Market Analysis

The Lost War

At the time of this writing US markets are up 9 weeks in a row following the December lows making for risk free markets since Jay Powell famously caved on January 4th signaling flexibility on the balance sheet run off. Every tiny dip is bought and bears increasingly look the ones trapped, not bulls.

And the parade of central bank jawboning has been as spectacular as it has been global. Consider what signals have been sent to markets by central banks in just the past few weeks: The US Fed: No more rate hikes, flexible on balance sheet reduction, even open to stopping it altogether and discussing making bond purchases a regular tool, not just an emergency measure. I thought we were done with those? QE4 coming? The ECB: Discussing bringing LTRO (long term financing operation) back which would constitute another liquidity infusion. Didn’t they just end QE six weeks ago? BOJ: Ready to ease more. More? They never stopped and the BOJ famously owns more than 75% of the Japanese ETF market already. And China has added record liquidity infusions in 2019 desperate to provide liquidity to its lending market.

There is no doubt that this renewed global central bank capitulation has succeeded in levitating asset prices from the abyss in December. Greed is back, daily headlines hinting at a successful China trade deal to come and POTUS tweeting “up, up, up” all add up to a buying panic atmosphere.

Global growth slowing? Who cares. Buy stocks vertically up:

A couple comments of principle on this linear $DJIA chart: 1. This is not a chart of a stable, normal bull market, it’s a highly erratic chart. 2. Vertical, extreme tight channel ramps don’t have happy endings and this is most extreme tight channel ramp in many years. These ramps can extend no doubt, but they eventually end in tears as we saw in February 2018, except this ramp is even steeper 3. Central bank capitulation amid slowing macro data have proven bears right as I outlined the other day. Central banks panicked and once again participants are witness to the awesome hold central banks have on equity prices.

But while central banks appear to have won the battle there is one chart that strongly suggests they’ve already lost the war.

There’s a chart I’ve been watching for years and it’s not an index chart, rather it is a ratio driven chart that divides the S&P 500 into $CPI (consumer inflation) and it produces a fascinating picture:

For decades this ratio has followed a very repetitive pattern: During bull markets the ratio rises and then forms lows coinciding with market corrections and these lows form along a very precise trend line. When markets enter a topping process the ratio wobbles, becomes unstable in its ascent until the ratio breaks below the trend line coinciding with a bull market top. And each time the ratio breaks the break coincides with a break in the S&P 500 bull market trend. At the same time, as we’ve seen with index chart tops, the relative strength index (RSI) prints a negative divergence (a lower high) while the ratio prints a new high. All of these things have now again come to fruition.

Coincidence? Judge for yourself looking at the chart above.

What is clear is that the ratio broke its trend line in December for the first time since 2009. The 2 previous breaks marked the end of bull markets and brought about sizable bear markets. But note also that these bear markets experienced sizable bear market rallies first and I’ll use a chart of the Industrials ($XLI) here to illustrate the point:

It sends the same message as the CPI ratio chart: The war is already lost, no matter how desperate central banks are in attempting to re-inflate asset prices. The larger message I take away from this: Market strength is an opportunity to sell, especially considering that this rally remains untested, technically uncorrected and dovish central banks have now been fully priced in. But hey, perhaps it’s different this time. It has to be, otherwise the CPI ratio chart suggests new lows are coming.

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19 replies »

  1. Teneral theme of your article reflects the sentiments of James Grant in an article in Barron’s this week (last page).

  2. think you’re exactly right…when the jawboning stops,and maybe before, and the actual trade deal is explained or extended once again, I expect an 87 type the end of which the Fed, in their ongoing ignorance, may actually cut rates and join Abe and Dragi in setting up the next GREAT RECESSION ?

    • interesting chart’s also interesting that you can draw the exact same on the top of the chart you show…may mean a sharp move one way or the other

  3. I tried reproducing your monthly SPX/CPI chart in Excel using FRED data, but it shows that the bottom hugging trend line from 2009 is not violated by the December ’18 trough…what gives?

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