Beware the Bear’s Bull Traps!


by David Haggith, The Great Recession Blog:

So, the bull market bounced back, right? Not so fast. When one appreciated reader suggested there would be a huge plunge the day after Christmas, given how badly the market plummeted the day before Christmas, I cautioned against that tempting thought.

Was this the Plunge Protection Team plunging into action?

Maybe. Consider how strenuously Secretary of the Treasury Steven Mnuchin tried to energize the PPT while knocking back piña coladas in Cabo on Sunday. Yet, it didn’t work. I guess the team was too lazy to kick into action on Christmas Eve. I mean obviously even Munchkin doesn’t want to work then, or he wouldn’t have been flying in private jets with is gorgeous wife down to Cabo. (At least, that is how he used to travel on the government dime in headier days. I don’t profess to know how he travels now. Maybe he takes his boss’s jet now that the boss has Air Force I. I don’t follow up on these things.

Maybe the Munchkin clan decided to get off their sorry butts after Christmas was over and work off a little of the egg nog. Of course, we had the president giving them a swift kick in the behind in the last 24 hours by telling everyone (which would include is PPT) to buy the dip because we are in the best of economic times.

So, maybe.

But. don’t think so.

I have two alternative suggestions:

#1 Bouncing off the 20-yard barrier

Beat the establishment before it beats you … again.

Bear markets are notorious for having some of the biggest rallies in history, and this market has taken a fearsome plunge into the bear’s territory. The Nasdaq buried itself below 22% down from its previous summit. The broader Russel 2000 was also well below 20%. Transports are way below 20%, and bank stocks are further down than that. Worst of all are the FAANG stocks, the former leaders, which look like sidewalk splat at the base of a tall Wall Street tower.

However, the S&P 500, arguably the index most astutely watched by market investors, smacked down hard on the 20% line that defies a bear market. What could make a better bearier line than that? If you want support, the 20% line is hard one to break through because of what it means. So, when the S&P stopped out (so to speak) there at Christmas Eve’s close, that makes a solid line for a super-ball-sized bear-market bounce the next trading day.

#2 Year-end Pension Fund Rebalancing

About a week ago, Wells Fargo reported $64 billion dollars held in bonds by defined-benefit pension funds that would have to be rebalanced into stocks in the last few days of year-end.

You may recall that I’ve said a couple of times that the new era we have entered because of the Federal Reserve’s Great Recovery Rewind is pushing up bond yields. That, in turn, causes money to move from stocks to bonds, bringing down the price of stocks and the yield on bonds (because bond sellers don’t have to offer as high a yield once money is flooding their way from stocks).

I called it “seesawing action” because there will be some pretty hard pumping back and forth between those two investment kingdoms. The money flooding over to bonds creates other anomalies in the overall marketplace that have to be rebalanced.

Wells warned about a week ago of a giant seismic wave that would hit in the last few days of this year. Wells reported that a huge end-of-quarter buy order for equities had been placed because of the peculiarly large divergence that had already taken place in the final quarter between equities and bonds — a divergence that got even bigger after they reported. (When you pop the Everything Bubble, everything moves!)

These pension funds define a split of 55% of their value to be held in stocks and 40% held in bonds. With the huge plunge stock values took as bond yields rose, the value of each kind of asset in the funds had moved way outside of this balance. That required buying many more stocks and selling bonds in order to get back into the defined balance by the end of the quarter. You can be sure many funds are doing similar things in order to close the year back in balance. (Not an enviable task because the ground shifts under the fund manager’s feet as everyone else starts doing the same thing, making it a slippery surface to stake a stand on.)

This move appears to be born out by today’s action in government bond auctions. If there are a lot of pension funds that need to rebalance from bonds to stocks in order to maintain their stated balance ratios, then you would naturally expect there would be a lot fewer buyers in today’s bond auction, and such was the case:

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