Market Forecast For the Week of October 3, 2022: The Bears Try Serving Aces But The Bulls Volley Aggressively And Keep Markets Tight Until Earnings Season Lights Up Next Week

FORECAST: Stalemate now grips the markets as the bulls feebly predict a Fed pivot to dovishness in order to forestall a liquidity crunch, while the bears claim the Fed will push rates ever higher and break financial stability. Neither view reflects knowledge of the true state of liquidity since that rests not just with money flows but the decisions of commercial and shadow banks to participate or not in an endlessly volatile marketplace. This speculative battle resolves in a modest drop in the S&P 500 to 3560 early this week followed by another monstrous bear market rally that sends the index back to the midpoint of last week’s range. The prudent position remains to be either short stocks or in cash.

With earnings season a week away the volleyball of uncertainty between the bulls and the bears will result in little more than hand-wringing over the Fed and global financial stability. Underlying these issues is confidence in corporate earnings. Estimates of 2023 earnings still average in the high single digits despite a raft of economic and geopolitical concerns. These likely come down hard. By mid-October we will know whether the issues bedeviling FedEx has spread like a forest fire across the MNC universe. I look at earnings quality as the best predictor of demand trends and note that over the first two quarters quality declined markedly. Now labor shortages across the US and Europe make a persistent drop off in demand all but certain as “less engaged workers” adjust their spending to reflect their income. Ensues deeper selloffs in the latter half of October. The graver issue is when demand comes back, since in the absence of an October stock market crash it’s global demand that determines whether this bear market ends in 2022 or takes most of 2023 to tire out.

But an October crash can’t be dismissed. Threats of financial contagion emanating from Credit Suisse are a serious concern despite reassuring statements from traders and pundits over the weekend. The fundamental issue is not Credit Suisse’s high capital levels but rather that high capital levels haven’t been tested until now, Prior to the GFC banks didn’t have such high capital ratios, and it was coordinated central bank regulations that made this happen. I see declining confidence that banks can pass this test, and 50/50 odds of a Lehman moment. Measures of COCOs (contingent capital bonds) look as bearish as that seen during the plunge in March 2020. The link between bank liquidity, inadequate margin requirements at CCPs (Central Clearing Parties) and ETF arbitrage mechanics is simply not known among the vast majority of investors, including myself. Logic suggests that existing fragility in CCP and ETF mechanics can’t be separated from capital concerns of the very banks that participate directly or indirectly in these large corners of global Wall Street. Increasing fear of contagion is another reason to expect much lower lows in the S&P before the bulls can firmly take charge sometime in 2023 or 2024.

My current positions include a large cash position, Goldman Sachs (GS), 3M (MMM), Pfizer (PFE), Starbucks (SBUX), and the inverse levered ETF SPXU, all of which still nets out to a meaningful short position in equities.