Fall Equinox Outlook
The market continues its fit and start jolting move higher. The main driver remains the zero interest rate environments, coupled with the enabling QE program. Searching for yield? Well the only liquid answer is equities. This week I reported that even central banks “sovereigns” are seeking better returns as their returns on interest continues to dwindle. The VIX, a measure of option’s premium, continues to price in a moderately bullish outlook, but has not dropped to a level of irrational exuberance. The underlying question remains how much margin (borrowed money) is available and when will it NEED to be paid back? That is and will always be the determining factor when a bubble bursts, just like the dot.com and housing bubble.
Fall Equinox Outlook
Courtesy of photobucket
Summer Solstice Review
The Summer Solstice came and went without too much fanfare in the market. The Fed gave its blessing by keeping rates at zero and QE moving forward. This helped calm the geopolitical concerns like Ukraine and Iraq, both of which could heat up again.
Oil prices shooting above $100, GDP negative 2.9%, weaker western economic data, real inflation on the rise and a host of issues that would normally rock the market and send investors running into the bond market for returns and seeking security, is not happening. There are no returns or yields in the traditional safe investments. One trader friend of mine said, “Sharpe Ratios are a joke now days!” His sarcasm was aimed at one of the traditional measurements for performance based on the difference of investing in bonds for yield vs. the market. His joke referred to interest rates at zero and the 10-year hanging around 2.5%. There is truth in his sarcasm, how can we measure risk and reward if the interest rates are fixed and NOT a true measure of credit risk and/or investor demand.
We can’t confuse the market rally with investor demand, if we look at volume, liquidity, and order flow there has not been huge drive by individual investors. Institutional money has been the biggest of drivers, along with sovereign funds. Sure there has been a rise in investor flow, but it is paltry in comparison. The traditionally large pension funds are only seeing gains from existing positions that had taken significant losses; there is not the flow of funding into pension funds as we see municipalities, states, and old-guard union companies strain to fund even their current obligations. More proof that flow is coming from leverage debt in a top-down approach from the Fed to their member firms, all seeking yield and taking advantage of arbitrage opportunities between the free money on the short-rate vs. the long rate. Additionally we saw a massive rush of money into foreign government bonds, once the ECB said and later proved they would print enough money to drive yields down as these Club-Med. nations joined the “Too Big To Fail” club.
Laws of Supply & Demand, courtesy of Wikipedia
The fact remains that money is not just chasing yield, it is chasing leveraged returns and that is something to seriously consider. Any investor (individual or big firm) can hold positions and take losses on unleveraged positions, but once you ratchet up the leverage, the risk of having your debt called is now a consideration.
We have tried everything to keep the market from crashing with interventions, trading curbs, circuit breakers, halt trading, slow order flow, etc. All our rules, regulations, and programming are geared at keeping the market from falling. Even index composites are reweighted with a bias to the strong and growing companies, flushing away and ignoring failure.
Yet as much as we try to halt the laws of Supply and Demand, it can and does rear its head and there is little we can do. Whether it be a “Flash Crash” from technical issues or calling in debts creating margin calls, at the end of the day the laws of Supply and Demand is driven by math and the course cannot be altered. Yet we try to alter the river of Supply and Demand, sometimes it “seems” to work, but it is nothing more than a temporary levy holding back the huge mounting pressure and one day the levee breaks. When those days come, rather than accept the fact that Supply and Demand can’t be contained, we turn to blame someone; Wall Street, Banks, The Rich, and anyone who may of prospered from the failure of the levy. However rather than blaming those that may have prospered in hindsight, where is the accountability and responsibility of those that built the levy in the first place, those that believed they COULD control the river of Supply and Demand?
The Fed and the government are the ones that are ultimately responsible for engineering, building, and monitoring these levees. They can’t fathom and will never admit that the laws of Supply and Demand are a force that can’t be controlled. If there is a demand, a supply will always be found, by hook or by crook. I am not saying the government should do nothing, but it should. However, rather than trying to control it they should focus on understanding it and building rules and regulations for those willing to wade and swim in the river.
