More Kale Smoothies On The Way
Regardless of whether or not the Bank of Japan’s statement this week is well received by the financial markets, the trend has been and will continue to be to print more in an effort to prop up an over-indebted global economy. China is a good example of the limitations of endless “stimulative” kale smoothies. From The Economist:
The country’s debt has increased just as quickly over the past two years as in the two years after the 2008 crunch. Its debt-to-GDP ratio has soared from 150% to nearly 260% over a decade, the kind of surge that is usually followed by a financial bust or an abrupt slowdown.
China will not be an exception to that rule. Problem loans have doubled in two years and, officially, are already 5.5% of banks’ total lending. The reality is grimmer. Roughly two-fifths of new debt is swallowed by interest on existing loans; in 2014, 16% of the 1,000 biggest Chinese firms owed more in interest than they earned before tax.
China requires more and more credit to generate less and less growth: it now takes nearly four yuan of new borrowing to generate one yuan of additional GDP, up from just over one yuan of credit before the financial crisis. With the government’s connivance, debt levels can probably keep climbing for a while, perhaps even for a few more years. But not for ever. When the debt cycle turns, both asset prices and the real economy will be in for a shock. That won’t be fun for anyone.
Gradual Shift To Helicopter Money
No central bank, including the Bank of Japan (BOJ), wants their policies to be associated in any way with the term helicopter money. However, given central banks are already engaging in direct-injection stimulus, including the Bank of Japan buying stock ETFs, over time a move toward purer forms of helicopter money is a high probability outcome. From CNBC:
Citi has forecast a “gradual shift towards helicopter money” by advanced economies, as countries struggle to boost growth and inflation in uncertain geopolitical climes.
The bank’s report came as the Bank of Japan started a two-day meeting on Thursday, after which it is widely expected to launch another major stimulus program. Prime Minister Shinzo Abe is seen announcing a fiscal stimulus package as well, which a report by news agency Jiji put at 28 trillion yen ($267 billion).
Direct Move To Helicopters Unlikely
Central planners in Japan have been doing a lot of talking recently, which means a disappointing reaction to the BOJ’s statement is well within reason. From MarketWatch:
The Bank of Japan starts a two-day policy meeting today and some investors expect it to team up with the government to announce more extreme stimulus measures on Friday. Prime Minister Shinzo Abe already said Wednesday that he is preparing a ¥28 trillion fiscal stimulus—much greater than previous expectations for a 10 trillion yen stimulus. Still a number of traders say the market may have priced in such expectations already, setting investors up for disappointment.
It becomes a bit easier to comprehend the S&P 500 pushing to new highs when viewed in the context of central planners throwing around stimulus figures in the neighborhood of 5% of a country’s total GDP. From Reuters:
The Japanese government is planning direct fiscal spending of around 7 trillion yen ($67 billion) to help fund an economic stimulus package totaling more than 28 trillion yen, two people briefed on the matter told Reuters on Thursday. That amount - at just a quarter of the total package - could disappoint some market players bracing for bigger outlays given the massive headline figure, equal to more than 5 percent of gross domestic product.
High levels of debt, tepid global growth, and hyper-dovish central bank policies have helped push a somewhat odd trio of ETFs to new highs, as outlined on July 22.
The 1994 case demonstrates the longer stocks go sideways, the bigger the move we can expect after a successful breakout. However, even under the successful breakout scenario, a retest of prior resistance may be in the cards, which is exactly what happened in early 1995. In 2016, the Dow Jones Industrial Average (below) may be in retest mode.
Given the high levels of global debt, the lesser of the evils alternative typically is to try to inflate it away. The chart below, showing the performance of materials stocks (XLB) relative to Treasuries (TLT), is one way to monitor the battle between inflation and lingering concerns about deflation.
Like the XLB/TLT ratio above, the ratio of energy stocks (XLE) to Treasuries (TLT) also has some work to do. With a Fed statement coming Wednesday and one from the Bank of Japan before the end of the week, these ratios should provide some insight into the market’s reaction.
Stocks vs. Bonds
The S&P 500 (SPY) has not yet broken out relative to long-term Treasuries, but has made some progress relative to intermediate-term Treasuries (IEF). If the SPY/IEF breakout below holds, it will improve the odds of the S&P 500’s recent push above 2,134 holding.
