An Honest Banker.
As we head into July and more calm before the Fed-induced market storm, I’ve got to give kudos to Bank of America’s chief strategist Michael Harnett. In publically calling out central banks for blatantly creating an artificial bubble that has led to a Wall Street rise and a Main Street fall, he has shown remarkable bluntness in an industry otherwise composed almost entirely of cheerleaders.
It’s one of many unspoken Wall Street secrets that bulls keep their jobs and bears lose em… Banks, like the markets they serve, require money to flow into, rather than out of, the markets. This means banks are put into an inherent conflict of fiduciary interest from the moment the market bell rings and the branch doors open.
That is, bankers don’t keep their customers or markets (or job prospects) strong (and your asset-based management fees high) by scaring the customers that feed them. (They and other wealth managers, after all, don’t get paid when you go to cash.)
In the shadows of the largest market bubble in recorded history, today’s wealth management and banking industry is essentially like a hospital that can’t tell you when you are sick—because bad market news (unlike bad medical news) is bad for business. Can you imagine such a medical system? Well, our financial system is actually that distorted…It’s, well, crazy.
If the chairmen of Goldman Sachs, JP Morgan or Deutsche Bank, for example, publically admitted in WSJ headlines that credit and equity markets were in a bubble, dangerously overbought and far more risk than reward profiled, the resultant sell-off in securities would be extreme. In essence, the truth would spite the truth-teller and banks would make their own markets (crash).
Net result: there aren’t a lot truth tellers in our revered banks…
Not surprisingly then, for a BofA executive to essentially admit this market is rigged by a failed central bank experiment shows a remarkable profile in courage. Truly. He’s essentially telling investors, clients and markets to wake up and beware—something few bankers have ever done –and our Federal Reserve bankers have never done…
Remember how bullish Greenspan and Bernanke were right up until the markets plunged? Yellen, for her part, recently stated publically that there won’t be a market crisis in her lifetime. (Wow. reminds me of “read my lips…”) That kind of central bank hubris is almost begging for a karmic kick in the asset class.
In fact, rising “Fed Hubris” levels are historically-confirmed leading indicators of market declines… (Central Bankers Getting It Wrong).
As for at least one brave banker, however, the indicators are honest rather than hidden. BofA’s Harnett is refreshingly candid in admitting that “greed is harder to kill than fear,” and hence he believes this central-bank bubble may still have a few months before it tops off. Who really knows? But for Harnett, he reminds us (with eerie numbers) that the SPX bull began at 666 and can likely get to 6666 on the NASDAQ before it collapses…
Time will tell, and for at least one candid banker, he sees this autumn/October (when peak central bank liquidity meets peak profits) as an indicator, trigger and turning point.
Market Indicators We Are Watching.
Of course, we, like Mr. Harnett, have our own indicators, triggers and potential turning points.
The Fed, naturally, is always on my mind, but you already gleaned that by now. The other market signals we are tracking at SignalsMatter are myriad, many of which are far too technical and boring for a blog, and other signals are just layered in fundamental filtering too extant for here. Such discussions are for our pending trading dashboard not the blog sphere. Nevertheless, there are some obvious elephants in the market room worth talking about.
The Russell 2000.
June saw this collection of small cap companies approach all-time highs at 1433. Now this is up, way, way up from the RUT’s March 09 lows of 360… So what makes an index climb from 360 to 1433 in eight years? Well, the answer rhymes with “central bank stimulus.”
Cynics will argue the real tailwind is earnings, and right now the RUT is trading at 80X LTM (last twelve month) earnings, with those always-optimistic bank analysts predicting (not surprisingly) a rise of $72 per share in operating earnings for the Russell’s 2000 co.’s in the next 12 months. What those pundits aren’t telling you, however, is that these projections are based on ex-items accounting, not GAAP numbers. In other words: bunk.
If you’ve been trading awhile, you also know that the Russell 2000 companies are like the little speed boats of the market ride: they roar up in good times and sweet conditions, but tank like rocks when the water gets rough. I personally look at the RUT as a leading indicator, and when I see it acting bullish and reaching record highs within a bearish backdrop (i.e. stalling GDP growth and a Fed about to tighten monetary policy, balance sheets and credit), I see trouble ahead.
These little speed boats usually burn bright, and then burn out.
The ETF Phenomena.
Our SignalsMatter eBook spends a lot of time on the rise of the actively traded yet entirely passively-managed ETF vehicle. Indeed, the proliferation of ETF vehicles and flows is nothing short of phenomenal, with ETF trade volumes ($4T today) now up 4X from their 08 levels (of $800B). We ourselves trade ETF vehicles based upon our own signals.
But there’s a hidden market danger behind these passive little creatures… ETF’s are essentially just baskets of stocks within a similar class or index, such as Tech ETF’s, or Energy ETF’s, or large-Cap/High Div ETF’s etc. But these baskets have a hidden little problem: they are often composed of a veritable hodge-podge of the good the bad and the ugly. That is, a single Tech ETF might include a percentage of roaring names as well as a percentage of boring names.
