Bear Market

The technical pattern for S&P 500 and many other US and global equity market indices is sell rallies, according to BofAML's Stephen Suttmeier, who notes that the market is as overbought now as it was in July. Current price action suggests “dislocation” rather than “capitulation” and we continue to see the risk of retest / undercut of the August 2015/October 2014 lows of 1867-1820.

The stock market is rapidly running out of props.

Presenting Exhibit A: Goldman's latest YTD performance breakdown by strategy basket. It reveals is that far from suffering even the most modest correction, the "Hedge Fund Hotel" strategy (aka the most concentrated holdings), is massively outperforming not only the broader market, but has returned double the second most profitable strategy - investing in companies with high revenue growth. In a world in which the Fed just saw its credibility crushed, expect this to change shortly.

Each of the 3 stages needed to move to a sustainable price have to be given time to play out. The rig count story has been told with a brutally fast 60 percent drop. Meaningful production declines are on. Next will be inventory draw downs; in that order. As to the latter, we’re just beginning to see the effects of the rig count. Large drawdowns will be here sooner than predicted.

Most just scoff at the notion that there has been a historic global Bubble, let alone that this Bubble has over recent months begun to burst. Talk of an EM and global crisis is viewed as wackoism. Except that the Federal Reserve clearly sees something pernicious in the world that requires shelving, after seven years, even the cutest little baby step move in the direction of policy normalization. The Fed and global central banks responded to the 2008 crisis with unprecedented measures. When the reflationary effects of these policies began to wane, the unfolding 2012 global crisis spurred desperate concerted do “whatever it takes” monetary stimulus. This phase has now largely run its course, and there is at this point little clarity as to what global central bankers might try next.

The current surge in deflationary pressures is not just due to the recent fall in oil prices, but rather a global epidemic of slowing economic growth. While Janet Yellen addressed this "disinflationary" wave during her post-meeting press conference, the Fed still maintains the illusion of confidence that economic growth will return shortly. Unfortunately, this has been the Fed's "Unicorn" since 2011 as annual hopes of economic recovery have failed to materialize.

Today, much of the world turns its lonely eyes to the Fed and its chieftain. The Fed has as much as promised to make the blind see and the lame walk. It claims that it – and it alone – is capable of improving the U.S. economy and, by extension, the world economy. People will earn more money. They will live better. And they will have less to fear from financial calamities, such as those that happened before the Fed was set up in 1913. In the popular mind – if there is such a thing – it is further believed that the Fed “won’t allow” a major bear market, because “it would be bad for the economy.” The Fed rules the entire universe of commerce, finance, and investment. Janet Yellen rules the Fed. But who rules Janet Yellen?

In the end, whatever the Feds announce at 2PM NY time today should not affect your long-term outlook on markets as neither of the two possible decisions will significantly alter the future fate of global markets. Instead, the most important thing to understand is the massive fraud that is systemic in the global financial system and to allow a deep and complex understanding of this fraud to drive your investment decisions.

Just like 13F clones end up getting burned more often than not, so too unfortunately for the Chinese copycats, an endorsement from the equity market’s savior has done nothing to ensure outsized returns. In fact, as Bloomberg adds, it was just the opposite - the stock picks have trailed the broader market. The 46 companies that reported the agency as a top 10 shareholder in the past two months lost an average 29 percent since the announcement, versus a 21 percent drop for the Shanghai Composite Index.

Chinese equity markets are holding modest 'bounce' gains after two days of carnage. After 3 days of stronger fixes PBOC devalued the Yuan but the Ministry of Finance made it clear that "devaluation is not aimed at boosting exports," which makes us wonder, is it aimed at selling Treasuries? No additional direct liquidity injections but anxiety grows as China National Erzhong Group Co. may miss an interest payment later this month after one of its creditors filed a restructuring request, putting it at risk of becoming the second state-owned company to default in the nation’s onshore bond market.

It is quite likely - given current valuation levels, deterioration in earnings growth, and a slower economic environment - that forward returns will be substantially lower. In other words, the "risk-reward" ratio for being an aggressive investor at this point in the market/economic cycle suggests that the "house will likely win." It is Deja Vu all over again...

In short, activist Fed policy is both ineffective and reckless (and the historical data bears this out), and that the Federal Reserve has pushed the financial markets to a precipice from which no gentle retreat is ultimately likely. Similar precipices, such as 1929 and 2000, and even lesser precipices like 1906, 1937, 1973 and 2007 have always had unfortunate endings. A quarter-point hike will not cause anything. The causes are already baked in the cake. A rate hike may be a trigger with respect to timing, but that’s all. History suggests we should place our attention on valuations and market internals in any event.

"It looks to me a bit like a bubble again with essentially a tripling of stock prices since 2009 in just six years and at the same time people losing confidence in the valuation of the market."

global bank credit looks like it is already contracting in key markets, such as China, in which case global fundamentals are definitely deteriorating. This being the case, it will take increasing amounts of newly-issued money from the central banks to perpetuate the illusion that markets are rising, and that the economy is still growing, with or without state-directed buying of equities.

This past week has seen a continuation of market volatility unlike anything witnessed over the last several years. Of course, this volatility all coincides at a time where market participants are struggling with a global economic slowdown, pressures from China, collapsing oil prices, a lack of liquidity from the Federal Reserve and the threat of rising interest rates.  It is a brew of ingredients that would have already likely toppled previous bull markets, and it is only by a hairsbreadth the current one continues to breathe.