Tag: Bear Market (page 1 of 6)

The Coming Economic Downturn In Canada

Authored by Deb Shaw via MarketsNow.com,

  • Canadian GDP growth has outperformed this year, helping the Canadian dollar
  • As GDP growth slows and the Bank of Canada turns neutral, catalysts turning negative
  • Crude oil and real estate look set for a downturn, with negative implications for the currency

Given its natural resource-based economy, Canada is a boom and bust kind of place. This year, the country has enjoyed a significant boom. Thanks to a government stimulus program, rising corporate capital expenditures and consumer spending, Canada’s GDP growth has been nothing short of spectacular in 2017. According to Statistics Canada, the latest reading for year-over-year GDP growth is a healthy 3.5% (as of August 2017). While this is stronger than all major developed countries, growth is decelerating from its most recent peak in May 2017 (when GDP growth was an astounding 4.7%). A visual overview of historical GDP growth is shown below for reference:

Turning a corner: Canadian growth comes back down to earth

11-17-2017 CAD GDP growth

Source: Statistics Canada

Following the crude oil bust in the second quarter of 2014, Canadian growth rates cratered. While the country avoided a technical recession, the economic outlook was poor until early 2016. After crude oil returned to a bull market in the first quarter of 2016, the fortunes of the country turned. Given limited growth in 2015, the economy had no problem delivering 2%+ year-over-year growth rates in 2016. As a substantial stimulus program ramped up government spending in 2017, growth rates have continued to accelerate this year.

Storm clouds on the horizon: crude oil and real estate

While Canada has delivered exceptional growth in the last two years, the future outlook is much more challenging. Beyond the issue of base effects (mathematically, year-over-year GDP growth will be much tougher next year), key sectors including the oil & gas industry and Canadian real estate look ripe for a downturn.

Crude bull market intact today, but at risk in 2018

As WTI crude strengthens beyond $55, crude oil is clearly in a bull market today. Looking at figures from the International Energy Agency, global demand growth continues to run ahead of supply growth. Thus the ongoing bull market is supported by fundamentals. Thanks to the impact of hurricanes and infrastructure bottlenecks in 2017, US shale hasn’t entirely fulfilled its role as the global ‘swing producer’ this year. The dynamics of supply growth versus demand growth are shown below:

Who invited American shale? US supply ruins the crude oil party

10-13-2017 crude oil supply demand

Source: International Energy Agency, forward OPEC supply estimates via US EIA

Unfortunately, the status quo looks set to change as US supply returns with a vengeance. According to estimates from the IEA, supply growth will outstrip demand growth in the first quarter of 2018. Digging deeper into supply estimates, US shale is once again to blame. Our view is that this changing dynamic will lead to a new bear market in crude oil. Looking back at recent history, crude prices formed a long-term top in the second quarter of 2014 once supply growth overtook demand. Similarly, crude prices bottomed in the first quarter of 2016 once supply growth fell below demand in early 2016. Given Canada's dependence on crude oil exports, a bear market for the commodity is likely to result in a weaker currency.

As China enters its latest real estate downturn, Canada not far behind

While Canadian real estate has enjoyed a great year, the future outlook is much tougher. Similar to its peers in Australia and New Zealand, Canadian real estate prices tend to lag real estate prices in China. This is both because Canada’s economy is deeply intertwined with China, and because the country is a big destination for overseas investment from China. While overseas investors make up a relatively small portion of buyers (around 5% according to government estimates), they serve an important role by acting as the marginal buyer for prime property. A comparison of new house prices in China versus Canada is shown below for reference:

Canadian real estate boom set to run out of steam

11-17-2017 China Canada real estate

Source: Statistics Canada, China National Bureau of Statistics

As Chinese new house prices accelerated significantly in early 2015, Canadian real estate prices followed in 2016. As the Chinese market is now decelerating, negative growth appears to be on the horizon. In March 2015, Chinese house price growth bottomed at -6.1%. While the Canadian bull market continues for now (September new house prices registered at 3.8%), a downturn is likely over the next 6-12 months. As real estate makes up 13% of Canadian GDP, a significant decline in the fortunes of the industry are likely to spill over to the broader economy.

Implications for the Canadian dollar

At the beginning of the year, the Canadian dollar enjoyed a wide number of bullish catalysts including accelerating GDP growth, rising rate hike expectations, a relatively strong crude oil market and speculator sentiment that was at a bearish extreme. These catalysts, and the Bank of Canada’s actions in particular, helped the currency strengthen until late September.

Today, almost every factor that drives the Canadian dollar is working against it. Future GDP growth rates are set to keep decelerating. Looking at the Bank of Canada, its outlook for future rate hikes is now “cautious”. This is a big change from its hawkish tilt earlier this year. While speculator sentiment is no longer at bullish extremes, waning interest in the Canadian dollar is weighing on the currency. The ongoing NAFTA negotiations are another source of potential political risk. Finally, an impending downturn for both crude oil and Canadian real estate further worsen the picture. Thus, our longer term outlook on the Canadian dollar is bearish.

 

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The ‘Junkie’ Market Is Back

Via Dana Lyons' Tumblr,

The past few days have seen a reversal from substantial net New lows to substantial net New highs – a condition that has preceded poor performance in the past.

We’ve posted several pieces in the past regarding what we’ve termed “Junkie Markets” – junctures characterized by a substantial number of both New 52-Week Highs and New 52-Week Lows.

Such conditions represent a key component of various and notorious market warning signals, such as the Hindenburg Omen and others. As the ominous sounding names would imply, the historical stock market performance following such signals has been poor. We have found the same to be true with respect to our “Junkie Markets”. Today’s Chart Of The Day deals with a new variation of the Junkie Market.

Specifically, we have seen an unusual development over the past 2 days. On Wednesday, the number of net New Lows on the NYSE, i.e., New Lows minus New Highs, exceeded 2% of all exchange issues, a fairly large amount. The very next day, yesterday, conditions completely reversed as we saw net New NYSE Highs, i.e. New Highs minus New Lows, actually account for more than 2% of all issues. If you think that sounds strange, you’re correct. It is just the 15th such occurrence since the start of our data in 1970.

image

Here are the dates of these reversals:

3/25/1970
4/14/1972
7/11/1974
10/20/1977
1/2/2001
4/22/2004
5/11/2004
4/18/2006
6/28/2007
7/19/2007
9/19/2008
5/30/2013
10/10/2013
1/15/2015
11/16/2017

What would cause such a phenomenon? Well, the only thing we can offer is that a Junkie Market, i.e., one with lots of New Highs and Lows, is really the only type of market in which such a reversal is even possible. Thus, it should not be surprising that the S&P 500’s aggregate performance going forward following these precedents has been less than stellar (incidentally, aggregate performance is similar following the 19 occasions of the opposite reversals, i.e., >2% Net New Highs to >2% Net New Lows).

image

With median returns negative from 1 week to 6 months, this appears to be another version of the Junkie Market that, for whatever reason, has not been kind to stocks going forward. Obviously, the presence of signals near cyclical peaks in the early 1970’s as well as 2001 and 2007-2008 do not help the aggregate returns (average returns are even worse than median).

Now, not all signals have occurred at the beginning of cyclical bear markets. However, as the chart shows, one interesting observation is that all of the occurrences have occurred during secular bear markets (that is, of course, if one accepts that we are still within the confines of the post-2000 secular bear market, as is our view – that is a topic for another time, though). The point is that, if true, the ramifications may reinforce the negative tendencies associated with Junkie Markets.

The bottom line for now is that, while it is certainly possible that stocks can continue higher in the interim, this condition of elevated New Highs and New Lows is a potential unhealthy headwind in the longer-term.

*  *  *

If you’re interested in the “all-access” version of our charts and research, please check out The Lyons Share. Find out what we’re investing in, when we’re getting in – and when we’re getting out. Considering that we may well be entering an investment environment tailor made for our active, risk-managed approach, there has never been a better time to reap the benefits of this service. Thanks for reading!

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Unbridled Exuberance…

Authored by James Stack via InvesTech.com,

From public confidence to bullish sentiment to the normally mundane employment data, the U.S. economy and stock market are reaching historic levels not seen in decades.  Last month, consumer confidence hit its highest level since December 2000.  The percentage of bullish investment advisors recently touched lofty levels that were last reached in January 1987.  And this month, the U.S. Department of Labor announced that job layoffs dropped to a 44-year low!

This might all sound like great news, and on the surface it obviously is.  But what is forgotten in today’s exuberant celebrations – and the above statistics – is that both the economy and stock market historically peak when skies are blue and no storm clouds are in sight: December 2000 was just 3 months before the start of the 2001 recession. January 1987 was 9 months before Black Monday struck. And 44 years ago (1973), the stock market was about to suffer its worst annual loss in 35 years! If the S&P 500 closes higher in November, it will have posted a positive total return for 13 consecutive months, surpassed only once in 90 years – 1959.  The next year (1960) the economy entered a recession.

We’re not sharing these insights because we have turned bearish in our market outlook.  We haven’t.  Most technical evidence and virtually all macroeconomic data still point to new bull market highs immediately ahead.  However, it is becoming increasingly important to remember that trees do not grow to the sky, and bull markets do not last forever.  And don’t forget that virtually every bear market except one (1956) has repossessed or taken back roughly one-half or more of the previous bull market’s gain. 

Today, that would equate to 8,500 DJIA points!

Unbridled Exuberance… While the Novice Make Merry, the Seasoned are Wary

One of the most apparent examples of investors’ increased appetite for risk lies in the “FANG” stocks.  These modern day “four horsemen” of technology and consumer stocks –Facebook, Amazon, Netflix, and Google– are considered leaders in the emergent areas of today’s economy.  Because of their outsized estimates for future growth, this narrow group of stocks has radically outperformed the S&P 500 since the beginning of 2015.

However, value-conscious investors have had difficulty justifying ownership of this speculative quartet due to valuation risk.

They trade at a combined P/E ratio of 48.5 based on trailing earnings – nearly twice that of the S&P 500.

