Warning Signs

Tyler Durden's picture

Authored by Lance Roberts via RealInvestmentAdvice.com,

Bull Market Still Intact…For Now

This past Wednesday, on the Real Investment Hour, I spoke with Greg Morris about the technical backdrop of the market. During that interview, he discussed that from a technical perspective the bullish trend of the market is still in place, and despite fundamental underpinnings being stretched, investors should remain allocated to the market.

This is shown in the chart below.

For now, portfolios remain allocated to the market currently. However, as I stated two weeks ago, we did lift profits and rebalance current holdings. Furthermore, we are not adding any “new” positions currently until some of the extreme overbought conditions are resolved. 

This is what the “technicals” dictate, at least for now.

As noted in the chart above, the market is very close to a short-term “sell signal,” lower part of the chart, from a very high level. Sell signals instigated from high levels tend to lead to more substantive corrective actions over the short-term. I have denoted the potential Fibonacci retracement levels which suggest a pullback levels of 2267, 2230, and 2193. To put this into “percent terms,” such corrections would equate to a decline of -4.7%, -6.2% or -7.8% from Friday’s close.

To garner a 10% decline, stocks would currently have to fall 237.8 points on the S&P 500 to 2140.20.  Given there is little technical support at that level, the market would likely seek the next most viable support levels at the pre-election lows of 2075 or a decline of -12.7%. Such a decline, of course, would not only wipe out the entirety of the “Trump Bump,” but would also “feel” much worse than it actually is given the exceedingly long period of an extremely low volatility environment. 

Speaking of low volatility, the market has now gone 108-trading days without a drop of 1% for both the Dow and the S&P 500. This is the longest stretch since September of 1993 for the Dow and December of 1995 for the S&P 500.

This is a pretty impressive feat given the rise in policy uncertainty since the election, geopolitical tensions on the rise, and economic data remaining weak.

In other words, there is a whole lot more downside risk than upside potential in the current environment.

This is particularly the case following the FOMC’s decision on Wednesday to hike rates further.

An Unlikely Outcome

On Wednesday, as the Fed hiked rates for the second time in the last three months, and a third time since December of 2015, the Atlanta Federal Reserve released their latest GDP NowCast which reduced estimates for first quarter growth to just 0.9% from nearly 3% in January. 

Interestingly, following the Fed’s announcement of a rate increase, stocks, bonds and gold all surged.

The reason I say “interestingly,” is that higher interest rates increase borrowing costs which slow economic growth and quells inflationary pressures. Therefore, since the primary argument to support the second highest valuation levels in history is an economic and earnings recovery story, higher rates slow both of those supports. 

Of course, the wisdom of hiking interest rates, thereby removing monetary accommodation, at the lowest average level of economic growth on record is also questionable.

Furthermore, there is also some doubt as to the veracity of the following justification from Ms. Yellen regarding the policy change:

“The simple message is the economy is doing well. We have confidence in the robustness of the economy and its resilience to shocks.” – Janet Yellen, March 15, 2017.

First, I guess we have to quantify what we mean by the “economy is doing well.” In 2016, the economy grew at 1.60% which is well below the expected average of 2.0%. But more importantly, take a look at the chart below of annual “real” economic growth rates.

There are three things of importance to note:

  1. The economy did well prior to the last two crisis as well. In 2000, the annual growth rate was 4.09% and 1.78% in 2007. It was a “Goldilocks” economy. 
  2. While there was a recession in 2001, the economy averaged a real return that year of 0.98%.
  3. The current “real economy” is currently growing, as of 2016, at a rate lower than that prior to the last two recessions and “crisis” in the market and only slightly above that of the recession based 2001 average. 

At a 1.6% growth rate, there is very little wiggle room between Fed rate hikes and a negative growth rate in the economy. The chart below adds the Fed Funds (effective rate) to the chart above.

Two important points:

  1. As soon as the Fed has started hiking rates previously, economic growth began slowing.
  2. While it is often stated the economy remained buoyant following rate hikes, it was ONLY a function of the time for starting economic growth rates of 4.09% and 3.79% to fall below ZERO.

The table and chart below show the historical time frames for the economy to fall into recession following the start of a rate hiking campaign. At 1.6%, historically, the economy has found a “crisis” withing 1-3 quarters. 

IMPORTANTLY: The number of times the Fed has started a rate hiking campaign and NOT pushed the economy into either a recession, crisis, or both equals ZERO.

So, as to Ms. Yellen’s second point of a resiliency to shocks, there is actually no historical evidence of that being the case. The only question is what “shock” eventually ignites the “gasoline” of excessive complacency, exuberance and leverage into a “panic fueled” explosion of liquidation.

Unfortunately, I do not know the answer to the “what” or the “when” of when such will occur. I am certain that it “will.”

But, if you need more evidence, here is this tidbit from Nautilus Research’s Tom Leveroni:

“Many are familiar with the Wall Street adage ‘3 Steps and a Stumble,’ popularized by Marty Zweig, for the tendency of stocks to sell off after the 3rd Fed rate hike in the cycle.

