The Stock Market is About Flows

I often hear the phrase “the stock market thinks” or “the stock market is pricing in”

People love to anthropomorphize everything. Stock markets are often depicted as both emotionally and fundamentally driven creatures driven by bulls and bears fighting it out on a pit like you see in the movie Trading Places. While it makes for exciting visuals, that isn’t how it works. Stock markets are driven by capital flows, many of which have little to do with underlying fundamentals.

The biggest flows are from employees with their 401k plans. Every week, a certain amount of money is allocated to the stock market along with payrolls, regardless of anything else. Typically, this creates a stock market that trends higher as unemployment trends lower until layoffs start to hit.

At that point, a few things happen: Employees start putting less money into their 401k’s in order to increase their emergency savings, employees lose their jobs and stop contributing to their 401k’s, after which they get the paperwork to move the accounts elsewhere and decide to move them out of stocks, and employees get nervous about the stock market and start moving their 401k’s toward bonds. These trends accelerate until the selling pressure stops as unemployment peaks out.

After unemployment peaks, you get a nice long bull cycle as the unemployment rate goes down, more people are hired and putting money into 401k’s, and more 401k money begins to shift back toward stocks. Here’s what this looks like on a chart:

As you can see, that 401k narrative fits pretty well up until our current cycle. This cycle is different from the past few in a number of unusual ways.

• First, the stock market usually climbs as the federal reserve starts hiking rates and falls as the Fed starts cutting rates. In this cycle, the market peaked before the Fed started its first rate hike, then started to fall significantly as the Fed hiked rates at a much faster rate.
• Second, the peak in unemployment and the bottom of stocks in 2020 happened in record time causing the NBER to declare the shortest recession ever. We went from lockdown layoffs en masse, to enormous fiscal stimulus, to a scramble to re-hire lost workers, causing a shock more like an EKG spike on a heart monitor than any kind of normal beat.
• Third, the data is still more screwy than ever. We have signs of recession all over the place – including
  • yield curves inverted for more than a year and more steeply than ever
  • Weak transportation and manufacturing data
  • Weak retail sales, even at Cosco
  • Retail inventories swiftly climbed from Oct 2021-Aug 2022 and then stayed there rather than dropping
  • Significant layoff announcements from large corporations, particularly focused on office and technology employees
• On the bullish side, the inflation rate has peaked but is coming down slowly, the unemployment rate is still very low, and the (highly questionable) job openings numbers have peaked but are much higher than we’ve seen in past decades.

Here are charts fitting a few of my notes above:

I’m still thinking that this enemployment rate is key. While the stock market is high, it’s mainly been driven by the top 10 stocks as money flowing into passive funds tends to pool there. AAPL for example is now the biggest stock in the S&P 500, making up 7.12% of the SPY S&P-tracking index fund and 12.33% of the QQQ Nasdaq-tracking index fund by itself. Despite being the largest company, making it unlikely to grow revenue in multiples, AAPL has a hefty P/E of 28 compared to the S&P 500 mean (avg value) of 16 and median (avg company) of 15.

Anyway, once unemployment spikes, it should spark a selloff from 401k funds as money is finally switched around out of stocks. With an enormous amount of that money piled into AAPL at sky-high prices, that stock can fall a lot quite quickly before it finds enough interested and capable buyers. I believe that’s beginning to happen, so I focused some puts there and even added one more on Thursday which expires in November.

Here’s AAPL’s chart:

It looks to me like AAPL is near the top of the descending channel on the weekly chart, and perhaps ready to break down from that ascending wedge on the daily chart.

Here’s my other focus for puts – LEN:

It looks to me like LEN is also near the dop of its weekly wedge while it is coming to the end of a wedge on the daily chart. To be honest though, I just couldn’t imagine why an enormous US homebuilder would be near its all-time highs after housing prices peaked and sales started to freeze up. These puts expire in January and I’m going to let them play out a bit, but I’m not planning on adding to them.

I’ll end with a chart of GDX:

The Gold Miner’s index GDX actually looks fairly bullish here. I wasn’t sure how to call it on the weekly – the descending channel with a false breakout is possible but ugly. On the daily chart it looks like an ascending channel which passed north of the tops of that bowl consolidation.

As for trading, it was actually quite a busy week. After finding out that I was getting charged a 14.25% interest rate on my margin which didn’t even offset tax gains, I was determined to get that cash balance positive. I sold off one of my gold miners (MGMLF), the portion of uranium miner BQSSF from my regular trading account, and some of my cannabis stock GTBIF. I also got more aggressive on selling covered calls on almost everything I could – gold, silver, and uranium. I did sell them all significantly out of the money in case they rip from here, as these mining stocks just haven’t seen the same level of gains we saw in both gold and silver. Still, hearing the strong narrative about the US Dollar being replaced – again – puts my guard up and makes me want to ease up a bit. This is the kind of narrative I’d expect to be trumpeting as gold and silver was sold to speculators before a significant smackdown. I’m bullish over the next few years, but I really don’t think these miners are going to make big moves until after the unemployment rate spikes and then peaks. My gut says they’ll probably go lower from here, and that they probably won’t take off until Q1 2024. Still, the moves in these things happen fast, so I plan to ride it through.

That’s all for now. Here are my latest allocations:

• HEDGES (7.9%)
  • TLT calls (5.9%)
  • AAPL puts (0.9%)
  • LEN puts (1.1%)
• PRECIOUS METALS (41.8%)
  • AG w/ cc (6.2%)
  • EQX w/ cc (5.0%)
  • MTA w/ cc (4.7%)
  • SILV w/ cc (4.5%)
  • LGDTF (3.4%)
  • SLVRF (4.4%)
  • SAND w/ cc (2.6%)
  • MMNGF (2.8%)
  • SSVFF (2.2%)
  • BKRRF (1.6%)
  • RSNVF (1.6%)
  • DSVSF (1.4%)
  • HAMRF (1.4%)
• URANIUM (20.5%)
  • CCJ w/ cc (3.6%)
• DNN shares (2.9%)
  • DNN calls (1.5%)
  • UEC w/ cc (2.8%)
  • UUUU w/ cc (3.3%)
  • BQSSF (0.6%)
  • UROY (2.7%)
  • EU (1.5%)
  • LTBR w/ cc (1.7%)
• BATTERY METALS (11.5%)
  • NOVRF (5.5%)
  • SBSW (4.2%)
  • EMX (3.2%)
  • PGEZF (1.8%)
• CANNABIS (8.5%)
  • AYRWF (0.4%)
  • CCHWF (0.6%)
  • CRLBF (1.1%)
  • CURLF (1.1%)
  • GTBIF (1.6%)
  • TCNNF (1.2%)
  • TRSSF (1.1%)
  • VRNOF (1.4%)
• OTHER TRADES (5.8%)
  • DOCN cloud computing, w/ cc (2.2%)
  • XRP crypto token (3.8%)
• CASH (0.9%)

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