Enthusiasm for the FANG stocks has reached such a feverish pitch that Wall Street is creating new products to tap into the public’s insatiable appetite for these exciting invest ments.  The four FANG stocks are joined by six other hot tech names to form the NYSE FANG+ Index.  Futures contracts on this Index began trading on the Intercontinental Exchange (ICE) last week.   Investors can now “Trade the Top of Tech” in the futures market to quickly increase or decrease their exposure to these speculative companies.

In past market tops of the late 1990s and 2007 we exposed the danger of investor and consumer exuberance along with the “boom” headlines that typically accompany a cyclical peak.  This is not an infallible relationship, however, so the appearance of the above headlines today does not necessarily mean the market top is in place.  Rather, it reinforces the need to maintain professional skepticism and an emphasis on risk management, which can be in short supply at this stage in the market cycle.

Nowhere is the bullish consensus more obvious than in the Advisors Sentiment Survey tracked by Investors Intelligence (graph below).  While the percentage of bears is typically considered a more reliable contrarian indicator at extreme readings, we find it interesting to note that the percentage of bullish advisors recently hit the highest level since January 1987 – only nine months before the 1987 Crash…

Valuation risk remains an overarching concern for today’s aging bull market.  Although the leading economic evidence remains overwhelmingly positive, U.S. stocks are not cheap by historical standards.  The current P/E ratio of the S&P 500 based on trailing earnings is 24.8, which is well above the 90-year average, as shown in the graph below. 

How expensive is the S&P 500 today?  The P/E for this popular Index has exceeded 24.0 just over 10% of the time since 1928, as shown by the dark blue bars on the graph at right.  The light blue bars eliminate the distortions from the Technology Bubble of the late 1990s and the Financial Crisis in 2008-09 when corporate earnings evaporated.  If we exclude those extreme periods, the S&P 500 P/E ratio has been in the rarified range above 24.0 less than 3% of the time. 

Lofty valuations do not cause bear markets, and stocks can remain overvalued for very long periods of time.  However, high valuations increase downside risk and diminish the margin of safety so essential to successful long-term investing.  Consequently, it is particularly important now to employ a safety-first strategy and avoid overvalued momentum stocks, as they will undoubtedly fall the hardest when a bear market does arrive. 

A Potential Warning in the Technical Evidence…

Sometimes it’s striking how quickly the technical picture can shift in an aging bull market.  Take the three graphs below, for instance.  When we last published this trio of charts in early October, all three were hitting new highs in unison.   Now both the Dow Jones Transportation Average (DJTA) and the small-cap Russell 2000 Index are starting to diverge substantially from the blue chip DJIA, which is sitting just below its recent all-time high.

Major peaks in the DJIA are usually preceded by a top in one or more of the economicallysensitive secondary indexes, but not every divergence necessarily signals trouble ahead.

When both the secondary indexes shown here diverge simultaneously, however, it’s a significant development, and time for heightened vigilance.

NLC:  Is Distribution Imminent?

Our Negative Leadership Composite (NLC) shown below remains steadfast on the surface with the bullish “Selling Vacuum” [*1] at +4 and no visible sign of “Distribution” [*2 – shaded region]…  yet! 

Even so, careful analysis of the underlying leadership data since mid-October shows a steady deterioration in the internal numbers.

Sometimes it’s striking how quickly the technical picture can shift in an aging bull market.  Take the three graphs at right, for instance.  When we last published this trio of charts in early October, all three were hitting new highs in unison.   Now both the Dow Jones Transportation Average (DJTA) and the small-cap Russell 2000 Index are starting to diverge substantially from the blue chip DJIA, which is sitting just below its recent all-time high.

Major peaks in the DJIA are usually preceded by a top in one or more of the economically-sensitive secondary indexes, but not every divergence necessarily signals trouble ahead. 

When both the secondary indexes shown here diverge simultaneously, however, it’s a significant development, and time for heightened vigilance.

Selling pressure is stealthily creeping upward, and it appears to be broad-based. If the current trend continues, we could start to see Distribution in our NLC by the time our December issue goes to press.  If Distribution appears and subsequently drops below -50, then bear market risk will become elevated and that could warrant a more defensive stance

 

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Weekend Reading: You Have Been Warned

Authored by Lance Roberts via RealInvestmentAdvice.com,

Investors aren’t paying attention.

There is an important picture that is currently developing which, if it continues, will impact earnings and ultimately the stock market. Let’s take a look at some interesting economic numbers out this past week.

On Tuesday, we saw the release of the Producer Price Index (PPI) which ROSE 0.4% for the month following a similar rise of 0.4% last month. This surge in prices was NOT surprising given the recent devastation from 3-hurricanes and massive wildfires in California which led to a temporary surge in demand for products and services.

Then on Wednesday, the Consumer Price Index (CPI) was released which showed only a small 0.1% increase falling sharply from the 0.5% increase last month.

This deflationary pressure further showed up on Thursday with a -0.3 decline in Export prices. (Exports make up about 40% of corporate profits)

For all of you that continue to insist this is an “earnings-driven market,” you should pay very close attention to those three data points above.

When companies have higher input costs in their production they have two choices: 1) “pass along” those price increase to their customers; or 2) absorb those costs internally. If a company opts to “pass along” those costs then we should have seen CPI rise more strongly. Since that didn’t happen, it suggests companies are unable to “pass along” those costs which means a reduction in earnings.

The other BIG report released on Wednesday tells you WHY companies have been unable to “pass along” those increased costs. The “retail sales” report came in at just a 0.1% increase for the month. After a large jump in retail sales last month, as was expected following the hurricanes, there should have been some subsequent follow through last month. There simply wasn’t.

More importantly, despite annual hopes by the National Retail Federation of surging holiday spending which is consistently over-estimated, the recent surge in consumer debt without a subsequent increase in consumer spending shows the financial distress faced by a vast majority of consumers. The first chart below shows a record gap between the standard cost of living and the debt required to finance that cost of living. Prior to 2000, debt was able to support a rising standard of living, which is no longer the case currently.

With a current shortfall of $18,176 between the standard of living and real disposable incomes, debt is only able to cover about 2/3rds of the difference with a net shortfall of $6,605. This explains the reason why “control purchases” by individuals (those items individuals buy most often) is running at levels more normally consistent with recessions rather than economic expansions.

If companies are unable to pass along rising production costs to consumers, export prices are falling and consumer demand remains weak, be warned of continued weakness in earnings reports in the months ahead. As I stated earlier this year, the recovery in earnings this year was solely a function of the recovering energy sector due to higher oil prices. With that tailwind now firmly behind us, the risk to earnings in the year ahead is dangerous to a market basing its current “overvaluation” on the “strong earnings” story.

Don’t say you weren’t warned.

In the meantime, here is your weekend reading list.


Trump, Economy & Fed


VIDEO – It’s A Turkey Market


Markets


Research / Interesting Reads


“The only function of economic forecasting is to make astrology look respectable.” – Sir John Templeton

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Rickards On Gold, Interest Rates, & Super-Cycles

Authord by James Rickards via The Daily Reckoning,

When the Fed raised interest rates last December, many believed gold would plunge. But it didn’t happen.

Gold bottomed the day after the rate hike, but then started moving higher again. 

Incidentally, the same thing happened after the Fed tightened in December 2015. Gold had one of its best quarters in 20 years in the first quarter of 2016. So it was very interesting to see gold going up despite headwinds from the Fed.

Meanwhile, gold has more than held its own this year. 

Normally when rates go up, the dollar strengthens and gold weakens. They usually move in opposite directions. So how could gold have gone up when the Fed was tightening and the dollar was strong?

That tells me that there’s more to the story, that there’s more going on behind the scenes that’s been driving the gold price higher.

It means you can’t just look at the dollar. The dollar’s an important driver of the gold price, no doubt. But so are basic fundamentals like supply and demand in the physical gold market.

I travel constantly, and I was in Shanghai meeting with the largest gold dealers in China. I was also in Switzerland not too long ago, meeting with gold refiners and gold dealers.

I’ve heard the same stories from Switzerland to Shanghai and everywhere in between, that there are physical gold shortages popping up, and that refiners are having trouble sourcing gold. Refiners have waiting lists of buyers, and they can’t find the gold they need to maintain their refining operations.

And new gold discoveries are few and far between, so demand is outstripping supply. That’s why some of the opportunities we’ve uncovered in gold miners are so attractive right now. One good find can make investors fortunes.

My point is that physical shortages have become an issue. That is an important driver of gold prices.

There’s another reason to believe that gold could be in a long-term trend right now.

To understand why, let’s first look at the long decline in gold prices from 2011 to 2015. The best explanation I’ve heard came from legendary commodities investor Jim Rogers.

He personally believes that gold will end up in the $10,000 per ounce range, which I have also predicted.

But Rogers makes the point that no commodity ever goes from a secular bottom to top without a 50% retracement along the way.

This means the 50% retracement is behind us and gold is set for new all-time highs in the years ahead.

Gold bottomed at $255 per ounce in August 1999. From there, it turned decisively higher and rose 650% until it peaked near $1,900 in September 2011.

So gold rose $1,643 per ounce from August 1999 to September 2011.

A 50% retracement of that rally would take $821 per ounce off the price, putting gold at $1,077 when the retracement finished. That’s almost exactly where gold ended up on Nov. 27, 2015 ($1,058 per ounce).

This means the 50% retracement is behind us and gold is set for new all-time highs in the years ahead.

Why should investors believe gold won’t just get slammed again?

The answer is that there’s an important distinction between the 2011–15 price action and what’s going on now.

The four-year decline exhibited a pattern called “lower highs and lower lows.” While gold rallied and fell back, each peak was lower than the one before and each valley was lower than the one before also.

Since December 2016, it appears that this bear market pattern has reversed. We now see “higher highs and higher lows” as part of an overall uptrend.

The Feb. 24, 2017, high of $1,256 per ounce was higher than the prior Jan. 23, 2017, high of $1,217 per ounce.

The May 10 low of $1,218 per ounce was higher than the prior March 14 low of $1,198 per ounce.

The Sept. 7 high of $1,353 was higher than the June 6 high of $1,296. And the Oct. 5 low of $1,271 was higher than the July 7 low of $1,212.