In good times (i.e. artificially created bull markets tied to central bank stimulus) a given ETF will be bought en mass by hedge funds, retail investors, pension funds etc., and thus all the stocks within that ETF—the good and the ugly—rise in tandem.
This is a bad thing. As money flows into ETF’s at record levels, the bad stocks within those ETF’s experience roaring (and entirely undeserved) stock price inflation.
This is just one more (of the oh so many) ways the Fed has distorted capital markets. By essentially creating QE/ZIRP market addicts who see only reward and no risk (the VIX continues to reach all-time lows as markets reach all-time highs), central banks in general and the Fed in particular, have absolutely demolished normalized price discovery and active risk management approaches.
With the central banks “eliminating market risk” via the post-08 steroid world of money printing and low rates, investors are rushing out of mutual funds and piling into ETF’s at an astounding $1T (!) pace since 2009. Markets have effectively lost interest in actively managed (i.e. risk managed) vehicles (like mutual funds) and are seeing only ETF’s in their starry-eyed gaze.
This means that all those bad companies lumped in with the good companies in the ETF baskets are shooting up in value, which further means the Fed has effectively made short-selling a dying trade at the same time it has made mutual funds a dying vehicle.
After all, why short a security that is being artificially lifted by ETF flows? Value no longer matters. You’ll get squeezed. Furthermore, who needs active management when markets just rise on their own?
Even more alarming, the flows into ETF’s have also put a huge spike into the art of stock-picking, the very heart of market investing. Why? Simple: Fed-addicted investors enjoying the greatest tailwind in history don’t need to actively pick solid securities based on balance sheets and income statements anymore; they just need to toss money into a passive ETF vehicle and ride the central bank wave…
But here’s the rub. That same wave will eventually drown you. And the wave is getting huge. Those archaic and boring ol’ market approaches like active risk management, short-selling and stock-picking will be very popular again once this ETF mania is humbled by market gravity rather than Fed steroids.
As the Fed looks into the barrel of a massive (and self-inflicted) market bubble which they are slowly losing the ability to manage (Central Banks Losing Control), they are desperately looking to cut off the steroids—i.e. reduce the Fed Balance Sheet and raise rates in anticipation of another recession (we are 8 years into the current “recovery,” which may or may not break new records in length, given the steroids behind it).
But whenever and however markets begin to turn over (Possible Market Triggers), those same passive ETF vehicles which rose at rocket speeds during the recovery, will fall at even faster speeds during the correction.
The ETF phenomenon will have historical implications on market volatility and the range, speed and depth of future market correction.
In short, many who live by the ETF sword will die by the ETF sword.
Investors therefore need to recognize the risks, size and potential volatility of this ETF-top-heavy market, which is increasingly traded by computers rather than risk managers. Cash, risk management, active strategies and recession-watching may not seem sexy right now—for as Harnett rightly noted above, “greed is harder to kill than fear.”
But for those of you who want to build the right portfolio for when that big-bad-market wolf comes around (Market Risk Ahead), a brick house is better than a mud house, and please consider this: the ETF’s can turn muddy fast.
The Real Estate Indicators.
Another indicator near and dear to any of us who remember the last bubble is real estate. And the real estate bubble today is real. I’ve been watching the NAR’s May reports stroll in, and the data is compelling. The numbers tell us that year-to-year home prices have seen a gain of 5.8%.
But as prices rise, the year-to-year volume of home sales has stalled, with PHS (pending home sales) numbers for May up only .5% from last May. By comparison, the same PHS increase the year before was up by 2.4%, and 2 years ago that number was as high as 7.9%.
Stated otherwise, real estate prices are rising and sales volume is tanking. The pundits are attributing the price surge to a supply shortage, and based on NAR and RedFin data, the pundits are actually right. Housing inventory is indeed going down, and thus there is a buying panic again to get what’s out there.
I remember the last “buying panic” in real estate: it was 2005 and 2006. And I also remember when that buying panic quickly de-volved into a selling panic and a dramatic plunge in housing prices.
Many of the same forces at work in 06 and 07 are at work again today. Then, as now, sales peaked and then collapsed. And behind this cycle, then as now, was a drunken Fed doing too little too late. Low rates and easy credit spurred a bubble, the bubble peaked and then popped.
This time around the Fed “stimulus” has created bubbles everywhere (the “everything bubble”), including real estate. Their response? Remove money from the system, tighten the Fed balance sheet, which will lead directly to higher rates, less mortgages and thus less buyers. Soon, it will be the sellers panicking to find buyers as asset values plunge.
So, if you’re looking to sell a house, do it quickly. And if you’ve got the cash to buy one, be patient. Your time is coming soon enough to get a helluva deal.