Bear Market

There's a debate in professional circles as to whether the stock market is in a correction or a bear market. It makes a difference...

When the bubble vision stock peddlers get desperate, they talk decoupling. So by the end of yesterday’s bloodbath you would have thought China was on another planet, and that “commodities” were some trinket-like collectibles gathered by people who don’t wear long pants, drink coca cola or jabber on their cell phones. On these fine shores, of course, its all awesome from sea to shinning sea. So don’t be troubled. Buy the dip.

If there is one thing more or less guaranteed to create a bullish scenario for stocks, it is the sudden flip-flop of world-renowned newsletter writer Dennis Gartman once again to a short-of-stocks position. Worse still, his fellow newsletter writers, according to AAII, have not been this 'unbullish' since the trough in March 2009. Of course, what many are missing this morning isd 120 points of The Dow's gains are due to the panic-intervention by The BoJ at last night's Japan open...

Since today was the last day of trading for Chinese stocks this week ahead of the 4-day extended September 3 military parade holiday to mark the 70th anniversary of the allied victory over Japan, and since Chinese stocks opened to yet another early trading rout coupled with the PBOC's biggest Yuan strengthening since 2010 as we observed earlier, there was only one thing that was certain: massive intervention by the Chinese "National Team" to get stocks as close to green as possible. Sure enough they tried, and tried so hard the "hulk's" green color almost came through in the last hour of trading and yet, despite the symbolic importance of having a green close at least one day this week ahead of China's victory over a World War II foe, Beijing was unable to defeat the market even once in the latest week which will hardly bode well for Chinese stocks come next week.

The discussion of why "this time is not like the last time" is largely irrelevant. Whatever gains that investors have garnered during the recent bull market advance will be wiped away in a swift and brutal downdraft. However, this is the sad history of individual investors in the financial markets as they are always "told to buy" but never "when to sell."

Whatever the message is in these mega intra-week rebounds (if there is one), we're afraid it just hasn’t been the “out of the woods” bullish sign that many were hoping it was.

"You take the blue pill, the story ends. You wake up in your bed and believe whatever you want to believe. You take the red pill, you stay in wonderland, and I show you how deep the rabbit hole goes." - Morpheus, The Matrix

With prices and valuations elevated, and earnings deteriorating, the backdrop for a continued "ripping bull-market" is at risk. The problem for the "perma-bulls" is that the deflationary backwash, combined with already weak economic fundamentals, continues to erode the ability for earnings to meet elevated future expectations. It is likely earnings will continue to disappoint in the quarters ahead and put further downward pressure on asset prices to close the current gap between "financial fantasy" and "economic realities."

Over the years, Socgen's Albert Edwards has repeatedly expressed his skepticism of both the economy and the market (the longest US equity "bull market" since 1945) both propped up by generous central banks injecting liquidity by the tens of trillions (at this point nobody really knows the number now that the 'black box' that is China has entered the global "plunge protection" game) and yet never did he have as "conclusive" a call as he does today. As the following note reveals, when looking at one particular indicator, Edwards is now convinced: 'we are now in a bear market."

Ben Bernanke and his cohort central bankers built a Brave New World (SOMA, SOMA, SOMA!) where central bank money printing would boost stock prices and the wealth created would trickle down to workers and cause a booming economy. If you doubted that, you are now seeing proof that maybe this world was a little bit of Lewis Carroll’s Alice in Wonderland along with the Aldous Huxley.

It is not hard to see history repeating itself all over again. Just look at the Chinese central bank this week cutting interest rates, just like the Fed had to do in 2008-9.

Crash waves are notoriously volatile – several of the biggest one day rallies in history have occurred before and during crash waves. This makes short term forecasting even more of a coin flip than it normally is. However, we believe it is important not to lose sight of the forest for the trees; stock markets around the world have been in bubbles driven by extremely loose monetary policy, which ipso facto allows us to identify them as an example of artificial price distortion. Such bubbles always collapse sooner or later – unless the monetary authority decides to simply destroy the currency it issues, as has happened in Zimbabwe and is currently happening in countries like Venezuela and to a slightly lesser extent Argentina. We don’t expect the central banks of the developed nations to follow suit, at least not yet.

From both and fundamental and technical viewpoint, there is mounting evidence that the current decline might just be sending a signal that there is more going on here than just an "overdue correction in a bull market." While it is too soon to know for sure, there seems to be little risk in being more conservative within portfolio allocations currently until the market environment clears. However, the proverbial "elephant" is margin debt.

"Given the size of foreign holdings of Asian equity and debt, should foreigners reduce their portfolio holdings by 2-3% over the course of a month, it would broadly offset the region’s current account surpluses, leaving their external balances in a shakier position. During the 'taper tantrum' period, foreigners sold markedly more than 3% of their portfolio holdings through June and July 2013, highlighting the risk that portfolio outflows could cause further Asian currency weakness."