Of course, this new trend is less than a year old and is not deterministic. Still, it is an encouraging sign when considered alongside other bullish factors for gold.

But more importantly, gold has held its own despite higher interest rates and threats of more.

That tells me we’re seeing a flight to quality, meaning people are losing confidence in central banks all over the world. They realize the banks are out of bullets. They’ve been printing money for eight years and keeping rates close to zero or negative. But it still hasn’t worked to stimulate the economy the way they want.

So gold has been moving up in what I would consider a challenging environment of higher rates. 

The question is, where does gold go from here?

The market is currently giving close to 100% odds that the Fed will raise rates next month.

I disagree. I’m skeptical of that because of the weak inflation data. There will be one more PCE core data release before the Dec. 13 meeting. That release is due out on Nov. 30.

If the number is hot, say, 1.6% or higher, that will validate Yellen’s view that the inflation weakness was “transitory” and will justify the Fed in raising rates in December.

On the other hand, if that number is weak, say, 1.3% or less, there’s a good chance the Fed will not raise rates in December. In that case, investors should expect a swift and violent reversal of recent trends.

Markets have priced a strong dollar and weaker gold and bond prices based on the expectation of a rate hike in December. If that rate hike doesn’t happen because of weak inflation data, look for sharp rallies in bonds and gold.

Now, the last time gold sold off dramatically was on election night, when Stan Druckenmiller, a famous gold investor, sold all his gold. It’s only natural that when someone dumps the amount of gold he deals in, the price will go down.

That move reflected a change in sentiment.

What Stan said at the time was very interesting. He said, “All the reasons that I own gold in the first place have gone away because Trump was elected president.”

In other words, he was buying into the story that Hillary Clinton would be bad for the economy but Donald Trump’s policies would be beneficial. If we were going to have strong economic growth with a Trump presidency, maybe you didn’t need gold for protection. So he sold his gold and bought stocks on the assumption that the economy would grow under Trump.

But earlier this year, Stan has said he’s buying gold again. What that means is that people are finally reconsidering the reflation trade. Tax reform is still a big question mark. And when’s the last time you heard a word about infrastructure spending?

Investors will once again flock into gold once reality sets in. Mix in rising geopolitical tensions in Asia and the Middle East, and gold’s future looks bright.

http://WarMachines.com

Gartman: “We Are Now Short Of One Unit Of The US Equity Market”

So much can change in ten days.

Having entered last week short, “world-renowned commodity guru”, Dennis Gartman, got spooked last Tuesday when faced with the relentless melt-up in global stocks, and admitted that he had “been wrong… badly… in taking even a modestly bearish view of the global equity market and effecting that bearish view via a position in out-of-the-money puts on the US equity market bought a week and one half ago.”  He then said he would immediately cover his short “and covered it shall be” because as he then explained, he was afraid  

“…we are about to enter that violent… and ending… rush to the upside that has ended so many great bull markets of the past. At this point, the buying becomes manic and prices head skyward. Speculation is the order of the day, not investment and when such periods have erupted in the past prices have gone parabolic until such time as the last bears have been brought to heel and the public has thrown investment caution to the wind. We’re there now; this may become wild.”

Fast forward to yesterday when, with nothing but price momentum changing in the interim, Gartman’s flipped 180 degrees, and boldly predicted that “the bear market is upon us we fear”:

Today’s “universal” weakness…only a week from the global market’s all-time high… is a harbinger of further material weakness we fear and sets the stage for the start of what we fear might well be a bear market of some serious vintage. There is concern… very real concern… on our part that one market after another has broken its upward sloping trend line that has heretofore been very well defined. A trend line drawn across the recent lows of the Dow has been broken; a trend line drawn across the recent lows of the S&P has also; trend lines of the Russel… of the Nikkei… of the DAX… of the EUR STOXX 50… of the Tadawul in Saudi Arabia… have all been broken, and we can go of if need be but our point here is made. Something material has happened to the global equity market and only the most fervent of stock market bulls shall not recognize that fact.

 

The equity market, by its very definition, anticipates the change in the economy, rising before the economy rises and falling before the economy falls. We are at the latter tipping point. It has been months in the coming, but it is here and adjustments in one’s investment policies must be made accordingly. The bear is upon is, we fear.

Fast forward to today when all those wondering why not only US equity futures, but markets around the globe have rebounded overnight, may find the answer:

As we said here yesterday, we are certain that we are at a turning point where economic activity is strong and shall likely grow stronger for several months into the future but where stock prices are weaker. Again as we said yesterday, it has always been thus and it shall always be thus. The equity market, by its very definition, anticipates changes in the economy, rising before the economy rises and falling before the economy falls. We are at the latter tipping point:

There was more in the rant, written just one week after Gartman predicted an imminent “violent, panic” rush in stocks, now anticipating a bear market, but it culminated with a new trade recommendation.

Short of One Unit of the US Equity Market: Yesterday… Wednesday, November 15th…we suggested that on any intra-day strength in the indices here in the US … and by strength we meant 8-12 “point” rallies in  the S&P we intended to “sell” the markets short, leaving the actual manner of being short to everyone’s individual preference. Given  that the S&P was 2568 as we wrote, a rally toward what had been support at 2572 would be a reasonable place to sell. It got there… barely… and we are now short a marginal sum.

For the bears out there the wisest thing to do may be to just step away for a bit, and certainly until Gartman’s already underwater position, is stopped out.

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The Complete Idiot’s Guide To The Biggest Risks In China

With both commodities and Chinese stocks suffering sharp overnight drops, it is hardly surprising that today trading desks have quietly been sending out boxes full of xanax their best under-25 clients (those veterans who have seen one, maybe even two 1% market crashes), along with reports explaining just what China is and why it matters to the new generation of, well, traders. One such analysis, clearly geared to the Ritalin generation complete with 3 second attention spans, comes from Deutsche Bank which in a few hundred words seeks to explain the key risks threatening the world’s most complex centrally-planned economy, and ground zero of the next financial crash.

Which, one day after our summary take on why the Chinese commodity, economic and financial crash is only just starting (as those who traded overnight may have noticed), is probably a good place to reiterate some of the more salient points.

As Deutsche Bank’s Zhiwei Zhang writes in “Risks to watch in the next six months”, the key thing to keep in mind about China now that the 19th Party Congress is in the rear-view mirror, is that the government is likely to tolerate slower growth in 2018. Han Wenxiu, the deputy head of the Research Office of the State Council, said that GDP growth at 6.3% in 2018-2020 would be sufficient to achieve the Party’s 2020 growth target. And while this is a positive message for the long term, it indicates growth will likely slow in 2018. And, as DB warns, recent economic data suggest the economic cycle has indeed cooled down.

For all those seeking key Chinese inflection points, here are the three big red flags involving China’s economy:

  • For the first time since Q4 2004, fixed asset investment (FAI) growth turned negative in real terms in Q3 this year.

  • Growth of property sales for the nation turned negative as well in October, the first time since 2015.

  • The property market boom in Tier 3 cities is also losing momentum.

We hope not to have lost by now all the Millennial traders who started reading this post. To those who persevered, here – in addition to the risks facing the economy – are the other two main risks facing China’s investors: (rising) inflation and (rising) interest rates.

The details:

Inflation. The benign headline CPI masks an important underlying trend. Nonfood inflation has been rising steadily – it reached 2.4% in Oct, an unusually high level compared to the historical average of 1.3%. This is largely driven by services prices, such as healthcare(7.2% yoy), education(2.8%), and domestic services(4.3%). Headline CPI inflation is expected to reach 3.1% by February 2018, with DB’s baseline is that inflation will moderate in H2 2018, but watch out for the risk scenario that it will stay above 3% through the rest of 2018.

If inflation becomes persistently high, the central bank’s hands will be tied, making any monetary loosening more unlikely, if not further tightening.

Interest rates. Interest rates are climbing around the globe, but more so in China than in the US.

Clearly it is not because of demand in the real economy, judging by weaker investment. One likely explanation is that financial deleveraging has caused NBFIs to reduce their (often leveraged) exposure to longer maturity assets. Inflation expectation may also play a role. If these are true, interest rates may face persistent upward pressure. This will in turn suppress borrowing: for example, LGFVs issue less bonds during periods of rising interest rates.

And while Deutsche’s veteran Chinese analysts have some soothing words for the world’s 25-year-old traders who have yet to see a bear market, and promise that nothing will break in China, we would disagree because as we have said for the past 3 years, the next global crisis will start in China, and with Xi’s role cemented for the next 5 years (if not for life) the smart thing would be to have the Chinese economic hiccup (because recession is clearly a taboo under central planning) as soon as possible, so the economy can recover by 2022. Judging by the tremors in the past few days, he may agree.

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Albert Edwards On The Selloff: “Comparisons With October 1987 Are Entirely Justified”

Last week, when equities were still blissfully hitting daily record highs, we showed the one “chart that everyone is talking about, or if they weren’t they soon would be: the sharp, sudden disconnect between the junk bond and stock market …

… a disconnect which – as we showed at the time – was last observed in mid-August 2015, just days before the infamous ETFlash crash. Fast forward to day, with stocks suddenly hitting air pockets around the globe and rapidly catching down to junk yields

… when this enveloping divergence between the conflicting narratives by equities and bonds was the center piece of Albert Edwards latest letter to clients. In it, the SocGen strategist highlights the ZH chart and, ever the pragmatist, wonders why it took not only stocks, but junk bonds so long to react to the steady deterioration in underlying balance sheet quality, a topic discussed most recently by his colleague Andrew Lapthorne

…  who showed that “interest coverage for the smallest 50% of US companies is near record lows, at a time when interest costs are extremely depressed and when profits are at peak.” Lapthorne’s conclusion, which echoed what the IMF said earlier in the year, “It is difficult to envisage a scenario in which this ends well.”

Albert picks up on this theme in his latest note released today, and writes that “investors are beginning to punish the corporate debt and equity of highly indebted US companies. We have highlighted consistently that excess US corporate debt is probably the key area of vulnerability that could bring down the QE inflated pyramid scheme that the central banks have created.”

