Is This Decline The Real Deal?

Tyler Durden's picture

Submitted by Charles Hugh-Smith via Peak Prosperity blog,

Is this stock market decline the "real deal"? (that is, the start of a serious correction of 10% or more) Or is it just another garden-variety dip in the long-running Bull market? Let’s start by looking for extremes that tend to mark the tops in Bull markets.

Extremes Eventually Revert to the Mean

There's little doubt that current measures of valuations, sentiment, leverage and complacency have reached historic extremes. Many analysts have posted charts depicting these extremes, and perhaps the one that distills well multiple extremes into one metric is Doug Short’s chart of the S&P 500’s inflation-adjusted Regression to the Trend, another way of saying mean reversion or reverting to the mean.

I have added two red boxes: one around the peak reached just before the Great Crash of 1929 (81% above the trend line), and one around the current reading (86% above the trend line).

That the current reading exceeds the extreme that preceded the Crash of 1929 should give us pause. And little comfort should be taken that the bubble of 2000 reached even higher extremes, as that should likely be viewed as an outlier rather than the harbinger of the New Normal.

What this chart demonstrates is the market tends to overshoot to the upside or downside before reversing direction and once again reverting to the mean.  Other than a very brief foray below trend line in 2009, the S&P 500 has been at or above the trend line for the past 20 years. While the Gilded Age boom of a century ago stayed above the trend line for over 30 years, more recent history suggests that markets that stay above the trend line for 20 years are getting long in the tooth.

Extremes in Risk Appetite and “Risk-On” Asset Allocation

One measure of risk appetite is junk bond yields, which as Lance Roberts shows in this chart, have reached multi-year lows:


Money managers’ appetite for the “risk-on” asset class of equities is similarly lofty:

Previous readings near the current level preceded major stock market declines—though high readings have been the norm for the past few years without presaging a major drop.

Can Extremes Be Worked Off Without Affecting Price?

From the Bullish point of view, these extremes have been worked off in relatively mild downturns in the seasonally weak periods of February to April and August to October:

Let’s look at a chart of the S&P 500 (SPX), with a focus on the seasonally weak periods:

Rather significant declines in indicators such as the MACD have translated into relatively brief, shallow declines.

From the Bull’s perspective, all the extremes in valuations, sentiment, leverage and complacency have been worked off in modest declines that haven’t reached the 10% threshold of a correction. So why should the present period of seasonal weakness be any different?

One potential difference in August 2014 is the sheer number of current financial/market extremes.  Analyst John Hampson prepared a list of all-time records that is impressively long:

Here are some of the all-time records delivered in 2014:

  1. Highest ever Wilshire 5000 market cap to GDP valuation for equities
  2. Highest ever margin debt to GDP ratio and lowest ever net investor credit
  3. Record extreme INVI bullish sentiment for equities
  4. Record extreme bull-bear Rydex equity fund allocation
  5. All-time low in junk bond yields
  6. All-time low in the VXO volatility index (the original VIX)
  7. Highest ever cluster of extreme Skew (tail-risk) readings in July
  8. Highest ever Russell 2000 valuation by trailing p/e
  9. Lowest ever Spanish bond yields
  10. Lowest ever US quarterly GDP print that did not fall within a recession

?And this week:

11.  Lowest HSBC China services PMI since records began

12.  Lowest ISE equity put/call ratio since records began

If we had to summarize the current set of extremes in risk appetite, valuations and sentiment, we might state the Bear case as: These extremes characterize the tops of asset bubbles that inevitably deflate in dramatic fashion, despite the majority of participants denying the asset class is in a bubble.

Conversely, we might state the Bull case as: The fundamentals of low interest rates, abundant liquidity, slow but stable growth and rising corporate profits support current measures of value, confidence and risk appetite.

For context, let’s go back in time to the Great Housing Bubble circa 2006-07, when the official and mainstream media narrative denied that housing had reached bubble heights even as the housing market was increasingly dependent on often-fraudulent stated-income (a.k.a. liar loans), interest-only adjustable rate mortgages (ARMs) for sales and mortgage originations.

