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Guest Post: Market-Top Economics

Tyler Durden's picture




 

Submitted by Nicholas Bucheleres of NJB Deflator blog,

Market-top economics could be an entire university course, if people cared enough about such phenomena.  Most only consider the signs of a market top months or years after a crash when some unyielding economics researcher puts the pieces together.  As human-beings we have developed an uncanny ability to rationalize what we know to be bad news and convince ourselves, "This time is different," despite the fact that it usually never is.

In a previous article I provided analysis on economic/equity decoupling (cognitive dissonance) and showed that the economy as we know it cannot persist--we are either due for a literal gap-up in leading economic conditions, or we are due for a serious correction in US equities.  With today's 5.4% slip in existing home-sales, let's go with the latter.

Velocity of M2 Money Stock (blue) and the S&P500 (red): Inversion in the velocity & SPX correlation led to a market crash in 2000 and 2007.  No evidence suggests that we should break that trend this time.

Market tops are classically defined by:

  • The revelation of fraud within the financial sector: With more banks being sniffed-out by the day, it would be a crime to call the LIBOR rigging collusion anything less than criminal fraud.  Fraud shakes up financial system (and the broader economy) because it redefines what was thought to be growth, revenue, and profitability as lies and untruths, and the market is eventually forced to reprice what was initially priced as success.  I have found that markets have a very difficult time retroactively pricing fraud; these are the type of downward corrections that keep on falling, and falling, and falling until they bring down the entire market and forcefully purge the fraudulent behavior.  Unfortunately for us law-abiding citizens who get ticketed for going a couple miles over the speed limit, banks currently involved in the LIBOR rigging scandal will likely not get more than a slap on the wrist.  I don't care about justice for the sake of justice; I care about confidence within financial markets, and the notion that big banks can do whatever they want makes investors (aptly) think that they don't hold a candle to the big boys that make their own rules.  Such loss of confidence is the cause of the exodus of funds from US equity markets, as shown by paltry volume, even by summer standards.
  • The collapse of financial institutions under their own weight: When supposedly low-risk financial services institutions like MF Global (collapsed October 2011) and PFGBest (collapsed July 2012) start dropping like flies it makes people wonder: "How is my broker any different than those guys?"  Further sucking confidence out of the market, the death of immoral financial institutions is not seen as a beneficial cleanse, but rather it is correctly seen as the tip of an iceberg of more deception.  When money was supposed to be in one place, but really wasn't, as in the case of MF Global and PFGBest, investors want to know where that money went.  What was financed with that illegal money?  Again, markets struggle to price-in fraud because it is unclear what was initially priced with the blood-money.
  • Sweeping revenue loss within the financial sector: By today it is clear that financials did not have a good Q2 2012.  There were sweeping revenue forecast misses, but conveniently for shareholders, earnings per share (EPS) came in at least right-in-line estimates, and many topped estimates.  With almost a dozen banks planning quadruple digit layoffs and salary cuts including Deutsche Bank, Morgan Stanely, and Bank of America it is clear that things are grim and growing darker in Midtown, Manhattan.  Even Goldman Sachs is being forced to reign in salaries and bonuses...The fact that these guys aren't winning at their own game should be very alarming to everyone; indicates that there is something going on beneath the surface.  
  • S&P500 (white) and financials ETF $XLF (white) show that financials have priced in a sliver of what they will be forced to.
  •  

 

  • The erection of massive buildings: Tall buildings are a sign of over-ebullience and rampant speculation (hello, market top).  The huge buildings are often financed heavily with credit when the market is booming and nobody worries about tomorrow, but once the market slows down a little bit and the reality of a massively over-leveraged, now-considered pile of steel is analyzed mark-to-market the results aren't pretty; the huge building that was meant to elevate society to the skies becomes an anvil on the back of a falling economy.  Case and point: The Empire State building of New York City was built in 1929--the height of the pre-Great Depression bubble.  "The Shard" just popped out of the ground March 30, 2012 in London and is the tallest building in the European Union.  Upon unveiling the building, the architect made it a point to clarify that his creation was not meant to be considered arrogant...If you have to say it, it's probably too late.  The chart below says more than I could:
  • UK Index Fund $EWU (white): Vertical red line marks the completion of the shard...more to come out of this compression.

 

Where there is smoke, there is fire; where there is coordinated financial fraud, there are systemic issues.  In this case, it seems that the banks involved in LIBOR rigging were attempting to manipulate short-term interest rates in order to literally engineer the price of derivatives contracts.  This is a scary notion, and I believe that it is apt to infer that these banks have trillions in losses on shadow derivative contracts that they have been attempting to cover up with interest rate manipulation.  It seems that the gaping balance sheet holes are immune to filling and that bank executives have decided to fraudulently cover them up rather than mark them to market (assuming a market exists).

 

S&P500 (white) and $VIX (blue): True market bottoms are put in place after significant volatility driven capitulation--something that has not happened this summer.  We may be gearing up for a 2007-esque double-top sell-off driven by higher-trending volatility coupled with lower lows in the equity markets.