To demonstrate this point, Edwards shows another bizarre “balance sheet debauchment” divergence, one between surging leverage, and record low junk bond yields, to wit:

… we think the high yield corporate bond market should have been revolting against balance sheet debauchment some time ago. That would be the normal state of things with net debt/profit ratios so very high (see chart below but note bottom-up data shows a far higher peak than this top-down Fed data but peaks normally occur as profits fall in recession).

As the chart above suggests, junk bond yields would have to be double current levels to be aligned with “fair value” as imputed by the current state of the corporate balance sheet, however with the ECB purchasing billions in corporate bonds every month, this clearly won’t happen for a long time.

Edwards also show a chart revealing why the US is unique among the major developed regions: only there has corporate debt bloated to levels last seen during the great financial crisis. As for the reason, we just discussed it earlier: all bond issuance has been used to fund stock buybacks, pushing the S&P to all time highs.

And speaking of the final frontier, i.e. equities, which are always the last to get any memo, Edwards’s biggest concern is the sheer euphoria and that various sentiment indices – such as the record expectations of higher market moves 12 months forward as per UMich – have reached extremes of bullishness which have rarely been seen. One among these is the Investor Intelligence Sentiment Survey.

CNBC reports that “the roaring stock market has professional investors riding high, so much so that it’s rekindling memories of the 1987 crash. In terms of sentiment, the difference between bulls and bears hasn’t been this high in 30 years, according to the latest Investors Intelligence reading… Investor Intelligence editor John Gray noted, sentiment readings have roughly followed their 1987 pattern. Then the bulls  peaked (near 65%) with initial market highs early that year and they returned to above 60% levels months later after more index records. In 1987 stocks crashed a few months after that. A repeat of that scenario suggests potential significant danger for over the remainder of 2017!” – see see chart below. Strangely we only recently compared the current conjuncture with 1987 in terms of valuation excess combined with extreme macro and market bullishness .?

Between the recent reality check for junk bonds, and the sudden decline in equities, Edwards believes that “comparisons with October 1987 are entirely justified.” Still, there have been so many headfakes in the past 9 years, could this be just the latest one? Here are Edwards’ 2 cents on how to decide:

“the market itself can signal a top. For example, I remember in early 2000 our then Japan Strategist, Peter Tasker, warning that the tech heavy Jasdaq index had turned down sharply ahead of the Nasdaq March 2000 peak. I also remember our technical analyst pointing out the significance of the Nasdaq Composite failing to follow the lead of the Nasdaq 10 to make a new high at the end of March 2000. These proved to be early warning signs of the subsequent September peak in the S&P. In short, the 2000 bear market was clearly flagged if you knew how to read the technical and macro runes. The same was true in 2007. Is the market?s current behaviour already ringing a bell to warn investors intoxicated by risk appetite that the party is over and it is time to head to the exits before the stampede starts?”

Not to put too fine a point on it, Albert, but everyone would like to know the answer.

http://WarMachines.com

Gartman: “The Bear Market Is Upon Us We Fear “

With the BTFD algos showing some uncharacteristic hesitancy this morning, Dennis Gartman’s overnight commentary may provide just the catalyst they need to do their sworn duty and ramp stocks into the green within minutes of the cash open for one simple reason: Gartman fears a bear market of “some serious vintage” is now be upon us.

As excerpted from his latest overnight letter to clients:

STOCK PRICES ARE UNIVERSALLY WEAKER THIS MORNING as all ten of the markets comprising our International Index have fallen and as two of the ten… the markets in Japan and in Brazil… have fallen by more than 1% with the former down 1.5% as we write and as we finish TGL and with the latter down a truly material 2.3%. In the end, our Index has fallen 86 “points” or 0.7% and is down 175 “points” from its all-time high of 12,012 on Thursday of last  week, or 1.4% below that high. 

 

We note the “universal” nature of the weakness for having all ten markets moving in the same direction is indeed quite rare and historically this occurs at major turning points; that is, the lows were made back in the spring of ’09 amidst panic, final liquidation of stocks when we had one or two days of universal weakness followed by a day or two of universal strength. That was a major turning point, obviously. Further, the interim lows made in January of this past year were accompanied by one day of “universal” movement, and there are other examples that we can recall when prices moved in “universal” terms and which marked major turning points. Today’s “universal” weakness…only a week from the global market’s all-time high… is a harbinger of further material weakness we fear and sets the stage for the start of what we fear might well be a bear market of some serious vintage.

 

There is concern… very real concern… on our part that one market after another has broken its upward sloping trend line that has heretofore been very well defined. A trend line drawn across the recent lows of the Dow has been broken; a trend line drawn across the recent lows of the S&P has also; trend lines of the Russel… of the Nikkei… of the DAX… of the EUR STOXX 50… of the Tadawul in Saudi Arabia… have all been broken, and we can go of if need be but our point here is made. Something material has happened to the global equity market and only the most fervent of stock market bulls shall not recognize that fact.

 

Interestingly, this incipient stock market weakness is happening just as the world’s economies are in the best synchronous strength we’ve seen or noted in many, many years. “How,” some might ask, “can stocks fall as economic activity is strong and appears likely to continue for some while?” The answer is that all bear markets begin when economic activity is indeed at its peak just as all great bull markets begin at the depths of economic activity because as economic growth is peaking the demand on the part of plant, equipment and labor for capital draws that capital from the equity market where it has been residing for the previous several years. Equity market lows are marked precisely when economic activity is at its worst for the demand for capital on the part of plant, equipment and labor is at its worst and capital moves to the equity market instead, aided of course by the usual imposition of new capital created by the central banks.

 

We are at that former turning point; economic activity is strong and shall likely grow stronger for several months into the future. Employment rates are rising in North America, in Europe and in Asia, demanding capital while new capital projects are being planned and spending plans are being made strong. The “capital” for that labor, for those plans and for that additional labor shall migrate from the equity markets, even now at a time when the monetary authorities are either already erring toward monetary tightness or are seriously considering doing so.

 

It has always been thus and it shall always be thus. The equity market, by its very definition, anticipates the change in the economy, rising before the economy rises and falling before the economy falls. We are at the latter tipping point. It has been months in the coming, but it is here and adjustments in one’s investment policies must be made accordingly. The bear is upon is, we fear.

http://WarMachines.com

It’s A ‘Turkey’ Market

Authored by Lance Roberts via RealInvestmentAdvice.com,

With Thanksgiving week rapidly approaching, I thought it was an apropos time to discuss what I am now calling a “Turkey” market.

What’s a “Turkey” market?  Nassim Taleb summed it up well in his 2007 book “The Black Swan.”

“Consider a turkey that is fed every day. Every single feeding will firm up the bird’s belief that it is the general rule of life to be fed every day by friendly members of the human race ‘looking out for its best interests,’ as a politician would say.

 

On the afternoon of the Wednesday before Thanksgiving, something unexpected will happen to the turkey. It will incur a revision of belief.”

Such is the market we live in currently.

In a market that is excessively bullish and overly complacent, investors are “willfully blind” to the relevant “risks” of excessive equity exposure. The level of bullishness, by many measures, is extremely optimistic, as this chart from Tiho Krkan (@Tihobrkan) shows.

Not surprisingly, that extreme level of bullishness has led to some of the lowest levels of volatility and cash allocations in market history.

Of course, you can’t have a “Turkey” market unless you are being lulled into it with a supporting story that fits the overall narrative. The story of “it’s an earnings-driven market” is one such narrative. As noted  by my friend Doug Kass:

“Earnings are there to support the market. If we didn’t have earnings to support the market, that would be worrying. But we have earnings.”
Mary Ann Bartels, Merrill Lynch Wealth Management

 

“Earnings are doing remarkably well.”
Ed Yardeni, Yardeni Research

 

“This is very much an earnings-driven market.”
Paul Springmeyer, U.S. Bancorp Private Wealth Management

 

This is very much earnings-driven.”
Michael Shaoul, Marketfield Asset Management

 

“Equities have largely been driven by global liquidity, but they are now being driven by earnings.”
Kevin Boscher, Brooks Macdonald International

 

“Most of the market action in 2017 has been earning-driven.”
Dan Chung, Alger Management

 

“The action is justified because of earnings.
James Liu, Clearnomics

 

In another case of “Group Stink” and contrary to the pablum we hear from many of the business media’s talking heads, the U.S. stock market has not been an earnings-driven story in 2017. (I have included seven “earnings-driven” quotes above from recent interviews on CNBC, but there are literally hundreds of these interviews, all saying the same thing)

 

Rather, it has been a valuation-driven story, just as it was in 2016 when S&P 500 profits were up 5% and the S&P Index rose by about 11%. And going back even further, since 2012 S&P earnings have risen by 30% compared to an 80% rise in the price of the S&P lndex!

He is absolutely right, of course, as I examined in the drivers of the market rally three weeks ago.

“The chart below expands that analysis to include four measures combined: Economic growth, Top-line Sales Growth, Reported Earnings, and Corporate Profits After Tax. While quarterly data is not yet available for the 3rd quarter, officially, what is shown is the market has grown substantially faster than all other measures. Since 2014, the economy has only grown by a little less than 9%, top-line revenues by just 3% along with corporate profits after tax, and reported earnings by just 2%. All of that while asset prices have grown by 29% through Q2.” 

The hallmark of a “Turkey” market really comes down to the detachment of price from valuation and the deviation of price from long-term norms. Both of these detachments are shown in the charts below.

CAPE-5 is a modified version of Dr. Robert Shiller’s smoothed 10-year average. By using a 5-year average of CAPE (Cyclically Adjusted Price Earnings) ratio, it becomes more sensitive to market movements. Historically, deviations above 40% have preceded secular bear markets, while deviations exceeding -40% preceded secular bull markets.

The next chart shows the deviation of the real, inflation-adjusted S&P 500 index from the 6-year (72-month) moving average.

Not surprisingly, when the price of the index has deviated significantly from the underlying long-term moving averages, corrections and bear markets have not been too distant.

Combining the above measures (volatility, valuation, and deviation) together shows this a bit more clearly. The chart shows both 2 and 3-standard deviations above the 6-year moving average. The red circles denote periods where valuations, complacency and 3-standard deviation moves have converged. 