A report by the U.S. General Accountability Office (GAO) found that almost 80% of all interest-only adjustable-rate mortgages (ARM) and Option ARMs nationwide were stated-income in 2006. In effect, prudent risk management had been thrown out the window. But participants chose to focus on the supposedly solid fundamentals of housing to rationalize their confidence in what was an increasingly obvious Ponzi scheme based on fraud and borrowers who were bound to default once the bubble popped.

(Chart source: Market Daily Briefing)

In other words, even as valuations, risk appetite, complacency and Bullish sentiment were reaching extremes, participants and Status Quo observers were confident that these bubble valuations were the New Normal.

Those who are confident that the current stock market is fairly valued have to explain why the many current extremes are different this time from previous asset bubbles, and provide an explanation of why extremes can continue indefinitely or be worked off without affecting price more than a few percentage points.

Indeed, what characterizes Bull markets is their ability to work off extremes of complacency (i.e. low volatility) and overbought conditions with only modest declines in price (for example, the S&P 500 is currently down 3.4% from its closing high around 1,988).

But the weight of these numerous extremes is significant, and a detached observer would naturally wonder if such a wide spectrum of extremes can be worked off without affecting price much.

The prudent observer would also ask: Have stocks been pushed to their current valuations by these extremes, or are these extremes merely temporary spikes of exuberance that have little to do with the fundamentals driving valuations higher?

It’s a critical question. For if extremes in risk appetite and sentiment have underpinned the market’s rise, then as these tides recede, price will inevitably follow.

If these extremes are merely temporary spikes that can dissipate without effecting price, then we have to ask: If this is the case, then what are participants afraid of?

We know participants are afraid of something, because the Put/Call Ratio—a measure of participants buying hedges (put options) against a downturn—has skyrocketed to a multi-year high in the past week:

This ratio has traced out a declining channel for the past two years. If nothing fundamental has changed, then what are we afraid of right now?

The Challenge To The Bulls

Those who are confident in the Bull case—that rock-solid fundamentals will drive stocks higher—have a daunting task ahead: they need to explain away the obvious spike in fear/caution, and explain why all these extremes in valuations, sentiment, leverage and complacency have no real bearing on the rock-solid fundamentals.

But given that the psychology of bubbles is characterized by precisely this rationalization of why extremes don’t matter,  Bulls must also explain why their rationalizations don’t mark this as the top of an asset bubble that is remarkably similar in terms of extremes to recent bubbles in housing and stocks.

In Part 2: Prepare For The Bear, we take a look at changing fundamentals that may affect the market’s five-year Bullish bias. We’ll look at how the fundamentals of the Bull case have been weakened or threatened, and determine whether indeed we are witnessing a key moment of direction-reversal in the markets.

Click here to read Part 2 of this report (free executive summary, enrollment required for full access)

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Say What Again's picture

Will the caller please repeat the question

flacon's picture

Shit. What was the question again?

BringOnTheAsteroid's picture

I don't understand the reference to cowbells.

Save_America1st's picture

WATCH and LISTEN then PASS IT ON.  Excellent interview with Marine Colonel Pete Martino:  I See Something!

This is the TRUTH, "Folks"!!!

Headbanger's picture

If the ""market"" drops below the lows seen this week it will crash immediately

But if the ""market"" bounces from horizontal support here, it could rally a good amount before crashing in a few weeks.


So go ahead and BTFD but set your stops tight

And reverse short as hell if it breaks below the recent lows.


Asteroid: This explains "cowbells" you mook:


And fuck you fonz you Goldman fag!

BringOnTheAsteroid's picture

This is a can of worms, what is a mook?

rehypothecator's picture

So long as everything is manipulated, nothing is the real deal.  Nothing can possibly be the real deal until the manipulations end. So, is this the end of manipulations?  Doubtful.  

MrSteve's picture

It isn't original so I'll quote the guy with the beard and sandwich sign: The End Is NEAR!


