Saturday, 17 May 2014

Stealth Bear Market

Back in November last year, I started a series of posts entitled How High Can Stocks Go? .  It looked at the fact that over the last 30 years, the real period of speculation was during the 1980's and 90's, rather than as most people believe over the period of massive money printing over the last 10 years or so.  In part 1 of that series, I pointed out that, “between 1980 and 2000, the Dow Jones Index rose by three times as much on an annualised basis, as it did in the high growth post war boom period from 1950 to 1980.” I also pointed out that there appears to be a 13 year cycle for stock market crashes, and 2013 was the next year in that series. It may appear that that has not yet happened. Maybe, but there has, in fact, across the globe already been a series of significant stock market corrections. In the US, the Russell 2000 index, has fallen by more than 10%, putting it in bear market territory. In addition, renowned technical analyst Ralph Acampora has described conditions as being a “stealth bear market”, in which he says we could be facing a mega crash of around 25%, and market guru David Tepper has said that although he would not short the market, he certainly would avoid being “too friggin' long” at the moment too. Meantime, George Soros has apparently sold out of all his positions in the big banks.

Back in 2008, when I predicted the outbreak of the Financial Crisis , just before it happened, I did so on the basis of observation of specific activity in the market at the time, that suggested to me that there was an imminent and serious situation. I don't see anything similar today, but I do see a whole series of underlying conditions that make the bursting of all the massive bubbles in shares, bonds and property inevitable in the not too distant future. I think that when those bubbles do burst, the effect may be an even more mega crash than Acampora is predicting, or even larger than Marc Faber's recent prediction that markets could be facing a 1987 style crash.

The inflating of all these bubbles occurred in the 1980's and 90's, but the money printing of the last ten years has been intended to keep them inflated. Between 1980 and 2000 the Dow rose by 1,000%, yet, despite the massive money printing, of the last decade, it has only risen by 60%, between 2000 and today. The money drugs are becoming less and less effective at keeping the bubbles inflated, as I pointed out in my post QE etc Sign Of Desperation. And that is what the money printing is intended to do, to keep the bubbles inflated, so as to protect the banks, rather than to stimulate the economy, just as the UK government's “Help To Buy” scam is intended to keep the property bubble from bursting, so as to protect the banks. The reason is the banks are insolvent, and as soon as the asset price bubbles burst, that insolvency will become apparent, and no amount of liquidity will make up for their lack of capital.

What does suggest that some huge market event might be not too far away – besides the fact of the 13 year stock market cycle, the fact that stock markets have been in an unprecedented five year bull market, and that on a series of valuation measures such as the Cyclically Adjusted Price Earnings, Tobin's Q and so on, they are already significantly over valued – is that since May 2013, markets have been moving up and down, in fairly large amounts, at fairly regular intervals. A look at the charts of nearly every major stock market over that period looks like a saw blade, and they are all currently at the top of a tooth, rather than the bottom. There seems to be a tug of war going on, reflecting underlying sentiment and concerns, which is also reflected in a rotation of the shares being held. As Acampora says, underneath the outward appearance the market is being torn apart.

That itself is a result of the effects of the huge quantity of liquidity that has been pumped into markets. Instead of the markets experiencing a cleansing purge, the excess liquidity has kept all boats afloat. That together with the low levels of interest rates, and artificially low levels of rates available to savers, as a result of deliberate government action, means that money managers have increasingly limited places to put money. That is one reason that, in a search for yield, money has been increasingly moving into the purchase of junk bonds, itself something that presents risks down the line. Its also part of the reason for the ludicrous situation that the yield on peripheral European sovereign bonds is now lower than for US Treasuries!

This is another reason to believe that some kind of big market event might be about to occur. That is the markets just seem to be acting in very odd and unpredictable ways. Nearly every market commentator has thought that the dollar would be rising, as would the US Treasury yield, as the Federal Reserve tapered QE. Globally interest rates are rising. Yet, the US 10 Year Treasury has fallen in recent weeks from 3%, to below 2.5%, and the dollar has failed to rise against the Pound, or Euro. Part of the reason for this is global uncertainty because of Ukraine, Turkey and so on, but part again also seems to be down to the unpredictable effects of all the money printing, because the low yields, on peripheral European bonds, seems to be largely down to an expectation that the ECB is about to engage in its own QE, buying up those bonds, and thereby pushing up their price, giving an immediate capital gain to their owners. At the same time, tapering means that emerging markets that have benefited from QE, are now suffering, and money is flowing out of them towards developed markets, until such time as interest rates, in the former, reach high enough levels to cause it to wash back in the opposite direction. In fact, its this unstable sloshing around of these huge amounts of liquidity, looking for marginally higher levels of yield, that creates a potential for sudden shocks.

But, this is not 2008. The conditions that existed then do not exist now. The global economy remains in a boom phase of the long wave cycle, but it has suffered damage in the heartlands from that crisis, that it has not recovered from. The damage to confidence has meant that levels of consumption and investment are subdued, whilst in some areas, that has been compounded by austerity measures by conservative governments. Official interest rates are already at rock bottom, and globally market rates are rising, as global productivity growth slows, and the general annual rate of profit begins to slowly turn down. Official interest rates of 0.5%, do not mean much to the 25% of the population in Britain, for example, who at some point have had to turn to Pay Day Loans, with rates of up to 4000%, or the much larger number who rely on credit from their credit cards at rates of up to 30%. In fact, the money printing used to keep the banks afloat after 2008 has made that situation worse not better.

The property market is a clear example. Germany is now suffering its first property bubble since the Weimar Republic; the US, where prices fell 60%, has seen the return of speculation, which in turn is making homes unaffordable to buyers once more; in the UK, everyone now recognises that an unsustainable bubble exists, particularly in London, and the majority sentiment is now that it would be a good thing for house prices to fall rather than rise, yet outside London, in many places, all the intervention is merely preventing the bubble from bursting dramatically rather than inflating it further. Every day, I get e-mails from a range of estate agents locally, for example, listing a series of properties that have had a further £20,000 knocked off their price.

In coming weeks, I will be resuming the series on “How High Can Stocks Go”, and monitoring the market action closely.

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