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 muck 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 Dot.com 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?
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.
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.
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.
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.
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.
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.