When the GOP threw the budget into the freezer, we got the sequester correction. If the GOP takes the Senate and  Senate Committees, the federal government will be perfectly gridlocked with House and Senate vs White House. Obama would have to veto every thing the GOP shoves at him because neither the Senate nor the House would be able to override veto decisions, so stagnation and sequester will be happening. The market will not approve and so when the winds of this crap-a-thon blow through to Wall Street, we'll see a lot more than X+1 reasons why prices are shaky.

BringOnTheAsteroid's picture

You're assuming manipulation is only to the upside. Do you realise how much money can be made on the downside if you have inside knowledge? The gains to the upside have be grinding on now for several years. The same amount can made, in a flash, to the downside. You don't think these mother fuckers pulling the levers don't know this and haven't planned accordingly. You don't think the Blanfeins and Dimons don't know exactly when QE ends? All that is needed is a nice cover story for why the market crashed that deflects attention and scrutiny from the central banks and primary dealers. Furthermore, the distraction that has people begging the central banks to intervene is even better. Rather than going after them with pitch forks and ropes they want people to come to them on their hands and knees.

These mother fuckers have it all sorted. The only bind they are in is choices, so many choices: WWIII, Ebola outbreak, dirty bomb in NYC, blow up multiple shopping malls in a co-ordinated attack. I mean, what's the CIA, FBI, Mossad supposed to do with so many exciting choices. I feel for them.

NickVegas's picture

Very well stated, Sir. They are sending out trial ballons on all fronts, to see the reaction. I would expect it to be coordinated, so it looks like a black swan. Maybe all of them, plus a few ideas still sitting in a think tank in Virginia or Tel Aviv.

venturen's picture

Banker bonuses are the real deal!


Who's all fake. 

disabledvet's picture

Well..if your a titty man.

My connection between treasuries (non correlated) and equities (wrongly correlated) is simply that what's good for one is good for the other. So sure...I was chasing momentum in treasuries last year and got whacked by Taper...but I see no intrinsic problem post "betazoid maassacre" last fall not at least trying to get out on the dance floor here.

Still haven't pulled the trigger yet though. Being greedy on the treasury trade I guess...

Never know when the Fed will...

jomama's picture

well that clears it up, thanks!

p00k1e's picture

In a cupola years everyone will be bragging about how they were ‘Paper Millionaires’ before the “Great Credit Collapse”. 

J 457's picture

Need to factor in corporate share repurchase plan and impact of FED bond buying.  Until that changes the bottom won't fall out.

theonewhowaskazu's picture

Even going by your own chart... 


And who knows, maybe this time the Fed will just speed up printing the moment we near a crash.

theonewhowaskazu's picture

Oh yeah 1 minute after I post immediate downvote for no adequately explained reason. 

seek's picture

The decline will be the real deal when you find out about it from reading a chalkboard in town or via ham radio, and the primary use of iPhones is as a flashlight or to pound tent stakes.

starman's picture

Is a prostatic limb a real limb?

NoDebt's picture

Yes.  No.  I don't know.  I'm confused.  Could you restate the question?

Whatever you think, remember:  "It's not a lie if YOU believe it."  - George Costanza

order66's picture

I would just like to see one person ONE actually layout a path where a soft landing occurs in the U.S.

It's simply not possible.

NoDebt's picture

How do you feel about Japan?  That's about as soft as it could be.  It's also part of the reason I think that is secretly their goal.  All other avenues only look like MORE pain than that scenario.

deflator's picture

 Japan is different. Japan went all QE and shit while the global economy was still growing. The U.S. is resorting to Japanification on the downside of the global economic cycle.


 Another thing Mish tends to overlook is the close relationship between the U.S. and Japan leadership role in global economic hegemony via Yen carry trade.

Spastica Rex's picture

Define "Soft" and "Landing."

Ms. Erable's picture

A financial soft landing is one where the bankers walk away unscathed* after all of the passengers die horrible, fiery deaths; review file Jon Corzine for a real-world example.

*does not include subsequent hot tub, nailgun, exploding vehicles or other accidents/acts of God, beheadings, hangings, or suicides via multiple stab or gunshot wounds. Offer valid in all 50 U.S. States, Puerto Rico, Guam, and U.S. Virgin Islands.