Of course, with cash balances low, you can’t foster that kind of extension without sufficiently increasing leverage in the overall system. The expansion of margin debt is a good proxy for the “fuel” driving the bull market advance.

Naturally, as long as that “fuel” isn’t ignited, leverage can remain supportive of the market’s advance. However, when the reversion begins, the “fuel” that drove stocks higher will “explode” when selling forces liquidation through margin calls.

While the media continues to suggest the markets are free from risk, and investors should go ahead and “stick-their-necks-out,” history shows that periods of low volatility, high valuations and deviations from long-term means has resulted in very poor outcomes.

Lastly, there has been a lot of talk about how markets have entered into a new “secular bull market” period. As I have addressed previously, I am not sure such is the case. Given the debt, demographic and deflationary backdrop, combined with the massive monetary interventions of global Central Banks, it is entirely conceivable the current advance remains part of the secular bear market that began at the turn of the century.

Only time will tell.

Regardless, whether this is a bull market rally in an ongoing bear market, OR a bull rally in a new bull market, whenever the RSI (relative strength index) on a 3-year basis has risen above 70 it has usually marked the end of the current advance. Currently, at 84, there is little doubt the market has gotten ahead of itself.

No matter how you look at it, the risk to forward returns greatly outweighs the reward presently available.

Importantly, this doesn’t mean that you should “sell everything” and go hide in cash, but it does mean that being aggressively exposed to the financial markets is no longer opportune.

What is clear is that this is no longer a “bull market.”

It has clearly become a “Turkey” market. Unfortunately, like Turkeys, we really have no clue where we are on the current calendar. We only know that today is much like yesterday, and the “bliss” of calm and stable markets have lulled us into extreme complacency.

You can try and fool yourself that weak earnings growth, low interest rates and high-valuations are somehow are justified. The reality is, like Turkeys, we will ultimately be sadly mistaken and learn a costly lesson.

“Price is what you pay, Value is what you get.” – Warren Buffett

http://WarMachines.com

Goldman’s Top Strategist Reveals The Two Biggest Risks To The Market Today

The past few months have been a very nervous time at Goldman Sachs, and not just because Gary Cohn wasn’t picked to replace Janet Yellen as next Fed chair.

Back in September, Goldman strategist Peter Oppenheimer wrote that the bank’s Bear Market Risk Indicator had recently shot up to 67%, prompting Goldman to ask, rhetorically, “should we be worried now?” The simple answer, as shown in the chart below, is a resounding yes because the last two times Goldman’s bear market risk indicator was here, was just before the dot com bubble and just before the global financial crisis of 2008.

 

One month later, and a decade after Black Monday, it was Goldman’s clients’ turn to be nervous. As chief equity strategist David Kostin  wrote in his Weekly Kickstart report, “In the ninth year of economic expansion, with S&P 500 up 15% YTD, the most common question from clients is, “When will the rally end?” He was referring to the chart below which he prefaced thus:

Thursday marked the 30-year anniversary of Black Monday. On October 19, 1987, the S&P 500 plunged by 22%, its worst single-day return on record. Following the decline in global equity markets, it took the S&P 500 a full year (October 20, 1988) to regain its pre-crash level. This week also marked 20 months since the last 10% S&P 500 correction and 16 months since the last 5% drawdown. This ranks as the fourth longest streak in history (behind 17-19 months in 1965, 1994, and 1996) and at 332 trading days is well above the historical average of 92 days. In the ninth year of economic expansion, with S&P 500 up 15% YTD, the most common question from clients is, “When will the rally end?”

Fast forward to today, when Goldman has dedicated its entire Top of Mind periodical by Allison Nathan to just one question: “how late are we in the business cycle”, and when does it end.  As Nathan writes, “more than eight years into the US economic expansion, there are few signs that it will end anytime soon. But with US equity indices at record-highs, 10-year Treasury yields only moderately off their lows, and valuations for both looking stretched, whether “no recession” also means “no correction” is Top of Mind.” To answer the question, she polls the opinions of Omega Advisors Vice Chairman Steve Einhorn, Sam Zell, and various of Goldman’s own strategists.

All agree that recession risk is low today and unlikely to move substantially higher before late 2019 or 2020. But they disagree on the amount of market risk today—and what to do about it.

As for Goldman’s own view, which we discussed last week in why “Goldman’s Clients Are Becoming Increasingly Schizophrenic“, the taxpayer-backed hedge fund advises clients “to stay invested rather than try to time the next equity downturn,” even though as Goldman itself admits, valuations have never been higher and the Fed’s tightening process introduces a major risk factor to the complacency of the status quo. 

And while there are several truly informative interviews in the report, the one we found most striking was that with Goldman’s Charlie Himmelberg, whose official title is Co-Chief Markets Economist at Goldman Sachs and, due to his focus on credit instead of equity, is widely seen as Goldman’s top strategist. Among the topics he covers are the following:

  • Where are we in the US business cycle today
  • Can the bull market can continue
  • Is the business cycle and the market cycle the same thing
  • Where are the vulnerabilities today
  • Do stretched valuations necessarily imply that we are heading towards a market correction
  • Would a major correction would play out differently in this cycle than in the last one
  • What should investors own today

But the most interesting discussion was what Himmelberg believes are the biggest risks to the market today. His answer is below:

Allison Nathan: So what do you see as the biggest risks to the market today?

 

I would focus on two. One is the withdrawal of quantitative easing (QE). In principle, it should be a non-issue. But I see good reasons to be worried, which are rooted in the psychology of markets. From my recent discussions  with investor clients in both Europe and the US, it’s clear that most market participants give QE a lot of credit for the current level of bond and equity valuations. Unless that QE narrative can be replaced with something else, I see a risk that withdrawing QE will significantly reduce investors’ willingness to own the market. So far, the Fed has deftly managed the unwinding of QE, with no major market impact. But other QE programs around the world have to unwind at some point. So I do think there is quite a bit of risk—not in the year ahead but over the next several years—that markets will struggle to reconcile stretched valuations with reduced support from central banks.

 

The other risk I worry about is the possibility of a downturn in corporate profitability despite the continued economic expansion. That’s actually a fairly typical late-cycle pattern. Profit margins tend to fall much sooner than GDP growth, partly because the labor market puts pressure on wages at a time when companies don’t have as much pricing power, and have already exhausted the productivity gains from redeploying spare capacity. Given that we expect the unemployment rate to fall to 3.8%—with risks skewed to the downside—I think the pace of wage growth only picks up  speed from here. And it isn’t obvious to me that companies can offset that. In addition to the usual competitive considerations, price inflation has been weak, and—again—stable inflation expectations have likely weighed on pricing power. So I have much higher conviction in wage inflation gaining traction in a tight labor market than in price inflation picking up in a world with such well-anchored expectations. So unless you’re quite optimistic about productivity gains to offset that wage growth, it’s hard to feel optimistic about the risks to profit margins over the next year.

 

Allison Nathan: These both look like longer-run risks to watch. What are you worried about nearer-term?

 

Charlie Himmelberg: If you told me six months from now that the market had sold off by 15%, I would say it was probably due to a shift in market psychology (like an over-reaction to the failure of tax reform or the end of QE) or some sort of marketglitch (like the 1987 crash). Market structure is very different today given the changes to broker-dealer balance sheet capacity since the financial crisis. We’ve also seen a growing allocation of retail and institutional money into “premium chasing” quant strategies, including, for example, ETFs that sell equity vol. I think many of these developments are positive, but the associated market structure remains largely untested. So I would not rule out the risk of a glitch that triggers, say, a 5-10% correction.

Want more? Below we excerpt the full interview with Charlie Himmelberg, Co-Chief Markets Economist at Goldman Sachs.

Allison Nathan: Where are we in the US business cycle today?

 

Charlie Himmelberg: There are many ways to date an economic expansion. Chronologically, the US economy is clearly late in the cycle. But when it comes to identifying the types of imbalances that could signal the end of the  expansion, we seem to be coming up short. The labor market has arguably tightened beyond the level of full employment, but imbalances there still seem mild. And it’s hard to pinpoint any areas of excessive or unsustainable credit growth like what we saw in the last cycle. The household sector has actually been deleveraging in this expansion. Given that we’re in such a low-rate environment, this means that the debt burden on households is remarkably low today. In the corporate sector, while there has been significant re-leveraging, companies have been able to finance themselves at extremely low rates, and lock in those rates at long maturities. So even though we should be mindful of today’s high corporate leverage ratios, it’s hard to see how a slowdown in corporate credit creation would bring an end to this expansion, either. Finally, any fiscal headwinds that we might expect from deleveraging in the public sector are probably more behind us than they are ahead of us, especially if tax reform provides some tailwinds. This lack of imbalances suggests to me that the expansion has more room to run.

 

That said, what may be even more important to the longevity of the current cycle—and may not be as appreciated by investors—is the extent to which inflation expectations are anchored. This significantly reduces the risk that Fed actions pose to the expansion. More often than not, at least in postwar history, recessions were preceded by monetary tightening. That’s arguably because central banks did not always have the luxury of well-anchored inflation expectations. If you think back to the Volcker era, for example, central banks weren’t just fighting cyclical inflation; they were fighting the movement of inflation expectations. And once those inflation expectations get built up, it typically takes a tremendous amount of economic pain to bring them back down. As a result, policymakers have historically been inclined to hike out of the mere fear of inflation, which raises the risk of stopping an expansion prematurely.

 

But today, well-anchored inflation expectations allow the Fed to move gradually and test whether we are actually at an inflationary point of capacity utilization. We may be forecasting more Fed hikes than the market is pricing, but we expect them to happen at roughly half the pace of past hiking cycles. It therefore seems much less likely this time around that the Fed will precipitate a recession.

 

Allison Nathan: Does that imply that the bull market can continue? Should we think about the business cycle and the market cycle as one and the same?

 

Charlie Himmelberg: Not quite. There has been a pretty close correlation over the last 50-60 years between the stock market and the real economy. The stock market tends to lead the business cycle by about eight months on average. But at the same time, asset markets experience a lot of volatility that doesn’t always signal an impending economic slowdown. As the economist Paul Samuelson liked to say, the stock market has forecasted “nine of the last five recessions.” My view is that the conditions today are actually pretty ripe for a market correction, but not a recession. Again, it’s very hard to tell a story where the real economy rolls over. It’s easier to tell a story where the market cracks on some other catalyst. 

