The U.S. Federal Reserve Bank (FED) and the Bank of Japan (JOB), made dual announcements about their respective monetary policies within hours of each other, to what seemed to be the breathless global masses……then… nothing. Yes, both equities and gold rose, 1.2% for the former and 1.8% for the latter, but the less-than-energetic move hasn’t changed the trajectory, or the patterns for either asset. We think we can say that our question from two weeks ago, “Is this the inflection point”. Has been answered in the negative and have to continue with insuring all new positions.
The patterns we have been following remain in play; the move in the SPX was within the range of the pattern. The chart below shows the topping patterns in all four sentiment indicators: bull and bear investor sentiment, and Rydex bull and bear fund assets. The SPX is pushing up against the upper boundary of the down channel, so the index could go in either direction, or stay at this level (question mark on chart). We expect the former.
It has been awhile since we last displayed the topping pattern of the bull and bear investor sentiment indicators. The chart below shows that bull sentiment spikes (pink vertical lines) one to six weeks ahead of the SPX topping-out (blue vertical lines). This pattern is pointing to continued downward pricing for the next several weeks (see red arrows.)
These two charts, approached the problem from the topping perspective, and the patterns that emerged indicated a downward bias. What happens if we approach it from the bottoming perspective?
The graph below shows the local bottoms (blue horizontal lines) and the pattern that is visible in the indicators: Rydex bear-to-bull ratio, Rydex bull assets, bull and bear investor sentiment. Notice that when the SPX corrects (red arrows on the SPX), the indicators respond in a very similar way every time the SPX correct. The indicators “sweep” into the bottom-indicating horizontal blue lines as the SPX corrects.
The pattern at this time is pointing to further corrective action, at least in the shorter-term.
It turns-out, that both approaches give the same probabilities and are in agreement about a downward bias, but both approaches only look at short-to-medium terms. The long-term picture is different; the Rydex bear/bull asset ratio is indicating a higher market in the works (red circles on the chart below); down for awhile, then up again despite the over-valuation of equities.
The long-term RSI, MACD, and 8, 12 month moving averages are also indicating a potential bull move in the S&P 500 (chart below).
It could be that the downside, predicted by the short-to-medium term patterns, will not last beyond a few weeks. There seems to be more upside coming.
What could possibly justify higher equity valuations when the PE ratio has rarely been higher than it is at the moment, home ownership is down, the FED is “generally pleased” with the U.S. economy where the GDP estimate is only 1.8% (lowered from 2.0%), business earnings growth has been negative for five quarters….,and much more?
All those reasons for the market not to go up are well known, if not obvious, yet prices continue to rise. That smells like a bull market. A mature bull, we have to admit, but a bull none-the-less. Valuations at the later stages of past bull markets were just as hard to rationalize as today’s market valuations, but they went on to defy gravity anyway. The same may be happening now.
Climbing a-wall-of-worry makes the market behave irrationally….or does it?
What if the market is betting that, even though monetary policy by itself has not been able to stimulate the real economy, the governments of the world will not allow the economy to be starved beyond what the people will tolerate? Intolerable inequity has always resulted in revolution. Maybe the market is betting that governments will act to reverse the inequity.
In the U.S., both candidates intend to use fiscal policy to get the ship sailing. Yup! You read correctly, they are going to build infrastructure and go further into debt in order to do it. But wait, isn’t high government spending and debt the reason for this economic mess in the first place? By that logic, more spending and debt would only make things worse, even cause a depression.
But what if that logic is wrong (as we continue to maintain)? What if governments borrow at the lowest interest rates ever and use this debt to rebuild and extend airports, bridges, highways, renewable energy infrastructure, and especially education and healthcare (because AI robots will do the less-technical work, leaving the less-educated out of the workforce)? What might happen then?
Business, and hence the real economy, needs the consumer to increase the velocity of money, and the consumer, in turn, needs business to provide the money (create wealth). The consumer cannot start increasing money-velocity on their own, and business is too busy at the moment “flipping their-own shares” to actually bother growing a business.
Unlike QE money, which has never made it past the financial industry, fiscal expenditures on infrastructure will have relatively unfettered access to the consumer. Recall that every dollar in the hands of labour will be circulated in the economy, while another billion dollars in the hands of the already-rich corporations or individuals, will simply gather dust in a tax haven somewhere.
Business will then have to respond to the demand and opportunity that is created by consumers spending money. In other words, corporations will have to stop the “share buy back” program, which is nothing more than financial masturbation, and actually invest in growing the business.
The debt is like a very large and long-dated mortgage that carries almost no interest. The higher revenues arising from the increased business activity will easily handle the mortgage payments.
This could turn company profits around and lower the PE ratio, while simultaneously increasing equity valuations. This will only happen after the election, but the market is a futures market, so maybe any correction could be short-lived, since it looks ahead six months.
If a certain candidate gets in, we might find that some of that infrastructure debt is used to build a “yuuge, beautiful wall”. Since we really don’t expect that another country will buy us this “yuuge” wall, we are resigned to the fact that we will be paying this particular tab.
In conclusion, there is still much uncertainty in the equities market, so we will continue to maintain our hedged positions.
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