Do You Really Think They Won’t Be Bailed Out?

DB Logo

C’mon world of finance!  Get a grip.  Lehman comparisons.  End of world talk.  It’s all so laughable.  While Deustche Bank going down in flames within weeks would certainly step up the timetable on a global depression; ask yourself.  Does that seem logical?

No, of course not.  They will be bailed out.  Just because Merkel came out and said that a direct bailout of Europe’s largest public bank is untenable, doesn’t mean it’s not going to happen.  Remember.  “When it becomes serious.  You have to lie.”  Period.  End of story.  Politics 101.

A backdoor bailout of Deustche Bank will occur.  It’s guaranteed.

Anybody remember this little document put out by the German central bank in July, just a couple of months ago?  It’s the inaugural listing by the Deutsche Bundesbank sharing their listings of investment grade bonds they purchased.  Who say’s they can not purchase junk bonds?  Equities are on the table.  When you’re pumping out that much stimulus via the ECB, it has to go into something as there simply isn’t enough supply of quality sovereign debt to purchase.

Enter the following:


The bonds of the staples of the German business world and economy are on the German central bank’s balance sheet available for lending.  Which from my last post, you know what that means.

I suspect because the issue is so white hot, front and center to the world that the Bundesbank will not directly purchase a new bond issue or equity rights offering from Deutsche Bank.  However, that doesn’t mean that the ECB can’t put together a syndicate of Deutsche Bank counterparties to their insane derivative book and insure wholesale funding for purchases of dilutive financing or share issuances to support Deutsche Bank’s capital level.

I’m sure it wouldn’t be too hard to convince JPM, Citi, Goldman, BofA, HSBC, and let’s throw in Belgium too to come up with wholesale funding in order to buy newly issued debt and shares.  It’ll be perceived as the banking world trying to maintain the safety of the entire banking system and world economy.  Really, it’s just a grab for more time to stave off the inevitable market and economic collapse.

So relax.  Deustche Bank ain’t going down yet.  Go short those Deutsche Bank credit default swaps zipping up in value currently?  Close out your put strategies.  The music will continue to play and you must get up and dance.  DANCE PUPPETS!

Financial System Liquidity–“When the Fun Stops”

At the end of my last post I stated I wanted to cover the,

…banking system and how it will exacerbate the shock to the financial system when whatever sovereign does what it’s going to do.  Specifically, I’ll expound on liquidity.  How it works and why every pro in the world already knows the danger it presents when it dries up.

For an outstanding and general explanation of liquidity within a market system, have a read of the excellent March 2015 piece, Liquidity, by Howard Marks.  He shares simple but keen insights on liquidity’s functionality across the entire financial market eco-system.  The masters always make the difficult seem simple.

The liquidity I’ll be referring to is really more akin to leverage and it’s how a significant percentage of the party is funded in the investment world between banks, asset managers, pension funds, insurance companies, corporations, hedge funds, and various other entities.

Let’s start with what I suspect to be the average opinion of how a financial layperson thinks the system works.

The financial layperson thinks the investment world takes in cash and assets from clients or customers and then redirects those resources into investments for the benefit of everyone involved.  On the surface, it is that simple.  Bank takes in customer deposit, then lends out cash at a premium.  Asset manager takes in customer investment capital, redeploys into assets with an expected ROI.

But for those in the know, there’s a much more sophisticated game played behind that simple perception.  The game of lending and insurance but under a different name called derivatives, specifically swaps and repos.  Observe how the financial world actually works, courtesy of the Office of Financial Research.

imageEven if you don’t understand all the components or every aspect of the diagram, the complexity and interconnectivity should jump right out at you.  “Securities Dealers” and “Broker-Dealers” are essentially just banks.  Major banks.  Systemically important banks.

What this diagram maps out is how the financial system constantly redeploys other people’s money (“OPM”) to eke out additional yield or lever up on a “winning” thesis.  This system diagramed above is the direct result of rocket scientists, PhDs, and all other people too smart by half taking their game to Wall St. instead of sharing their talents with the world of science.

That too is a direct result of too much money and glory heaped upon the successful investment managers in the the last four decades.  But all the low-hanging fruit has been picked and what we’re currently left with is an investment ecosystem fraught with risk, overloaded with high IQs, and very little excess returns on investment.

A very significant percentage of the asset classes flowing through the diagram up above are interest rate swaps and credit derivatives.  Major institutions think they can outsmart the sovereign entities of the world by hedging against the interest rate risk created by the central banks of the world.  So trillions of dollars are traded in interest rate swaps, which in turn can be funded via a repo transaction.  Do you see how the complexity of the financial system’s plumbing increases total system risk?

What’s a swap?  What’s a repo?  Well they don’t involve spouses or cars, sluggo.

