Market Implosion Is Already Here. Do Not Believe The Hype (take #2)

I have noticed that US based (and some Nordic) investors are mostly focused on what is going on in their domestic large-cap space. As the S&P 500 keeps on soaring some may not be fully attuned with the state of the global markets and the risks they pose. At the same time as the S&P 500 is doing great, the global equity markets, US small-cap stocks and commodities have imploded, or are in the process of imploding. Most markets are in or entering into bear market territory. In my perception this fact makes the ongoing S&P 500 bull vs. bear debate obsolete as it is only a matter of time before the S&P 500 which is highly correlated with international markets (graph #1) starts to move lower.

Graph #1: S&P 500 correlation with international equities 2010 - 2015

Source: BNY Mellon

In my humble opinion the post 2008 - 2009 credit buildup/ business cycle has ended. The credit buildup has even ended for US stocks as reflected in the demand for US margin debt (graph #2). I have been told that the S&P 500 is a safe heaven index where I can stash my cash. I do not believe that stocks can ever be a safe heaven.

Graph #2: Margin Debt & S&P 500 Discrepancy

Source: Yardeni Research

The German DAX is currently 17 % down from its 2015 peak, the Japanese Nikkei 225 is down by 20 %, the Chinese Shanghai Composite is down by 40 % and brent oil is down by 64 % from its 2014 peak. Furthermore the US small-cap index Russell 2000 is down by 5 % from its 2015 peak (I am short Russell 2000).

The only reason some investors believe that the markets are fine is due to the fact that the S&P 500 have not yet started to trend downward. The US large-cap stocks are still holding up mainly due to what I perceive to be record low unsustainable interest rates combined with a chase for "safe heaven" yields while both economic activity and earnings are deteriorating in the US and abroad. During a normal business cycle the S&P 500 will perform very well post the FED starting to rise interest rates. At this point I would not bet on the average historic appreciation (graph #3) as the FED started rising rates at the end of 2015, a couple of years too late. It is my perception that they started rising rates at the end of the business cycle, not in the middle of the business cycle as usual.

Graph #3: Stocks performance before and after first FED rate hike

Source: Fidelity Investments

I believe that the day of reckoning will be here soon enough for the S&P 500. The index will at some point start to trend downwards alongside its international counterparts. Both the S&P 500 Shiller PE multiple and the market-cap to GDP ratio currently are at or above pre financial crisis levels (graph #4 and #5). The rich valuation is combined with an ongoing earnings recession (graph #6). The S&P 500 is clearly in a bubble. Furthermore the downtrend in international market will at some point catch up to the S&P 500 bubble index. In bad times global indexes start to correlate more than normal. I do not believe that it will be different this time around (graph #7).

Graph #4: S&P 500 Shiller PE Multiple @ Pre Financial Crisis Level

Source: Gurufocus

Graph #5: Total Market Cap to US GDP Above Pre Financial Crisis Level

Source: Gurufocus

Graph #6: Ongoing S&P 500 Earnings Recession

Source: Gurufocus

Graph #7: Asset Class Correlation to US Stocks

Source: Hedgable

Disclosure: I wrote this article myself, and it expresses my own opinions. I am not receiving any compensation for it.

Margin debt vs. S&P 500. This time it is different?

When investors utilize margin debt they borrow from a brokerage firm through a margin account in order to make investments in risky assets such as stocks with the borrowed money.

The accumulated amount of margin debt utilized by investors to buy risky assets has consistently predicted turning points in the stock market in the past. As illustrated by the below graph the amount of accumulated margin debt started to decrease before the 2000 and 2008 stock market peaks. During the current debt cycle (post 2008 financial crisis) the level of margin debt in billion of dollars peaked in early 2015. What is different this time around is that the S&P 500 stock index did not implode shortly after the top of the margin debt cycle.

Accumulated margin debt in billion USD vs. the S&P 500:

                                Source: Yardeni Research

Is it different this time around? Will the S&P 500 index keep on climbing to new heights while investors deleverage? I personally do not think so. I believe the current discrepancy between the movement of margin debt and S&P 500 is proof of irrational exuberance, where retail investors desperate to miss out on the fun and foreign investors desperate for yield pump up stock prices one last time.

The below chart (blue line) illustrates that the "dumb" money is a lot more confident in the current market situation than the "smart" money. The "smart" money is defined as investors who have been good at timing the market in the past.

