice its mean of 17.03x.

Yesterday, FedEx which is a great economic barometer missed earnings badly and warned about lower activity. FedEx and UPS are terrific tells and if they're warning, then its likely the economy is slowing and earnings won't be able to support the stretch in valuations markets are currently trading at.

DeMark Exhaustion

DeMark is a widely-followed leading indicator used to determine price exhaustion, identify market tops and bottoms, and assess risk levels and right now, they’re running in the red zone.

S&P and Nasdaq are both flirting with DeMark exhaustion levels (courtesy of Hedge Fund Telemetry).

• The Russell and S&P RSI (relative strength index) levels are also quite high.

Markets expecting more & faster rate cuts than even the most dovish Fed members are forecasting.

This isn't a big one, as neither markets nor the Fed have a great track record here but the Fed has been much more conservative than market participants over the past 2 years.

The 'higher for longer' mantra and Fed actions caught investors by surprise as almost no one believed the Fed's terminal rate would be up here at 5.5% a year ago and they certainly didn't expect it to stay this high this long.

Market participants believe we will have 6 rate cuts next year (1.50%) with the decreases starting in March.

The Fed has telegraphed 3 cuts (0.75%) starting mid-year.

Someone is going to be wrong (again).

And if you think the Fed is eager to start cutting rates when markets are making all-time highs, you are sorely mistaken.

Debt Spiral and Delinquencies are mounting

This is a too big a topic to cover here but deficits and debt financing costs are spiking. Interest on that debt is beginning to dwarf all other payments. We're at $34 Trillion and counting and the deficit this year will be larger than anyone expects.

Tax revenues are dropping as we're seeing massive shortfalls at the Federal and State levels (California went from a $97B surplus to a $70B deficit in less than a year).

There are plenty of other bearish signs. Auto repos, credit card debt and late payments are near all time highs.

When student loan payments kicked off again in October, nearly 40% of borrowers failed to make a payment. Those are monstrous numbers.

There's an old investing maxim that markets 'climb a wall of worry' -  this is the opposite.

We're at all time lows on the VIX, no one's worried about ANYTHING.

Geopolitical tensions

Pick your poison (Gaza, Ukraine, Red Sea, Taiwan).

The most current and compelling cause for concern is the threat from Islamic jihadists to global shipping lanes.

The closing of the Red Sea due to Houthi rebels jacked oil up $5 quickly. Peter Zeihan is rarely right about anything, but he did flag the immense 'cost' to goods and trade if the US Navy withdraws from it's post-War position as the enforcer of the seas.

Big Macro Tells are Weak

Oil and the 10yr Treasury bond are both great macro tells.  And right now, both are telegraphing weakness.

Prior to the Red Sea closing mentioned above, oil had sold off from $100 to $68 in a straight line over the last 2 months.

The 10yr has done the same dropping from 5 and change to 3.8%.  Closely-watched, deep trillion dollar markets are signaling all is not well with the global economy.

2024 Election Mayhem

Markets like certainty. Right now there is nothing more uncertain than whether the US continues as a Constitutional Republic. The ruling party has attempted to jail the leading candidate of the opposition party by open lawfare and weaponizing the DOJ. If you think people are in a bad mood now due to inflation, see what happens if you prevent them from voting for their preferred candidate.

SPY ETF had all time record inflows of $20B last month.

• The severity and size of the rally feels like a chunk of the gunpowder has already been fired.

Here are a few more stats from inflows over the last month that give me pause:

1. Month to date buy skew ranks in the 99th percentile across all channels.

2. Long only buy skew ranks in the 95th percentile, largest since March

3. MTD buy skew is 5x greater than prior monthly average

The Official Santa Claus Rally is about to begin:

While I flagged the likelihood in mid-November of a positive skew into year end, the 'official Santa Claus Rally' window historically is the last 5 trading days of the year and the first 2 days of the new year.

"Turns out, these 7 days are more likely to be higher than any other 7 days of the year, up 79.5% of the time." (Ryan Detrick)

However, everyone knows this, and some of the rally has been frontrunning this and the Fed pivot. When everyone expects markets to do something, they tend not to play along.

We still may get a decent lift into year end but don't overstay the welcome.

Bottom Line: I'm a seller not a buyer in this phase.

Talk to me mid-February and let's see who was right. -MK