Below, we look at the possibility of a market wave melt-up in the face of rising interest rates. Above, we see my son, in well….Malibu.
Is This Market Wave Worth Riding?
Of all the great surf spots in the world, one has to wonder if the environs of NYC are worth squeezing into a wetsuit.
On the subway from Grand Central Station to Long Beach, I’ll occasionally see some transplant from the West Coast or even Down Under with a board bag, Metro Card and hopeful expression.
Then comes the knowing glance…Followed by swapping tales of exaggerated waves and how it might just be worth renting a car and heading out to Montauk.
“It’s usually better in Montauk.”
Actually, that’s not really true. It’s frankly better in Malibu.
But we’re not in Malibu. We’re in New York. The waves are small, closing out, mostly chop and of course, at least right now, the water is cold…
And yet there’s that urge to paddle out anyway.
The same is sometimes true of markets and investing. The conditions sort of blow, the valuations are flat, and rumors of sharks abound.
Nevertheless, there are those who head into bad market waves, hoping to catch one more ride and avoid getting pummeled.
Can The S&P Wave Get Bigger? Maybe 3000?
The S&P index has been churning lately as the Street struggles to surpass the January high of 2873 and possibly hit a 3000 price target this year or the next.
The bulls are waxing their boards, seeing dollar signs and attribute their optimism to the tailwinds of: 1) tax cuts, 2) stock buy-backs (predicted at $650B for 2018?!), 3) the synchronized global growth meme and 4) future S&P in-flows from overseas.
In addition, there’s a great deal of faith and talk right now about 11th hour opportunities in trending niches like electronic vehicles, drone technology, the cloud, renewable energy, a booming Chinese middle class demand miracle, and middle east oil disruptions (i.e. war) pushing oil to 100…etc. etc.
In short, there’s a bunch of folks hoping for (and promising) more market surf.
Again: always hoping.
But can any of this mean good, safe market waves for 2018?
Is a 3000 S&P a possibility?
If we get there by 2019, that would put the S&P at 26X LTM.
In a debt-driven bubble, anything is possible. Yep, even Long Beach, NY can sometimes have better surf than Malibu.
But I wouldn’t bet on it.
Some, of course, will and can.
Animal spirits and Fed-driven crazy markets have all but taken prudence as well as patience out of these markets, which have become increasingly reliant upon robo-trades, ETF flows and hope-selling, from the White House to the MSM.
But if the S&P does hit 3000, that means we would be doing so against the following equally undeniable headwinds, namely: 1) another $1.2T in new Treasury debt by 2019 and $600B of QT (i.e. Fed bond dumping).
Big Swell or Not?
So, what can we reasonably expect—a booming S&P wave or an interest-rate-driven wipeout?
When Trump was campaigning for the Presidency, he famously declared that the US was living under “one big, fat ugly debt bubble that will pop the moment rates go up.”
Well, rates are going up.
One wonders if he remembers his own words? One wonders if he’s watching the yield curve?
In short, one just wonders if he’s even aware that the US spends $5.4B per day just to fund our national deficit.
Needless to say, that number gets more painful (i.e. unsustainable) as interest rates climb.
The debt bubble Trump inherited is by no means of his doing. But why is he making it worse?
Surely his Goldman Sachs alumni in the Cabinet are aware of that very bank’s own recent warnings, which predicted the Federal deficit to hit 5.5% of GDP by 2021.
And Mr. Dimon over at JP Morgan see’s the yield on the 10-Year UST hitting 4% sooner than later.
Earlier this year, Michael Wilson, the Chief Equity Strategist at Morgan Stanley, announced that the “melt-up” in stocks was over, having peaked in the January 7.5% rise, and unlikely to peak again this year, predicting an S&P at no higher than 2750 at year end.
In short, even some of the bankers are putting aside their surfboards and seeing trouble ahead. That is, the surf conditions don’t look too safe.
So why aren’t the market pundits or DC leadership worried?
Hard to say, for what we basically have here is a face-off between a “global growth” bull and a yield-shock bear.
Or in surfer lingo: some folks are “stoked” and others, well…aren’t.
So, who’s right?
The Bull Case—Ride the Wave!
On the bull side, there is a popular argument that anticipated inflows from over-seas will add to the rising tide of the US equity markets.
Again, the basic view here is that US markets, however “choppy,” still offer the best swell in a world otherwise gone flat.
In other words, we are the ironic “safe-haven” in a world awash in debt.
The Bear Case—Shark Warning.
But this ignores one problem. If rates rise, which they will and are, that means the USD rises with it, which means all that predicted/hoped-for in-flow of foreign capital will be subject to rising hedging expenses
In other words, the in-flow may not be as “flowing” as the bulls expect…
Nor should we underestimate the bond jockeys, whom most of us that worked Wall Street admit, are the smarter guys in the room—the sort of varsity players against the JV stock-peddlers.
