Playing Positions

Moved all across the Baseball field. Same mentality applies to active market positioning. Framework of the cycle remains in tact. Will discuss M2 y/y at new cycle lows vs. inflation.

Apr 28, 2023

Highlights

Create ways to be flexible and adaptable within the context of the overall economic cycle.
M2 and ODL continue to decelerate and both making new cycle lows year over year.
The Fed is making decisions based on lagging indicators at very dangerous points in cycle time.

My sport of choice growing up was baseball. I played ball starting around the age of 6 and from that early age, it was always incredibly important to me to have the ability to play different positions on the field. The game was substantially more exciting when I would contribute to the team from various roles within a single game. Over the duration of an entire season, I played catcher, center field, right field, pinch runner, and pitcher. Occasionally, I would have to sit out a game to give my arm a rest. Unfortunately, I started having shoulder and elbow problems around the age of 14. Both not playing on the field and having a busted arm would drive me crazy. Hated watching the game from the sidelines. Constantly, I asked myself why, why, why about my arm. My arm was doing something completely out of my control on any given day, which was incredibly frustrating for my younger self. Amidst the anguish, I started getting myself in the game as a pinch runner on the days where I could not fully play. This was where I found a new way to alter the course of a game as the X-factor, and it was extremely gratifying. These experiences facilitated my adaptability and flexibility. My mind was set on doing whatever needed to be done to boost the team win that particular day. Every game was different and I welcomed the unknown.

Markets and Behavior

Switching to markets and behavior, how many readers that are actively trading thought that the game was easy on the short side heading into Tuesday’s and Wednesday’s close? Having fun yet? If not actively trading, I can describe the last few days as manic and emotional. An incredibly valuable lesson that I have learned from Keith McCullough and through my own personal experiences is to never short and hold. There is a “special circumstance” to every rule, but the majority of the times when I have violated this rule, the outcome was exceptionally unfavorable. That being said, I covered most of my shorts to a minimum position leading into the MSFT and META reports. Some of the readers over the last few weeks are probably thinking, “Aaron…………..all of these articles that have been published have pointed to significantly negative data points and contained proactively bearish undertones. How can he be talking about covering shorts? How is the market not crashing? This guy is full of shit”.

First, impossible to know when or if the market will actually crash and one can only infer a higher probability of such an event given the macro conditions (will discuss below). For that reason, it is important to actively risk manage short positions. As discussed in previous Friday Reading, “Truckin” (click here to review), the majority of participants are always going to be afraid of missing out to the upside. Let them chase. Second, I did take down a large portion of my short book throughout the sell-off which in turn made my long book larger for a short time period. Third, after a crazy one-day squeeze on Thursday this week, it is time to start putting it back on again incrementally to names that remain in a bearish trend. As stated in the introduction, I can play several different positions on the field.

Turns out, I got out of the way of a freight train and that was the right decision to make based on the process. Process hint: everything went down a lot for almost a week straight into catalyst events (mega-cap-tech earnings). See Crypto? Those things fell into the abyss following that airplane conversation I overheard (Friday 4/14/23) where two middle-aged men were pitching each other obscure illiquid alt coins. For now, that behavioral moment was the local top for that market. After a week where asset prices have moved violently in both directions within the current trading range, let’s look at the macro metrics.

Data

Today, the focus will be on market liquidity via money supply, CPI, and historical comparison to the relationship between the two variables. For liquidity, the study is going to incorporate M2 and Other Deposit Liabilities year over year. Updated M2 data was released this past week. This will ultimately be compared to CPI over longer periods of time. These are metrics that I have talked about before, but following up not only because these are important leading macro indicators, but the current deceleration in money supply is moving at historic pace.

The conclusion will be that Overall CPI is already well on its way moving lower and money supply year over year continues to move deeper into the negative. Credit is contracting and lending conditions are becoming tighter. The fed is focused on lagging indicators and is likely going to continue raising rates into this growth and inflation slowdown. Will be funny to see if “higher for longer” becomes what was the Fed’s late 2020-2021 “transitory inflation”.

M2 (Money Supply): What is M2? This is the Federal Reserve’s estimate of total money supply. Fundamental to study M2 given it plays a crucial role in the piece of the business cycle that is shown below. Recent chart of M2 year over year demonstrates another deceleration to a new cycle low for the month of March 2023.

Easy monetary policy→ Credit expansion→ Money supply acceleration→ inflationary pressures→ Stimulative to asset prices→ Excessive risk taking

Tight monetary policy→ Credit contraction→ Money supply deceleration→ disinflationary/ deflationary pressures→ Unwind of excessive risk taking→ Creates probabilistic outcome for total economic failure