Remember, they’re typically utilized as a hedge and very often just an outright speculation.  One of the terms I love that banking pros use in place of hedge is “immunization overlay.”  Really?  I need an immunization overlay to protect my bet on the 3 ponies in the 5th race for the trifecta.  Only bankers.  Anyways…

A swap is a “simple” transaction between two parties.  There is a multitude of various types of swap transactions but significant percentage of swaps are used for interest rate derivatives.  As an unrealistic but clean example, let’s say Entity A owns $50 million in Deutsche Bahn 5-year bonds yielding whatever and Entity B owns $50 million in floating-rate notes from the US Treasury yielding who cares.

Let’s say Entity A is worried that the Fed Funds rate will somehow affect the value of its fixed rate bond from the German Railway company, and they know Entity B has some floaters that will create a potentially more profitable use of their money in light of their thesis.  Entity B has the opposite stance and thinks volatility in Fed Funds rate will negatively affect the value of their floaters and they think a steady-eddy holding in Deustche Bahn debt in euros may be a better allocation of capital.  The two entities can simply swap the cash flows of each of the debt instruments and voila!  Asset quality is altered and risk is hedged.

Did you see how simple that was?  Reality is never that simple.

Now here’s where the game get’s even more interesting.  Entity A believes so strongly in its thesis that it thinks it can use its German Railway debt to speculate a little more.  Entity A calls up Bank X and says it has $50M in Deutsche Bahn 5-year bonds and wants some cash to speculate against US entities sensitive to movements in the Fed Funds rate.  Bank X says ok and it’ll give Entity A $45M for the DBahn bonds which Bank X will hold as collateral for 90 days.  At the end of the 90 days, Entity A has to repurchase (“repo”) the Railway bonds from Bank X at the full $50M.  That $5M difference between the cash amount and the repo amount is called the “haircut” and it’s a gigantic source of cash flows for the banking system.  Everybody wins!  Right?

Technically, this repo example is just a collateralized loan, and repo is often utilized in government securities as opposed to private sector assets.  None the less, a repurchase agreement is a repurchase agreement.

Entity A can now go short the companies sensitive to US interest rates.  Bank X gets a cool $5M for lending out other peoples’ money.  Observe a simple diagram of a repo transaction below.

imageThere’s another kicker for Bank X, as now it has those Deustche Bahn bonds on it’s balance sheet but maybe it doesn’t want them.  So Bank X finds another entity willing to take those bonds in another repo transaction but only for 60-days, so that it may use the cash generated to go speculate in some other asset class.

Let’s say instead that Bank X does nothing but holds onto the DBahn bonds as collateral.  In the event that Entity A runs into financial troubles and depending on how the contracts of the transaction were worded, then Bank X can liquidate those bonds when and where they see fit in order to be made whole if it looks like Entity A is in trouble.

These kinds of transactions are the lifeblood of the financial system.  This is how the banks, hedge funds, asset management shops, etc., find liquidity to speculate in whatever endeavor in need of cash flow.  You might know this system under another guise, shadow banking.

This is precisely how the 2008 crisis was exacerbated.  There were trillions of dollars of these sorts of transactions in the mortgage backed security (“MBS”) arena.  Unfortunately, the whole system is based on confidence.  Each of the players believe in and have confidence in the stability of the system and the valuations of the assets classes in which they are playing as well as the valuation and credit worthiness of the other players.  We all know what happens when confidence leaves the station.

The central banks of the world think they have risk managed within the financial system via their controls, regulations, and ability to manipulate the money supply as well as interest rates.  Here’s their perception of a ring-fenced system.image

But literally every pro and every central banker knows this pic to the right is a joke.  And a cruel one at that.

Everyone knows that there is literally no stability once confidence decides to jump out of a window.  When players in the financial system lose confidence in the financial system due to the sheer amount of debt in existence at the sovereign level in combination with the incompetent monetary policies already in existence, it’s going to be a fire sale.  Everything will go in the most indiscriminate manner which will only fuel the fire.  Every single banker, professional investor, PhD economist, and educated corporate executive knows this.  But you aren’t going to see reports about this on MSNBC or the front page of the Times.

Here’s the reality of the interconnectivity of risks within the financial system.  The risks are shared throughout the system.

It’s one giant, incestuous orgy to share cash flows and risks and it can’t be stopped.  The only way this game stops is via a crash and a reset of the financial system.  New laws.  New regulations.  New players.

The rules change but the game is the same.  Why do you think all these quotes stand the test of time?

Securitization was dreamed up as an innovation to hedge risk tied to debt.  Unfortunately, all the incredible amount of debt and innovation have achieved is to gum up the financial system and turn liquidity(smooth oil) into a viscous sludge when it disappears along with confidence.

