Below, we’ll examine four reasons that markets are crazy and how YOU can prepare for even stranger days ahead.
Wow. We live in interesting times. Markets are ripping, fear and fundamentals are fading, politicians are dumbing, rumors of war are increasing, wages are falling, debt is skyrocketing, the Fed is back peddling (from easing to tightening), even bank cheerleaders are shrugging.
And to top it off (for me at least), the Dodgers just crushed my Cubbies and clinched their first trip to the World Series in three decades…
In short. There’s a lot of crazy going on.
And writing today from Los Angeles, it’s not the World Series that has me down (one, after all, has to give the Dodgers due respect), it’s the rest of the world. And more to the point for a market guy, it’s the financial world that just continues to fascinate me/us here at Signals Matter.
So let’s pause for a moment at look at four reasons the financial world feels, well: crazy.
Since the Trump election, the S&P is up 20%, the Dow 26% and the NASDAQ 28%. Normally, one would assume that such a market ride must be driven by equally record-breaking earnings, no?
But as the graph below reminds us, earnings (black line) have stagnated since 2014 while markets (blue line) have risen on algos, ETF in-flows and sell-side, MSFM hype rather than anything at all resembling fundamentals—i.e. actual FCF, profits or that once so precious notion of supply and demand, which the Federal Reserve effectively destroyed since 2008.
On the eve of the last financial crisis in 08, the average earnings for the S&P was $85 per share. One decade, market bubble, and 5X increase in monetary balance sheet (Fed cocaine) later, and that average has only climbed by 2% a year to about $100/share. In short: a complete earnings yawn…
In a market gone mad, we see indices at record highs, earnings at yawning averages, PE multiples at dangerous peaks and the VIX at record lows. In short, a perfect backdrop to a perfect storm.
And for those of you trading since 2000, we all can say this: “we’ve seen this movie before.”
What’s even more amazing to us is that even the bankers are starting to ring warning bells rather than shake their traditional pom-poms. That’s right, even the market’s cheerleaders are starting to worry about the outcome of this dangerous game.
Back in July, for example, I gave well-earned kudo’s to Bank of America’s Michael Hartnett, who had the courage and candor to warn the markets about the dangers of central bank tampering with security valuations/bubbles.
Recently, that same bank published 20 metrics for measuring S&P valuation, and concluded that 18 of those 20 indicators show dramatic overvaluation in the S&P.
Even the folks at Goldman Sachs are issuing warnings rather than their typical sell-side “rah-rah-rah,” announcing this week that median stock prices are in the 98th percentile of historical overvaluation.
As for bonds (the one asset class which I have consistently warned as being of even greater concern than stocks), Goldman reported that the high price (and hence low yield) on the 10-Year UST is at the 96th percentile in historical overvaluation (!) while the junkiest bonds of the credit market (the miss-labeled “high yield” paper) has ballooned to the 98th percentile in historical over-valuation.
In other words, we’re not the only ones talking about bubbles any more.
Republican, Democrat or Cynic, we can all pretty much agree that the DC swamp has never felt swampier.
It’s also odd to us that very President who honestly campaigned about a “big fat, ugly market bubble” created by the Fed, is now publicly taking credit for the double-digit rise in that very same bubble. Trump has made over 20 tweets taking personal credit for this crazy market bump.
(Trump’s not a reader or an academic, but if he were, I’d suggest he brush up on Greek tragedy in general or the concept of hubris in particular… This market, to which so much of his credibility is tied, could very easily take him down with it…)
Meanwhile the same Trump who lambasted the eminently “lambastable” Hillary for cow-towing to Goldman Sachs, has since made one of Goldman’s partners, Steven Mnuchin, our Treasury Secretary.
“There is no question that the rally in the stock market has baked into it reasonably high expectations of us getting tax cuts and tax reform done.”
“To the extent we get the tax deal done, the stock market will go up higher. But there’s no question in my mind that if we don’t get it done you’re going to see a reversal of a significant amount of these gains.”
