I want to discuss several points you brought up, but if I sound like I'm nit picking please call me on it - that's not my intent. I want a discussion where I may have to change my view.
To some extent, the various prophets of our Athens are worth listening to if they can change our mindset or teach us new things. You can learn a lot freeloading off their media interviews, while taking everything with a grain of salt. Not as much as with an actual textbook, but a lot nonetheless.
Of the investment books I've read, I'm not sure how many qualify as textbooks - could you give some examples of what you mean?
I subscribe to the Fed Model. In a nutshell, if 10 year treasuries yield X%, then the earnings yield (inverse of PE) on stocks should be X% plus a risk premium. This is certainly an "all else being equal" simplification, ...
By Fed Model, you mean "Federal Reserve" model? I've never seen the Fed discuss earnings yield of stocks or P/E ratios for that matter. Is there anything from Fed Chair Powell which mentions this in his 4 years at the Fed?
The PE had to fall until there was a big enough risk premium between the EY and the 10Y yield.
I've heard "risk premium" mostly mentioned by academic studies and in Larry Swedroe's books. I believe it can turn negative, an example being 2022 YTD, where cash has beaten stocks.
If the gap between Treasuries and EY in November 2021 is our baseline, the risk premium was (4-1.4=) 2.6%. With the EY now at about 5% and the 10y yield now at 2.86%, the risk premium is (5-2.86=) 2.14%.
In other words, despite all this bear market talk, we have still not caught up with the risk premiums that were in place before Russia invaded Ukraine or before we realized inflation would reach highs last seen in the Volker era. One would think the risk premium would expand in uncertain times like these, not contract.
On CNBC today, Josh Brown talked of how extreme sentiment has been for a long time, with CNN's Fear & Greed Index being one way to measure that.
https://edition.cnn.com/markets/fear-and-greedAnother guage of fear, the ^VIX (volatility index of S&P 500) has been in an oddly tight range around 25-32 for weeks. It's not spiking to levels you might expect in a crash, not does volatility calm down to reflect things have improved. I think the market is wearing people down, rather than crashing dramatically.
https://finance.yahoo.com/quote/%5EVIX/Now I think it's safe to assume that the next two Fed meetings (June and July instead of skipping a month) will involve 0.5% rate hikes, even if inflation starts to taper downward ... the Fed may still have further to hike from there because inflation is unlikely to be lower than 5-6% three or four months from now!
In terms of predicting the Fed, I've been mistaken in using CPI-U inflation. As you mention later, the Fed prefers "Core PCE" inflation, which has risen been: 6.0% Jan, 6.3% Feb, 6.6% Mar ... and April due this Friday. I believe there's a strong correlation between CPI-U and PCE, so from that I believe Core PCE will remain strong.
https://www.bea.gov/data/personal-consumption-expenditures-price-indexAn odd point: "Core PCE" excludes energy and food, which would make it a terrible measure during the oil embargo 50 years ago, and not a great choice now with two major energy and food producers being at war. I hope the Fed looks at both CPE and Core CPE.
Fiddle with the details all you want, the result will remain that valuations have to fall 10-30% from here if the already announced series of rate hikes happen. Earnings growth may help keep stock prices higher than the drop in valuations, but recession talk will likely take the wind out of that sail.
Two well run retailers, Walmart and Target, both had massive misses on earnings. Walmart down -20% in a week, Target -25% in a day. I liked the back & forth between Scott Wapner ("the Judge") and Steve Liesman (Fed expert). Mr Liesman pointed out the strength of travel, so the Judge pointed to weakness in retail. Mr Liesman brought up that consumer goods are 30% of the economy, versus services the other 70%. I wished they had dug into that other 70% ... but it's a fair point to claim goods can fall separately from services.
ON THE FLIPSIDE - and you should always think hard about the flipside - the PCE numbers that come out Friday could show significant improvement, China could give up on lockdowns any day, Ukraine could agree to let the Russians keep Donbas and Crimea in exchange for a ceasefire, the USD could strengthen against the Euro and Yen, the rate of QT could be increased, COVID could come back and suppress monetary velocity, and oil prices could collapse just like metal prices have collapsed.