Markets Move On Shifts At The Margin
Markets are constantly monitoring and assessing data on numerous fronts (earnings, interest rates, debt, etc.). Market prices are determined by facts in hand and expectations about future outcomes related to each data set. Therefore, changes at the margins of the data sets tend to be what move markets.
Earnings: Weak With A Possible Silver Lining
If you were told corporate earnings were on track to decline for five or six consecutive quarters, you would not guess the S&P 500 would be breaking out to new highs (as it did earlier this month). Earnings season for the current quarter remains a work in progress, however some marginal trends are emerging. From CBS Moneywatch:
And as is typical, the results have been coming in ahead of expectations: 68 percent of S&P 500 companies reporting to date have beaten their consensus earnings estimates. But the results haven’t been good enough to end the ongoing corporate earnings recession, now in its fifth consecutive quarter. And what’s worse, early indications are that blended S&P 500 earnings are now set to decline in the third quarter as well.
The Shift At The Margin Shows Some Improvement
If the economy is heading for a recession, which may or may not be the case, we would expect earnings to be getting worse. Earnings growth is still ugly on a year-over-year basis, but the recent trend is showing some marginal improvement, rather than deterioration. From CBS Moneywatch:
Overall, FactSet analysts note that the expected second-quarter S&P 500 earnings decline stands at -3.7 percent, an improvement from the -5.5 percent decline they expected last week and at the second quarter’s end. Yet, even factoring in the typical improvement in average earnings growth during an earnings season, they believe it’s likely the quarter will end with an outright decline in profitability on a year-over-year basis. Third-quarter earnings expectations have now fallen into negative territory as well — suggesting the earnings recession could stretch to six consecutive quarters.
Hypothetical Example – Earnings
A year-over-year earnings decline of 3.7% does not sound good, but it shows marginal improvement relative to last quarter’s decline of 6.5%.
To illustrate the concept of marginal shifts in data sets, we can take a look at earnings growth over the next three quarters. The blue areas below show the data we have in hand today (knowns). The red and green areas show two very different and hypothetical paths for earnings growth for the coming quarters (unknowns).
It seems obvious to say “if earnings improve, it will be a positive for stocks”. What is not so obvious in the short run is that “if earnings growth is negative, but not as bad as the previous quarter, that represents incremental improvement”. Earnings declined by 6.5% in Q1 2016, which is quite a bit worse than the current decline of 3.7%. The 3.7% is not etched in stone since earnings season is not over yet, but odds say this quarter’s decline will be smaller in magnitude relative to last quarter’s.
Example: Marginal Shift In Rate Expectations
A recent example of markets reacting to a marginal shift in expectations was the Fed’s dovish about face between January and June 2016 (see headlines below).
When the Fed backed off their multiple rate hikes script, markets adjusted. Keep in mind, the Fed did not say they are on the cusp of adding new liquidity to the financial system; they simply said they planned to drain less liquidity than the market expected, which represented a marginal shift in liquidity/interest rate expectations. A similar shift will occur with corporate earnings; the question is will the shift be in the marginal “getting better” or “getting worse” camp.
Time And The Margins Will Tell
If the new information at the margin follows the green or bullish path below, it will help explain why the S&P 500 was able to break out to new highs. Conversely, if the market’s marginal new data follows the red or bearish path below, it is likely the recent push to new highs in stocks will revert back to the “failed breakout” category. Time, the charts, and the data will tell.
Other Marginal Data Sets
The recent breakouts by bonds (TLT), stocks (SPY), and gold (GLD) tell us quite a bit about current expectations regarding a wide range of potentially market moving data sets, as outlined in detail on July 22.
A Tale Of Two Markets
The two S&P 500 (SPY) charts below paint a starkly different picture from a risk-reward perspective. On June 27 (top), the S&P 500 was below prior resistance, inside the long-term trading range, below the 50-day, and below the 200-day. As of July 22, the S&P 500 was above prior resistance, above the long-term trading range, above the 50-day, and above the 200-day.
Even if the S&P 500’s breakout above 2,134 holds, some “give back” or even a retest of prior resistance may be needed to bring in additional “waiting for a pullback” buyers.
What Messages Are Being Sent By The Markets?
