Market Analysis

Distortion

Once again they took all the pain away. What looked like the beginning of a larger market correction, amid renewed reductions in global growth outlooks, was again aborted in its tracks by renewed panic interventions by central banks, namely the PBOC which injected vast amounts of liquidity, cut rates and banned short selling as the Fed continued on its track of massive repo liquidity injections and continued treasury bill buying and voila: New market highs.

The net effect was so violent that the previous week’s sell-off was forgotten by Monday morning, by Tuesday $NDX made new highs again, by Wednesday $SPX made a new all time close highs and by Thursday $DJIA, $SPX and $NDX all made new all time highs with most of the market gains for the week driven by magic overnight gap ups and marked by tight intra-day ranges. Nothing matters or so it seems.

The liquidity wave continues to dominate the market action, yet the warning signs keep mounting, the distortions keep expanding in a market that is dominated by a handful of stocks that control the index price action via historically unprecedented market cap expansion while the broader market shows marked weakness beneath,.

Yields again croaked, not confirming any notion of reflation with the 10 year closing at 1.58%, banks didn’t make new highs, neither did small caps, or transports, the laggers keep lagging.

A narrowing of leadership, vast price extensions above key moving averages, and negative divergences on new highs leading to a pullback below previous highs raising the possibility of a double top.

Are central banks and their interventions leading investors off a cliff I asked this week, as sentiment indicates desperation to buy every conceivable dip abandoning all sense of risk. Yet corporate insiders are selling strength and asset managers did not buy the rally to new highs, rather continued to reduce long exposure signaling that not all are in the ‘pile in at all cost’ camp.

Indeed Mohamed El-Erian, who previously urged investors to resist the temptation to buy this dip, put out another warning out on Friday:

Confidence is high, as it is in every market bubble, confidence that investors all can get off the train in time. So far this confidence continues to be validated as markets are continuing to avoid any damage that the fundamental global economy would indicate while valuations remain historically stretched and central bank liquidity injections continue to control the price action.

Yet did this vertical surge in equity prices last week put in conditions for a larger sell-off still to come? Indeed did the rejection of new highs amid building negative divergences signal something more sinister? Or will the distortions in markets run unabated forever ignoring all risks?

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7 replies »

  1. Sadly, fortuitously, up until I reached the point in your piece concerning the ‘train,’ I had been visualizing a train, traveling along its tracks, full speed ahead, edging closer and closer to crashing. (Your wisdom must been sinking in!) Thankfully, I appreciate your accompanying sense of humor and just-the-right-touch-of sarcasm, as I have come to expect is your style. It helps balance the harshness of the reality as to what is happening in our world, Sven!

  2. My take here is we plunge like a lightning strike into the 200 day moving average. 3,000 points to the downside then up again into the election where Trump wins by a landslide. The dow jones reaches new highs. Then RUN! SELL! gold/silver eagles used to cross borders.

  3. Did you guys see the cnbc article about how Jeremy Siegel and others are saying that the 60/40 sotck/bond asset allocation is no longer going to cut it so they are now saying it should be 75/25? Interesting timing… They say the dividends of the stocks will be the new bond yield.

  4. Sven,

    The world’s central banks are suffering from a human condition in which most humans deal with the dynamic complexity by minimizing detail complexity. Harvard Buisness Review wrote a good research paper on this topic, showing that the more humans become “experts” in their very narrowly defined inter-domains utilizing knowledge silos, the more they can not connect the various knowledge bases in solving more complex issues involving larger sets of variables. Ironically, the “expert” syndrome also creates a condition in which humans will tend to ignore anyone without training in their own same disciplines. Simply put, the central banks have become arrogant utilizing their narrow knowledge silos, which funny enough are the self-same knowldege silos that created the inter-domain complexity in the first place. In summary, the central banks attempted cure for self-inflicted complexity creates a self fullfilling prophecy of future failure. And unfortunately the world rewards such behavior, as unintended consequences of such behavior are labled as impossible to have predicted and carry virtually zero societal consequences. Personally I believe this will be the fate of all humans until we sufficiently destroy our way of life in ways that will force massive changes in the way we process self-inflicted complexity. And the central banks are accelerating the timeline for such an event. The fed is the very definition of “SiC” —-> Self-inflicted Complexity.

  5. The fiscally irrespnsible legislative and executive branches of our Government are part of the root cause here. Actually its not fair to call this part of the root cause because somehow our system of Government allows for this unconstrained spending. Profilgate spending is a human reaction bounded only by harsh control. CB’s are part of the problem because they act as if they know how to control the economy and as Anon… has stated they unfortunately dont know and cant know all of the variables. You can remove quiite a few of those out of a system that controls spending to revenue.

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