In recent weeks I’ve outlined the case for increased volatility coming to markets in 2015 which may well bring higher prices, but possibly also much lower prices. In context of insights derived from market behavior in 2014 and current market structures we’ve also outlined our trade strategy for 2015.
As we enter 2015 Wall Street is telling the world to be bullish and nothing but higher prices are to be expected:
They may well be correct, but note even the outlying bearish voices on Wall Street have all but disappeared. Yet I want to put these uniformly serene forecasts in context of a larger macro paradigm shift that this market has yet to reconcile or come to terms with:
The coming rise of interest rates.
Why does it matter? There have been plenty of times when rising rates also were accompanied by increased stock market prices. A review of the Fed funds rate chart shows that in the run up to the 2007 market highs rates increased for at least a couple of years before the financial crisis forced the Fed to go to ZIRP:
Yet it is precisely ZIRP that has created the never before seen current paradigm of TINA: There is no alternative. As we all know any interest bearing accounts were placed on death watch and cash was forced into what were previously classified “risky” assets: Stocks. Central banks ensured the perception that they have the market’s back and downside risk was virtually eliminated.
And who is to argue with success as we can all marvel at a market that makes even the 10% pullback in October appear as nothing but a temporary Ebola induced blip, an outlier that was not supposed to happen:
Besides cash forced into markets as evidenced by record ETF inflows corporate buybacks have continued to be a key driver of demand for equities, but of course also a key driver of the appearance of earnings growth (often at the expense of CAPEX spending):
Now one can clearly argue that as long as this supply demand equation is not changing nothing should really change in the trend and I agree with this perspective in principle. After all Janet Yellen is preaching “patience” and who really expects the super dove to raise rates before she is forced to kicking and screaming?
In addition to the current ZIRP policy by the US Fed global central banks are still on the all-in train with the recent Japanese, Chinese, Swiss and upcoming ECB central bank actions continuing to push cash into the same asset classes as evidenced by the exponential growth in bullish asset allocations to all time human history highs:
In a world where there is indeed no alternative one should then not be surprised that this is the result.
Janet Yellen has made it perfectly clear she won’t raise rates any time soon and hence markets are not expecting a rise until at least June of 2015 or later in September. Plenty of time for markets to engage in a blow-off type scenario such as the one I had outlined recently in “Crescendo”.
No doubt corporate buybacks can continue for quite some time even in a rising rate environment considering we are starting from zero here, yet markets tend to be a forward discounting mechanism and the anticipatory element of an emerging alternative could weigh heavy on investors’ minds as they all own the same asset class. Who will exit first? Who wants to be last?
The paradigm watch then is rooted in the following premise: What happens when there is an alternative again? Where will all this cash go? And what will happen to the uniformly allocated assets? And when will this all happen?
Wall Street tells you not to worry about any of this and prices will be higher.
My take: No trend lasts forever and this trend has been manufactured through enormous artificial financial engineering efforts. ZIRP will end and a process of normalization will recreate what once was a competitive market for cash. And competitive markets tend to be volatile. Will 2015 bring about this paradigm shift? Nobody can tell, but at least be prepared to trade it if it happens.
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