When Will Wile E Coyote Look Down?

Recent posts have focused on the increasingly precarious position of the financial markets. Stock prices in particular have remained lofty while the principal basis of valuation – the time value of money – has been pulled out from under. Bonds have sold off sharply to levels cheaper than at any time since last October, largely on stultifying Treasury supply. Higher risk-free yields mean a higher discount rate applied to future earnings, while earnings themselves remain under pressure.

So far it’s been a momentum game, with individual investors playing catch-up as the narrative shifts from inflation yielding to recession to one of inflation being vanquished in a recession-free manner. This is unlikely to last, as discussed in CPI Hijinks. We could be looking at both inflation and recession. And bearish sentiment had been the main support for stock prices. But as I observed in Up Up And Away, this support has rapidly evaporated. Wile E Coyote has run off the edge of a cliff, but has yet to look down and realize it.

Since my last comments on the state of stocks, another wrinkle has been added. Just in the past few days an intraday pattern has emerged that we haven’t seen in a while. To oversimplify the situation, the “dumb money” tends to dominate early in the trading session, while the “smart money” dominates late in the session. Until recently, rallies have been marked by stocks tending to trade higher in the last hour of trading, suggesting that institutions were buying the market. But just since the beginning of the month, selloffs have begun to appear late in the session, suggesting institutions are pulling back.

Yesterday’s trading is a clear case in point, with stocks not only selling off into the close after rallying earlier in the session, but with it being Friday, doing so on the week as well. Some big money didn’t want to be long over the weekend.

News flow dominates the very short term, a push and pull of economic and corporate releases, making daily timing a veritable obstacle course of virtually random impulses. But each passing week has been adding a few more grains of sand to the bearish side of the ledger. Another one of which is that bullish seasonality gives way to bearish as the calendar turns from July to August. No one factor is usually enough to turn a trend, but when multiple factors including valuations, fund flows, sentiment, monetary policy, market internals and seasonality all start pulling in the same direction as gravity, gravity tends to get its way.

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