Care for a better diagram than the previous.  Take Deustche Bank.  It has the highest derivative exposure of any major bank in the world.  It’s easily in the worst financial position amongst all the largest banks in the western world. image

It’s financial connectivity just might be enough to spark a chain reaction if Deustche Bank fails.  As I stated in my previous post, I think it’s a sovereign nation that ends the music for the next crash.  But that doesn’t mean that bank failures aren’t on the program.

A majority of these swaps, repos, and other derivative transaction are done bilaterally; meaning just between the two parties.  Central banks would love for all these kinds of transactions to go through a third party to clear these transactions and the third party be obligated to report the transactions.  Makes sense, right?

But there are no laws forcing the use of a central-clearing, third-party.  And in the financial system, entities are always going to act for their benefit.  A majority of these transactions provide a superior benefit via bilateral facilitation.

Don’t think for one second that the risks associated with current worldwide debt levels and the transactions I just described up above aren’t entirely real.  Why do you think the Fed makes the major banks conduct a stress test under an “adverse” scenario?  Have a look, courtesy of JPM, at the very plausible scenario below that the Fed ensures each major Wall St. bank will be able to “survive” at current capital levels.


Unemployment jumps to 10%.  House prices fall by 25%.  Equity markets tank by half.  I’d say this is a very real scenario.  What’s totally fiction is the safety of the banks based on their capital levels in the event that a crash creates the stated conditions.

These stress tests are called the Dodd-Frank Stress Tests (“DFAST”).  There’s nothing stressful about these stress tests for the banks, as DFAST is a farcical play put on for the masses to make it seem as if the banking system is properly capitalized.

It’s not.  That’ll be proven again.  In spades.

The DFAST is a well-intentioned undertaking that even makes the banks detail the key risks in the event of an adverse scenario.  Observe.


All the obvious and most important risks to the financial system are conveniently laid out for anyone to see via these DFAST summaries.  I’ve highlighted what I think are the 5 most critical risks to the system.  “Country” and “Credit” are what I spent a lot of time on in the last and current post, but the “Model” risk is interesting to see.

All these derivatives, the swaps, the repos, etc.; they’re all evaluated with a risk-assessment model called Value-at-Risk or “VaR” for short.  VaR is simply a statistical methodology for determining the risk level of an asset or portfolio.  And VaR is how all the financial system institutions essentially measure the risk in their portfolios, not just the banks.  The problem is that VaR works under stability until it doesn’t under instability.

VaR was utilized to assess the mortgage backed securities in the lead-up to 2008.  The problem with a model is that it’s garbage in, garbage out; whether it’s a human or machine performing the assessment.  The MBS valuations and thus risk assessments were off in another galaxy because the ratings agencies were saying the debt securities were AAA-rated and the models statistically showed virtually no chance of default.  A biblical flood, major meteor collision, and lightning striking 20% of the world’s population would have to occur first before the AAA MBS began defaulting.  Once again, we all know how that one played out.

Well we’re back at the same place as 2007 – 2008.  This time, instead of housing, the name of the game is sovereign debts via the central banks and the financial institutions and corporations keeping the system propped up via debt issuance and bilateral/trilateral funding.  And what models are being used to assess risk?  You got it.  VaR!  Yarrrrr!

You may be thinking, “No way.  There’s no way all these players still use the same or similar models to assess the risks of all these derivatives within their portfolios.”

Ok.  Have a look at what S&P peddles.  Oh wow, it’s a shiny automated VaR model to assess credit risk.  And you get a nice little whitepaper to go with it to explain why you need their particular tool.

So where is all this information on derivatives?  In the same places as always.  The quarterly and annual reports of the publicly held players and the US Office of the Comptroller of the Currency puts out a quarterly update on bank trading and derivative activities.  It’s how I obtained some of the information for this post.  Have a look.


What we haven’t seen a significant amount put into operation yet is credit default swaps (“CDS”).  Not only do they have the negative connotation from 2008 but players are fearful to be a counterparty in one of those transactions.  As the central banks continue to flood the world with liquidity, players will begin to get greedy and believe they can structure CDS to take advantage of the next crash.

I suspect this next crash will alter the financial system and environment permanently, in light of that, entities are not going to be made whole for their CDS exposure like in 2008.  That would be politically untenable and I’m not so sure that even the politicians would sign off on another bold ass-fucking of the tax-paying public.

The reason you should care so much about this component of the financial system is because of the risk it introduces to the world economy and markets.  Not only are the models flawed in assessing the risk in all these financial instruments, but the counterparty risk in all these derivatives are the true danger.  Because of the inter-connectivity of the world’s financial institutions.  It’s only going to take one.  One major bank or one major insurance company.  Just one to begin the domino process.