Ben Ghazi's picture

Use giant "Stay Puft" Marshmellow men to soften the landing.


khakuda's picture

This is following the same pattern that developed after QE1, QE2, twist, etc ended. Rates dropped, stocks declined, Fed shit their pants and printed yet again.

Maybe not QE next time. Maybe buying stocks, negative rates, stealing from kids in addition to robbing seniors...

besnook's picture

you are onto something. the fed won't stop until the market returns to normal fundamentals which could be a few more years away.

bid the soldiers shoot's picture



The decline that cried 'wolf.'

You know how that fable ended.

Keltner Channel Surf's picture

'Mean reversion’ as a predictor is rather silly when you think about it.  The prices didn’t ‘revert’ to the mean, they moved then you drew a new regression line – after the fact.  If they plummet or soar off the top or bottom margins, you’d draw a new line, perhaps angled down, or possibly steeply higher.  The current mean doesn’t draw prices like a magnet, but moving averages can, only because big players use them to establish positions, thinking everyone else is doing the same, in prophetically self-fulfilling fashion.

Dead Man Walking's picture

Yeah, this is true. Traders pay attention to the moving averages.  Pick your time frame, it will be tested.

besnook's picture

shhhh, don't give away the secret to day trading. front running the markers institutional traders use makes my life easy.

Keltner Channel Surf's picture

Sorry -- going forward, beware of the new double-secret moving average anticipation retail-crushing algo, created moments after your reply was posted, quite automatically, by word-parsing machines that roam these boards regularly.  Bastards.

Oxygen's picture

A crash occuring this fall look really real with
All the lay off coming..
And the war..
And the pandemie..

deflator's picture

Nope--don't try to call a top until you see this shit go hockey stick parabolic. On a brighter note--I expect, since it is all so choreograhed by bureaucrats that you will not even have to be a good trader to telegraph the, "volatility". lol

I Write Code's picture

More CHS?  I'm getting tired of responding to it.  I'm bearish on CHS, decline already would you please dude?

Cliff Claven Cheers's picture

No Israel stuff on this thread yet.  I'll throw something out.

I suspect this to be propaganda by the jews to try to show that they were in the land 2000 years ago and had the Romans not destroyed the Temple they would have inhabited the land ever since.  We all know they have no reason to want to live in the City of David.

Iriestx's picture

Dip into the normal running of the bull market.  If you're not buying into this with everything you got, you're a fucking sucker.  This market isn't going to stop going up until it goes to zero and it's going to take a cataclysm of bibilcal proportions to make that happen.  A couple of dozen blackies in Africa with some STD they got from sticking their cocks in fruit bats and monkeys, the Ukranians fighting a civil war and the Heebs bombing the shit out of some rag head, terrorist, dirt-worshipers ain't gonna change things.



Ghostdog's picture

No. If it corrects a bit too much the Fed will come back in with lollipops to give the big money one last shoot to get out while the suckers pile in. Today was am interesting day and right at an inflection point in several indexes. If she holds we'll get at least a dead cat bounce to next fridays opex and then decide. A big mess is coming but the Fed WILL give the big boys one chance to get out or insure their positions

cn13's picture

Given the amount of manipulation, liquidity pumps and outright lies by those "supposedly" in charge (hello FED), I would guess the eventual drop in the markets whenever it may occur will be something never before witnessed.

We have now undeniably seen three FED engineered bubbles during the 21st century which is not even 15 years old.  The internet bubble popping in 2000-2001 followed by the housing bubble in 2002-2008.  We now have stocks and junk bonds at record high levels which makes very little sense besides money being basically free thanks again to our friends at the Federal Reserve (unless you are a saver or pensioner).

Anyone with half a brain knows the stock and junk bond markets shouldn't be priced anywhere close to where they are today.

But it seems to me that those in the "know" also expect to be able to exit markets before the eventual collapse begins.

Think of the Michigan Wolverines football stadium of 100,000+ slowly being filled over 2 hours time.  No problem.

But set off a blast or something else to panic the crowd and very few people would be able to hit the exits without a complete lockdown.

We may be reaching that point in all these markets.