Lily Tomlin may have been speaking about today’s stock market when she said, “No matter how cynical you get, it’s impossible to keep up.” Wall Street has been working for months to cast a gloomier future, prepare for uncomfortably corrosive inflation and dampen optimism about the economy. So far, however, these efforts have been overtaken by reality. Friday’s hotter-than-expected CPI barely blew forecasts, but it was enough to melt bond yields, roil the Federal Reserve’s rate hike expectations and send stocks nearly a retest of their 14-month lows and only reach three weeks earlier. In the face of a summer with an aggressive Fed, consumers on high spirits amid high gasoline prices, and with the burden of proof firmly on those predicting inflation, it will come down decidedly, and investors will be held back to look for conditions to “ so bad it’s good”. In other words, the moment when most plausible bad news seems to have been priced in and the forces of mean reversion begin to blow behind the bulls. We’re probably not quite there yet, although some elements are beginning to move in that direction. Testing the Band After holding a tight range for eight trading days and holding almost all of its 9% recovery from the intraday low of May 20, the S&P 500 eased starting Thursday, eventually falling more than 1% for three straight days and lost 5% for the week, ending right at 3900 – right on the May 20th closing low. The intraday low from a few weeks ago was 3810, so a few percent cushion remains. I was suggesting here that the market should be more frightening of the very confident bears who claim that any rally should be sold. This did not materialize, the recovery rally stalling well before it even reached the index’s 50-day moving average, let alone the early May high of 4300. At its yearly low, the index is essentially 20% below its peak. There’s no compelling reason why the decline should stop there, aside from the quirky story of 19% total pullbacks in the index on some corrections with no or mild recession (2018, 2011, 1998, 1990). (There are other technical trend reasons why many observers were targeting 3800-3900 as a decent downside target, as detailed here more than a month ago when the index had yet to drop below 4100.) The average Nasdaq Composite stock is down 50% a fairly comprehensive flush from its high, but preceded by an unusually exuberant and sustained surge in momentum in Nasdaq names. When indices fall in price, they also fall in time, and the S&P 500 is now trading at levels first seen more than 16 months ago in early February 2021. This now qualifies as a rather lengthy consolidation of the post-Covid crash Advance into stocks. There is no hard and fast rule for such things, but the complex, multi-wave corrections that peaked in February 2016 and December 2018 both reached levels first seen nearly two years ago. In a narrower sense, the three consecutive days that more than 80% of S&P 500 stocks have fallen have approached “so bad, it’s good” status. Canaccord Genuity strategist Tony Dwyer notes that only 3% of S&P shares ended the week above their own 10-day moving average, the lowest since the sharp declines in June 2020 and October 2020 came close to theirs to run. Dwyer doesn’t say this is a clear signal to go for a snapback, preferring to see the Volatility Index (VIX) move higher much faster than he has. Still, he said in Friday’s final hour of trading: “Today’s inflation data has raised expectations of an even more aggressive Fed, which may lose some clout at its meeting and the likely rate hike at next week’s FOMC meeting… Expectations are already pretty grim and then I try to be cautious and not get too negatively caught up in a sharp decline.” A fairly grim, or at least defensive, stance is also evident across various aggregate measures of investor positioning. Deutsche Bank says asset managers and leveraged funds have since Mid 2016 Brexit vote and before near the correction lows of early 2016 and the US debt downgrade panic in late 2011. The Bank of America Bull & Bear Indicator, Fund Flows and others market-based measures of risk appetite tells a similar story, well into the fearsome lowers typically implying a contrarian buying opportunity that worked well in 2016, 2018 and 2020. Although, of course, longer periods of market stress such as the recessionary bear markets of 2000-2002 and 2008-2009 kept this gauge near the floor while prices continued to trend lower. Valuations have been pulled sharply lower, with the S&P 500 back below 16.5 times expected earnings, right where it last rose a few weeks ago. However, this is only in the range of fair value and not cheap, even if the median stock appears significantly cheaper than the overall index. Earnings forecasts are holding up reasonably well, but that’s thanks in large part to massive upward revisions in energy earnings, with the rest of the sectors flat in terms of earnings growth overall in 2022. This suggests that valuation is no longer the main headwind for the market, but neither has the pendulum swung enough to rebuild an ample margin of safety. The gloomy consumer The fear visible among investors is rather tame compared to the anger and desperation reflected in consumer surveys. The University of Michigan preliminary consumer sentiment survey on Friday was extremely weak, at lower levels than during the global financial crisis and, unless revised upwards, will be considered the worst monthly reading since 1978. This affects inflation almost exclusively, with an overlay of general societal malaise. And even with a strong labor market and broadly healthy consumer finances, it’s hard to see that such poor sentiment isn’t fueling broader consumer dovishness. The silver lining is that negative extremes in Michigan consumer sentiment over time have been pretty good contrasting signals of how stocks will perform over the next 12 months. JPMorgan calculates that the S&P 500 is up an average of 25% in the year since Michigan’s eight sentiment lows dating back 50 years, with the worst return coming in at 14%. The catch is that lows are known only in hindsight when sentiment recovers from a low, and we’re not there yet. The Conference Board’s consumer confidence measurement asks what respondents expect from stocks, and in the latest report, the 28% who said they expect stocks to rise was the fewest since the known moment in February 2016, with a six-month correction of 15 % and the peak of recession/deflation fears. Other work on public opinion shows that the lowest percentage of Americans on record say it’s a “good time to buy a house,” a pretty good sign that the Fed’s tightening forward guidance, which expired on March 30, is on track -year fixed mortgage rate is well above 5.5%, prompting a sudden and severe slump in the real estate market. All of this paints a blurry but vaguely discernible picture of an environment that is bad enough to allow for some market relief soon, but not so bad that it is unequivocally positive for risk assets.