So what does that process look like?  Let’s look at a feasible but extreme scenario.  Italian debt as a percentage of it’s GDP is out of control.  Even worse, nonperforming loans (“NPL”) i.e. bad debt within Italian debt instruments are at Depression-like percentages.  Observe the following chart of Italian banking NPL through 2015 from the World Bank.


It’s clearly a problem.  Now let’s say Deutsche Bank is woefully exposed to this nonperfoming debt in Italy.  All it would take is a trigger like a major accounting fraud is discovered at Citigroup while derivative instruments begin crashing at Deustche and the counterparty massacre begins.

While this happens and to help allay fear, let’s say Japan and the ECB simultaneously co-announce deep cuts in their central bank interest rates of an additional -1.5% each.  At the same time, the ECB announces it is going to buy 10% of all European companies with market caps over $10B.  Additionally, the Netherlands announces their exit from the EU.  You think fear might start rising?

Let’s add another fear factor to the scenario, Japan announces it’s going to spend $1 trillion USD on infrastructure and technology development to create jobs but simultaneously announce a $27,000 USD annual living wage.  Economists call this “helicopter money” and it’s the last blank bullet Western central banks possess to stimulate animal spirits.

The scenario is extreme, but the world’s markets are dancing on a razor’s edge.  Do you see why gold sounds so sound?  Do you see why some exposure to precious metals could possibly help carry portfolios through the next crash?  Millennia of monetary utility.  Zero counterparty risk.  Accepted value around the world by all people.  Doesn’t sound so crazy to have exposure to the asset class, does it?

It’s just about quitting time so let’s address the two most important aspects of even knowing or sharing this information.  How is it actionable and in what kind of timeframe?

Well if you’ve read any of my material over the years, you should have a pretty good idea of how I think it’s actionable.  Increase cash levels.  Increase precious metals exposure via the physical metal and intelligent allocations into precious metals stocks.  For the latter, see the J-perp portfolio.  It’s a basket of junior players that in 2016 is outperforming virtually every index and hedge fund known to man.

Begin to pare back winning positions that are leveling off.  Going to cash means liquidating where appropriate in order to raise the cash.  Many of the world’s best value investors have started that process some time ago.

As for timeframe, I’m more convinced than ever that sometime in 2017 is when it all begins.  By begins, I mean the wobbling.  Like a top slowing its spin and starting to topple.  We may not see an outright initiation of a crash, but I’m confident that serious wobbling will begin.  I already believe that the action at the end of 2015 and beginning of 2016 was the start of everything.  That period of volatility was the waking up of the bear and the starting point for the last-gasp melt-up in markets around the world; the final blow off for profit grabbers.

Bear in mind that central banks control everything now.  Sentiment and liquidity via free market operations are a thing of the past…for now.  Which means that through their actions, many players believe that the universal bull market can continue for years.

I believe this to be flawed thinking.  When confidence takes its leave, there’s no amount of money that can be thrown at the issue.  There’s no amount of negative rates that can spur true economic development, because animal spirits will be neutralized by fear.  Banks and sovereign wealth funds will be monetizing even more ludicrous amounts of varying asset classes.  You thought it was crazy for central banks to start buying stocks and corporate debt?  Just wait.  Desperation will breed decisions that will go down in history.

It’s a fine line between pessimism and realism.  I’ve shared enough of both in this post and the last.  You’ve gotten useful charts.  I’ve provided what I think are some important points about how the financial system truly works.  Now it’s up to you to make key decisions for your own portfolios, because when the fun does stop, the amount of leveraged liquidity wending its way through the system will hasten a cataclysmic financial event.

All that being said, let’s ride the final melt-up for all that it’s worth and try to get paid.

I’ll leave readers with one final quote to sum up my thoughts on the complexity of the financial system.  It’s a pithy little ditty by a recognized genius and one of history’s greatest brains, Leonardo da Vinci.

“Simplicity is the ultimate sophistication.”  Here, Here.

Are You Prepared?

Fear sells.  It’s one of those unfortunate, steadfast truths of life.  Just look at the rise of politicians like Trump and the other fear mongers around the world.  Look at the news.  People love to be scared.

Fear is not what I’m selling.  Rational thinking.  Clear analysis.  Proper asset allocation.  But mostly, cognizance and comprehension.  These are concepts being sold in today’s post.

I wanted to take some time to break down how I think this current economic-business-investment cycle, which started off of the 2009 lows, reaches its peak.  This post may be a bit lengthy, so consider yourself duly warned.  Read it in chunks if the need to go catch a virtual critter or watch some naked dating is simply eating at you like a heroine withdrawal.