This week’s video breaks down the fundamental messages being sent from recent action in stocks (VTI), bonds (TLT), and precious metals (GLD). The messages from this diverse set of asset classes shed light on investor perceptions about the economy, valuations, earnings, central banks, and global debt.
Busy Final Week Of July
It will not be a quiet summer week in the financial markets. From CNBC:
The coming week is packed with lots of potential market movers, starting with the release of earnings from about 35 percent of companies in the S&P 500. There’s also a Fed meeting Tuesday and Wednesday, the Democratic National Convention starting Monday and a much anticipated Bank of Japan meeting at the end of the week. Before the week even gets underway, the G-20 meets in China over the weekend, and next Friday, stress test results are expected for those worrisome European banks.
Retest Is One Of Many Scenarios
The big picture still looks good relative to the S&P 500’s breakout from a multiple-year consolidation pattern (see below). In terms of common action after breakouts, price often (not always) wants to retest the breakout area. The market will make the call over the next few days. The potential significance of the S&P 500’s breakout was outlined on July 12.
Stocks Make Progress Versus Bonds
The S&P 500 vs. intermediate Treasuries (IEF) chart below has cleared two hurdles this week: (1) the thin downward-sloping blue line, which dates back to the S&P 500’s 2015 peak, and (2) the multiple-month consolidation box. The longer those breakouts remain in place, the higher the odds the S&P 500 will hold its breakout above 2,134.
The S&P 500 vs. long-term Treasuries chart has not cleared the hurdles described above. Both charts remain helpful in terms of the sustainability of the bullish breakout in equities.
Energy Testing Overhead Resistance
If energy stocks (XLE) can break out from what may be a consolidation/bottoming process, it would also improve the bullish case for the broader stock market. For now, XLE is still below an area of potential resistance.
Total Debt Is Much Worse Than 2007
Global debt levels have increased at a rapid rate since the financial crisis. Debt, of course, has to be taken in the context of an economy’s ability to generate value. From Mauldin/Dillian:
The US has a 103% debt-to-GDP ratio. It’ll go up a lot under either Trump or Clinton. Italy’s debt to GDP is about 170% or so; Japan is at 240%. There really isn’t any chance that Japan is going to pay you back, or Italy, or even the US, once you take out-of-control entitlements into account.
Default, Extend And Pretend, Or Inflate
Debt has been and continues to be a well-known problem, and yet, it just seems to keep growing and growing. The easiest way to reduce the economic drag from bloated debt is to grow your way out of the problem. For numerous reasons, that has proved to be a difficult task.
If growth does not pick up, there are three major ways to deal with debt: (1) default, (2) extend and pretend, or (3) inflate. From Mauldin/Dillian:
Nobody is going to default here. You want to talk about Financial Armageddon… that would be it. Greece hasn’t had a lot of luck with extending and pretending. They’re in this sort of endless depression. I doubt anyone would want to copy them. Nope, everyone is going to inflate, which is the stealth way to default. There has already been open discussion about helicopter money in Japan (essentially the BOJ retiring or canceling outstanding debt).
Central Bankers And The Law Of Diminishing Returns
This week’s stock market video looks at how we got to this point and what are the possible next moves from global central bankers. The video takes a detailed look at the economic limitations of zero rates, QE, and helicopter money.
What Is The Market’s Current Read?
When the Fed was talking about entering a traditional interest rate hiking campaign, the markets were having difficulty coming to grips with a rising inflation scenario. However, once the Fed flipped the interest rate playing field in the first half of 2016, inflation-protection assets started to catch a bid. Notice gold started to turn just as the Fed backed off their “four rate hikes in 2016” stance (late January-early February 2016).
Does The Market Feel Inflation Is Imminent?
Given the look of the charts for long-term Treasuries (TLT) and intermediate-term Treasuries (IEF) below, the markets do not appear to be overly concerned about inflation in the short run.
However, like anything in the markets, that tame read on inflation is subject to change in the coming months; something we will continue to monitor closely.
Stocks, Bonds, And Gold All Holding Up Well
The mathematical readings from our market model for stocks, bonds, and precious metals all reflect bullish trends. The demand for all three assets classes aligns with an expectation that central banks will continue/expand their ultra-dovish policies (good for stocks and bonds), along with a growing acceptance that inflation/currency debasement may be the preferred long-term approach to deal with overwhelming global debt levels (good for gold and silver).
