What if bears were right all along? What if it’s not different this time?

What if this Fed liquidity inspired rally produced precisely the kind of exuberant final thrust we often see at the end of business cycles? After all, people were really bullish in 2007, people were really bullish in 2000, both final rallies inspired by easy Fed liquidity. In 2000, the Y2k bug, in 2007 giving us the subprime mortgage crisis.

What if this latest rally has produced exactly the same conditions we’ve seen during prior tops?

Be clear: I’m not calling for a top here, that’s a fool’s errand. After all so far all we’ve seen is a minor pullback off of very overbought conditions. Heck, tech hasn’t even begun to correct yet.

But yields keep dropping like a brick, as does the Baltic Dry index, small caps, transports, the banking sector never confirmed new highs, equal weight indicators suggest a major negative divergence inside a market that appears entirely held up by tech, and perhaps by only 5-10 highly valued stocks that are massively technically extended and control more market cap in a few stocks than ever before. At the same time we have a market more extended above underlying GDP than ever and now suddenly a potential trigger nobody saw coming: The coronavirus.

Look, the track record on viruses and diseases over the past 20 years has been clear: Any market impact is temporary and/or minimal at best. Look at SARS in 2003, $SPX rallied over 20% in 2003. But the backdrop was different. The US just came out of a recession and markets had bottomed in 2002. Markets in 2003 were at the beginning of a new business cycle.

This cycle here is old, and one could argue was merely saved again by a Fed going into full easing mode in 2019.

But given the fact that the Fed failed to normalize in the lead up to 2018 and was stopped dead in its tracks because of a 20% market correction and was forced to go back into full easing mode the concern is that the Fed just wasted precious ammunition.

My concern:

Good thing the Fed has been prudent in preserving their ammunition to deal with a real crisis instead of blowing their wad with a bunch of rate cuts & a massive balance sheet expansion at the first sign of an earnings slowdown inspiring a big fat asset bubble in the process.

Oh.

— Sven Henrich (@NorthmanTrader) January 27, 2020

These very concerns now suddenly very much echoed at Citi:

CITI: “What we find particularly troubling is the potential interaction between the shock from the virus, already stretched market valuations, and central banks approaching the local limits of their ability to prop up markets.”

(via @pattidomm)

— Carl Quintanilla (@carlquintanilla) January 31, 2020

None of us can know how this plays out, we can’t know when this virus will be contained and subsides. What we do know is that the economic impact is already real, flights are canceled, businesses are shutting down in China, etc.. To the extend that this is all temporary for a couple of weeks, fine, to the extent it drags on for months and the virus spreads quickly in other countries as well it’s not hard to imagine that a vastly richly valued market finds itself in trouble and with it: The global economy.

Markets, except tech, pretty much gave up all their gains in January with many indices now in the red. The potential good news for investors: Markets are approaching oversold readings and could be setting up for a bounce, and a larger relief rally if the news on coronavirus shows improvement, the bad news: Tech hasn’t even begun to correct and technical patterns suggest more downside risks.

And if bears have been right all along on the macro front, then rallies may well remain selling opportunities. And so far, strength in January has proven to be a selling opportunity on the larger market.

For now it’s a ‘What if” and confirmation remains outstanding and won’t come easy. But clearly some of the major banks are starting to ask similar questions.

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