 

The S&P 500 has endured significantly below average results from 1 to 12 months after 3rd rate hikes in 11 events back to 1955. Six (more than half) of those hikes occurred within a year of a major cyclical top for stocks (1955, 1965, 1968, 1973, 1980, 1999).

The only exception was in 2004, when stocks rallied for another three years before the Great Recession.

 

Hikes are generally bad for stocks, somewhat bad for the US dollar, and bullish for 10-year yields and commodities. Will rate hikes derail stocks this time around? In a general sense, yes. Is there a deterministic formula or trigger for precisely when? Probably not.”

Warning Signs

So…let’s add this all up.

The bullish trend is intact which keeps portfolios on the long-side of the ledger for now. However, such does not mean one should become complacent and ignore the rising number of warning signs.

Valuations are stretched by most measures. While valuations are not reliable “timing” indicators, they are useful in predicting forward rates of returns.

Leverage is extended. Margin debt, or the dollar volume of stocks bought with borrowed money, surged just before the US election to a record high.

Retail investors are suddenly rushing to buy. Following eight years of net outflows, they poured nearly $80 billion into mutual funds and exchange-traded funds in the post-election rally. This year, however, corporate insiders have been selling at the fastest pace in nearly 30 years.

The technicals are showing vulnerability. From Monday through Thursday last week, the number of stocks making 52-week lows surpassed new highs. It was the longest streak since November 4 and was a sign of a toppy market, Rosenberg said. Also, the S&P 500 has traded as much as 10% above its 200-day moving average.

Investors are complacent, and it seems like the calm before the storm. The Chicago Board Options Exchange volatility index, or VIX, remains unusually low. The S&P 500 has not swung 1% intraday for almost 60 days, the longest streak in at least 35 years.

The Fed is raising rates. The rise in short-term yields could invert the yield curve before the Fed Funds rate is at 3%. An inverted curve — which reflects investors’ expectations for slower future growth — is seen as a precursor of recession.

Inflation is picking up. The core personal consumption expenditures index is at a 30-month high. Though it is likely not sustainable, it is a “classic late-game signpost.”

The gap between economic growth and sentiment is large. The pace of policy change in Washington could disappoint investors.

Households have over-ownership. Their exposure to the stock market is 42% above the norm.

Credit markets are frothy. The compensation investors demand for choosing risky US high-yield bonds over risk-free assets — the risk premium — is widening.

Like gasoline, all of these warnings are “inert” and, other than smelling really bad, are harmless.

Well, that is until your cousin “Randy” shows up and decides to have a quick smoke.

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Doña K's picture

In these situations the cousin's name is always "Vinnie"

John Law Lives's picture

You fvcking spam dildo.  

Why do the administrator(s) of this site seem not to care about spammers.  Perhaps this spam dildo is paying for the privilege.

xythras's picture
xythras (not verified) John Law Lives Mar 19, 2017 1:08 PM

Tyler likes it just so losers like you can be triggered for our amusement.

If you can't take it, go hide under your mom's skirt. There's where you belong snowflake.

 

 

Now STFU and eat a cock. 

Jubal Early's picture

You are one nasty piece of shit.

chunga's picture

Tyler should notice because Drudge linked to ZH yesterday right in the center, then changed it to a bloomberg link with the same title, probably because the atricle got pounded by the serial spammers who have made ZH their home.

John Law Lives's picture

You have added zero value to this forum.  You should change your handle (i.e. the one you use to post links) to zerothras.

City_Of_Champyinz's picture

First of all stop projecting, you obviously have dick on your mind.  2nd of all, you really provide nothing to the forum, you are truly useless and Tyler should ban your ass ASAP.

New_Meat's picture

That Rusty guy used to want to take me out for a "quick smoke."

SILVERGEDDON's picture

No one needs friction burns on their dicks. 

BritBob's picture
The world wants UK goods and services. Ad by Department for International Trade  above. Brexit - There is a trade imbalance in favour of the European Union so it is in the interest of the EU to make amicable arrangements with the United Kingdom.  What's more, the UK can do its own trade deals on a one-to-one basis instead of having the EU to deal 27 member states before it makes a trade deal.  The UK will opt for a  hard Brexit especially when one country (or part of a country in Belgium) can stall negotiations for so long. Spain could act in a similar fashion over Gibraltar and has the cheek to maintain its Gibraltar sovereignty claim. Claim? Gibraltar - Some Relevant International Law: https://www.academia.edu/10575180/Gibraltar_-_Some_Relevant_Internationa... So it looks like a quick hasta luego !
Greenspazm's picture

We see here technical analysis and pimped-up charts that don't mean dick.

Consuelo's picture

 

 

 They mean a whole lot when your livelihood of annual management $$$Fees depends on bamboozling your client base into thinking what a wise market sage you are, and that you cannot possibly hope to secure your own wealth with your limited knowledge of all things technical...