Courtesy of aquafornia
The Fed’s current monetary policy, by their own admission, is “extraordinary”. Bonds are no longer priced on Supply and Demand, nor are they priced on credit risk. The Fed has simply FIXED the rate and has become a market participant by creating artificial demand. Ironically all those college students graduating with an MBA or business degree being taught what interest rates are, how one measures risk, and the formulas for calculating their function will enter a world where REAL math has been turned into government math in which all their learnings don’t apply.
At the start of the crisis only those that are objective, critical and anti-Keynesian, were critical of the course the Western central banks and governments have taken, this small circle of critics were of the Austrian realm. The Keynesians and even Chicago School economists initially supported radical monetary action at the start of the crisis, even supported the TARP and TALF, low interest rates. However, when QE was first introduced, skepticism rose quickly. How could the Fed print money and buy bonds without the world losing FAITH in the dollar? Yet QE came and went, the market rallied and the dollar didn’t fail. Perhaps the criticism was unwarranted, everything “seemed” fine. QE2, Operation Twist, QE3, Abenomomics, LTRO, and now negative interest rates are present, all while the balance sheets of liabilities surpass a billion, 100 billion, and now trillions. Yet the market continues to move higher and the faith in the Western currencies haven’t failed. The Austrian Economic concern was wrong, dead wrong – everything is fine. The Keynesians feel redeemed and even many Chicago School believers concerns have diminished, believing the Fed can unwind their trillions and raise rates, just as easily as they lowered rates and printed money. However, the Austrians would argue, this is nothing more than buying time, much like those people that lived in their “interest only” McMansions for years, borrowing more to sustain their lifestyle.
Reasonable Men are concerned.
Recently two prominent people well respected and also initial supporters of the extraordinary measures by the Fed have raised their own alarms.
Courtesy of Forbes
Wilbur Ross stated while in England yesterday that the ultimate bubble will be Sovereign Debt, naming the U.S. specifically. His concern is that we are so far below any reversion to the mean of interest rates on the 10-year, that if we reverted back to the running average over the last few decades, around 4.5%, we would have incredible and terrible losses in the bond market. The biggest holder of these bonds is the U.S. government and other sovereign (governments), the losses will be incredible, additionally governments would not be able to afford higher rates as they continue to borrow money, simply because of the one-two punch of inflation and lack of tax revenue growth to off-set rising rates. Lastly, none of these nations are paying off debt; they are just paying interest and raising more debt. He suspects we could see problems sooner rather than latter, most likely next year in 2015.
Courtesy of wikipedia
Stephen Roach believes that the Federal Reserve is “wildly accommodative” and ignoring the stresses and strains that their monetary policy coupled with trillions in liabilities would suggest. He believes we are now in a sovereign debt bubble as well and believes that the initial problems may come from those that nations that have borrowed heavily from U.S. and Euro would be the first to crack, not being able to make payments. Much like what we saw a couple of years ago with Greece and others when they could no longer make debt obligation payments, until they were bailed out. However, Roach wonders who will bailout those that have been doing the bailing out and now hold trillions in liabilities? He thinks the Fed does not seem concerned at all about their monetary policy and he sees the ECB being cautious but being forced to take similar action like the Fed and the BOJ.
These two individuals are not the typical naysayers that the media and Keynesians ignore or criticize, like Jimmy Rodgers, Marc Faber, Schiff, Roubini, Williams, and others. These two have firmly been non-critical of the QE policy camp, initially believing (like all of us) that it was to be temporary. Going on 6 years, with no end in sight, the market rallying, and no real concerns – perhaps the Fed has become blinded by their own ideology.
Perhaps we should start listening to the likes of Roach and Ross, who have moved up their own time line of concerns to a couple of years. I suspect we may hear concerns from Buffet and others soon as well and I would argue that if the big boys are concerned and starting to hedge positions or liquidate (Ross liquidated 100% of his Irish Bank Holdings), the flood gates open.
Fall Equinox Outlook?
For now, the Fed will do what they can to keep bonds elevated and the market from crashing. They still have a printing press and the world continues to have faith in the dollars. We are seeing a rise in inflation, but the Fed doesn’t seem concerned.