Markets are choosing to hold-off on pricing this negative news and are instead bottling it up to be released in what will surely be a "pop."

Uncle Ben, will you tuck me in and read me a bedtime story?

 

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Thu, 07/19/2012 - 17:28 | 2633770 HelluvaEngineer
HelluvaEngineer's picture

I call this pattern "Three humps and a dump", otherwise known as "Friday Night"

Thu, 07/19/2012 - 18:32 | 2633996 ihedgemyhedges
ihedgemyhedges's picture

I lost interest when I read in his first paragraph the term "usually never."

I go nuts when I see a modified superlative, especially when it's written in an article I would probably like to read.........

Thu, 07/19/2012 - 19:07 | 2634111 flacon
flacon's picture

I'm trying to think of something pithy to say, and I usually never fail to think of something...

Thu, 07/19/2012 - 17:27 | 2633771 disabledvet
disabledvet's picture

Here's your course in calling tops in a market in one word: "bullshit."

Thu, 07/19/2012 - 17:36 | 2633776 realtick
Thu, 07/19/2012 - 17:43 | 2633832 NJBDeflator
NJBDeflator's picture

haven't seen that; good call.  Thanks

Thu, 07/19/2012 - 21:18 | 2634503 dondonsurvelo
dondonsurvelo's picture

This is how that article ended:

 

Any stock market rally in 2012 will not reflect the real economy, credit, money stock and velocity or employment visible in these charts. Until these charts shows positive fundamental improvement, a rally can only be smoke and mirrors, a trick of central planning manipulation that is unlikely to last longer than a sugar high.

Thu, 07/19/2012 - 17:29 | 2633778 Flakmeister
Flakmeister's picture

It is one fugly chart.....

Thu, 07/19/2012 - 17:30 | 2633780 zero19451945
zero19451945's picture

Wrong from the start.

The stock market has nothing to do with the real economy.

Thu, 07/19/2012 - 17:36 | 2633808 gjp
gjp's picture

It sure looks that way these days, if not longer.  The stock market is not reflecting the broader economy in any way whatsoever, though small (upper class) niches of the economy certainly reflect the stock market.

If the disconnect is permanent, I guess it will only be revolution, or at least a few heads rolling, that breaks the disconnect

Thu, 07/19/2012 - 17:36 | 2633809 Lohn Jocke
Lohn Jocke's picture

Market looks toppy? That's Bullish. S & P to 1500.

Thu, 07/19/2012 - 17:40 | 2633810 Great Unwashed
Great Unwashed's picture

"As human-beings we have developed an uncanny ability to rationalize what we know to be bad news and convince ourselves, "This time is different," despite the fact that it usually never is."

Usually never is? WTF is that supposed to mean? I guess it just usually isn't.

Thu, 07/19/2012 - 17:42 | 2633829 Fedophile
Fedophile's picture

"usually never is [different]."

Thu, 07/19/2012 - 17:38 | 2633813 zorba THE GREEK
zorba THE GREEK's picture

It appears that all markets are rigged and people are losing faith

at a fast pace. Soon there will be no suckers for their shell games,

or at least any suckers with any money left.

Thu, 07/19/2012 - 17:42 | 2633828 Meesohaawnee
Meesohaawnee's picture

once again are we trying to apply fundamentals to the computer game that has none?

" Again, markets struggle to price-in fraud because it is unclear what was initially priced with the blood-money."

 

once again. "Pricing in" asumes a free non rigged non propaganda  market. not.

Thu, 07/19/2012 - 17:44 | 2633835 RobotTrader
RobotTrader's picture

zorba, the only guys with "no money left" are the poor schlubs who went head first into mining stocks and got obliterated.

 

Thanks to King World News, Casey Research, jsmineset.com, and all the rest.

Thu, 07/19/2012 - 17:49 | 2633851 Dr. Engali
Dr. Engali's picture

You're assuming of course that they sold.

Thu, 07/19/2012 - 17:57 | 2633868 Bennie Noakes
Bennie Noakes's picture

You sound bitter. Remember, it's only money.

Thu, 07/19/2012 - 23:08 | 2634748 Fecklesslackey
Fecklesslackey's picture

How can one be so right and 'invest' in NFLX. When ES goes the way of NFLX, I think Robo will dissapear. But wait till AAPL earnings and then short everything .... especially retail

Thu, 07/19/2012 - 17:46 | 2633841 Meesohaawnee
Meesohaawnee's picture

i lost all faith what little i had on that jam job brian sack pulled on 6/28 6/29 so da boyz could grab their bonuses ..... sorry no free non rigged market does what it did those 2 days.

Thu, 07/19/2012 - 17:46 | 2633842 Rainman
Rainman's picture

Housing sales is a meaningless outlier.....mark-to-unicorn has that handled....BTFD

Thu, 07/19/2012 - 17:47 | 2633847 Diamond Jim
Diamond Jim's picture

Don't know about you but I've been trying to short this market for a while, only with limited success. Even with all the bad news current and in the future it just doesn't seem to go down hard. Something is holding it up...whether it is the Eurozombies showing up with their money and buying US equities, skynet / algos buying on dips (remember "buy the dips" in gold), or the Fed supporting the market, there just does not appear to be a wash out in the cards (at present). Guess we will have to wait for the Emperor to be re-elected and do his final act on the American economy, or Congress with their kubuki theatre dance.

