Market 'Addicts' Are Trading on Hope, Not Reality

The market is holding on to its gains made since the lows seen in October, even though since last June it has moved in a violent range-bound fashion. We have not really made new highs or new lows as the S&P 500 remains stuck in a tight range between 3850 and 4200, with false breaks in October and August last year.

But if one goes back to the headlines and sentiment over the past year, it would seem anything other than boring with the market moving from extreme pessimism to optimism as it pinballed between the range. The narrative always seemed more convincing at each extreme. The economy is far from boring as we see more and more pain in commercial real estate and other parts of the banking market. As usual Wall Street is not the same as Main Street.

What makes this cycle slightly different in the way the stocks and sectors are trading is that this new generation of "investors" has only seen a Fed that has come to the market's rescue each time there has been any financial "plumbing" issues. In their defense, buying the dip has always paid off as the market has eventually recovered, if one managed to hold on for years after.

After the U.S. regional banking crisis seen at the end of March, most are now convinced that the Fed is done raising rates and will soon start to pump the market with liquidity as in past quantitative easing cycles and cut rates. It is with that notion that they are buying long duration assets, especially large-cap technology names as those are usually the ones to benefit if and when the Fed does embark on QE.

It is true to say that once the Fed pivots, markets do "eventually" rally, but to look past all the systemic issues and the path it takes to get there may be blissful ignorance. The stronger the market holds up, the more the Fed will be convinced to keep rates higher for longer, especially as their inflation target is far from where real embedded inflation is trading. It is a known fact that predicting or preempting a crisis is way above the Fed's paygrade. They only react to one when it hits them.

To compare the U.S. regional banking crisis of 2023 to the financial Armageddon of 2008 is naivety at best. The former was a symptom of a system that had seen excess growth of stimulus and ultra-easy monetary policy. It was not the cause and is certainly not the main finale. Institutions have been taking too much risk to make meager returns for years as the Fed has kept its ZIRP (zero interest rate policy) ongoing.

Today we are moving to a more normalized world, one where normal rates are in the realm of 4%-5% as they used to be before this mad MMT (Modern Monetary Theory)experiment started back in early 2000s. As we normalize, credit lending and growth will not come as easy as before, so institutions will need to get used to pricing risk in a more efficient manner.

But the market is so used to moving from ultra-loose monetary policy to ultra-tight, there is no middle ground. Therein lies the new world of investing as investors will need to do more work on picking quality companies than just playing the momentum. CTAs (commodity trading advisors) have had it tough this year as the market has whipsawed without a trend.

The market now awaits the U.S. CPI numbers for March, to be reported Tuesday. Consensus expects 5.2% year over year, which is lower than the 6% seen last month. A downtick will be appreciated by the market, but as the Fed said, "There is more work to be done."

The non-farm payrolls on Friday showed just how resilient the labor market is, to the Fed's detriment. Despite these warnings, the market is positioned for the post-recession playbook. Just like the banks that did not pay heed to Fed's warning paid the price last year, perhaps these investors, too, will have to face a rude awakening.

At the time of publication, Maleeha Bengali had no positions in any securities mentioned.