The volatility we have seen in the markets since early February is enough to put bears and bulls alike at unease. Prior to early February, the markets were climbing up and up, making it worth maintaining a long position and buying each and every dip.
Just have a look here at the SPX:
But early February was the warning shot across the bow for the bear market that I expect. If you had been following the advice that I published throughout the third and fourth quarters of last year and into January, you would have converted to 60-70% cash and saved yourself from the headache and loss, which that shot would have inflicted.
Since February, the markets have been up and down. There are times when the market gets locked into a trading range and the market chops and churns, and the past 6 months have been a case in point. I call these periods “meat grinder” markets, because they tend to chew traders up.
Nevertheless, I’ve been on record saying that a bear market will arrive soon – and I had anticipated that it would arrive even sooner. But when things go against our expectations it’s critical not to panic. We must continue to watch the charts, and stick to our analysis and conclusions about what is fueling the larger emerging trend.
So I harken back to three ideas that I’ve been harping on, all of which point to increased market risk.
In This Euphoric Market, 3 Factors Are Fueling Maximum Financial Risk
Bulls currently have the upper hand in this market, but their participation is riding on speculation using increase leverage, and this is dangerous. Let’s consider this in light of 3 of the pillars of my bearishness…
The first pillar is that Treasury supply is ballooning. I expected that to bring pressure on stock and bond prices. It may have, but it’s not obvious because bonds have been treading water and stocks have kept rising, much to my chagrin. I showed you at least part of the reason for that earlier this week-the growing use of leverage, debt financing aka margin, to propel prices higher. This is dangerous because underlying macro liquidity is falling.
The second pillar is that the strong economic data would keep the Fed on a tightening course. We’ve seen a lot of squealing out of Wall Street that the Fed may, or should, slow its tightening. That’s because some big players are out of position in fixed income and getting squeezed.
But with the topline economic data rising at about the same rate that it has for the past couple of years, there doesn’t seem to be any basis for the Fed to back off. There’s a new sheriff in town, one Jerome Jerry Jay Powell, and he’s a tough guy. He’s what Wall Street pundits call a “hawk” on monetary policy. He says the economy is strong and that there’s no reason to deviate from the set course of tightening policy.
The third pillar is that the economy would run hot, thanks to the bulging federal budget deficit goosing economic activity. And the CPI is ratcheting higher, as it always does when the Fed tightens policy. So a hot economy with rising inflation will keep the Fed on course for the foreseeable future.
But what if the economy doesn’t stay hot? Will the Fed back off? It’s an interesting question now because I saw some hints in the tax data that suggest that maybe, just maybe, the economy is starting to cool. It’s in the excise tax collection data.
The US collects excise taxes on a broad cross section of goods and services. They are based on unit volume of sales, not dollar value of sales. They have therefore been an excellent means of seeing the trend of the economy without the need to make haphazard inflation adjustments.
Total excise and customs tax collections have been rising, suggesting increasing economic activity. There’s no indication of economic weakness, therefore no reason to expect the Fed to back off from its bloodletting, balance sheet “normalization” program.
But alas, President Trump began imposing tariffs on our European and North American allies at the beginning of this period, and those show up in the customs data. So maybe it’s not such a good idea to include that. So I constructed a second chart without the Customs taxes.
When I backed out the customs taxes, April was flat, May was up, but June was down slightly vs. last year. This could be the first sign that the tariffs are beginning to slow the economy. And it’s one reason why Fed doves, and various Wall Street shills, are squealing about the need to slow or halt the rise in interest rates, and slow the “normalization” of the Fed’s balance sheet.
They call it “normalization.” I call it “bloodletting.” And that bloodletting is the lynchpin of my analysis. As money continues to be withdrawn from the banking system demand for investment securities will weaken, and increasing Treasury supply will absorb an increased share of diminishing available money (liquidity).
But what if the economy weakens. What will the Fed do and when will it do it? Will a weakening economy trigger a reversal of Fed policy back to QE?
If it does, it would take months for the Fed to respond, and the Fed has said that its first response would be to “lower rates,” not restore QE. In essence that means that the process of shrinking the balance sheet and thereby pulling money out of the system will continue until Janet Yellen’s “material adverse event.” Powell seems inclined to follow that doctrine.
What’s a “material adverse event?” I highly doubt that it would be a mere slowing of the economy. More likely it would be a market crash or an upward crash in interest rates.
The rise in rates actually reinforces and invigorates rising consumer spending and inflation, as consumption rises at the margin to beat expected increases in interest rates. We saw that in the just released June retail sales data. I examined that, and while it wasn’t quite as strong as the headlines suggested, it was nevertheless modestly positive after adjusting for inflation. So the Fed faces a double bind of rising consumer prices and a modestly growing economy. In other words, 1970s stagflation redux.
This will end badly. That “material adverse event” will happen before the Fed comes to the rescue and starts printing again. The fact that speculators have been leveraging up to chase momo stocks higher only means that the market’s “adjustment” will be that much more severe when it finally comes.
Downturns Still Ahead: Chasing This Rally Isn’t Worth the Risk
Sure, the SPX could make a run at 2900 before it’s over, or it might not. But chasing this rally isn’t worth the risk that the collapse will start sooner rather than later. The S&P edged above my suggested mental stop of 2813 by the end of the day yesterday but opened today below that line in the sand and remains below it at mid-day. If short the SPY, I would step aside if the market closes strong, above 2813 again. But I would hold short if it stays below that benchmark.
If on the sidelines, I would wait for the market to signal weakness before jumping back in on the short side. That could happen today if the market closes down today. Closing below 2790 would be additional confirmation. I’ll be on the lookout for that signal in the days ahead.
RWR on the other hand has not broken my suggested stop level of 95.73, and has briefly fallen below the re-short area of 94.
While the RWR is due for a minor bounce over the next 2-3 weeks, it remains a hold short, with the chart indicating the likelihood that a top is in progress.
I’ll be keeping an eye on this chart as the weeks progress, and will send you updates as they arise.
Meanwhile, if you are looking for other trading ideas, long, short, or market neutral, check out my special collapse to profit/ collapse to protection report, or check out Shah Gilani’s put play research and recommendations in Zenith Trading Circle.