Market Forecast For the Week of May 8, 2023: Financial Exuberance Fells The Bears This Week But The Punch Bowl Is Almost Empty

FORECAST: The S&P 500 rises to 4210 as the bulls dismiss a plethora of bad news and the bears begin giving up in exasperation. Lower interest rates combined with investor’s large cash balances trump everything now, including the reasons for low rates. But the bullish enthusiasm that breaks through resistance breaks down soon afterward, as investors fully digest April’s earnings reports and realize that not only were earnings poor, but balance sheets worsened, meaning the good times are about to end.

Earnings quality in the first quarter was worse than any period since the summer of 2019, as firms accumulated inventories and extended credit to beef up sales. But investors so far have keyed off the wholesales inventories data, which shows that economy-wide stock of inventories has plateaued and growth has turned negative. Investors are effectively betting that firm-level inventories are a coincident or even lagging indicator of trends, while history shows when firms build up inventories and particular those of finished goods over raw materials and works-in-progress, that earnings will only get worse. And on the national level inventories haven’t declined as much as normal during a recession, so the bulls are effectively betting against the Fed with both fists. History also shows how futile that strategy is.

The Fed is hitting the economy in three ways: 1) via higher rates and its negative balance sheet impact on households and firms; 2) via its own balance sheet reduction, which forces down long-term rates as demand for risk-free assets used as collateral grows, and; 3) by cratering net interest margins for regional banks by forcing their deposit beta up via the combination of a high Fed funds rates and high rates on Fed deposits by mortgage securitizers and money market funds. The bulls believe this triple whammy is impotent against the American consumer’s voracity for spending, despite recent earnings reports that showed real spending is declining and pulling down firm balance sheets. The come down for investors is next, as the bulls find there is no one left to buy at high valuations.

This morning I bought a large position in the levered ETF UPRO, in order to benefit from the near-term move up to 4210. Consequently my current positions include a moderately large cash position, 3M (MMM), Pfizer (PFE), the levered ETF UPRO and inverse levered ETF SPXU, all of which net out to a significant long position in large-cap equities.