Too Much Love Will Kill You

Too Much Love Will Kill
You: Velocity and

Vulnerabilities
By Cameron Dawson, CFA® on Feb 03, 2023 05:02 pm
Too much love will kill you

Just as sure as none at all
It’ll drain the power that’s in you
Make you plead and scream and crawl
–Too Much Love Will Kill You, Queen

Respect the tape. That’s the message from market technicians (those who analyze price
and volume data in markets) after this week’s rally. The ebullient response by equities
to the Fed’s seemingly dovish press conference resulted in meaningful “breakouts” and
surges in momentum in many stock indices. Taken alone, this springing price action,
often referred to as “escape velocity”, could suggest that the Bear of 2022 is over and
that a new Bull is upon us.
There is solid historical precedent to respect this high-velocity message from prices.
Markets are forward-looking and often change direction long before fundamental data
justifies these moves. The overarching market narrative is even slower to change
course, with overly optimistic or pessimistic outlooks persisting long after the market
turns for the worse or better, respectively.
One reason for markets changing course before data and narrative is that it takes time
for broad market participants to appreciate what is truly driving the price action. A stale
market narrative could be focusing on the wrong driver and miss what is most
important for prices.
Recall the months coming out of the March 2020 COVID low. Markets ripped higher
despite frightful virus data, corporate profit warnings, and shuddering economic
activity. It turns out that trillions of dollars of financial and monetary stimulus were a far
more powerful driver for markets than pandemic lockdowns. The bearish market
narrative was slow to appreciate the bullish backdrop of stimulus. Those who respected
the tape, with its massive surges in momentum, were the earliest to pick up on this shift.
A similar story happened in 2019 when an earnings and economic slowdown kept many
market participants cautious, but stock prices rose rapidly thanks to the Fed’s pivot
away from tightening policy. The market was the first to know and the narrative was the
last to know.
Same in 2016. The fundamental world felt like it was ending due to the “industrial
recession” all throughout 2016, and yet markets ripped higher due to renewed
accommodation from Fed policy.
So, it is at times like this, when the narrative seems clear (growth is slowing, stocks are
rich, the Fed remains tight) but markets seem to disagree (breaking above downtrend
lines, momentum surges, breadth thrusts) that we have to ask ourselves how we can
respect the tape.
First, we have to acknowledge that there are occasionally, but not often, false signals in
price action. We had one as recently as the summer of 2022, when prices rose rapidly,
with strong breadth and momentum, and yet this surge did not lead to the start of a new
bull market at that time.
Second, respecting the tape may come with a finite horizon. Momentum is clearly to the
upside in the near term (note the resilience of equity indices on Friday after the blow-
out jobs report and weak tech earnings). The next level of resistance is up to 4,300 on
the S&P 500 (the August 2022 high), while seasonality could fade as a tailwind as we get
into the second quarter.
Third, and this is where Queen comes in, respecting the velocity of the tape does not
mean ignoring our vulnerabilities.
Too high of a valuation multiple, too much exuberance, too much soft-landing
optimism, and too much anticipation of Fed accommodation could all kill this rally if the
data does not come in at ideal levels. Too much love will kill you.
Put another way, we think that the higher markets trade in the near term, the more
vulnerable they become to unhappy surprises in data or policy.
This may not seem like an overly groundbreaking assertion, but there is an important
distinction between today’s rally and the 2016, 2019, and 2020 recoveries we mentioned
earlier. All of those rallies had measurable shifts in policy and liquidity that allowed
markets to shake off challenging incoming data. Money supply growth (M2 Money
Supply YoY) reaccelerated at the same time that each of these rallies began. This
expanding liquidity supported the rebound in valuations and drowned out the fearful
sentiment that (lagging) economic data was still weak.
Today we have yet to see any reacceleration in money supply growth that would
suggest that increasingly abundant liquidity conditions can overwhelm challenging
data. The market may want the Fed to pivot to easing, but Fed policies have not yet
resulted in more improving liquidity conditions that would allow us to ignore
fundamental considerations.
It is vital to observe in the chart below that the turns in liquidity were coincident with
the market recoveries in 2016, 2019, and 2020 and did not lag the recoveries like the
data, sentiment, and narrative did at those times. If October 2022 was the start of the
next bull run, it would be unique in its lack of support from money supply growth.
As we think of our vulnerabilities, we see equity valuations priced at near perfection. For
many indices, we are now nearing or above the pre-pandemic highs in valuation. We do
not think a return to pandemic-era valuations is justified, even if the Fed pauses, as
these effervescent valuations were made possible by unprecedented stimulus (0% fed
funds rate, -1% 10-year real interest rate, peak 20% money supply growth YoY, $5T
balance sheet expansion).
We have also seen a return to exuberance in markets and a normalization in positioning.
The Bloomberg Intelligence Market Pulse Index is now back to levels not seen since the
irrational exuberance of early 2021 (a market period that legendary short seller Jim
Chanos says was the most pronounced period of speculative fervor that he has ever
observed in his career). Of course, this positioning and sentiment could have room to
run further (positioning could become extremely long vs. just neutral), but the bar for
upside surprise to expectations is certainly getting higher as investors become more
optimistic.
Lastly on vulnerabilities, we must consider that a rapid deceleration in inflation (at no

expense to growth) is not just consensus but is likely fully priced into markets. Last week
we discussed the risks posed by energy prices for month-over-month inflation data, and
this week we may have seen early evidence of this rebound in inflation momentum. For
the first time since March of 2022, the Price component of the manufacturing PMI turned
higher. We are not calling for a return to 2021-2022 levels of YoY inflation (much of the
pandemic-era, truly transitory inflation drivers are behind us), however, we do think it
could be too soon for markets or the Fed to call the all-clear on the fight against
inflation.
When we balance all of these factors of velocity and vulnerabilities, we see the potential
for markets to continue their bullish run in the very near term, but the higher we push,
the less attractive the risk reward becomes. Higher prices become even more precarious
as we have not seen any coincident shift in liquidity conditions and now have perfectly
priced optimism about the path forward for inflation and growth. And so we won’t
forget that, “too much love will kill you…”

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Too Much Love Will Kill

You: Velocity and

Too much love will kill you

–Too Much Love Will Kill You, Queen

Lastly on vulnerabilities, we must consider that a rapid deceleration in inflation (at no

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