In a world where blog readers want the meaning of the universe in under 800 words, this post will take some time to layout how arguably the most important component of the banking system works.  Specifically, I want to visit swaps, repo, and the collateral needed to fund the whole party.  I want to explain for the people that don’t know; the lay people.  People that have no idea about finance, accounting, and economics.  People that watched The Big Short and have an inkling but need a legitimate breakdown of what’s really going on in the financial system.

What’s most annoying for me about the investment fear mongering today is that there’s no clear how or why we can expect a major market crash across all asset classes.  Numerous potential causes are cited.  Some say extended valuations.  Others say central bank intervention has lost it’s efficacy.  Still, others say a black swan will reveal itself to cause entire markets to be re-priced.

These are rational, true hypotheses and I agree that all three will hasten a great crash, but the fact of the matter is they all fall under the umbrella of debt.  Debt was taken off of the private balance sheets(publicly traded entities) and shifted to the public balance sheets(sovereigns).  All the owners of associated derivatives tied to that debt were either made whole or have continued to utilize the current system to keep the party going.

Worldwide debt levels are and will be the cause of the next crash.  Debt sits like a boa constrictor with its coils wrapped around the world, slowly squeezing the economic life out of all markets.  Think of the snake in The Jungle Book cartoon with its mesmerizing eyes.  “Trust in meeeeeee.”  Debt beckoned and the world heeded the call, only now there’s no escape and it’s getting harder and harder to breathe.

This is sort of a revelation for some who are just beginning to truly understand the error of the central banking cabal’s ways.  The negative rates.  The buying of investment grade assets and equities with taxpayer funds.  The backstopping of public, systemically dangerous banks with taxpayer funds.  The waterfall of money creation.  The thought process that more debt on top of debt will somehow cure a situation caused by excess debt.

At this point of the post, any pros reading this are probably rolling their eyes and thinking “Go buy another gold bar you doomsday schmuck.”

No matter.  I want my friends, family, and financially unsophisticated to gain some insight.

Where’d all this debt come from?  It went from the private coffers to the public coffers.  From the publicly-held, systemically important financial institutions (“SIFI”) to the central banks.  And now that the developed sovereigns are sitting on all of it and then some from the 2008 system-save, the SIFIs have continued their unaccountable ways and the financial system is sauntering closer to the edge.

There’s nobody for the central banks to turn to.  There isn’t an intergalactic central bank out on the edge of the solar system just waiting to be a lender of last resort to planets where the dominant sentient species decides to fuck the whole financial system up.

Why did every single SIFI have to survive (except for Lehman, of course) after 2008?  If the banking system blows up, there’s zero way to process sales transactions?  People aren’t going to continue buying at Wal-Mart, Amazon, Kroger, and other retailers?  Oil won’t be burned?  Businesses will never hire and never expand again?  Tightening the belt is not the same as eliminating altogether, but that’s not the picture painted by the players in control.

Just ask Charlie Munger or any other uber-wealthy and they’ll tell you how close the whole American system was to utter annihilation.  It’s easy to take that stance when you have rainy day cash in the billions just waiting for an investment yielding 10% with a 100% government backstop.

The people that constantly state not to bet against American resiliency and determination, did just that by supporting SIFI bail-outs.

But those who lean towards the Austrian school of economic thinking, have long had a grasp on the consequences of current central banking Keynesian policies.  And those consequences are now beginning to painfully avail themselves to a larger and larger percentage of the world’s population.

The good news is that the crash is not imminent.  I know this because investor psychology dictates that we have a last-gasp, melt-up in the broader stock market.  Not to mention, everybody is currently inclined to say that the game is over right now.  Sell everything!

As I’ve said before, bull markets don’t end with everyone staring right at it while expressing their negative sentiments.  We’ll need that final push upward in the S&P 500 to the range of 2,400ish.  Who knows?  Maybe even higher, but about 10% to 15% higher than 2,125 which proved to be such a strong area of resistance.

If you’re strong of gut, stay positioned to the top.  If prudence guides your investment principals then it is way past time to have begun increasing cash levels.

When nobody’s looking, something’ll go down over a weekend; a major event or perhaps some sort of Western government proclamation.  And on Monday, panic will likely ensue to get the real party started.

It’s been suggested that it will be the banking system, specifically a major bank such as Deustche Bank or an institution of similar magnitude that will stop the music.  I disagree.

I think it’s going to be a country.  Either via a currency policy error or an outright repudiation of debt or both or some other ill fated decision involving a SIFI, but I suspect a major developed country will be the entity that kills the dance music via a one in “ten-thousand year” tail-event.

