Stock and Awe, Bears in Bondage

by David Haggith, The Great Recession Blog:

The Trump Rally pushed ahead relentlessly through a summer full of high omens and great disasters, all which it swatted off like flies. Even so, all was not perfect in the market as nerves began to jitter midsummer beneath the surface even among the most longtime bulls. Wall Street’s fear gauge (the CBOE Volatility Index) lifted its needle off its lower post to a nine-month high after President Trump’s comments about “fire and fury” if North Korea didn’t toe the line. (Mind you, the high wasn’t very far off the post because of how placid the previous nine months had been.)

As volatility stirred languidly over the threat of nuclear war, stock prices took a little spill with all major stock indices seeing their biggest one-day drop since May. The SPX fall amounted to a 1.4% drop in a day — nothing damaging. The Dow dropped about 1% in a day. But beneath the surface, the market is looking different and shakier.

For example, trading narrowed to fewer players as more stocks in the Nasdaq 100 finally moved below their fifty-two week lows than moved above them. Likewise in the S&P. This phenomenon is known as the “Hindenburg omen,” and tends to precede major crashes.

HindenburgOmen.jpg

It’s a serious signal that highlights times of decoupling within an index or an exchange. The S&P hasn’t suffered five signals so tightly clustered since 2007 and 2000…. This year the pattern has been popping up more often in all four indexes … 74 omens so far in 2017, second only to 78 recorded in November 2007…. That they are manifesting in several indexes and forming so frequently are good reasons to brace for weakness. (MarketWatch)

Long credit cycles like the current one always end with a crash. But first they deteriorate. The headline numbers remain positive while under the surface a growing list of sectors start to falter. It’s only when the latter reach a critical mass that market psychology turns dark. How far along is this process today? Pretty far, it seems, as some high-profile industries roll over: ‘Deep’ Subprime Car Loans Hit Crisis-Era Milestone…. Used Car Prices Crash To Lowest Level Since 2009 Amid Glut Of Off-Lease Supply…. Junk Bonds Slump…. The worst is yet to come for retail stocks, says former department store executive Jan Kniffen…. U.S. Stock Buybacks Are Plunging…. “Perhaps over-leveraged U.S. companies have finally reached a limit on being able to borrow simply to support their own shares.” (–John Rubino, The Daily Coin)

The fact is that the market is breaking down beneath the shrinking number of Big Cap stocks and levitating averages. This has all set-up a severe downside shock within the coming weeks. As to the market’s weakening internals, consider that there are 2,800 stocks on the New York Stock Exchange (NYSE). Back in early 2013 when the bull market was still being super-charged with massive QE purchases by the Federal Reserve, 85% or 2,380 of them were above their 200-DMA. By contrast, currently only 1,050 of them (37.5%) are above that level, meaning that the bull is getting very tired. (–David Stockman, The Daily Reckoning)

Trading shifted this summer from the major players (often called the “smart money”) buying to smaller buyers trying to jump in, which is also the typical final scenario before a crash where the smart money escapes by finding chumps who fear missing some of the big rush that has been happening. And buybacks seem to be slumping as corporations hope for a new source of cash from Trump’s corporate tax breaks.

In spite of those underlying signs of stress, the market easily relaxed back into its former stupor, with the fear gauge quickly recalibrating, from that point on, to absorb threats and disasters with scarcely a blip as the new norm. The market now yawns at nuclear war, hurricanes and wildfires, having established a whole new threshold of incredulity or apathy, so the fear gauge stirs no more.

With the New York Stock Exchange eclipsed by the larger number of shares that now exchange hands inside “dark pools” — private stock markets housed inside some of Wall Street’s biggest casinos (banks) where the biggest players trade large blocks of stocks in secret during overnight hours —  the average guy won’t see the next crash when it begins to happen. He’ll just awaken to find out it has happened … just like much of the nation woke one Monday to find out that northern California had gone up in flames over the weekend.

Bulls starting to sound bearish

While concern over these national catastrophes never came close to letting the bears out of their cages, it did change the dialogue at the top as if something was beginning to smell … well … a little dead under the covers. Perhaps these slight and temporary tremors in the market are all the warning we can expect in a market that is now almost entirely run by robots and inflated by central bank largesse.

While the bearish voices quoted above can be counted on to sound bearish, many of the big and normally bullish investors and advisors became more bearish in tone as summer rolled into fall. For the first time in years, Pimco expressed worries about top-heavy asset valuations, particularly in stocks and junk bonds, advising its clients in August to trim risk from their portfolios. Pimco argued that that the new central bank move toward reversing QE could leave equities high and dry as the long high tide of liquidity slowly ebbs. Pimco’s former CEO said much the same:

Bill Gross … perhaps the preimminent bond market analysts/ trader/ investor of the age… has gone on record as stating only just recently that the risks of equity ownership are as high as they were in ’08, and that at this point when buying weakness “instead of buying low and selling high, you’re buying high and crossing your fingers.” (Zero Hedge)

Goldman Sachs even took the rare position that the stock market had a 99% chance that it would not continue to rise in the near future, and places the likelihood of a bear market by year’ send at 67%, prompting them to ask “”should we be worried now?” The last two times Goldman’s bear market indicator was this high were right before the dot-com crash and right before the Great Recession. In fact, there has only been one time since 1960 when it has been this high without a bear market following within 2-3 months. Of course, everything is different under central-bank rigging, but some central banks are promising to start pulling the rug out from under the market in synchronous fashion, starting last month. (Though, as of the Fed’s own latest balance sheet shows, they have failed to deliver on their promise, cutting only half as much by the close of October as they said they would.)

Morgan Stanley’s former chief economist said at the start of fall that the combination of high valuations and rising interest rates is about to reck havoc in the market. He claimed the Fed’s commitment to normalization should have come much earlier, as the market now looks as frothy as it did just before the Great Recession.

Citi now calculates the odds of a major market correction before the end of the year at 45% likelihood. Even Well’s Fargo now predicts a market drop of up to 8% by year’s end.

Speaking of big banks, their stocks look particularly risky. Two years ago, Dick Bove was advising investors to buy major banks stocks aggressively. Now, he’s taken a strikingly bearish tone on the banks:

A highly-respected banking stock guru warns that financial storm clouds loom for Wall Street’s bull rally. The Vertical Group’s Richard Bove “warns that the overall market is just as dangerous as the late 1990s,and he cites momentum — not fundamentals — as what’s driving bank stocks to all-time highs,” CNBC.comexplains. “If we don’t get some event in the economy or in politics or in somewhere that is going to create more loan volume and better margins for the banks, then yes, they would come crashing down,” Bove told CNBC. “I think that the risk in these stocks is very high at the present time,” he said. (NewsMax)

It’s a taxing wait for the market

These are all major institutions and people who are normally quite bullish. Some of the tonal change is because of concern about the Fed’s Great Unwind of QE, while much is because enthusiasm over Trump’s promised tax cuts has become muted among investors deciding to wait and see, having been burned by a long and futile battle on Obamacare. In fact, the market showed more interest in Fed Chair Yellen’s suggestion of a December interest-rate hike than in Trump’s release of a tax plan.

Retiring Republican Senator Bob Corker predicts the fighting over tax reform will make the attempt to rescind Obamacare look like a cakewalk, and he intends to lead the fight as one of the swing voters to make sure it is not a cakewalk now that he and Trump are political enemies.

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