The Run Ends At The Highs
It always fascinates me how technical analysis is, more often than not, confirmed by some event. As I noted in last week’s missive:
“Currently, the ‘bulls’ remain clearly in charge of the market…for now. While it seems as if much of the ‘tariff talk’ has been priced into stocks, what likely hasn’t, as of yet, is the rising evidence of weakening economic data (ISM, employment, etc.), weakening consumer demand, and the impact of higher rates.
While on an intermediate-term basis these macro issues will matter, it is primarily just sentiment that matters in the short-term. From that perspective, the market retested the previous breakout above the March highs last week (the Maginot line) which keeps Pathway #1 intact. It also suggests that next week will likely see a test of the January highs.”
“With moving averages rising, this shifts Pathway #2a and #2b further out into the August and September time frames. The potential for a correction back to support before a second attempt at all-time highs would align with normal seasonal weakness heading into the Fall.”
As shown in the updated “pathway chart” above, the market did indeed attempt to test all-time highs in the market. But, as I noted, the overbought condition provided the fuel for a correction given the right catalyst.
That catalyst appeared on Friday as the Lira plunged and Turkey edged closer to an economic crisis. As Daniel LaCalle noted:
“The Turkish Lira collapse should have surprised no one. Yet, in this bubble-justifying market, it did.”
“First and foremost, the lira decline has been ongoing for some time, and has nothing to do with the strength of the US dollar in 2018
The collapse of Turkey was an accident waiting to happen and is fully self-inflicted.”
We will come back to Turkey in a moment, but the important point here is with the market overbought, and extended following the recent run, we have been suggesting that holding onto cash in the short-term may be wise. As noted last week:
“With our portfolios nearly fully allocated, there are not a lot of actions we need to take currently as the markets continue to trend higher for now. We will continue to monitor our exposure and hedge risk accordingly, but with the weekly ‘buy signal’ registered, we are keeping our hedges limited and are widening our stops just a bit.
As noted above, a short-term correction is needed before adding further equity exposure to portfolios.”
Also, last Tuesday, I discussed the bond yields were potentially signaling a problem for the market.
“On a very short-term basis, the 10-year Treasury yield has started a potential-topping process. Given that ‘yield’ is the inverse of the ‘price’ of bonds, the ‘buy’ and “sell” signals are also reversed.
As shown below, the 10-year yield appears to be forming the ‘right shoulder’ of a ‘head and shoulder’ topping formation and is currently on a short-term ‘buy’ signal. Such would suggest lower yields over the next couple of months.”
“The two ‘bond buy; signals above aren’t a rarity. The chart below expands this view back to 1970. There have only been a few times historically that yields have been this overbought and trading at 3 to 4 standard deviations above their one-year average.”
“The outcome for investors was never ideal.”
Now, back to Turkey.
Over the last couple of weeks, I have been repeatedly discussing the importance of rising geopolitical stresses from Iran, to Russia, China, and now Turkey. The common thread to all of these can be traced back to the current Administration and the fiscal policies currently being implemented.
While “tariffs” and an ongoing “trade war” have been largely dismissed in recent weeks in the exuberance to push the financial markets to all-time highs, the economic realities of higher interest rates, rising input costs from tariffs, economic impacts from sanctions, and tighter global liquidity are not a healthy mix for the economy or the markets.
Turkey is a far more relevant risk to the global economy than Greece was. As Daniel notes:
“On one hand, the exposure of eurozone banks like BBVA, BNP, Unicredit to Turkey is very relevant. Between 15% and 20% of all assets.
On the other hand, the rise in non-performing loans is evident. Turkey’s loans in US dollars account for around 30% of GDP according to the Washington Post, but loans in euro could be as much as another 20%. Turkey’s lenders and governments made the same incorrect bet that Argentina or Brazil made. Betting on a constantly weakening US dollar and that the Federal Reserve would not raise rates as announced. They were -obviously wrong. But that erroneous bet only adds to the already existing monetary and fiscal imbalances.”
Not bailing out Turkey,on the other hand, would cause a much larger crisis than Greece was.”
A Risk Without A Backstop.
While many will likely quickly compare the current “Turkey Tragedy” with “Greece” and deem it to be a “non-event,” there is one difference you may want to pay attention to.