As I’ve warned elsewhere, there’s potential reasons to doubt the substance, let alone passable form, of any meaningful tax cut. But whether such a “baked-in” tax bill/cut comes or not (Mnuchin, btw, is “guaranteeing” it by year-end) is not the real issue.
What’s more alarming is the fact that our Treasury Secretary Mnuchin has effectively confused what’s best for the country with what’s best for the stock market.
His public guarantees and warnings (and Trump’s public bombast) are essentially a policy of coercion rather than public service. That is, Mnuchin is basically telling congress to pass a tax cut or else the markets are gonna crash…
Is that a bad thing?
Remember, capitalism, upon which America once made itself great, is supposed to be about productivity (i.e. GDP, stagnate for 10+ years) and earnings (stagnate since August of 2014), not veiled political blackmail or a ripping S&P casino.
A return to actual productivity, manufacturing, low debt and honest price discovery—not a stock bubble—is what made America Great.
Back in May, I wrote a piece on the dangerous implications of a record low VIX, or “fear index.”
I had used the analogy of the three little pigs fable to make a true point that short-sighted market strategies like selling volatility (i.e. collecting put premiums) by managers who have no long-term fear of a big bad market wolf, has been profitable but dangerous.
I compared these vol-sellers to the two little pigs living in the mud or straw houses: having lots of fun and profits, headless to the market wolf (i.e. volatility) patiently lurking in the woods.
If you recall, I also warned that such piggy’s (and strategies) will get slaughtered the moment volatility returns, because those strategies (and portfolio managers) selling vol in the “happy times” will immediately need to cover their shorts the moment volatility (unhappy times) spikes, creating the disastrous domino effect of volatility begetting more volatility…
Of course, as of this writing, no such Big Bad Market Wolf, is huffing and puffing. But he’s out there, waiting, sharpening his teeth…
Meanwhile, those in the straw huts of todays markets are confident that all will be fine. They say no volatility spikes (wolves) are coming because of: 1) predictable central bank policy 2) low inflationary pressures, 3) solid corporate earnings growth and 4) the synchronized global economic “recovery” that’s been seen this year, among others.
Hmmmm. As I, and many others have written elsewhere, each of these so-called volatility assumptions are arguably fictions rather than facts. I’d maintain, for example, that “predictable central bank policy” is about to get very unpredictable…
As to “low inflationary pressures,” I feel my blog on the inflation lie puts that meme to a hard test.
And as far as their faith in “solid earnings growth,” I’d bluntly argue that there has been nothing “solid” or “growing” at all about earnings, as the graphs, figures and even banks above would agree/corroberate.
The hard and blunt reality, as we see it today, is that market fundamentals died years ago. The day (circa 2008) that central banks rather than natural demand stepped in and fully distorted price discovery and asset classes was a dark stain in the history of capital markets.
Sure, $15T in collective “stimulus” (i.e. market cocaine) form the ECB to Bank of Japan to the Federal Reserve, avoided lots of pain, but it did not eliminate it—it merely postponed and augmented it. The price (or reckoning) for that failed bail-out experiment has yet to come.
The big question now, in a crazy market without volatility, is simple: when and how will the volatility return and this market turn south?
Here at Signals Matter, we keep our macro opinions to the side and focus on signals rather than personal frustrations when it comes to monitoring the horizon for the big bad market wolf. Of course, no one can say today precisely when or how this party of crazy will end.
But our Signals Matter “Iceberg Watch” and “Trend Watch,” going public next month, provides our Subscribers with a massive advantage in early-warning signs. We look at hundreds of volatility indicators to provide a better sense of just how close that iceberg (or market wolf) really is.
Whether its war, politics, monetary policy, or some other odd catalyst—we’ll be the boring piggy in the brick house, not the mud house.
Want to join us?
We’ll see you in November. 🙂