The Fed Who Cried Wolf
Just weeks after Janet Yellen outlined a new normal marked by low rates, the chatter has started about hiking again as early as September. Are investors buying it? Not really, the market, as of 10:30 am ET Tuesday, is pricing in an 81% probability the Fed does nothing at their September meeting.
A Logical Question
Casual market followers, along with many seasoned Wall Street veterans, may have recently had an internal voice ask:
What the heck is going on in the financial markets?
The short answer is everything we have come to know over the past 20 years about the latter stages of economic, interest rate, and market cycles, changed in early 2016. The shift is clearly evident in the odd behavior seen across numerous asset classes, which the tweet below captures:
The tweet above basically says stocks and bonds simultaneously experienced record-inducing demand. Is it uncommon for stocks and bonds to rise together? No, in fact it is quite common. The extremely rare part of the equation is that maximum confidence (new record high in growth-oriented stocks) occurred, for the most part, simultaneously with maximum fear (new record low in bond yields). Common sense tells us that maximum economic confidence and maximum economic fear should not occur in the markets on the same day, but that is exactly what happened on July 8.
How Did The Market’s Narrative Change In 2016?
After all the 2016 New Year’s confetti was cleaned up, the Federal Reserve was talking in a very unfriendly tone from an asset price perspective, as evidenced from the January 6 headline below (full Reuters story):
The Fed’s intention to raise rates as the economic data improved fits the script we have all come to understand over the past 20 years. Often bull markets and periods of economic growth come to an end after the Fed hikes rates a few times in an effort to keep inflation in check (or to restock their policy toolkit).
January 2016: Market And Fed Were Following Traditional Script
All things being equal, the financial markets frown upon Fed rate hikes. The S&P 500 responded to the hawkish and “old-script” Fed with the worst ten-day start in U.S. stock market history. During the January plunge in risk assets, the financial markets were reading from the deflation/weak economy/bear market script, as depicted by the chart of silver relative to defensive Treasury bonds below.
Today, the same silver:bond ratio looks quite a bit different, reflecting the market’s reaction to the Fed’s new and recently communicated late economic cycle script.
Debt, Helicopter Money, And The Fed:
This week’s video expands on the concepts covered in this post. How did we get to a point where central banks are seriously talking about helicopter money? What does it mean for the markets and investing?
Debt And Valuations Make Raising Rates Difficult
Why has the Fed adopted a new late economic cycle script? Given extremely high levels of global debt and elevated valuations, central bankers are terrified of inducing anything remotely approximating a Japan-like deflationary spiral. The Fed is concerned if they follow the traditional late-cycle script, asset prices could experience a significant and sharp reset, which could ignite a wave of bond defaults and/or a recession. From the Los Angeles Times:
Eight years ago, unsustainably high debt was the root cause of the worst recession since the Great Depression. Yet, world debt overall now is far above 2008 levels…The overstretched include plenty of governments. Total government debt outstanding worldwide was worrisome in 2008. It has since doubled to $59 trillion, according to Economist Intelligence. But that is just one slice of the global debt pie. Add in household, corporate and bank debt and the grand total was a mind-boggling $199 trillion in mid-2014, up 40% since 2007, according to a study last year by McKinsey Global Institute.
Inflated Asset Prices Reacted To Threat Of Rate Hikes
The Fed was given a taste of what a global reset might look like after they raised rates in late 2015. The S&P 500, as of January 20, 2016, is shown below.
What Markets Were Anticipating In Early 2016
For illustrative purposes, the S&P 500 is shown below from 1997 to 2004. The old script says central banks raise rates near the end of a bullish cycle (1999); the economy eventually slows, and risk markets eventually fall (2000). Sometime during the bearish/recessionary period that follows, the Fed starts to ease policy again (2001) and eventually a new bullish cycle begins with an improving economy and a new bull run in risk assets (2003).
How Did Central Banks Flip The Playing Field?
After the Fed’s early 2016 deflationary spiral scare, central banks slowly started delivering a message that they have gone down a policy road (zero/negative rates) that is very difficult to reverse using the traditional late economic cycle playbook.