During the entirety of the Greek, Ireland, and Cyprus economic disasters, not to mention Brexit, the Federal Reserve was hard at work suppressing interest rates and pushing an unprecedented amount of liquidity into the financial markets. Not only was the Fed fast at work, but was joined by the Central Banks of Europe, China, Japan, and England. The chart below shows the timeline of the Greek crisis as compared to the S&P 500 and the Fed’s balance sheet.
Not surprisingly, corrections in the market were quickly arrested as floods of liquidity, and assurances from the Fed of ongoing accommodative support, kept Wall Street in coordinated play.
Today, the world is vastly different. As Turkey hits center stage with its current economic and debt crisis, the Fed is hard at work reducing monetary accommodation and hiking interest rates. Japan, China, and the ECB have all signaled they too are beginning to slow monetary interventions.
Without a safety net this time, the current crisis in Turkey may well reveal the fragility of the global financial system once again.
A Quick Trip Through History
By Doug Kass
“A bull market is like sex. It feels best just before it ends.” – Warren Buffett
Today it can be argued that the stock market is as uncritically loved (with the S&P Index at an elevated 2850) as it was unreasonably loathed nearly nine and a half years ago (with the S&P Index at a horrifying 666)
Investors are prone to be bullish at the end of a Bull Market when prices are high and bearish at the bottom of a Bear Market when prices are low – as speculation is a social activity carried on by herds and what I like to call “Group Stink.’
Since the mass of people have most of the money, the crowd is more often than not on the winning team.
However, when the majority is confident in view, are all on the same side of the boat and have fully discounted a profitable future (“first level” v. “second level” thinking) — Mr. Market becomes vulnerable to a surprise as markets become exposed to the unexpected. We may imagine the financial future, but it can never be surely known.
We know the past and the present and, at times (and perhaps too often) we project the familiar out into the unknown. At inflection points, this act of projecting the familiar frequently produces unsatisfactory results.
History teaches us investment lessons but it doesn’t tell us which lessons to apply and when.
As Howard Marks writes,
“The markets are a classroom where lessons are taught every day. The keys to investment success lie in observing and learning.”
I have observed that, at the end of every Bull Market, progress is blurred and becomes fantasy. A new Utopianism dominates financial thinking and the consensus is swayed towards the notion of a long and uninterrupted economic and profit boom – world without risk .
Markets tend to make opinions. There is a strong inclination and nature to extrapolate as “group stink“ is the favorite market odor. Or as The Divine Ms M regularly writes,
“There is nothing like price to change sentiment.”
We are nearly a decade into an economic recovery and Bull Market. We must look for signposts – both fundamental (as I outline every morning in my Diary) and anecdotal.
Market tops come in all shapes and colors.
Perhaps the first stock market crash (Kipper und Wipper), occurred in 1623. It was caused by fraudulent foreign coins minted in the Holy Roman Empire for the purpose of raising funds at the start of the Thirty Years War.
Fourteen years later it was the Tulip Mania Bubble in the Netherlands during which contracts for bulbs of tulips reached extraordinarily high prices (which suddenly collapsed).
A century later, in The Mississippi Bubble, Banque Royale by John Law stopped payments of its note in exchange for specie and as a result caused an economic collapse in France.
The South Sea Bubble of 1720 affected early European stock markets during the early days of chartered joint stock companies.
Fast forward to The Panic of 1901 which lasted three years and was sparked by the assassination of President McKinley to be followed by a severe drought.
Six years later a panic followed President Roosevelt’s attack on the railroad monopolies (think Alphabet’s Google (GOOGL) and Amazon (AMZN) ).
Over history, and as we have moved towards an increasingly flat and interconnected world, the dominoes of currency have had broad economic and investment ramifications – becoming ever more influential contributors to possible stock market panic in a U.S. dollar debt-denominated world. (See the recent collapse of Russian and Turkish currencies, as an example, of modern day risks).
Consider some other, more recent warning signs in history that produced market tops:
A failed leveraged buyout of (UAL) led to a stock market plunge in 1989 (undermined future leveraged deals).
The Russian Debt Crisis in 1998 happened when the ruble was devalued and Russia defaulted on its debt.
The ill fated Time Warner/AOL combination closed minutes before the Nasdaq top in 2000. (Ultimately the OTC market fell by -81% in the next few years).
Maybe this market top, too, will be caused by the unexpected – choreographed by a modern day P. T. Barnum, an ostrobogulous Elon Musk and his sui generis automobile.
“There’s a sucker born every minute.” – P.T. Barnum
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