End Of The Great Market Illusion

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A series of data which normally would be considered anomalous is growing at such an accelerated rate, it's no longer 'black swan' data; now the flock seems to be all black and it's flying north for the winter.

Take a look at the following chart showing Consolidated Foreign Transactions in Long Term US Assets:

(click to enlarge)

This shows more foreign selling than after the credit crisis in 2008/2009, and this data is from June, the only down month in the S&P 500 since November of 2012. Why does this matter? Foreigners own more than $15 Trillion of US assets, according to the Federal Reserve. Foreign money flowing into the US in all forms not only is a boost for the markets and the economy, it is now significant because it provides a balance of real money inflows to the Fed's artificial QE.

Wal Mart (WMT)

(click to enlarge)

The biggest retailer in the US struggles with revenue growth. Wal-Mart is the largest private employer in the United States, also with one of the worst track records as far as employee treatment. Finally someone notice the obvious fact economists seem to miss: employees are consumers! If Wal-Mart paid it's employees more they would have more money to shop in their stores. That's not the entire reason for the above chart, but being the biggest private employer also means that they have ability to increase discretionary spending of large consumer base, and could incentivize them to keep the money in the company by offering discounts or giving them gift card bonuses. In any event, the above chart is disturbing coming from a retail behemoth such as Wal Mart .

10 Year breaches key level 2.75

The 10 year today went beyond a key 2.75% reaching a high of 2.88%.BofA/ML says:

With a 14bps move higher in 10-year interest rates over the past two days, the key question is how much will it take to accelerate outflows from bond funds enough to lead to wider high grade credit spreads? While we already expect outflows from (non-short term) funds to increase based on the move in interest rates so far (see Figure 4 at the end of this piece), clearly a move to 3.0% on the 10-year over the next several weeks would lead to much more meaningful outflows. Whether such scenario actually leads to wider credit spreads depends on the extent of institutional buying interest at the new more attractive levels. That in turn depends on whether interest rates are perceived to stabilize at the new higher levels - thus the other key variable to watch is rates volatility.

These levels come at a time when China and Japan are selling more US paper than ever. And it should be noted the Yuan has reached an all time high against the dollar, and is currently a growing means ofexecuting international trade deals.

Many institutional traders watch the 10-year yield as a type of market sentiment based on the Fed's QE program.

Gold near backwardation

While the price of Gold (GLD) is up today, it's far from it's peak. At the same time, demand for physical gold is surging making Gold traders scratch their heads. Large Gold trader Paulson cut his holdings by 53%in the Gold SPDR.

Another strange phenomenon is happening with Gold , warehouse supplies used to back commodity contracts are near all-time lows. Gold is being repatriated by Germany and other countries, while China and Russia are buying Gold at a record pace, increasing their reserves.

Hindenburg Omen

Wall Street is a buzz with sightings of the "Hindenburg Omen" named after the great crashed Zeppelin. Art Cashin of UBS says the last time we saw this many omens was before the start of the 2007 bear market.

With the latest market rally, the Omens are flaring up again. There have been 5 Omens triggered out of the past 8 trading sessions (your data may vary - we're using the same sources we've always used for historical data). That's actually the closest-grouped cluster since early November 2007.

It's extremely rare to see as many Omens occurring together as we've seen over the past 50 days. The last time was prior to the bear market in 2007. The time before that was prior to the bear market in 2000.

The Fed

Market focus is on the Fed with "Taper Talk" the discussion. Fedwatchers remember the Greenspan days when paparazzi would photograph Alan and Fedwatchers would speculate on decisions based on the size of his briefcase (bulging briefcase, Fed worried, unexpected rate decision). In an interview Greenspan later admitted that usually his briefcase contained his lunch. Today the Fed is a different Fed, having gone through audit the Fed proposals by congress, a series of Fed assisted asset relief programs, and an unprecedented QE infinity program.

The taper question is with all the Fed money floating inside the system, what will happen during a big sell off considering the Fed's recent report on LETFs, and the increase in margin debt usageespecially on the NYSE?

Does the stock market really matter

Traders and investors live and breathe the markets. Certainly the more than 100 Million unemployed Americans would rather get a job than have the stock market go up. Corporations, rich people, and banks are sitting on record amounts of cash. This contributes to the decline in velocity of money, which is at depression levels. Instead of hiring full time employees, the trend is to hire temp workers just enough that they don't get benefits. Temp jobs have seen a 50% increase.

But is the stock market really a driving economic factor? If companies are sitting on cash, not hiring full time workers, and a company the size of Wal Mart has zero YOY increase in revenues, what difference does it make what the stock price is? This rally has proven to be an illusion. Rumors circulate about a bond market bubble, dollar bubble, stock market bubble, and real estate bubble. Paul Craig Roberts calls this the triple bubble (Dollar, Bond, Stock). But aside from long stock investors losing in the event of a market crash, would a potential stock market crash cause other externalities or 'collateral damage' ?

One near certainty, it will prove the failure of QE as a means of solving the credit crisis of 07/08, and show the recent rally for what it is, a financial illusion.

Just imagine if the Fed gave the QE to the unemployed 100 Million people how that would benefit the economy. Like the controversial 'entitlement' programs, what do people do when they get paid? They spend their money. Banks don't - banks are sitting on massive amounts of QE dollars, in some cases keeping them in custody right back at the fed, gaining a risk free 50 bps by doing nothing! The US economy is losing it's largest value: human capital.

Actionable intelligence

Of course no matter how much data indicates the broader market may decline, it means nothing if the Fed keeps propping the market albeit indirectly with QE and other instruments. Also, in the age of high frequency institutional trading in dark pools, there's no way to know if some type of high frequency Plunge Protection Team has been put into place, the stock equivalent of the Fed's bond buying program. In a world where the NSA is recording all emails and internet traffic in and out of the United States, but can't track its own internal emails, anything is possible.

But if we take the data on face value, it might be a good time to take profits if you are long the market. Not every stock will decline in a market collapse and some will even benefit. Otherwise, it's a good time to buy (SPY) puts while they are still cheap.

Wal Mart data is not alone, Cisco (CSCOdropped 10% recently due to poor growth. These are not small companies, they are large and very integrated in the economy. How many Cisco employees shop at Wal Mart , and how many Cisco products does Wal Mart buy?

In the case of potential Gold backwardation, why not buy some far out calls on itself, again while they are cheap? If any Gold contract defaults, we could see rise huge in 1 day. Other events could cause to rise, even if it's not so extreme, such as the situation in Egypt and potential escalation of neighbors. Just remember, the Fed can print as much money as it wants (and give it to banks and institutions who can buy stocks or increase margin debt), but there is limited quantity of Gold in the world. Of course this is true of any commodity, but the metals have financial allure throughout human history.

To conclude, buy puts on and calls on and take any profits in long stocks before its too late.

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