 

Allison Nathan: Where do you see vulnerabilities today?

 

Charlie Himmelberg: Equity and bond market valuations look extreme by any metric. While there are some good fundamental reasons for that, it’s hard not to worry that the risk premium in risky assets has fallen to unsustainable levels.

 

Allison Nathan: But on the equity side, aren’t valuations justified by low interest rates?

 

Charlie Himmelberg: That is a common refrain, but the devil is in the details. Much of the decline in long-term rates is due to factors that have nothing to do with how one should value future dividends for equities. I would argue that the single biggest reason for the decline in ten-year bond yields over the last 30 years is the decline in inflation. Since the early 1980s, estimates of the term premium have declined roughly five percentage points, which is tied not only to the lower levels of inflation, but also to the lower risk of inflation. In theory, these factors should play no role in the discounting of dividends for equities. Adjusted for these factors, rates have not declined by nearly as much as ten-year bond yields. That means that the equity risk premium has not fallen nearly as much as the decline in 10-year yields would seem to imply. So in my view, the equity market can’t use the decline in bond yields as justification for current valuations; valuations are just high.

 

Allison Nathan: Do stretched valuations necessarily imply that we are heading towards a market correction?

 

Charlie Himmelberg: No. That’s the tricky part—the pain trade, so to speak. If you look historically at the effects of high valuations on tactical returns, say, one or two years ahead, it’s surprisingly difficult to get bearish readings off of valuations. Now, over a longer horizon, the current level of equity valuations does imply very low expected returns. In fact, by my estimates, they imply expected returns on the order of zero over the next five years. That is obviously far below historical averages, suggesting that at some point in the next five years, we are indeed going to see some kind of correction. But how much edge do valuations give you in predicting the timing of that correction? Statistically, the answer is disappointingly little.

 

Allison Nathan: So what do you see as the biggest risks to the market today?

 

Charlie Himmelberg: I would focus on two. One is the withdrawal of quantitative easing (QE). In principle, it should be a non-issue. But I see good reasons to be worried, which are rooted in the psychology of markets. From my recent discussions with investor clients in both Europe and the US, it’s clear that most market participants give QE a lot of credit for the current level of bond and equity valuations. Unless that QE narrative can be replaced with something else, I see a risk that withdrawing QE will significantly reduce investors’ willingness to own the market. So far, the Fed has deftly managed the unwinding of QE, with no major market impact. But other QE programs around the world have to unwind at some point. So I do think there is quite a bit of risk—not in the year ahead but over the next several years—that markets will struggle to reconcile stretched valuations with reduced support from central banks.

 

The other risk I worry about is the possibility of a downturn in corporate profitability despite the continued economic expansion. That’s actually a fairly typical late-cycle pattern. Profit margins tend to fall much sooner than GDP growth, partly because the labor market puts pressure on wages at a time when companies don’t have as much pricing power, and have already exhausted the productivity gains from redeploying spare capacity. Given that we expect the unemployment rate to fall to 3.8%—with risks skewed to the downside—I think the pace of wage growth only picks up speed from here. And it isn’t obvious to me that companies can offset that. In addition to the usual competitive considerations, price inflation has been weak, and—again—stable inflation expectations have likely weighed on pricing power. So I have much higher conviction in wage inflation gaining traction in a tight labor market than in price inflation picking up in a world with such well-anchored expectations. So unless you’re quite optimistic about productivity gains to offset that wage growth, it’s hard to feel optimistic about the risks to profit margins over the next year.

 

Allison Nathan: These both look like longer-run risks to watch. What are you worried about nearer-term?

 

Charlie Himmelberg: If you told me six months from now that the market had sold off by 15%, I would say it was probably due to a shift in market psychology (like an over-reaction to the failure of tax reform or the end of QE) or some sort of market glitch (like the 1987 crash). Market structure is very different today given the changes to broker-dealer balance sheet capacity since the financial crisis. We’ve also seen a growing allocation of retail and institutional money into “premium chasing” quant strategies, including, for example, ETFs that sell equity vol. I think many of these developments are positive, but the associated market structure remains largely untested. So I would not rule out the risk of a glitch that triggers, say, a 5-10% correction.

 

Allison Nathan: Do you think a major correction would play out differently in this cycle than in the last one?

 

Charlie Himmelberg: Yes, because the search for yield in the current cycle has evolved differently. In the run-up to the last crisis, the search for yield went off the tracks by applying high leverage to structures that featured some pretty dramatic mismatches between maturity and liquidity. When that came apart, it resulted in forced liquidations and a downward spiral in prices. In the current expansion, the search for yield has probably been at least as intense, but I think the lessons learned in the crisis have discouraged a repeat of these mistakes. Instead, I think illiquidity is the new leverage. With so much competition for assets at increasingly high prices, many investors—especially long-duration investors like insurers and pensions—seem to be putting as much of their portfolio as possible into illiquid assets. That includes private equity, private debt, direct lending, and commercial real estate (CRE), among others. You can see this shift in the differential between the rate of return on CRE and real yields on Treasuries, which is closing in on 30-year lows. So the premium required to sacrifice liquidity has compressed.

 

The silver lining is that not only have investors deployed far less leverage than in the last cycle; in many cases, they’re also sitting on a lot more cash. So if a market dip reaches fairly sizeable levels—say, 10% or 15%—there is money on the sidelines that could step in to seize those opportunities. So there is limited leverage to fuel a fire, and maybe even a little water to help douse the flames.

 

Allison Nathan: Given everything we have discussed, what should investors own today?

 

Charlie Himmelberg: Investors will have to strike a difficult balance. On the one hand, this recovery can probably power through 2018 and even a couple of years beyond that. Even if investors knew with perfect foresight that a recession would start in two years’ time, history suggests they would want to stay fully invested; the year prior to a recession has historically been the best year to own equities, and it has not made sense to rotate out of them until the recession was practically upon us. That said, it’s hard not to want to be defensive, given where current valuations are.

 

I would describe my own view as “reluctantly bullish,” which in practice means I’m bullish on economic growth, but cautious on valuations. So, for example, if you want to own equities today, I think you want to own “growth betas,” like global industrials. I think it also means you want to own emerging market equities, many of which are further behind in the cycle, and companies in developed markets that can keep up rapid sales growth. I also think that 10-year Treasury yields in the mid-2% range are not as over-valued as many assume, since growth risks skew toward recession beyond the next one to two years. If we do find ourselves in a recession, markets will know that policy rates are going back to zero, in which case duration should provide a valuable hedge to risk portfolios.

Finally, here is a chart from Goldman that puts over 160 years of the US business cycle, including booms and busts in context:

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This Is Where The CME Would Halt The Bitcoin Plunge

If Bitcoin futures were trading, they would have just triggered the first circuit-breaker at a 7% plunge threshold…

As we detailed previously, having taken a gamble on bitcoin futures, which are set to begin trading by the end of the year, the CME is now seeking to avoid the consequences of what has emerged as both the cryptocurrency's best and worst selling point: its unprecedented volatility. To do that, the Chicago-based exchange will do what it does to virtually every other asset class traded under its roof, and impose limits on how much prices of bitcoin futures can fluctuate within a day.

While the CME already uses daily vol limits on most other markets, including crude, gold and market futures, to temporarily halt trading when price swings get out of control, the CME has never before dealt with something like bitcoin, which in addition to being the world's best performing asset classes in recent years, is also its most volatile. And, as the WSJ adds, it is also unclear how much impact CME’s limits will have on bitcoin, since its futures market has yet to emerge and most trading in the digital currency is on exchanges outside of CME’s control.

In any case, based on the CME's preliminary term sheet, bitcoin trading limits would kick in when the price of its bitcoin futures move 7%, 13% or 20% up or down from the previous day’s closing price. The first two thresholds, for 7% and 13% moves, are “soft” limits, which would trigger a two-minute pause in trading of bitcoin futures. The 20% limit would be a “hard” stop on how far CME’s bitcoin futures could swing on any day.

By comparison, the CME has similar staggered volatility control on its popular E-mini S&P 500 futures contract, which also has three successive price-fluctuation limits at 7%, 13% and 20% during regular trading hours. A nighttime limit of 5% was hit in the S&P 500 futures on Nov. 8, 2016, when news of Donald Trump’s upset win in the U.S. presidential election triggered wild volatility in stock-market futures, only for the S&P to surge 21% in the 12 months since.

Of course, bitcoin will be a far "wilder" and more volatile instrument than the S&P 500 (one hopes). According to Coindesk calculations, so far in 2017 there have been two days in which bitcoin’s price swung more than 20% in a single day. There were 11 days in which it moved at least 13%, and 69 in which it moved at least 7%.

The full bitcoin contract specsheet is below.

*  *  *

For now Bitcoin is down 18% from its record high – closing in on a bear market…

 

http://WarMachines.com

Could A Commodity Rally Help Spark Silver?

 

Could A Commodity Rally Help Spark Silver?

Written by Craig Hemke, Sprott Money News and TF Metals Report 

Could A Commodity Rally Help Spark Silver? - Craig Hemke

 

While it is widely believed that commodities are one of the few “undervalued” sectors, sustained rallies have been hard to find over the past few years. Could all that be finally beginning to change?

 

The key to any commodity rally is weakness in the US dollar. Most commodities trade in dollar terms so a rising dollar generally puts pressure on the sector. In contrast, a falling dollar is usually good for the sector. As you can see in the chart below, the general trend since 2015 has been a flat to falling US dollar as measures by the Dollar Index:

 

 

It could be argued that the two most globally-important commodities are copper and crude oil. Let’s start with copper where, for the past year or so, we’ve been following a growing bottom and breakout on the chart. Does this look to you like a bear market or a reversal and switch to a new bull market, instead?

 

 

And now look at WTI crude oil. Note the similar chart pattern to copper. Could a move into the $60s be construed as a breakout and renewed bull market after a three-year bottoming process?