Kefeer's picture

BitCoin - pure speculation, which means timing and some "luck" can be profitable. 

Will be interesting to see how the Chinese BitCoin black market manifests itself in the next 6-18 months. 

Equally exciting will be the chosen sacrificial lambs the Chinese government decides to makes examples of when they are caught circumventing the rules.  The latter is sarcasm; I do not want to see anyone hurt.

Tom Green Swedish's picture

Excuse me for pointing this out but .25 basis point increase when rates are the lowest they have been for decades really isnt anything if they put it at 4 percent that would be different. This could go on for years without a catalyst. P/E are not high relative to the last 30 years. I only see up from here. The average rate since 1971 is 6 percent. We are at 1 percent I think?

BullyBearish's picture

With everyone on one side of the boat...Soooooooooooo much money to be made on the short side...

HopefulCynical's picture

"Markets can stay irrational longer than you can stay solvent." One of the only things Keynes ever got right.

Tom Green Swedish's picture

Yea that though came through my head too too much to fast. But I cant find anything out there to dispute it from going up other than high PEs which are useless. Unless something comes from europe which i doubt there isnt any reason we see any more than a 10 percent drop which is just another opportunity to buy. SP 4000 by 2021. Oh and a 1 percent drop another stupid thing. A .5 percent drop is the same in basis points as it would have been 6 years ago equivlanent to a 2 percent drop, Im sick of this correlation crap.

flaminratzazz's picture

Look, when the BDI went into the basement, the global economy stated " we are fvked" but yet the money machine still keeps the illusion that all is fine as it keeps staggering along..

What can break the trillions in digits from applying bandaids indefinitely?

 

Tom Green Swedish's picture

BDI tanked because of a glut of ships not because of anything related to economic growth.

flaminratzazz's picture

There was a glut? How can there be a glut in an economy that continuously grows?

The glut was a symptom.. NOW the BDI is back to 1170 but do you deny that the global econ is not in the toilet, or am I all wet?

Tom Green Swedish's picture

Take a look at the data. The volumes have not decreased.

Tom Green Swedish's picture

You are semi right this aint no 2007 but its just like oil. We are using more of it every year but have more supply thus prices go down not because exonmic activity but becuase of a surplus. Competition is a wonderful thing.

any_mouse's picture

I have to laugh at a chart that labels a point on the line "price support level".

Low earth orbital P/E ratios.

Hey, P/Es could go to the moon, Alice!

Tulips had "price support levels" until they did not.

Kefeer's picture

Human nature!  The greed factor; how much greed it too greedy; just a little more please.

Logan 5's picture
Logan 5 (not verified) Mar 19, 2017 12:25 PM

I see a QUADRUPLE EVEL KNIEVEL FORMATION forming to co-incide with the next Triple Lindy Quad Witching expiry...

Consuelo's picture

 

 

Close...

 

But if you really want the inside scoop, belly up to my annual management $$$Fee schedule and let's get you on the path to a prosperous retirement...  

AGuy's picture

"But if you really want the inside scoop, belly up to my annual management $$$Fee"

LOL! If your "inside scroop" was really good you be rolling in $$$ and won't bother trolling for fees for your trash.

stacking12321's picture

A little slow to get sarcasm, eh?

That's ok, you'll catch on. Eventually.

A rope leash's picture

That was some good chart, baby!

 

O yeah...

luna_man's picture

 

 

Just using robot's that can "paint the tape"...Just waiting for the paint to dry in the can.

 

I'm gonna be rich, I tell'ya!

In.Sip.ient's picture

What exactly is the big surprise here???

 

Your surprised the US$ went down after a 0.25% rate hike?

There was no other market action to justify any other move.  The

FX market simply downgraded the US$ because of the higher rate.

Simply balacing out the FX relationship with that ONE new factor.

 

Now give it some time,  for other factors to come along...

they always do ;) ...

and the US$ will rise again.

 

What? You think competitive devaluation is dead???

 

LOL

 

Fundies's picture

It's all good. .....until you hear......" danger Will Robinson   ".

NobodyNowhere's picture

The Rothschilds haven't ordered a doom yet.

All those charts - duh.

Kefeer's picture

All of this proves the one thing we already know; there are no real markets and this statement cracked me up "In other words, there is a whole lot more downside risk than upside potential in the current environment." because it assumed that fundamentals matter.  If fundamentals mattered; we would be a true banana republic.  As it is; the question is when?

 

The markets go up until the largest heist in history is ready to be exercised; we do not know when - only that it is coming.  After that it will be the "reset".  What I wonder is, will the cashless aspect of the grand scheme take place before or after the "reset"? 

We are almost cashless as it is and the millennial generation will never care about cash since they have none and prefer electronic devices & transactions and have no concept of money; not all of them.

Iconoclast421's picture

I love how the average growth of the last DECADE is less than half of the worst of the 1982 recession, and yet they wont even call this a recession let alone what it truly is.