I see many people speculate about a ceasefire without projecting past it. Plenty of evidence points to killing of civilians by Russian soldiers. Will the U.S. and Europe just drop sanctions after the war? My answer is no, that even the end of a war doesn't normalize energy & food markets (and prices).
I haven't researched it well, but believe China has low vaccination rates. I don't know if their vaccines are comparable to AZ or not, but I doubt it's anywhere near the effectiveness of Pfizer & Moderna. If they reopen, hospitals get overwhelmed. I also vaguely believe China's government made this a point of national pride, which makes them even more cautious. Finally, Covid-19 has surged back in the U.S., and could easily surge in China again if lockdowns are lifted.
I'm not sure I follow the other points: USD has already strengthened against the Euro and Yen, to historically wide spreads. QT, being the reverse of QE, acts like more rate hikes at specific points on the yield curve. It removes cash from the bond markets, which makes money harder to find, and "tigher" financial conditions. Good for bond yields, not so good for stock prices.
What looks like a no-brainer bet on stocks going down could reverse into a ferocious bear rally, and for this reason I'm not as bold as @MustacheAndaHalf who is going short with leverage. I think you'll win, but I'm not sure I want to bet my financial life on it. I'm doing deep-ITM covered calls on short ETFs with part of my AA and keeping a large percentage in cash. The other reason I'm less bold is because bear markets are typically brief (see 12/2018), even if all signs point to this year being a repeat of 2000, minus the rate cuts to rescue us.
I reached a point where I was overconfident and viewing things as a "no brainer", but I considered that dangerous and tried to find a solution. Remembering Annie Duke's "Thinking in Bets", I thought about my stock market prediction as a bet.
If I predict the S&P 500 will fall 20% or more from here over the next 12 months, would you bet against that? What if you had 2:1 odds (you bet $20, bookie puts in $40, winner take all)? If I'm willing to offer someone that 2:1 bet, I'm probably more than 67% confident (2 of 3). But I avoid 4:1 (risk 100% for +25% gain?), so call that 75% confidence.
Since all I said was a crash, I can wrap two ideas in one: high, persistent inflation crashes the market... or, the longest bull market is increasingly likely to end in a bear market. The business cycle may start with growth, but also includes the destruction of companies that lack access to cash (no profits, struggle to raise cash - original freudian slip "stuggle to raise crash").
Something I'm keeping in mind is this: I don't necessarily have to hit a home run with leveraged short bets in 2022. If my portfolio is merely intact 12 months from now, I might be able to retire at valuations that allow for 5% withdraw rates. Still kicking myself for not buying PFF when the yield was 7.5% in April, 2020.
Using -3x ETFs, I hold -100% stocks and -50% bonds, which tend to be uncorrelated in these markets. I mostly have small gains or losses, until the Fed pushes both stocks and bonds down. I'm lumping SARK as a -3x ETF despite lacking leverage. If 2022 recovers, I was wrong and I sell these and ease back into the market. I can afford to lose that fraction of my NW - but more importantly, I'm prepared to do it. I have no mercy for a losing investment strategy, even if it's mine.
Unlike 2020-2021 where I spotted Covid-19 in the news, this time around I had the fortune or bad luck to be invested in risky stocks, which caused me to get fed up (Fed up?) with taking losses. I moved out of crypto & call options (Dec), then went to 1/3rd equities and inverse bonds (Mar), and finally just went with 0% equities and SPY puts (early April). In May I pushed into an actual inverse ETF position, which I currently hold.
*although there are cases where one out of thousands of New York City money managers manages to outperform the market for multiple years in a row - even decades - but that outcome is to be expected in a statistical sense, just like heads heads heads heads heads is a coin flip series that will come up by chance if you flip the coin enough times, and means nothing about the next flip.
I believe professional managers aren't allowed to invest like I do. As one put it, "cash looks really good right now, but I don't get paid to invest in cash". I think the funds they run dictate terms of their investment strategy. Although active managers do best (against index funds) in bear markets, they can't flip to 100% cash per the terms of their fund.