The following commentary is from the latest issue of the Short Seller’s Journal. SSJ analyzes economic developments and presents fundamentally-driven short-sell ideas on a weekly basis. You can learn about this newsletter here: Short Seller’s Journal information.

A massive disconnect between consumer sentiment and the retail stock allocation has developed. The graphic below ( shows the U of Michigan Consumer Sentiment index (blue line, left y-axis) and the AAII (American Association of Individual Investors) equity exposure (orange line, right y-axis) going back to 1990. The two metrics have been highly correlated up until the stock market took off after March 2020.

Despite the onset of a bear market, the allocation of investment portfolios for retail investors and mainstream, dumb-money institutional money managers remains historically high. Consumer sentiment reflects the growing contraction in economic activity (as discussed below), while the historically high stock holdings (65%) reflects the persistence in perma-bullish sentiment. A similar set of data shows that household average allocation to equities on a percentage basis is back to early 2000 levels (right before the tech bubble popped). The bear market in stocks will not be complete until stock allocations are down to the levels seen in March 2003 (32.8%) and November 2008 (22.2%).

The rally in the SPX, which is up 13.7% from the bottom of the sell-off that started at the beginning of August, began on October 12, 2022. That was when the idea of a “Fed pivot” began to intoxicate the perma-bulls. While the Naz trended laterally from 10/12/22 until the end of December, it’s up 13.8% since the 12/28/22. The Naz has jumped 7% in just the last six trading days.

According to Morgan Stanley’s Quantitative and Derivative Strategies team, other than normal short-covering most of the buying is coming from “systematic” and retail buyers (“systematic” would be the hedge fund and CTA money flow dictated by algorithm programs). The group said that there was $20 billion of systematic demand this week on top of roughly $11 billion of net retail buying over the last nine days.

But the usual indicators that have marked the previous bear rallies over the last year once again reflect the frantic FOMO YOLO urgency of stock chasers on amphetamines. The melt-up over the last couple of days this past seek was fueled by a huge buying in Friday-expiry “gamma squeeze” call options. On Friday Goldman’s most-shorted stock index soared 7%. And Goldman’s index of unprofitable tech stocks shot-up 13% off of Wednesday’s lows. This index is up 30% YTD. Additionally, the market decided to completely ignore bearish earnings reports and guidance from 3M, Microsoft and Intel this past week.

It’s anyone’s guess how much longer this insanity can persist. But I would suggest that it’s closer to the end than the beginning. It took a couple of days into the month, but January is usually a strong month seasonally for the market, as pension and 401k funds have to put new cash to work and there’s a general “New Year’s” optimism. Fundamentally the stock market is expensive. The SPX is trading at 18x 2023 guesstimated earnings. After each of the bear rallies in 2022, the market sold off when the SPX traded back up to an 18 forward P/E. I am confident, moreover, that earnings estimates will be lowered several times by the Street this year, which means the market needs to go lower just to maintain an 18 forward P/E.

All three broad stock indices are above their key moving averages (21, 50, 100, 200). The Nasdaq closed over its 200 dma for the first time since knifing below it in January 2022:

While the Naz managed to close over its 200 dma, it double-topped in the last hour of trading and sold off 70 index points (0.6%) in the last 25 minutes. The SPX and Dow also sold off 0.6% in the last 50 minutes of the day.

In reference to 3M, MSFT and INTC mentioned above, it’s becoming more clear that the bottom is falling away from the economy, particularly household disposable spending. The chip sector is a leading indicator for economic activity as chips are used in a wide swathe of end-user products as well as manufacturing/industrial applications at every level of the economic system. At some point I believe that the market will shift its focus from pivot hopes to the deteriorating corporate earnings.