We should expect to see the market contract again soon, as word spreads about Ross and Roach concerns, but I don’t see a massive sell-off yet. It will hit a support area and then consolidate and bounce again. However, the clock is ticking and if Ross thinks that problems could surface as early as 2015, then I think we should all take a heed.
The mid-terms will also be a factor and the Fed will most likely become MORE accommodative later in the summer and early Fall to give the economy a boost. If we also get a positive GDP for the 2nd quarter, it could bring a reprieve to concerns in the market and help give it a boost. The Fed will say, “See, the first quarter was just about the winter storms, everything is FINE!” and the Keynesians will buy into it, the media will believe it, and the Sheeple will continue to be placated. However, the mountain of debt will continue to build and Ross’s concerns will not diminish.
The VIX, while low, is still not pricing “irrational exuberance” at this point and remains in the 11-13 range. We could see a spike on a pull-back in the market, but as investors again realize that equities remain the only place to be, we could see buying on the supports, which will bring the VIX back down into the 11-13 range on any spikes.
If we do get the Fed to take a more accommodative action we could see the market rocket higher, create more short-covering, and drive the VIX down into the single digits. If this does happen, it would happen coming into the mid-terms. The Fed still has some wild cards to play and will hold those until their September meeting, as I don’t think that they will do anything in July. September 16-17th FOMC meeting will be the earliest we see them take action; the latest would be October 28th-29th right before the mid-term election.
So I don’t see any massive corrections until the 3rd – 4th quarter, we could certainly have some short-term sell-offs in the 2-5% range, but I suspect we see bounces off those. The only early big disruptor to our market that could cause huge selling pressure is a move by the BRICs, namely China with some huge currency play, but I place the odds of that happening before the mid-terms as being low. Oil can send some shocks to the market, but I don’t see it as being the catalyst event that sends the market down and inflation upward.
For now I think we have a choppy market until Fall Equinox.
Support & Resistance
This continues to be short-term support. I suspect we bounce or consolidate around here if we decline. If we do get a pre-Fall Equinox sell-off I would look at 16,400 levels for support. Again, I don’t expect any major correction until later in the year, most likely after the mid-terms.
The highly volatile tech index has been moving higher. I would look at short-term consolidation at 3800 and any summer correction would be down to 3700 or 3600, but see support in there.
The VIX remains in the 11-13 range, not panicking about the downside and also not over exuberant about the upside. It is pricing a moderately bullish market at this point. I would look at 1920 as short-term summer support and 1880 for any big summer correction, but I also believe we will not see any major sell-off, inflation risk, or corrections until after the mid-terms.
The Russell continues to be the best gauge of general market order flow. I would look at 1140, with a low of 1120, for the late-summer correction areas.
The market’s core driver, the fuel driving the broad market rally, is the Fed’s monetary policy. There is nowhere to go for returns BUT the equity markets. The leverage debt levels in the equity markets are at all-time highs and continue to move up as the market moves higher.
Sure there remains great stories in technology and emerging markets for REAL growth and returns, but I don’t believe these sectors or individual situations are enough to buoy the entire market, even in a correction environment.
The Fed is betting, and so far correct, that money will chase equities as bond’s offer no real return. They still have some ammo and can further flatten the yield curve (perhaps a call to Belgium will help); they can also take short-rates, like the ECB, negative. However, their ammo is running low and that means they will save it until the last minute.
If the market remains elevated and risk abated, they can wait, however they may make a last big all-in bet come September or the late October FOMC meeting right before the mid-term election. After that, they are pretty much done pushing on the string. At this point it comes down the faith in the dollar and there comes a point in which that faith erodes and quickly.
I believe that Ross and Roach are correct and if these two well respected (by Keynesians and Politicians alike) are correct, we could see inflation start ramping and market volatile as earlier as 2015. Note, John Williams (economist of Shadowstats) is predicting the end of 2014.
Safe and NOT Sorry strategy is:
- Hedge your long positions.
- Don’t buy U.S. or Western sovereign debt (bonds)
- Buy gold / silver
- Buy income generating real-estate
- Buy income driven commodity programs, like oil investments
- Buy inflationary assets
- Don’t hold dollars in a bank account (money market or CDs)