The system-altering crash is not going to happen tomorrow.  Crashes are like being pantsed.  A pantser doesn’t pull down the trousers of the victim while the potential pantsee is looking them right in the eye.  No.  A pantser waits until the pantsee is not looking and in a position for considerable embarrassment before striking fast to yank down the pantsee’s trousers, inflicting maximum damage to the victim’s psyche.

That’s a market crash in a nutshell.

So investment portfolio’s are safe for now, but let me share some charts just to get readers’ old fear-juices flowing.  Gotta break the monotony of my prattling.

It’s critical when making comparisons to previous market-tops to only go back about 18 years, because that’s when true financialization took over the world with the passing of Graham-Leach-Bliley.  That gave immeasurable power to the banking system and set us on the path we’re currently on.  Everything before that was during an entirely different era.  Sure, you could point to 1971’s USD unhitching and the creation of the credit destiny or 1986 and the MBS birth or Greenspan’s run, but the lead-up to the crash is my preferred beginning comparison point.

The first chart I’d like to share is the divergence between earnings in the S&P 500 and the performance of the S&P 500 on a monthly chart with the Ultimate Oscillator (“ULT”).   You’ve probably already seen this one in some iteration around the web.  Am I the only one that thinks that divergence in earnings and the index’s price action looks a little off?

GAAP Earnings Recession and the Ultimate Ossy (8-2-2016)

Yes, the index is sitting right at new highs while earnings continue downward, but look at the ULT.  The depth and duration the indicator is hitting has only been seen two other times in the last 20 years…subsequent to the 2000 and 2008 market crashes.  And yet here we are at highs across multiple financial assets classes and no recession in sight.

PHEW!!!  We’re good then.  End of post.

Actually, let’s look at another chart, courtesy of SentimenTrader.  Want to know what those red arrows indicate?  Then buy a subscription to Jason Goepfert’s site.  It just may be the best research value available.  SentimenTrader’s value is so good that I’d liken it to a stock with a $5 billion dollar market cap that trades for less than the cash on it’s balance sheet.  It’s that undervalued.

Margin Debt - S&P 500 Within 1% and MD More than 10% (July 2016)

Those arrows indicate each time in the last 25 years that the S&P 500 was within 1% of its all-time high and margin debt was more than 10% below its all-time high.  Definitely ominous, but ultimately may mean nothing, however I’m willing to bet that this signal is far from meaningless.

Feel reassured about your current asset allocation yet?  I’ll wager that you don’t have nearly enough exposure to the precious metals space.

Ready for another scary picture?

Back in May of this year, Michael Harris of the Price Action Lab shared a post about his Bear Market Probability indicator (“BMP”).  You can see that over the last 20 years and for the last two major market meltdowns, the BMP was highly accurate.

Bear Market Signal - PAL (5-17-2016)

In 2000 and 2007, the BMP would have gotten you out with plenty of time to spare to take profits and shift your portfolio allocations accordingly.  Each time the indicator has cleared a probability of 0.90, a true bear market followed shortly there after.  Our current market cleared 0.90 in late summer last year just before all the fireworks.  I don’t think it’s a false signal in the least.  The BMP’s efficacy is proven.

The bear-market delay is in all likelihood due to ridiculously low interest rates and accommodative monetary policy by the developed players of the world.  But the bear will be staved off for only so long and not very long at that.

The Price Action Lab (“PAL”) software is another incredible value readily available for market research.  I am not a subscriber however their software packages provide a window of access to the plebs of the world who want to see and know how the pro’s find trading opportunities.  If you are statistically inclined and serious about trading your account or OPM, then PAL software can help you find an edge.

Additionally, the PAL blog is not only insightful but pretty funny.  Harris consistently puts technical analysts, like myself, and over-exuberant quants in their place.  Great site.  Great content.  I plug it and SentimenTrader often.  Read’em.

Let’s look at a few more charts to really get you thinking that the end of this bull market just may be near.  Afterwards, we’ll segue to the plumbing of liquidity within the financial system.

The following two charts are courtesy of the Leuthold Group.  The top chart depicts the percent of publicly traded companies with rising YoY earnings per share.  Not too healthy looking.  And you can see what happened the last time we crossed under the 55 line in 2008.

Two Signs of Recession - Leuthold (Q2 2016)

The bottom chart is the HWOL via The Conference Board.  As for the indicator’s composition,

The Conference Board Help Wanted OnLine®Data Series (HWOL) measures the number of new, first-time online jobs and jobs reposted from the previous month for over 16,000 Internet job boards, corporate boards and smaller job sites that serve niche markets and smaller geographic areas.”

Just more compelling, supporting evidence of what’s in store for the world-wide financial system.

This next chart is a little dated from the end of last year but these common valuation ratios still stand in the same over-valued condition.  Observe how close to the top these values in the PE, PS, and PB existed.

