My spidey senses are tingling again. I am the most nervous about the current market environment than I have been in a long time.
I know the “secular bull” guys will tell you how the recent insane market strength is nothing to be worried about. They will point to all these other times when we had the same sort of vicious rally which precluded the start of a decade long bull run. I understand their argument, I just don’t buy it.
I recently read some wise old market sage say how profits are the most mean reverting data series out there. Well, even if he is wrong (which I doubt he is), I just don’t see how profits are going to rise significantly.
This graph of corporate profits as a percent of GDP is hitting all times highs. Could we go higher? Sure, I guess anything is possible. Is this the right bet? Not on your life.
But you might be saying to yourself, “that graph represents corporate profits as a percent of GDP. What if GDP rises?” I don’t doubt that the US economy is going to continue to grow, but I don’t know how they are going to get anywhere near the growth that the stock market expects.
The world is quickly slipping into a deflationary funk. If the US stock market thinks that they are somehow immune, then it has a big surprise coming.
At this point you might argue, “corporate earnings and the growth rate is only half the puzzle. What about the discount rate for those earnings? Maybe stocks are being lifted because of a general rise in all asset classes due to lower rates.”
You would be correct that the bond market has rallied recently, which has provided some support for stock valuations. But step back and look at the long term picture.
Do you think that betting on this trend continuing is a good risk reward? And if you do, then bonds are most likely going to rally even further because the economy has slipped into a deflationary downward spiral which is going to be terrible for stock earnings.
I look at stocks, and instead of seeing the start of the next great secular bull move like many pundits are suggesting, I see nothing but a stupidly priced overvalued disaster waiting to happen.
And the really scary thing is that even those that are sympathetic to my argument, like GMO’s Jeremy Grantham, are counting on the overvaluation to continue to expand. Jeremy is a person that I have a tremendous amount of respect for. Yet Jeremy’s call for a move up another 10% before “crashing as it always does” scares me. Doesn’t this remind you of Citibank Chairman Chuck Prince’s famous “we’re still dancing speech?” Look at the entire Prince quote, he knew what was coming, but was foolish enough to think he could somehow get out in time.
“When the music stops, in terms of liquidity, things will be complicated. But as long as the music is playing, you’ve got to get up and dance. We’re still dancing.”
You might acknowledge that my arguments make sense, but these points were just as valid 250 S&P handles lower as they are today. The market is going up, so obviously there must be something that I am missing.
I am not missing anything, I understand full well why the market is rising. The massive Japanese Yen carry trade and corresponding GPIF asset shift have set off a buying stampede the likes of which we have never seen. The bulls can go ahead and kid themselves that the fundamentals justify this rally, but I am calling bullshit. You don’t get month long moves of constant, relentless upticks because of a natural market environment.
There is absolutely nothing to justify this sort of rally. Earnings are not getting better. There hasn’t been a massive revaluation because of a lowering of the discount rate. The Fed has not changed from a tight policy to an easy one. This is nothing more than a piling into the one asset that has been rising. I have often talked about the rolling bubbles that we have experienced over the last few years. Due to the massive amounts of liquidity in the system, the theme of the day often creates these mini-bubbles. Today’s mini-bubble is the S&P 500.
But when is the fever going to burn out? I am not sure, but I am willing to take a shot on the dark side up here. Even the biggest bears are scared of the dark side.
The high yield market continues to trade like crap. Have a look at the BBB spread vs the S&P 500.
And although the big liquid S&P 500 is hitting new all time highs, the small cap stock market is nowhere near that lofty level. Yesterday it rolled over and hit a new two week low even though the S&P 500 was ticking at new highs.
So even though the fundamentals continue to weaken, and many other warning signs like small caps and corporate spreads are screaming caution, the bulls are rabid with excitement. They are quick to make fun of anyone who dares suggest that this isn’t the start of the most amazing bull move ever.
And who knows, maybe they are right. Maybe the Yen is going to keep going down 50 basis points every day and all that money is going to continue propping up the S&P 500 to infinity. Maybe every dip of 5 to 10 handles in the S&P 500 is nothing more than a buying opportunity.
But somehow I doubt it. I am as scared as I have ever been about the possibility of a big accident. The market is so crowded on the long side, with nothing more than the Yen carry trade holding it up. I know the Yen keeps going down, but what happens when it stops? Lord help us if it even rises. It would not surprise me at all if we were to see a day when the Yen moves 3 or 4 big figures against the speculators.
Yesterday the FOMC minutes were released. They should give the bulls concern. A lot of market participants are assuming there is a Fed put. They are counting on the Fed riding to the rescue at the first sign of trouble. Well, have a look at what the Fed said about that:
… members considered the advantages and disadvantages of adding language to the statement to acknowledge recent developments in financial markets. On the one hand, including a reference would show that the Committee was monitoring financial developments while also providing an opportunity to note that financial conditions remained highly supportive of growth. On the other hand, including a reference risked the possibility of suggesting greater concern on the part of the Committee than was actually the case, perhaps leading to the misimpression that monetary policy was likely to respond to increases in volatility. In the end, the Committee decided not to include such a reference.
The Fed is not riding to the rescue on the first downtick. And if the bulls are assuming that the global slowdown is going to temper the Fed’s path towards normalizing rates, this was idea was also rejected. The Fed does not tune their policy for global conditions, but instead focuses on the domestic situation.
“It was observed that if foreign economic or financial conditions deteriorated further, U.S. economic growth over the medium term might be slower than currently expected,” the minutes said. “However, many participants saw the effects of recent developments on the domestic economy as likely to be quite limited.”
The Fed is not going to deviate from their path to normalize rates. They are already engaging in Quantitative Tightening through their reverse repo and term deposit programs. They are going to keep tightening until something big breaks.
For years, the Fed has been goosing the market with the expansion of their balance sheet.
Their balance sheet is no longer expanding, and even though it is going to remain roughly the same size, make no mistake – they are withdrawing liquidity through their two new programs.
The two previous times they ended QE, the stock market rolled over a month later. This time not only are they ending the expansion, but they are sopping up liquidity with their new programs.
No one thinks that stocks can ever go down again. Lately I have noticed that even the biggest bears that were steadfastly still clinging to the notion that this rally would fizzle have abandoned their short positions. There are simply no shorts left.
Although I know that I might seem foolish beyond belief for stepping in front of this runaway train, I think the time to put on the short stock market trade is here. I started adding to my short yesterday, and I am going to continue to add to it today. I know we are already down this morning, but the dip buyers should take care of that shortly. But one day it is going to go down, and stay down. At that point the stampede is going to reverse course. Be very careful. The possibility of a big accident are way higher than the market realizes.