The Unseen

Yesterday Mohamed El-Erian advised investors not to buy the dip this time. What do they do? Jam fully into markets again. The addicts can’t be stopped.

And so the market follows the script of every bubble. Buy till you die with the risks unseen. Each bubble has its poster child and perhaps $TSLA will be this time’s poster child as investors are relentlessly chasing the stock higher as the hype builds daily.

But this post is not about $TSLA, it’s about the historic macro script.

Here’s what generally happens. We have a recession, then a major economic recovery that lasts for years, then the yield curve inverts, there’s a momentary scare usually accompanied by a larger correction, then the big relief as the yield curve un-inverts, new highs come in markets, risks remain unseen, people get super bullish as the final cycle rally is super aggressive, people pile into stocks, warning signs are ignored, valuations expand and then pow, it’s over at some point.

Nobody can ever call a top, but one can observe the historic script of these final rallies and that is: All highs come on monthly negative divergences and equal weight is dragging as the rally narrows to the big winners and the broader market does not participate.

I submit we’re seeing all these elements now:

Yesterday the yield curve inverted again seemingly showing a very similar roadmap to 2007 when the same thing happened: An inversion, a un-inversion, a renewed inversion, and then an aggressive steepening.

In 2007 that process brought about new market highs and we may well be in a similar phase now as all risks are once again ignored. In Fed we trust, you can’t fight the Fed or so the sentiment goes. In 2000 the final rally phase lasted into March following some initial weakness into late January, similar to what we just saw.

But Mohamed also warned about central bank efficacy, the same issue I’ve been raising.  It bears repeating that in 2000 and 2007 it took over 500 basis points in rate cuts to fight off the recessions that caused massive market damage.

The Fed has barely 6 rate cuts left now before hitting zero again. There is not much room in case of a real emergency and the Fed has already aggressively expanded its balance sheet and has cut rates 3 times. Investors today are quickly ignoring the coronavirus and its economic implications that Mohamed El-Erian warned about yesterday.

They are also ignoring the message of the bond market which, with its renewed inversion of the yield curve, is sending a continued message of slowing growth. And markets are ignoring the historic valuations we are witnessing with a lot of optimism built into future growth that may or may not come.

These are the risks unseen at this stage, but the historic script suggests the final rally is the most aggressive, the most reason defying, and the most wrong to be buying, rather the best one to sell.

But, in keeping with the historic script, all warnings fall on deaf ears, as did Mohamed’s warning yesterday. Addicts.

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Categories: Opinion

5 replies »

  1. There are quite a few of my stocks that are hardly doing great. And they are cut down for relatively good results like Northrop.

  2. Sven,
    Did you not feel the same way as now in the beginning of 2019? I agree with what you say but it seems like we thought the same thing in January-Feb 2019 and the market went straight up since then.


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