Smart money vs. dumb money confidence spread:

                                Source: The Fortune Teller


Disclosure: I wrote this article myself, and it expresses my own opinions. I am not receiving any compensation for it.

The yield curve and the day of reckoning

A former professor of mine who was more of a practitioner than an academic (Merrill Lynch guy) once told me that the only factor I had to focus on in order to detect a incoming crash was the slope of the yield curve. He told me that the flattening of the yield curve usually screams "there is a recession coming!". When the yield on a 10 year treasury note minus the yield on a 3 month treasury bill moves close to zero, it is time to sell everything. He also stated something along the lines of: "don't listen to the fucking talking heads telling you that it is different this time around".

As observed from the below chart I have drawn a thick line from today's point on the chart. I have also drawn tangents from past intersecting points. The 10Y yield minus the 3M yield was the same value as today in 2008, 2006 and 1999. You do the math. Sell everything.

I can't predict when the US market will crash, however, I know it is getting close. I am on the sidelines for this one (frankly, my intention is to profit from it).

Yield on 10Y treasury minus the yield on 3 month bill:

Source: Federal Reserve Bank of St. Louis and Oeistein Helle

The professor and me (who will stay anonymous for the most of you):

I was truly in need of a haircut back then.


Disclosure: I wrote this article myself, and it expresses my own opinions. I am not receiving any compensation for it.

The US FED balance sheet and the current asset bubble

In my last blog I concluded that the US market is in a bubble and that the day of reckoning is close (Oeistein Helle: Market implosion is not imminent, it is already here). I started this week by selling everything and moving into a defensive portfolio of US treasuries, managed futures, gold, short European stocks and long some solid oil stocks.

These graphs tell the whole story of the current US stocks, bonds and real estate bubble:

Federal Reserve Balance Sheet, 2003 - 2015:

Source: Econbrowser.com

Federal Reserve Balance Sheet vs. S&P 500:

Source: Raymond James

Explanation: The US Fed buys less risky assets such as treasuries from market actors in order to pump liquidity into the system. The liquidity is invested by banks and others in stocks, bonds and real estate (the second chart illustrates the tight correlation between FED money printing and the value of the S&P 500). All the buying will push up asset prices. The FED recently stopped propping up the markets with liquidity (cash), making the bubble system super fragile. The fragility in combination with any external or internal shock (such as the Brexit) will eventually and most likely very soon popp the US bubble. As previously mentioned, the bubble has already popped in many other markets.


Disclosure: I wrote this article myself, and it expresses my own opinions. I am not receiving any compensation for it.

Market implosion is not imminent, it is already here

The global equity markets have already imploded even if the S&P 500 (large US companies) is still holding up.

The fact is that six out of eight main national stock indexes have crashed since June 2015 (approximate values from the top of my head):

• Chinese stocks are down 40 %
• Japanese stocks are down 25 %
• German stocks are down 20 %
• UK stocks are also down and the sterling has collapsed
• French stocks are down 20 %
• Italian stocks are down 30 %

• Oil prices have collapsed

The only reason we believe the markets are fine is due to the fact that the S&P 500 have not yet collapsed. The US stock market is still holding up, mainly due to record low unsustainable interest rates. On Average the S&P 500 will appreciate by 30 % post the FED starting to rise interest rates (which they started with in December of 2015, resulting in a stock market correction). At this point I wouldn't bet on the normal 30 % appreciation. 

The day of reckoning will be here soon enough for US stocks as both the Shiller PE multiple and the market-cap to GDP multiple currently are @ pre financial crisis levels. The rich valuation is combined with an ongoing earnings recession. The US stock market is clearly in a bubble. Furthermore the collapsing Japanese stock market tend to be a leading indicator for the US market. When the US market collapses, everything collapses. I have been super overweight oil and oil related stocks all of 2016 and my returns have been fantastic. I am now selling everything in order to regroup and rethink the situation. I believe last week's post Brexit bull was a dead cat bounce. The day of reckoning may once again be upon us.

US Shiller PE:

Source: http://www.multpl.com/

US market-cap to GDP:

Source: Gurufocus.com

US earnings recession:

Source: Gurufocus.com

Japanese vs. US stocks:

Source: Google.com

Disclosure: I wrote this article myself, and it expresses my own opinions. I am not receiving any compensation for it.