The dated headlines below, along with links to each article, illustrate the shift that took place between early January 2016 and the present day. The first headline aligns with the traditional late economic cycle script. The last headline aligns with the new “too much debt and valuations say asset prices are vulnerable” late economic cycle script.
The Fed Saw The Writing On The Asset Price Spiral Wall
Experienced investors would quickly label the January 2016 S&P 500 below as a “possible head-and-shoulders topping pattern”. Bull markets often end when earnings slow, valuations become extended, and stocks move sideways for a long-period of time. All three were in play early in 2016, which makes it easier to understand why the Fed shifted abruptly from “four hikes in 2016″ to “helicopter money should be in our toolkit”.
A Major Bottom Near A New All Time High?
The Fed’s flip flop on rates helped spark the current rally in stocks, which put the mini deflationary spiral fire out. Recently, pre-and-post Brexit and ultra-dovish comments helped markets come to grips with the fact that the central banks plan to extend their zero/negative rate policy experiment further, rather than reign it in as the Fed indicated in January. A July 12 article referenced an extremely rare breadth event that occurred as central banks communicated their asset-price-escalation game plans. The rare event was described via SentimenTrader’s tweet below:
In the chart/tweet above, notice the last time the rare breadth event occurred; in early 2009 after an incredible amount of bear market related stimulus had been announced (green arrow). The 2009 bottom in stocks fit into the traditional market and interest rate cycle script (stimulus came during the bear market/recession and helped create a new bull market/expansion).
Trying To Create A Major Bottom From A Major Top
As pointed out by @DowdEdward (see tweet below), notice how the first breadth event occurred near a major market low (green arrow); a low that was assisted greatly by central banks and government bailouts/stimulus. The second occurrence in 2016 (blue arrow) also followed talk of possible bank bailouts in Europe and even more stimulus from central banks. The big difference is the first rare occurrence happened near a major market low (green arrow) and the second rare occurrence took place in the context of what appeared to be a traditional end of a bull market topping pattern in stocks (blue arrow).
Central Banks Scratching And Clawing In An Attempt To Avoid Deflationary Spiral
The concept of creating a “bottom near a top” is exactly what global central banks are trying to engineer. They keep hoping the next batch of rate cuts, money printing, asset purchases, etc. will create sustainable economic growth, allowing earnings to catch up to artificially propped up asset prices. Central planners hope the next “wealth effect” program will allow them to grow their way out of the zero/negative rate mess they have created over the past nine years. If their grand policy experiments fail, central bankers will lose a considerable amount of power.
Helicopters Dropping Money?
In the United States, the Federal Reserve has gone from “four rate hikes in 2016” to “we should have helicopter drops” in our policy toolkit. With Janet Yellen and FOMC member Loretta Mester both having talked about helicopter money within the last thirty days, more and more market participants are coming to the conclusion that it is highly unlikely the Fed has entered a traditional late-cycle campaign to raise interest rates, but instead the next two or three policy moves could push the Fed’s already hyper-dovish stance into maximum hyper-dove mode. From Australian Broadcasting Corporation:
Dr Loretta Mester, president of the Federal Reserve Bank of Cleveland and a member of the rate-setting Federal Open Market Committee (FOMC), signaled direct payments to households and businesses to stoke spending [a helicopter drop] was an option central banks might look at in addition to interest rate cuts and quantitative easing. “We’re always assessing tools that we could use,” Dr Mester said in response to a question from the ABC about the potential use of helicopter money.
Japan Is Already In Near-Helicopter Mode
The Bank of Japan has a policy statement due to be released on July 29. The financial markets will be looking for additional stimulus. From a July 14 Bloomberg story:
Etsuro Honda, who has emerged as a matchmaker for Abe in corralling foreign economic experts to offer policy guidance, said that during an hour-long discussion with Bernanke in April the former Federal Reserve chief warned there was a risk Japan at any time could return to deflation. He noted that helicopter money — in which the government issues non-marketable perpetual bonds with no maturity date and the Bank of Japan directly buys them — could work as the strongest tool to overcome deflation, according to Honda. Bernanke noted it was an option, he said.
