Wall of Worry
Have the S&P 500 and Dow Jones Industrial Average seen their highs for the year? At this point in 2014, it’s probably a coin toss. There are several factors in favor of a further rally, to be sure. Corporate profits are still robust, revenue expectations are modest, and long term interest rates remain equity-friendly. On the flip side of the U.S. equity market coin: long term valuations are toppy, plenty of other markets (commodities, bonds) seem to signal an impending global recession, and a host of geopolitical concerns now seem to be hitting a full boil. Also, let’s not forget that the Russell 2000 peaked in, oh, March (1209) and July (1208) and is down 8.8% from that last high. By that measure, equities are already rolling over. It is true that markets climb a wall of worry. Until it falls on them.
The attached Barron’s article appeared in December 2007 as an outlook for the year ahead, and Wall Street strategists were waxing bullish. Notwithstanding the advanced state of disarray in the housing and mortgage markets, soaring global oil prices and a domestic economic expansion cycle that was faltering and getting long in the tooth, Wall Street strategists were still hitting the “buy” key. In fact, the Great Recession had already started but they didn’t have a clue: "Against this troubling backdrop, it’s no wonder investors are worried that the bull market might end in 2008. But Wall Street’s top equity strategists are quick to dismiss such fears."
While the current bull market remains "bulletproof" at the moment to geopolitical events, technical deterioration, overbought conditions and extremely complacent conditions; it is worth remembering what was being said during the third phase of the previous two bull markets...
It is common knowledge among those that prefer to see the glass of aggregate demand always half-full (in need of fiscal or monetary stimulus and thus always time to BTFD) that stocks "climb a wall of worry" and that stocks can't drop if so many people are negative. However, while we are sorry to steal the jam from their exuberant 'cash on the sidelines' donut, the truth is that eventually 'strong hand' short positions build to a point where they dominate and provide the tipping point of weakness in stocks. As Goldman Sachs highlights in the following two charts of short interest ratio (days to cover) and aggregate short interest (dollars), the last time there was this much money short was mid-2007... and that didn't end well.
It seems David Tepper's "frigging" "dangerous" market is hitting home as asset managers have greatly rotated their portfolios to hold the most cash in 2 years. Of course, as BAML is quick to point out - this is great "wall of worry" climbing news, "it’s people taking money off the table and playing defensive. There is some inherent buying power." We have now seen almost 6 months of institutional selling and retail investor buying and Bloomberg does a great job rounding up the best market mantras for why it's different this time, and everything is fine... remember "Today’s bearish investors are tomorrow’s bulls."
- Qatar Bank: Deutsche Bank to raise $11 bln with help from Qatar (Reuters)
- AstraZeneca rejects Pfizer's take-it-or-leave-it offer (Reuters)
- China Home-Price Growth Slowdown Spreads as Sellers Discount (BBG)
- The new face of NSA: Mike Rogers (Reuters)
- Putin orders troops near Ukraine to return home (AP)
- Wall of Worry Rebuilt as Nasdaq Rout Sends Cash to High (Nasdaq)
- Bank of England's Mark Carney highlights housing market's risk to UK economy (Guardian)
- Greek Selloff Shows Rush for Exit Recalling Crisis (BBG)
- Anti-austerity Greek radicals ahead in Athens local election (AFP)
Markets are deteriorating around the world but what could cause a real correction in the markets?
Fed's Fisher Says "Investors Have Beer Goggles From Liquidity", Joins Goldman In Stock Correction WarningSubmitted by Tyler Durden on 01/14/2014 13:40 -0500
"Continuing large-scale asset purchases risks placing us in an untenable position, both from the standpoint of unreasonably inflating the stock, bond and other tradable asset markets and from the perspective of complicating the future conduct of monetary policy," warns the admittedly-hawkish Dallas Fed head. Fisher goes on to confirm Peter Boockvar's "QE puts beer goggles on investors," analogy adding that while he is "not among those who think we are presently in a 'bubble' mode for stocks or bonds; he is reminded of William McChesney Martin comments - the longest-serving Fed chair - "markets for anything tradable overshoot and one must be prepared for adjustments that bring markets back to normal valuations."
