At what point do the citizens of a world dominating power realize that the peak of their society lies behind them? Were there symptoms of policy that signaled the decline was already in progress and, by history’s evident record, inevitable?
As every single world dominating power in history had to face the eventual decline of their influence at some point it is a poignant question. None of these declines seemed fathomable to those in power at the time. As brilliant a politician and military strategist as Julius Caesar was the eventual collapse of the Roman Empire would have seemed as unfathomable to him as the daggers that eventually fell him on the Senate floor. For centuries no power was as dominant militarily, technologically and economically as the Roman Empire, yet the Roman metropolis went from an urban global center of over 1 million people to less than 50,000 people by the 6th century.
Was there a single symptom one could point to that the empire was about to fall? Possibly yes and ironically it was one act of central planning. Rome by the 4th century had increasingly become ungovernable. Social tensions had risen driven by economic, political and religious divisions. In 325 Emperor Constantine convened the Council of Nicaea which resulted in the elevation of Christianity as the Empire’s official and only religion while others were outlawed. Now I’m of course not saying that Christianity caused the fall of the Roman Empire, but the centrally imposed policy was an act symptomatic with an empire already falling apart at the seams. It could no longer successfully function and failed to produce the results it had before. Consider the timeline: 70 years after Nicaea the Empire split in two, another 15 years later and in 415 Rome was sacked by Alaric’s Goths. The end game was in play.
Fast forward 1,600 years. Empires have come and gone but the time cycle has nothing but shortened dramatically and much of it driven by the advent of the industrial revolution and now the technology/information age. One could argue that the new global power on the scene reached its peak in dominance and influence somewhere between Kennedy, the moon landing and the dissolution of the Soviet Empire. Hailed as a victory of free thinking, free markets and capitalism over the forces of central planning the US started slowly, but exponentially, on a path of central planning on its own. The symptom: Debt. The policy: Central Bank intervention. Further potential allegory symptoms: Political divides that leave the US ungovernable with little political progress apparent (we can’t even agree on health care), failed and expensive foreign adventures as evidenced by ISIS overrunning Iraq and Syria with Afghanistan remaining a failed state. Lots of money spent and debt incurred with little progress to show for.
The reality remains that without an exponential expansion in debt and monetary policy the prospect of organic growth has seized to be a reality. Central planning has rapidly morphed into the tool of desperation for global societies as without it the economic system as we know it cannot simply function. Don’t believe me? Look around you. ECB, BOJ, and FOMC can’t keep their fingers off the button. And now they trade $ES futures directly. Yet as we know from history no effort in central planning has yielded an ultimate successful outcome.
We’d like to think that our new technological age will somehow get us out of this mess, but what is the evidence? Is society as a whole improving and advancing? Somehow cat pictures and ice bucket challenges posted on Facebook leave me somewhat unconvinced as do record wealth inequality accompanied by falling real wages and increases in low paying temp jobs. Global growth remains abysmal despite all the central planning efforts to elevate global equity prices to ever higher levels.
The recent ramp in August to new highs again is littered with symptoms of a potential hard fall to come. I’ll walk you through some of my key findings and my conclusions below:
1. M1 money supply has suddenly dropped below the previous month’s low for the first time since 2009:
I love this chart as it is in essence unmasking what this rally has been all about: Multiple expansion driven by an increase in money supply engineered by the Fed. QE3 is coming to an end. This does not mean the FOMC is letting markets act on its own of course as Janet Yellen is still refusing to let interest rates to move above 0%. But we can take note of the most sizable drop in M1 money supply in many years.
2. No bears. If anyone tells you there are many bears and people are too negative they are at best ignoring the facts. The Rydex bull/bear ratio has reached its lowest level since 2000:
As we remain at record deviation levels from long term moving averages this indicator is of note here. The Rydex sentiment indicator confirms these extreme levels of bullishness as does the AAII sentiment survey which just reached its highest level of bulls in 2014:
What are the confirming indicators of these record price levels? I can’t really find them, rather the opposite. Let’s review:
The high/lows and cumulative advance volume are all showing negative divergences and the $CPCI ratio just spiked to levels commensurate with imminent declines:
As you may note we have a megaphone structure building on key indices. On the daily chart this pattern is fairly prominent:
For those that say that the low volume in August has been due to holidays or seasonality please note that this year’s volume is barely half than it was last year. In fact, every single big rally since last year has taken place on ever shrinking volume. As I’ve pointed out before most of the increases in price have occurred due to overnight gap ups on extremely low volume. The magic hands keep lifting it before open.
Yet the negative divergences keep mounting. A similar megaphone pattern can be found on the strongest index, the $NDX, yet note these prices display underlying weakness as well:
A similar picture of relative weakness emerges for the $DJIA and the $RUT:
Now clearly further upside cannot be excluded as the powers that be clearly want prices to keep rising, but frankly their actions reek more and more of desperation. The shocking low volumes indicate a complete lack of participation. Are we witnessing a buyers’ strike where the only marginal buyers left are central banks, mutual fund money inflows and corporate buyback?
Sellers remain completely absent for the same reason that has been in play for a long time. They don’t know where to put their money. Bonds as the safety trade? Well it seems it already is:
Given the M1 reversal and the underlying signs of weakness it seems some are getting prepared for something to happen this fall. The above mentioned $CPCI ratio is one such indicator. The positive divergence in the $VIX is another:
Ever since QE3 has commenced the $VIX has been held prisoner by its weekly 200MA and the ever supported $SPX trend line. Yet since the July $SPX highs the $VIX has diverged and had made a higher low. It’s a long way to the 17/18 area but an eventual break of the $SPX trend line would likely change this dynamic quickly.
Gold has been languishing all of 2014, but interestingly enough even its weak seasonality into the end of August has not seen it break its trend line making the case for potentially higher prices into the fall:
So the picture that emerges is fairly clear: Central banks are doing their dearest to keep the game afloat, but a buyers’ strike may be emerging and at some point something more organic than easing, buybacks and 0% interest rates is needed. In the case of the Roman Empire it took 85 years between the time of central planning and the sacking of Rome. How long before reality catches up to the symptoms this time?
I couldn’t tell you, but people trading long here might be well served remembering where they are buying:
Last week saw precious little progress on indices, but the slope is getting steeper to maintain. This coming week Super Mario shall bless us maybe with more QE or not and September should see a major increase in volume. Should make for fun and volatile trading:
— TheNorthman (@NorthmanTrader) August 29, 2014
Categories: Market Analysis