“There’s a strong allergy to so-called helicopter money in Japan, though the definition of the word differs from person to person,” Honda said in an interview on Wednesday. “While looking at the BOJ’s bond purchases and fiscal policy as a package, which I see as a kind of helicopter money, it would be beneficial if the prime minister understands that there is a global leading scholar clearly advocating helicopter money,” said Honda, who was speaking by telephone from Switzerland, where he is serving as Japan’s ambassador.
The markets may not get a textbook helicopter plan from the Bank of Japan on July 29, but the degree of accommodation may be in the same money-printing ballpark. From Bloomberg:
Ben S. Bernanke earned the nickname “Helicopter Ben” for once suggesting a central bank could overcome deflation by cranking up the money presses to finance tax cuts. He’s always made clear such efforts would be a last resort, the equivalent of dropping money from the sky. So when the former Federal Reserve chairman arrived in Tokyo for talks with Japan’s top policy makers this week, bond traders, stock investors and economists had reason to wonder. Was Shinzo Abe’s economic team (Bank of Japan) ready to break the glass, pull the emergency lever and entertain such a radical shift in policy as direct fiscal financing by the central bank. While officials Wednesday played down the most extreme scenario, two of Abe’s top advisers did call for a double-barreled blitz of coordinated fiscal stimulus and money printing.
Why Is There Too Much Debt?
There are numerous reasons, but extremely low interest rates and debt bailouts are a good place to start. Recessions, like other processes in nature, help identify weak players in the public and private sector. During recessions, the rate of bond defaults increases, which is a natural way to purge bad debt from the global economy. The problem is central planners have pumped up asset prices to such lofty and artificial levels, central bankers fear that letting economic natural selection into the debt purging process could set off a hard to stop deflationary spiral in asset prices. Below are just a few examples from the central planning bailout collection:
More Bailouts Coming In Europe?
When policy makers continually prevent major debt defaults via bailouts and keep interest rates near zero, the global debt mountain just keeps getting bigger and bigger. The problems are still with us in 2016. Europe is currently debating how to prevent zombie banks from defaulting; some are calling for a $166 billion dollar bailout. From The Wall Street Journal:
Nowhere is the risk concentrated more heavily than in the Italian banking sector. In Italy, 17% of banks’ loans are sour. That is nearly 10 times the level in the U.S., where, even at the worst of the 2008-09 financial crisis, it was only 5%. Among publicly traded banks in the eurozone, Italian lenders account for nearly half of total bad loans. Years of lax lending standards left Italian banks ill-prepared when an economic slump sent bankruptcies soaring a few years ago.
Helicopters And Paper Currencies
How confident would you feel about the cash in your wallet if global central banks started making direct payments to households and businesses or simply printing money to retire government debts? The answer may help us understand why investor demand for hard currencies (gold, silver) has increased substantially as more and more serious chatter emerges about fueling up the money-drop helicopters. From CFA Institute:
Why has the post-crisis recovery been so disappointing? … Are we stuck in a world of diminished prospects and subdued demand? These were the key questions Lord Adair Turner, chairman of the Institute for New Economic Thinking and author of Between Debt and the Devil… “Debt has become unsustainable across the world,” Turner explained… “The trouble is,” Turner explained, “once we have these cycles of credit, asset prices, more credit, if we then get a swing from the exuberant upswing to the depressive downswing, if we get that when leverage is already high, we seem to enter an environment where the leverage never actually goes away. All it does is move around the economy.”
Debt is never paid down, in other words. It’s only shifted: from corporate debt to public sector debt, from advanced economies to emerging markets, and so on. Citing both Milton Friedman and Ben Bernanke, Turner proposed “helicopter money,” or what he prefers to call “overt monetary finance of increased fiscal expenditure.”
“You can use central bank money to finance tax cuts or expenditure increases in a fashion that does not require the government to borrow money,” he explained. “Or you can monetize existing government bonds. Central banks can buy existing government bonds and simply write them off, which frees up the government to run larger fiscal deficits in future.”
How Long Will The Prop-Up Approach Work?
Only markets can answer that question. However, history tells us that central banks tend to experience waning effectiveness when economic data begins to hint strongly at a recession (especially a U.S. recession) and/or when inflation starts to become a problem. Given recent economic data in the United States is not warning of an imminent recession, and inflation trends around the globe do not fall into an elevated category, the prop-up asset prices strategies have continued to be respected by the markets (see vertical ascent in stock prices off the Brexit lows).