It’s therefore more than likely that these clever bond athletes will start front-running (i.e. accelerating) the sell-off in the very same bonds the Fed has already promised (“forward-guided”) to sell.
A sell-off in bonds, in turn, means a rapidly escalating (and potentially uncontrollable) rise in rates (i.e. the cost of borrowing).
And rising rates in a bond bubble is to markets what a shark fin is to surfers: bad news.
Given the unspoken dirty little secret that our stock bubble is driven by a borrowing binge, once the per-share interest expense on public company debt rises alongside rising yields, the beach party in the equity market comes to an abrupt stop.
It’s just math folks.
So, what will it be? A great big market wave or a great big market wipeout?
Surf Conditions Are Hard to Predict
But then again, in a momentum market driven by hope, spin and headlines, making predictions based on math and common sense is almost as hard as predicting surf conditions in Long Beach, NY.
Some of the best traders have been predicting volatility for almost 5 years now, and yet the markets do nothing but climb.
So, in all humility, making sense of the senseless has never been harder for investors trained in fundamentals, history, deficits or just old-fashioned market common sense.
Even cautious, value-investing legends like GMO’s Jeremy Grantham seem to have capitulated a bit, admitting that markets could go “dramatically higher” this year despite poor balance sheets and high valuations.
Similarly, banks like UBS and Bank of America, as well as mutual fund stars like Bill Miller, remain extremely bullish for 2018—predicting a 30% rise in stocks. Yep. 30%…
Surf’s Up or Melt-Up?
30% for 2018? Well, that’s actually what we would call a “melt-up.” Is it possible? Good God, today, anything is possible…
But let’s consider what a melt-up really boils down to, for a “melt-up” is basically just another term for momentum investing at the tail end of a bubble.
We saw an S&P melt-up (>40%) commence in April of 2014, as well as a 60%+ melt-up in the NASDAQ. Historically, melt-ups can last up to 20 months.
Given today’s valuations, there’s little doubt we are already in the midst of a melt-up…
And melt-ups (i.e. momentum trades) are fun—as long as you get out before they reverse. That’s the not-so-fun part: paddling back to the beach before you drown.
So, do you feel lucky?
In the 20-month “melt-up” prior to the October 07 peak (i.e. just before the 08 bust), the S&P trailing PE ratio was 17. Today it’s at 24. (During the dot.com bubble in 01, the ratio was 23).
In short, we are sitting in pretty “melty” territory right now. The waves are getting big. Real big.
Markets have never been more expensive, frothy and poised for a dangerous beach-break.
But then again, there are those of you who like to buy at tops, rather than bottoms. There are those who like to take risk. I’m not one of them. It’s like paddling out with sharks in site.
I hate sharks.
The problem with melt-up buying is that it’s driven by psychology and greed (or a fear of missing out) rather than a respect for such pesky little concepts like multiples, CAPE indicators or balance sheets.
Again, it’s up to you. If you have the experience to balance risk vs. uncertainty, then going long today is ultimately a question of personal temperament and market surfing skills.
If you’re not a SignalsMatter Subscriber, and even if you are, it pays to watch flows and signals rather than rely upon hope or the need for one more ride. In short, it’s nice to know the conditions before you paddle out, and right now red flags are flying on the beach.
But Washington doesn’t see them.
Washington: Ignoring the Warning Signs
Regardless of your political bend or party color, don’t look to DC for an honest wave report. Both Houses of Congress, ignoring the debt Tsunami before it, are currently stunned like novices caught on longboards in Waimea Bay…
Neither House has even come up with a budget mark-up or resolution for FY 2019.
Why? Because they are completely over their heads. Paddling in circles. Panicking.
Like so many investors, it seems our elected officials would rather bury their heads in the sand rather than look at our national balance sheet, which is an historical embarrassment (and nightmare) by any measure, political party or honest accountant.
Instead of facing the debt tidal wave before us, Washington is selling us a miracle scenario—namely another 10 years of unbroken fiscal expansion greater than the last 10 years of steroid-driven (i.e. Fed-created) profligacy. (That’s like promising perfect, a summertime of perfect, glass-smooth, overhead North Shore waves on Long Beach, NY. In short, theoretically possible yet highly unlikely…)
If you believe that is possible in the backdrop of: 1) a hawkish Fed, 2) an historically bloated deficit and 3) stalling GDP, then by all means buy the dips and go long. In other words, paddle into the big surf and hope you don’t swallow water.
If, however, you’d rather miss a few rallies and live to ride another day, you may want to consider being a bit cautious, even if that means missing the current melt-up, which in most cases, leaves the majority of trend followers gasping for air…
As always, be careful out there.