The eye of the needle of pulling off a clean exit is narrow; the camel is already too fat. As soon as feasible, we should change tack. We should stop digging. I plan to cast my votes at FOMC meetings accordingly.
Could we have another bullish year in 2014? It is certainly possible as long as the Federal Reserve remains engaged in their ongoing balance sheet expansions. But maybe the ongoing inflation of assets, without the underlying improvement in organic, sustainable, economic growth, will eventually lead to the next market bubble and bust. Of course, for anyone that has payed attention, such an outcome would be of little surprise. The important point is that, as an investor, you need to pay attention to the ever decreasing reward/risk ratio of chasing the financial markets. The "low hanging fruit" has long been harvested and the risk currently far outweighs the potential reward of being aggressively invested. Of course, it is not popular, or fun, to rain on the bullish parade. However, while they will likely appear to be correct in the short term; the long term outcome will most likely be far less pleasant.
Two phrases sum up the 'new normal' farce that is the world's equity markets in 2013... "Don't fight the Fed (or BoJ, or PBoC, or BoE)" and "Climbing the wall of worry"... one wonders, of course, what happens to 'climber' once the central bank's 'belay' is taken away (but that's just silly talk because it's all priced in, right?)...
While we are sure there are considerably more major events that deserved "worry" status in 2013, the following 10 'crises', as LPL Financial notes, represent the tempests-in-a-teapot that sum up the wall of worry in 2013. Of course, for your convenience, we provide a hint at what 'calmed' the anxiety as anyone fearful was instantly water-boarded by a pipe of Central bank liquidity the likes of which has never been seen...
The risk of a more meaningful reversion is rising. It is unknown, unexpected and unanticipated events that strike the crucial blow that begins the market rout. Unfortunately, due to the increased impact of high frequency and program trading, reversions are likely to occur faster than most can adequately respond to. This is the danger that exists today. Are we in the third phase of a bull market? Most who read this article will immediately say "no." However, those were the utterances made at the peak of every previous bull market cycle. The reality is that, as investors, we should consider the possibility, evaluate the risk and manage accordingly. With the current bull market now stretching into its fifth year; it seems appropriate to review the three very distinct phases of historical bull market cycles. While the current bull market cycle may not be set to end tomorrow; it seems sensible to take a pause to question mainstream beliefs.
For all expectations of a big jump in US futures overnight on the largely priced in Janet Yellen nomination announcement which is due at 3 pm today, the move so far has been very much contained, as expected, with a modest 90 minute halflife, as the markets' prevailing concern continues to be whether the debt ceiling negotiation will be concluded by the October 17 deadline or if it would stretch further forcing the government to prioritize payments. There is however some hope with Bloomberg reporting that some possible paths out of the debt impasse are starting to emerge with less than a week before U.S. borrowing authority lapses after Obama said he could accept a short-term debt-limit increase without policy conditions that set the terms for future talks. Whether this materializes or just leads to more empty posturing and televized press conferences is unclear, although as Politico reports, the stakes for republicans are getting increasingly nebulous with some saying they are "losing" the fight, while the core GDP constituency is actually liking the government shutdown.
Here are six things to ponder this weekend:
1. Inflation Debate Continues
2. The Obamacare Nightmare
3. The Disconnect Between "Main Street" and "Wall Street"
4. Payroll Number Become Even More Manipulated
5. Congress Living The High Life At The Taxpayers Expense
6. What If The "Fear Trade" Bubbles Up?
- China, the single biggest contributor to global growth over the past decade, slowing markedly.
- World trade now flirting with recession.
- OECD industrial production in negative territory YoY.
- Southern Europe showing renewed signs of political tensions as unemployment continues its relentless march higher and tax receipts continue to collapse.
- Short-term interest rates almost everywhere around the world that are unable to go any lower, even as real rates start to creep higher.
- Valuations on most equity markets that are nowhere near distressed (except perhaps for the BRICS?).
- A World MSCI that has now just dipped below its six month moving average.
- A diffusion index of global equity markets that is flashing dark amber.
- Margins in the US at record highs and likely to come under pressure, if only because of the rising dollar.