Valuation Ratios - FPA Crescent (12-31-2015)

SPX Dates Lining up Crescent Valuation Chart (August 2016)

The common denominator is once again debt.  Easy money policies and the continued backstopping of all markets via sovereign debt issuance is really the only thing holding confidence together.  Once the confidence goes and liquidity dries up, you’re going to wish you’d heeded charts like the ones in this post.

The last chart selling market fear illustrates loan issuance drying up in the commercial and industrial space in the US.  The Federal Reserve releases a survey of Senior Loan Officers every quarter and what we are currently seeing is 4 straight quarters of tightening loan standards in the commercial and industrial space.  This is something only seen at the outset of recessions, literally.

ZH - Fed Senior Loan Officer Survey C&I Q2 2016

Care to guess why these condition exist and yet we are “not” in a recession in the US?  That’s right.  Excess debt issuance.  Cheap money backstops.  And a cost of capital that has been perverted for far too long.

The charts all paint a clear picture.  Ignore them at your own risk.  Is a crash imminent?  No, but you better be socking away some cash for value opportunities and you better be taking profits on positions that are starting to run out of steam anyways.

Let’s move on to the banking system.  No, let’s take a break.  My next post will be on the banking system and how it will exacerbate the shock to the financial system when whatever sovereign does what it’s going to do.  Specifically, I’ll expound on liquidity.  How it works and why every pro in the world already knows the danger it presents when it dries up.

Are you fearful?  Based on average portfolio construction out there, the average investor is not nearly scared enough.  Remember asset allocation only works over long durations.  Diversification in the short term is just as susceptible as any other investment approach.  Sure, the strategy is to offset so you lose less than the stock market as a whole.  But if you’re near retirement, there’s not a lot of solace in thinking about how well asset allocation models hold up over several decades.

You know what also holds up over the decades?  Intelligent trend following and value.  Craftily insert risk assets that can carry your portfolio returns when times get rough.  Don’t give in to the fear and don’t give up on the markets as new highs are being hit but now is the time to start questioning all your allocations in preparation.

Standby for part 2 on liquidity within the banking system.

It’s Like the Old Days in Commodities

For the traders out there, action in commodities has been highly volatile presenting opportunities as if it was the 80’s.  Basic technical analysis has been rather effective, especially within the softs and agriculturals.  Now the precious metals swell appears to be breaking, if only to regroup for the next move

It’s important to remember that large-scale traders and high-frequency traders are the beginning, middle, and end when it comes to trading.  Not only do they control breakouts and breakdowns, but they often make the market, too.  It’s important to exercise patience before positioning into a play.  Before a larger breakout or breakdown is firmly established, there can be see-sawing volatility that can jar traders out of position.  Patience allows you to skip a few waves before finding that swell you decide to ride.

What’s been hotter than the precious metals or related investments in 2016?  Not a whole heckuva lot, and silver has been on mad recent run but price action says it’s time for a pause.  The price of silver has already started turning over the last two weeks.  Because of the intrinsic volatility in the metal, it could be a quick ride down to the breakout point around $17.75.  I think this breakout in the precious metals is the real deal and I suspect we could see a sort of V-bounce right back up to the two-year highs once the breakout point is retested.

Silver Weekly (7-21-2016)

One of the calls I made in my last post was that sugar was looking blow-offy.  I wasn’t precise on the timing but clearly the action is looking corrective.  More importantly, the price action has been controlled to squeeze final long-profits and allow positions to be lightened.

Sugar ETF Weekly (7-21-2015)

I think sugar’s action could go one of two ways.  One, it could be like in the chart above where we see a downmove and then a bounce where final profits are taken and it gets sold off pretty hard down to a natural support point.  Or the market-controlling speculators could just sell the sweet stuff down in a hard, volatile move.  My gut tells me the first option is the probable play.  If you haven’t positioned for a sugar short, there’s still time.

Trading intense moves in an asset class is a lot like trying to catch a metro train.  You may have missed it going away on a long, but you can always catch it when it comes back on a short.

I don’t know nor can I explain why basic resistance/support chart analysis has been working so effectively since late 2015.  Maybe it’s the patience.  Maybe I’ve learned to read the action with HFT-tinted glasses before executing.  I don’t know.  All I know is that I don’t feel like I’m doing a whole lot different from most other years, but 2016 has been one for my own trading record book.  Who knows?  Maybe that whole 10,000 hours thing actually means something.

Let’s take a final look at bonds.  They’ve been driven up right along stocks.  In a bizarro turn, American equities are being viewed with virtually the same risk premium as corporate bonds and even treasuries, primarily because of solid credit ratings coinciding with high relative yields and developed-world central bank backing.