Thu, 07/19/2012 - 22:17 | 2634652 Nobody For President
Nobody For President's picture
  1. I feel your pain, DJ, but I do not believe we will have to wait til November. The bullshit can't ge stacked much higher at this point - it usually never gets stacked this high before it falls over anyhow. It will take very little to commence traveling in the other direction at this point - three weeks tops, probably less, before some flash point somewhere unstacks the HTF house of cards.
Thu, 07/19/2012 - 23:50 | 2634822 J 457
J 457's picture

Three weeks if that.  The dirty laundry will come home to roost any day now.  VIX at 15 while Spanish bonds are at 7, EU in recession, US probably already in recession as well, China slowing, earnings/revenues stalling, Iran, fiscal cliff, election, CA cities BK, 4.2 mm homes in distress and another 2mm REO, unemployment still stuck above 8% even with 1.5 trillion annual deficit spending, banks can't make money even while forging LIBOR and running HFT, and on and on, yet SPX hanging on at near 1,400. I'd say a repeat of last Aug is almost inevitable.  That wil be the only way to provide a reason for Ben to "get to work" in Sept.  

Thu, 07/19/2012 - 17:51 | 2633859 Bennie Noakes
Bennie Noakes's picture

No worries! Don't they always ring a bell (or sound a klaxon) at market tops? I'm waiting for that.

Thu, 07/19/2012 - 17:52 | 2633861 I should be working
I should be working's picture

Based on your M2 chart shouldn't we have entered a bear market in early 2010?

Thu, 07/19/2012 - 18:46 | 2634038 mark mchugh
mark mchugh's picture

It looks to me like there's a significant lag between Velocity of money tops and market reaction.

The story's maybe a little more complicated as well.  As velocity drops the Fed pumps more money in, so there's more money available.  It takes a while for the slowdown to become apparent.

I'd also think MZM velocity would be more meaningful than m2 velocity.

Thu, 07/19/2012 - 17:56 | 2633881 XitSam
XitSam's picture

revelation of fraud: they make more money than the possible fines they are charged on the few crimes that are caught.

collapse under their own weight: Uh, bailouts. Duh.

revenue loss: execs still make millions, and bailouts.

big buildings: monuments to their success and excess, besides bailouts.

Thu, 07/19/2012 - 18:00 | 2633894 magpie
magpie's picture

BuBa purchasing Australian Dollars should hold up risk for a while.

Thu, 07/19/2012 - 18:26 | 2633980 you enjoy myself
you enjoy myself's picture

historical correlations are meaningless in the age of Ben.  the real economy can implode and we'll still be hitting 1500.  Ben can prop up equities for years via the NYFRB, "loans" to the primary dealers, and EUR swaps that swing back to the US market.  and he will, behind the scenes, in secrecy. 2008-09 changed everything.  once the Fed started down the ZIRP/bailout path it has to continue. 

the only reason we won't feel runaway inflation is because demand will be collapsing at the same time.

 

Thu, 07/19/2012 - 18:38 | 2634014 Meesohaawnee
Meesohaawnee's picture

which is basically one reason why the teaching of Economics in Colleges all across the good ole land of ubummer should be banned until further notice. Serious. Would you let your kid waste a dime on an Econ or Finance degree now? Yea go tell little johnnie to go take a class in P/E ratios, ethics, and what have you. Totally all blown out the door and made useless.

Thu, 07/19/2012 - 18:43 | 2634027 TwoHoot
TwoHoot's picture

"In this case, it seems that the banks involved in LIBOR rigging were attempting to manipulate short-term interest rates in order to literally engineer the price of derivatives contracts.  This is a scary notion, and I believe that it is apt to infer that these banks have trillions in losses on shadow derivative contracts that they have been attempting to cover up with interest rate manipulation.  It seems that the gaping balance sheet holes are immune to filling and that bank executives have decided to fraudulently cover them up rather than mark them to market (assuming a market exists)."

Uh-Oh - somebody said it out loud.

 

Thu, 07/19/2012 - 18:48 | 2634045 Jumbotron
Jumbotron's picture

Bubble...Bubble...Toil & Trouble......

Thu, 07/19/2012 - 19:40 | 2634223 adr
adr's picture

I call a market top when a crappy dollar store with really shitty products shoots up 60% over its IPO price at the market open.

There is irrational exuberance, and then there is Corky hitting the buy button.

Thu, 07/19/2012 - 19:49 | 2634249 adr
adr's picture

The blatant rigging of the market won't stop until someone makes it stop.

Fri, 07/20/2012 - 03:39 | 2635020 Floodmaster
Floodmaster's picture

Counterfeit pile of paper create overvalued piece of garbage like Facebook stock and other misallocation of capital.

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