Current trading conversations kinda remind me of surfing. That is: balancing the need to get one more wave (after wave, after wave) of pleasure against the risks of getting pummeled…
I spent my younger years traveling a handful of zip codes looking for places to surf. From about age 12 to even a recent beating in Malibu, I’ve been hooked, often paddling into conditions and waves bigger than my talent, tri-fin and bruised ego…
Like many who catch the surfing buzz, it’s not unusual to risk a reef-beating, shark bite, jelly fish kiss and even a drowning just to catch an epic ride (or in my case, epic wipeouts).
For investors, the temptation to catch an epic market buzz can be equally strong, as are the risks and personal skill levels that require a balancing against our pride/greed. In short, some are prepared for the swell, others are not.
Which type are you?
This week ended with new market highs and record-breaking volatility lows. In short, the markets seem extremely confident, and the risks seem distant when our thoughts are on great rides. In sum: many of us are itching to paddle into more of this market swell.
It’s tempting, no? One look at the S&P rally (wave) since Trump was elected is evidence enough that Wall Street is excited about a pro-business, pro-infrastructure and pro-tax reform administration (at least as promised, though yet to be delivered):
And one look at the equities market since the post-08 Fed began injecting trillions of fiat dollars into the securities ocean further explains how tempting conditions have been for market surfers. Add to that a Fed wave of artificial bond buying (and prices) rising to “gnarly” highs, and this market swell just gets more and more tempting.
Finally, given the nearly $10T in cashflow waves from stock-buybacks, unearned dividends, LBO’s and M&A deals compliments of the Fed’s zero-bound rate policies, even more gorgeous market cash flow waves are tempting us into the water. I mean, just look at the following correlation between Fed policy and record market wave action…
Of course, these graphs are impressive and tempting. But even for bears and bulls alike, they are a little disturbing, no? The world seems a little frothy, a little odd. Again, just look above…
But that’s not all…
Remember those reefs, jelly fish, sharks and riptides? That is, let’s also consider the risks beneath these waves.
European junk bonds are now trading at lower yields than the US 10-Year.
The nosedive in yields (and spike in pricing) on European junk bonds sank from 10% to today’s 2.3% ever since the ECB decided to do “whatever it takes” to totally erase normal credit markets, replacing natural demand with central bank perma-bids.
China, meanwhile, is sitting on top of $60+ Trillion in debt, with a 7:1 debt to productivity ratio that is a ticking time bomb not only for Beijing, but for global markets who continue to rely upon China’s “growth engine” to keep their export markets above water-level.
Even JP Morgan’s analysts recently dropped their pom-poms and admitted than nearly 60% of the new loans being issued in China are being used to re-pay old debts.
As any of us who have traded market cycles bloated by promiscuous credit can attest, never make the assumption that debt roll-overs can be perpetually rolled-over.
Chinese debt is a real problem.
Eventually the tide goes out, and as Buffet joked, we discover who was swimming (or surfing) naked…
And here in the US., small caps –the riskiest of the equity flotilla—are trading within a Russell 2000 (RUT) whose collective PE is nearing 100…
Such risk reality-checks, regardless of our market views, talents or risk appetites, force a simple question, namely: If central bank stimulus and the non-existent, yet already priced-in Trump agenda, got us this far, what could happen if the stimulus ends and/or the politics fail?
Fair question, no?
I’ve written elsewhere about 1) our national budget issues, 2) the unlikelihood of any realistic tax reform, 3) the Fed tightening ahead and 4) the over-valuation of all asset classes, including the RUT.
That is. Much of what is expected to support this bull market is just not there…It’s weird.
But just because fantasy now trumps fundamentals, doesn’t mean the fantasy can’t continue even longer. Nothing surprises us anymore about today’s markets…
If markets continue to swell, we’re ready. If the wave dies, we’re still ready.
Here at Signals Matter, we learned long ago that market signals are far better guides of market direction than common sense or macro-economic sanctimony. After all, if common sense, economic knowledge or market efficiency determined asset prices, nobody would be buying a RUT that is trading at 20X one-year forward earnings…
And yet the markets just keep rising. Fine with us, but it still baffles anyone who looks past the headlines and at the numbers. We have to laugh, even cringe, when following our signals rather than our gut, but that’s how much we trust our risk filters here at Signals Matter.
Sure, we see an iceberg ahead, a big one. A market on steroids is a fake market, but it doesn’t mean it can’t continue to break records—at least for a while…We see a Lance-Armstrong fall ahead, just not yet. Either way, we continue to beat the markets going long or short, as conditions and signals dictate.
For those who don’t use our (or other technical/fundamental signals) to navigate these surreal markets, we remind you to be careful, to look deeply into your own risk profile and to consider the critical differences between market risk and market uncertainty, as we’ve touched upon elsewhere.
We all know it’s tempting to buy at tops and chase/catch this wave of optimism, and we know many will do precisely that. As long as you know the risks, how to swim, and how much money to leave on the sidelines (or on the beach towel), then these are decisions each investor (like each surfer before a monster wave) must make for themselves.
We are not here to mock bulls or champion bears—but we do feel everyone should be candid about prudence in a market trading on momentum, MSM cheerleading, spin and hope rather than reality.
The fact that the RUT is up 30% since November (having made us some money on the long and short side in 2017) is enough to warn any of us that a sell-off is approaching.
In short, that small cap wave will crash soon, keeping you underwater longer than you can hold your breath…
As always, be careful out there.