Buying Bonds Is Not Supposed To Be A Risk-Free Proposition
It may be hard to believe, but there was a time when a poorly run company or country couldn’t make ends meet, they were allowed to default on their debt. When investors buy stocks and invest in bonds, it is not supposed to be a risk-free proposition. Bond defaults are part of the risk-reward equation, or at least they used to be. And yet, we hear more and more policy makers complain about too much debt in the system; maybe they should take a look in their never-ending bailout mirrors.
The data and image above from the Los Angeles Times (full article here).
Negative Rates Are Sending Common Sense Messages
Interest rates are set in the marketplace based on the supply and demand for money (credit). When rates are near zero or negative, it is the market’s way of saying the demand for new credit is incredibly low relative to the availability of credit. If demand for new credit was high, then lenders would have the power to charge higher interest; they do not have that power today. Zero/negative interest rates are a strong and incredibly clear signal to central banks and policy makers that the “wealth effect” approach has been pushed well beyond its useful life.
We Have Arrived At The End Of Reason
The wealth effect approach has been pushed beyond the bounds of economic common sense, and yet, instead of saying enough is enough, we may be on the verge of becoming very familiar with the term helicopter money. The tweet below from @ReformedBroker sums up just how far off track global central planners have taken the financial markets and global economy.
A Period Of Asset Price Desperation
Central banks are already buying stock-based ETFs and corporate bonds, as outlined on May 11. When serious talk of dropping money from helicopters and fear of “growth causing a recession” enters the equation, it becomes crystal clear that central banks are on the doorstep of asset price desperation.
After A Failed Breakdown, Stocks Broke Out
In what is a microcosm of the last two years, the S&P 500 broke below its recent trading range roughly two weeks ago. The bearish breakdown quickly turned into a failed breakdown as stocks reversed and shot back up in a vertical manner.
Big Moves Have Come In Both Directions
As a reminder of how quickly things can change in the present day markets, it may seem like a distant memory, but the S&P 500 was in negative territory for 2016 just a short time ago.
A Break Above The Box
The S&P 500’s recent breakout, thus far, is impressive. Since stocks have been moving inside a box for over two years, a significant push above the box is quite possible based on the expression “the longer you go sideways, the bigger the move you can get once a breakout or breakdown occurs”.
1994: An Anecdotal Example
While we understand 1994 is a significantly different period relative to 2016, 1994 can be used to illustrate the generic concept of a long-term consolidation in stocks.
What Happened Next?
Once the multiple-year logjam was broken in early 1995, stocks rallied over 39%.
Is there anything else, other than the 2014-16 consolidation box, that indicates the 2016 breakout in the S&P 500 could have some serious upside legs? Yes, the tweet below from Sentimentrader outlines another in a long line of rare stock market occurrences that we have experienced in the last two years. Prior to the last ten trading sessions in 2016, the market stat described below had occurred only once in the last 20 years. Now we have two examples. The last time it happened, very good things happened in the stock market.
These 2016 Charts Can Assist With Probabilities
Hypothetically, if 2016’s breakout from the stock market box were to be followed by a double-digit push higher, the odds are very good the chart below would do two things: (1) break the pattern of lower highs (see orange arrows), and (2) break out above the top of the box. Those things may happen, but they have not happened yet.
The ratio of stocks to intermediate-term Treasuries paints a similar picture. Compare and contrast the look of the blue boxes on the S&P 500 chart and the two stock/bond ratio charts; all three charts cover the same time period.
How Can We Use This?
Do the charts above negate the S&P 500’s impressive breakout this week? Absolutely, positively, no. The stock/bond charts have additional confidence hurdles that we can use as guideposts. If the stock/bond charts break out, it will increase the odds of (a) the S&P 500 holding its bullish breakout and (b) additional upside in risk assets. Conversely, if the stock/bond charts retain their hesitant look, we can continue to approach the stock market’s breakout in a prudent and measured manner.
Is This A Bearish Analysis For Stocks?
No, it is a bull/bear probability analysis. The stock/bond ratios can help us with bullish probabilities and bearish probabilities. Also, it is difficult to label the 1994 example as bearish.