 

 

With dynamic rallies already underway in other commodities such as zinc and palladium, the question becomes…Are we in the early stages of a renewed bull market for commodities, in general? On the chart below of the the Continuous Commodity Index, you can see the possible beginnings of a turnaround.

 

 

What might this mean for silver which, despite its long history as a monetary metal, is now currently perceived primarily as an industrial metal and considered a “commodity”? If we view Comex silver through the same five-year lens, we note a reverse head-and-shoulder bottom, similar to those seen on the charts of copper and crude. However, we also note that unlike copper and crude, silver has yet to begin a rally of any consequence.

 

 

What to make of all this? Actually, it seems rather simple. Should the commodity rally continue, it will begin to take on a life of its own, with global money managers and asset allocators recognizing the new bull market and creating a virtuous cycle of higher prices through their inflows of cash to the “undervalued” sector. In this case, copper will move higher and toward $4.00 while crude oil breaks through $60 and heads toward $80.

 

If this happens, we could imply a price of silver that easily reaches the mid-to-upper $20s sometime in 2018. Is this possible or would/will The Banks be able to keep their collective thumbs on the price? Your answer to that question will depend upon the size and scale of the cash flow into the sector.

 

So again, it may be rather simple. Resolution of this will be a function of the dollar, copper and crude. Forecast those three for 2018 and you’ll likely be able to correctly forecast the price of silver, too.

 

Questions or comments about this article? Leave your thoughts HERE.

 

 

 

Could A Commodity Rally Help Spark Silver?

Written by Craig Hemke, Sprott Money News and TF Metals Report

http://WarMachines.com

“We Have Been Wrong… Badly”: Gartman Covers Short, Expects “Violent, Panic Rush Skyward” In Stocks

Back in January 2016, Dennis Gartman said that oil would “not hit $44 during my lifetime.”

 

Then, just a few months after oil jumped above $44, yet failed to kill the “world renowned” commodity guru, Gartman made another bold prediction: “oil is not going above $55 for years.” Predictably, just over a year later, oil hit $57, the highest price in two and a half years.

Fast forward to today when we have some bad news for equity bulls and some good news for bond bulls.

First, Gartman unveiled that he is shorting bonds, whose “bull 35 year market ended last autumn”:

NEW RECOMMENDATION: The 35 year bull market in bonds ended in the autumn of last year when the bond future traded to $175; it is now $155 and although we might have missed the first year of the new bear market we are  still very early. Nonetheless, after 7 days in a row to the upside, the bond future is moving back into “The Box” marking the 50-62% retracement of the break that bean when the bond future peaked recently at $158 3/8’s and fell to $150 ½. If the nearby bond future is able to trade to $154 ½ today we’ll sell it there… one unit being sufficient. We’ll have stops in tomorrow’s TGL if the trade is effected later today.

Second, the frequent Fast Money guest announced with great fanfare that he is closing his equity short, in anticipation of a “violent, manic” surge higher in the market:

We have been wrong… badly… in taking even a modestly bearish view of the global equity market and effecting that bearish view via a position in out-of-the-money puts on the US equity market bought a week and one half ago. Fortunately we effected that bearish view with puts rather than with direct short positions in equites and/or via short position in the futures themselves, so the damage wrought has been minor. But the real damage is that we are not long of equities as obviously we should have been. Our position has to be covered and covered it shall be, for we fear that we are about to enter that violent… and ending… rush to the upside that has ended so many great bull markets of the past. At this point, the buying becomes manic and prices head skyward. Speculation is the order of the day, not investment and when such periods have erupted in the past prices have gone parabolic until such time as the last bears have been brought to heel and the public has thrown investment caution to the wind. We’re there now; this may become wild.

And so the slam dunk pair trade has been set. Trade accordingly.

http://WarMachines.com

Stock and Awe, Bears in Bondage

The following article by David Haggith was published on The Great Recession Blog:

Is the US stock market going to crash in 2017? [By Philip Timms [Public domain], via Wikimedia Commons]

The Trump Rally pushed ahead relentlessly through a summer full of high omens and great disasters, all which it swatted off like flies. Even so, all was not perfect in the market as nerves began to jitter midsummer beneath the surface even among the most longtime bulls. Wall Street’s fear gauge (the CBOE Volatility Index) lifted its needle off its lower post to a nine-month high after President Trump’s comments about “fire and fury” if North Korea didn’t toe the line. (Mind you, the high wasn’t very far off the post because of how placid the previous nine months had been.)

As volatility stirred languidly over the threat of nuclear war, stock prices took a little spill with all major stock indices seeing their biggest one-day drop since May. The SPX fall amounted to a 1.4% drop in a day — nothing damaging. The Dow dropped about 1% in a day. But beneath the surface, the market is looking different and shakier.

For example, trading narrowed to fewer players as more stocks in the Nasdaq 100 finally moved below their fifty-two week lows than moved above them. Likewise in the S&P. This phenomenon is known as the “Hindenburg omen,” and tends to precede major crashes.

 

 

It’s a serious signal that highlights times of decoupling within an index or an exchange. The S&P hasn’t suffered five signals so tightly clustered since 2007 and 2000…. This year the pattern has been popping up more often in all four indexes … 74 omens so far in 2017, second only to 78 recorded in November 2007…. That they are manifesting in several indexes and forming so frequently are good reasons to brace for weakness. (MarketWatch)

 

Long credit cycles like the current one always end with a crash. But first they deteriorate. The headline numbers remain positive while under the surface a growing list of sectors start to falter. It’s only when the latter reach a critical mass that market psychology turns dark. How far along is this process today? Pretty far, it seems, as some high-profile industries roll over: ‘Deep’ Subprime Car Loans Hit Crisis-Era Milestone…. Used Car Prices Crash To Lowest Level Since 2009 Amid Glut Of Off-Lease Supply…. Junk Bonds Slump…. The worst is yet to come for retail stocks, says former department store executive Jan Kniffen…. U.S. Stock Buybacks Are Plunging…. “Perhaps over-leveraged U.S. companies have finally reached a limit on being able to borrow simply to support their own shares.” (–John Rubino, The Daily Coin)

 

The fact is that the market is breaking down beneath the shrinking number of Big Cap stocks and levitating averages. This has all set-up a severe downside shock within the coming weeks. As to the market’s weakening internals, consider that there are 2,800 stocks on the New York Stock Exchange (NYSE). Back in early 2013 when the bull market was still being super-charged with massive QE purchases by the Federal Reserve, 85% or 2,380 of them were above their 200-DMA. By contrast, currently only 1,050 of them (37.5%) are above that level, meaning that the bull is getting very tired. (–David Stockman, The Daily Reckoning)

 

 

Trading shifted this summer from the major players (often called the “smart money”) buying to smaller buyers trying to jump in, which is also the typical final scenario before a crash where the smart money escapes by finding chumps who fear missing some of the big rush that has been happening. And buybacks seem to be slumping as corporations hope for a new source of cash from Trump’s corporate tax breaks.

In spite of those underlying signs of stress, the market easily relaxed back into its former stupor, with the fear gauge quickly recalibrating, from that point on, to absorb threats and disasters with scarcely a blip as the new norm. The market now yawns at nuclear war, hurricanes and wildfires, having established a whole new threshold of incredulity or apathy, so the fear gauge stirs no more.

With the New York Stock Exchange eclipsed by the larger number of shares that now exchange hands inside “dark pools” — private stock markets housed inside some of Wall Street’s biggest casinos (banks) where the biggest players trade large blocks of stocks in secret during overnight hours —  the average guy won’t see the next crash when it begins to happen. He’ll just awaken to find out it has happened … just like much of the nation woke one Monday to find out that northern California had gone up in flames over the weekend.

 

Bulls starting to sound bearish

 

While concern over these national catastrophes never came close to letting the bears out of their cages, it did change the dialogue at the top as if something was beginning to smell … well … a little dead under the covers. Perhaps these slight and temporary tremors in the market are all the warning we can expect in a market that is now almost entirely run by robots and inflated by central bank largesse.

While the bearish voices quoted above can be counted on to sound bearish, many of the big and normally bullish investors and advisors became more bearish in tone as summer rolled into fall. For the first time in years, Pimco expressed worries about top-heavy asset valuations, particularly in stocks and junk bonds, advising its clients in August to trim risk from their portfolios. Pimco argued that that the new central bank move toward reversing QE could leave equities high and dry as the long high tide of liquidity slowly ebbs. Pimco’s former CEO said much the same:

 

Bill Gross … perhaps the preimminent bond market analysts/ trader/ investor of the age… has gone on record as stating only just recently that the risks of equity ownership are as high as they were in ’08, and that at this point when buying weakness “instead of buying low and selling high, you’re buying high and crossing your fingers.” (Zero Hedge)

 

Goldman Sachs even took the rare position that the stock market had a 99% chance that it would not continue to rise in the near future, and places the likelihood of a bear market by year’ send at 67%, prompting them to ask “”should we be worried now?” The last two times Goldman’s bear market indicator was this high were right before the dot-com crash and right before the Great Recession. In fact, there has only been one time since 1960 when it has been this high without a bear market following within 2-3 months. Of course, everything is different under central-bank rigging, but some central banks are promising to start pulling the rug out from under the market in synchronous fashion, starting last month. (Though, as of the Fed’s own latest balance sheet shows, they have failed to deliver on their promise, cutting only half as much by the close of October as they said they would.)

Morgan Stanley’s former chief economist said at the start of fall that the combination of high valuations and rising interest rates is about to reck havoc in the market. He claimed the Fed’s commitment to normalization should have come much earlier, as the market now looks as frothy as it did just before the Great Recession.

Citi now calculates the odds of a major market correction before the end of the year at 45% likelihood. Even Well’s Fargo now predicts a market drop of up to 8% by year’s end.