However, the boat is awfully crowded on the one side of interest rate direction.  The world has negative rates everywhere.  The crowd thinks there’s no way rates can move upwards just because the central banks are not in a position to act.  That is fallacious logic.  Observe:

10-Year Yields Weekly (7-21-20156)

Remember, the Fed’s final QE announcement in 2012.  You see that upmove in 10-year rates?  That was a market-driven move, not Fed-driven.  And yet money is allocated today as if there ain’t no way the market can drive rates up again in any sort of treasury selloff.  There is a widely held belief that American debt is one of the only pure safe havens, and it is to an extent.  That doesn’t mean that market controllers won’t inflict maximum pain for bettors letting their guard down.

We’ve already seen a sharp move up in rates recently.  Is there more to come?  I’d bet that the odds favor a continued, but possibly choppy ascent in interest rates.  This provides logical plays shorting TLT.

It’s not just developed sovereign debt that has seen a run.  Corporate debt has been plowed into as well.  Trading the exuberance on US corporate debt is as easy as some puts on LQD.  Have a look at the upward spike since Brexit:

LQD Weekly (7-21-2016)

LQD is already beginning to turn.  It may not fall down to support but hedging within a structured option play is well documented and easy to execute.

For my few followers out there, don’t give up on me.  I’ve been extremely busy with very little personal time.  I hope to post more regularly in H2 of 2016.  Have fun out there with your money.  Just don’t blow it.

When Last We Was Trading…

…I’d shared some thoughts on trading volatility and the action of the S&P 500. I was right about the down-move in the S&P 500. I thought a small move was possible of no more than 5% and a 3% percent move down is what we got, then a continuance of the sideways consolidation. However, I was very wrong about volatility. I suspect the reason is because the trade was simply too crowded. Volatility became a trade du jour as the intense bounce that had started in February had obviously grown long in the tooth.

But crowded trades are a trading fool’s errand and my thesis was wrong. And so ended one of the greatest 6-month runs I’ve ever had in reading the tape, but now I’ll just have to start fresh on a new run of prognostications. The crowded trade of long volatility and short the S&P 500 was skewered by the “market making” bot shops. Even Mr. Bonds himself, Gundlach, came out and stated during a Reuters interview that from the 20th of May and on the action in the stock markets felt like a short squeeze. JPM backed that assessment as one of the largest broker dealers out there. Observe a chart they released verifying the quick spike at the end of May in short covering.


As this short-covering burst has squeezed a chunk of the volatility hedging, too, we still very well may get a correction of 5%ish down to just below 2,000 on the S&P 500. Volatility is still worth watching for a quick scalp if enough weak hands have been washed out and the robots let some negative momentum push the S&P 500 down and volatility up.

Let’s return to the soft commodities market as sugar has just been on a silly tear. Observe:


Just look at the last week, specifically. Talk about momentum ignition. The Commercial Hedgers have gone supremely short but this softy keeps ripping higher, moving 16% in the last week. Crazy. But the last two trading days look suspiciously like blow-offs. Have a look at what’s happened during the last two blow-offs in sugar over the past 9 months.


You can see that prior to each of the blow-offs there were frenzied gains in very short time periods, but then astute traders could have made a nice rip quickly shorting sugar for 2 to 4 weeks. Has another opportunity presented itself for one of those rips? It sure looks like it. Go elsewhere for your farm reports, international weather patterns, crop output, regional flood potential, yada, yada, yada. This is straight up tape reading.

Using the futures proxy ETF of SGG, it is clear to see that $36 is an important number for sugar. Magnetic almost.


Using Fibonacci from the August 2015 low to the current June high, $36 also happens to be the 38.2% retracement point on the weekly chart. Tread lightly, if you’re inclined, as the action in sugar has been fast and furious. Just look at that whipsawing action since the start of 2015. Hedge. Trade with discipline. Manage the position.

One final note from a macroeconomic standpoint, have a look at this chart of negative yield curves in Germany and Japan.


If this doesn’t scream insanity to you then nothing can phase you. Maybe all the developed world’s central bankers have been secretly, partially lobotomized. A little frontal lobe here, a little hippocampus there, and you have a compliant banker with the inability to remember what negative rates actually mean and the lack of cognition to act effectively. Germany and Japan combined equal approximately two-thirds of the US economy. Which means their economies matter. A lot. Germany has negative yields out to a decade and Japan out to 14 years, just screaming recession is near if not already present in those two countries. You think the US is in better shape economically because we don’t have negative yields? These are different and unique times, folks. The kind of times that are remembered with head shaking and derisive snorts by future students of the economic past. Trade smart. Build cash. Stay disciplined. New highs are coming, but new lows are closer than you think.