Speaking of big banks, their stocks look particularly risky. Two years ago, Dick Bove was advising investors to buy major banks stocks aggressively. Now, he’s taken a strikingly bearish tone on the banks:

 

A highly-respected banking stock guru warns that financial storm clouds loom for Wall Street’s bull rally. The Vertical Group’s Richard Bove “warns that the overall market is just as dangerous as the late 1990s, and he cites momentum — not fundamentals — as what’s driving bank stocks to all-time highs,” CNBC.com explains. “If we don’t get some event in the economy or in politics or in somewhere that is going to create more loan volume and better margins for the banks, then yes, they would come crashing down,” Bove told CNBC. “I think that the risk in these stocks is very high at the present time,” he said. (NewsMax)

 

It’s a taxing wait for the market

 

These are all major institutions and people who are normally quite bullish. Some of the tonal change is because of concern about the Fed’s Great Unwind of QE, while much is because enthusiasm over Trump’s promised tax cuts has become muted among investors deciding to wait and see, having been burned by a long and futile battle on Obamacare. In fact, the market showed more interest in Fed Chair Yellen’s suggestion of a December interest-rate hike than in Trump’s release of a tax plan.

Retiring Republican Senator Bob Corker predicts the fighting over tax reform will make the attempt to rescind Obamacare look like a cakewalk, and he intends to lead the fight as one of the swing voters to make sure it is not a cakewalk now that he and Trump are political enemies.

The Dow took a 1% drop in the summer when Bannon was terminated so that anti-establishment resellers felt they were losing the battle and when the Republican government seemed deadlocked on all tax-related issues, which it still may be.

On the bright side, with Mitch McConnel’s Luther Strange losing his senate race and Bob Corker quitting, anti-establishment forces appear to be gaining a little power. That’s, at least, something. On the other hand, Trump has just chosen an establishment man to run the Fed, and Trump, who once ridiculed Janet Yellen for propping up Obama’s economy with low interest rates, said a few days ago,

 

I also met with Janet Yellen, who I like a lot. I really like her a lot.

 

President Trump’s new Federal Reserve chair, Jerome “Jay” Powell, “a low interest-rate kind of guy,” was obviously picked because he is Janet Yellen minus testicles, the grayest of gray go-along Fed go-fers, going about his life-long errand-boy duties in the thickets of financial lawyerdom like a bustling little rodent girdling the trunks of every living shrub on behalf of the asset-stripping business that is private equity…. Powell’s contribution to the discourse of finance was his famous utterance that the lack of inflation is “kind of a mystery….” Unless you consider that all the “money” pumped out of the Fed and the world’s other central banks flows through a hose to only two destinations: the bond and stock markets, where this hot-air-like “money” inflates zeppelin-sized bubbles that have no relation to on-the-ground economies where real people have to make things and trade things…. The “narrative” is firmest before it its falseness is proved by the turn of events, and there are an awful lot of events out there waiting to present, like debutantes dressing for a winter ball. The debt ceiling… North Korea… Mueller… Hillarygate….the state pension funds….That so many agree the USA has entered a permanent plateau of exquisite prosperity is a sure sign of its imminent implosion. What could go wrong? (–James Howard Kunstler)

 

Powell doesn’t sound like a man who sees a need for change in the current Fed programming, but he is the very best Trump could think of for carrying out his desire to make America great again.

 

Bulls still climbing to dizzying heights

 

While some of the leading bulls have started sounding like bears of late, the bulls still lead the bears by more than 4:1, and investors remain in love with technology almost as much as they were before the dot-com crash. ”Still, as Sir John Templeton famously said,

 

Bull markets are born on pessimism, grow on skepticism, mature on optimism and die on euphoria.

 

We are clearly in the euphoric stage where the market just cannot stop itself from rising. It’s been a year-long euphoria now as the Trump Rally, which stalled for some time midyear, found a second wind. It is now on track to soon become the greatest rally in 85 years. You have to go back to FDR and the recovery from the Great Depression to find anything greater. No euphoria there, given that is all based on tax cuts that have as much likelihood of failing as the Obamacare repeal had.

What is peculiarly interesting at present is the euphoria over volatility itself. Look at the following two graphs: (The first indicates what is happening in terms of market volatility. The second shows where people are betting volatility will go from here.)

 

 

 

The CBOE Volatility Index dove 8% last Friday to close the week just a hair’s breadth above its lowest volatility record ever! So, at a time when volatility in the stock market is essentially as low as it has ever gone, bets that volatility will go lower have risen astronomically. Yeah, that makes sense.

Essentially, hoards of investors are so certain that volatility is down for the count that they are betting it will practically cease to exist months from now. As Mauldin Economics has argued, we are now, among all our other bubbles, in a volatility bubble.

Such low volatility when the market is priced to its peak means market investors see no risk even at such a high top and even in an environment that has been literally plagued for months by external risks from hurricanes to wildfires to endless threats of nuclear annihilation by a lunatic. That’s because all investors know the market will stay up for as long as the Federal Reserve chooses to keep propping it up. Investors must not be taking the Fed’s threat of subtracting that support seriously, or they are choosing to stay in to the last crest of the last wave and then all hoping to be the first ones out before the wave crashes. Is that rational or irrational euphoria?

This market is not just notable for how long its low-volatility euphoria has gone on but also for how low the volume of trades have been. We are almost at a point of no volatility and no volume. That means nobody is selling stocks if they don’t get a higher price, but there aren’t many buying either. The few companies whose stocks are pushing the market up are trading less and less. That trend holds in both the US and Europe. European trading volume is its lowest in five years; and in the US, it is 22% below last year and still falling. That things are so calm in the middle of global nuclear threats, devastating hurricanes and wildfires and constant political chaos on the American scene and with such a do-nothing congress strikes me as surreal.

The Wall Street Journal concludes,

 

The collapse in trading volumes is closely tied to the recent fall in volatility, where measures of daily stock price movements have plumbed multiyear lows. When markets aren’t moving, there are typically fewer people scrambling to protect their portfolios against further losses or seizing an opportunity to buy things that look cheap.” (The Wall Street Journal)

 

What does it mean; where do we go from here?

 

Even the WSJ says it isn’t sure what this low-volatility/low-volume stasis means. I have to wonder if the market will reach such a lull in volatility that everyone just sits there, looking at each other, wondering who will be the first to move again. Is that finally the moment panic breaks in? Even the Journal wonders if the eery calm means investors have simply become so bullish they refuse to sell. Or is it that everyone is already in the market who wants in at current prices now that the Fed has stopped QE and is now even reversing it. Is the lull extreme narrowing happening because there is no longer excess new money in the market to invest but no one scared enough to drop their price and sell? Is there no money that wants in at current prices and under the current knowledge that money supply will now be deflating for the first time in years?

Is this the way the unwind of QE starts to suck money back out of the market … by reducing the number of interested traders to a thin trickle while the fewer number of interested players who do have money to invest keep bidding up prices? If you’re already in this hyper-inflated market, where earnings only look good on a per-share basis because companies keep spending a fortune buying back shares, then you may see no reason to sell; but, if you’ve been sitting on the side with a pocketful of cash, it may look awfully late in the game to jump in.

(Consider also that growth in earnings throughout the first half of 2017 was easy to show because it compared to the first half of 2016, where earnings were terrible. Now the climb in earnings has to steepen in order to show growth year on year.)

So what if the tax reform that everything seems to be depending on flops? Charles Gaparino warns,

 

If tax reform bellyflops the way ObamaCare repeal did, many smart analysts are coming to the conclusion that the market will turn sour. Without tax cuts, one Wall Street executive told me, “the markets will drop like a rock….” This is a significant change in investor attitudes…. As much as stock values represent economic and corporate fundamentals, they also represent raw emotion known as the “herd mentality.” And that mentality, according to the investors I speak to, has begun to shift in recent weeks…. The market mentality that once said anything is better for the markets than Hillary is now saying to the president and Congress: Deliver on those promised tax cuts or face the consequences. And they won’t be pretty.(The New York Post)

 

Evidence of how reactive the market will be if tax cuts are less than expected came a couple of weeks ago when the Russel 2000 fell the most it has since August on news that the Republicans’ proposed corporate cuts would be phased in over a period of years. That demonstrated that the Trump Rally is mostly about the tax cuts; they are fully priced in; so, if the tax cuts fail or even get dragged out over years, the market fails.

With savings way down, personal debt extremely high, corporate debt quite high, and central banks threatening to reduce liquidity, consumption will have no means of support if asset prices also fall; so, the whole broader consumer-based economy goes back down if the stock market fails. Of course, central banks will revert to more QE if that happens; but each round of QE has been less effective dollar-for-dollar.

And where have we arrived under complete Republican leadership in the midst of all this? As the Committee for a Responsible Federal Budget stated,

 

Republicans in Congress laid out two visions in two budgets for our fiscal future, and today, they choose the path of gimmicks, debt, and absolutely zero fiscal restraint over the one of responsibility and balance. While the original House budget balanced on paper and offered some real savings, the Senate’s version accepted today by the House fails to reach balance, enacts a pathetic $1 billion in spending cuts out of a possible $47 trillion, and allows for $1.5 trillion to be added to the national debt…. The GOP is now on-the-record as supporting trillions in new debt for the sake of tax cuts over tax reform…. “Tax cuts do not pay for themselves; they can create growth, but in the amount of tenths of percentage points, not whole percentage points. And they certainly cannot fill in trillions in lost revenue. Relying on growth projections that no independent forecaster says will happen isn’t the way to do tax reform. (TalkMarkets)

 

This is progress? The Republicans are proving month after wearying month they are incapable of doing everything they have sworn for years they would do if they were in power. They could complain as an obstructionist body about the other sides, but they have no solutions they can agree on. The Republican answer in the budget and tax plan that have just come out guarantees mountains of additional debt as far as the eye can see … with the perennial promise that cuts will eventually be made in some distant future by a congress that will not in any way be beholden to the wishes and slated demands of the present congress. (Always tax cuts now, spending cuts promised to be made by other people far down the road.)

If the program passes, however, it will shore up the stock market which has been banking entirely on that possibility; but at the cost of deeper economic structural problems to be solved (as always) by others later on. If it doesn’t pass, you do the math as to what that likely means for all the underlying weaknesses presented above when huge tax breaks are already baked into stock prices.

If you want to see whether or not tax cuts have EVER created sustained economic growth, read the last article linked above, but here is a chart from that article for a quick representation of the truth:

 

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