Recession in 2020? Don't bet on it

Since my last post we saw the market decline a little bit and then stage another rebound. Markets have been going sideways for the last 4 months. Bears will say that the market is topping while bulls will say that the market is just consolidating after that torrid run from September to January. I'm siding with the bulls at this point. What I see here is a market that is adjusting to a higher interest rate environment and with the economy showing no material signs of stalling with inflation still under control it's too early to say that the economy has hit a cyclical peak which would usher in the next recession. I still think there is a reasonable possibility of some scare in the market in the coming months that sends it below the 200 DMA and really flushes out weak holders. That type of cleansing would go a long way to propel the market to significant new highs. Of course, the market doesn't always give us what we want or when we want it.

I also think that the prospect of 3-4 rate more hikes by the fed won't happen...at least not as quickly as the market is pricing in. It simply seems too much too soon especially when the rest of the developed world i.e. Europe still hasn't followed suit. I think the Fed is a lot more mindful of the consequences of raising rates too quickly and inverting the yield curve.

I've been hearing/reading  a lot about how the consensus view from economists is that a recession in going to happen in 2020. When have these "experts" as a whole ever correctly predicted a recession? The answer is never. Given the motto of this blog which by now you should be a believer in after the countless number of times the market has humiliated the consensus view, we should expect a recession well before or well after 2020. What would be more surprising? To me it would be the latter.

Another thing I keep hearing/reading a lot about is how we are late in the cycle and that we need to position portfolios accordingly? Really? Were these same people telling you 6-7 years ago that we were early in the cycle and that you should be super bullish about the market? Of course not. The consensus has been chronically underestimating this bull market cycle from day 1. Yes, there have been times when the consensus felt bullish like what happened in late 2017 but the market corrections that followed extinguished such bullishness and turned it back to cautiousness/pessimism and we are seeing this process play out right now however I don't believe we have reached an extreme yet. Deep down people are looking over their shoulder for the next bear market/recession and like I said, I believe it will either happen a lot sooner or a lot later than 2020 unless the consensus view shifts in the future.

If we go back to 1994 and 2004 you will see that we are similar phase in terms of the interest rate cycle whereby rates were rising for the first time in years from recession low levels. The markets had turbulence during those 2 years and basically traded sideways the entire year. Once the market sensed that the economy was able to handle the rate hikes without stalling much and that the fed was going to stop raising rates for the time being, the markets took off again to make new highs.

I ask myself, where could I be wrong here? Didn't we see some classic signs of a bull market top like the cypto bubble bursting and the January blow off top fueled by a mad rush into ETFs? It's certainty possible but my gut says to be skeptical because that could very well just have been a flash of euphoria and there's room for more before we truly reach an extreme. I never got the sense from the media or from the investing public that they have truly, fully embraced the bull market. Plus, monetary conditions are not tight which is what you also see at the peak. What the January peak could very well represent is similar to the 1987 peak whereby structural bull market conditions were still in tact (growing economy, non-tight monetary conditions) but investor optimism got too high and Mr. Market had to punish them. When the market hit bottom after the 1987 crash, optimism turned to deep pessimism.  People feared a recession and even a depression would be immanent as comparisons were being made to the crash of 1929.  Perhaps we will see this type of deep pessimism before this consolidation phase that started in January has truly run it's course.

Market in precarious position

Since my last post we saw the market have a strong rebound as I expected which was got totally undone which was also expected. With the SPX now at the 200 DMA there could be a knee jerk bounce again but I wouldn't hold my breath. I don't expect this downdraft which began in January to be over until we see true capitulation and fear. I suspect we will ultimately get a break below the 200 DMA and all these technical and momentum types get shaken out. As I mentioned in recent posts, the bullish herd expects the yield curve to go inverted to signal the end of the bull market and that created complacency. It looks like Mr. Market  plans to make fools of them or at the very least punish them with a 20%  decline to get enough people to believe that the bull market is over before it resumes course.

We have to also consider the possibility that the bull market has indeed peaked and we are in the early stages of a bear market. As I said before, I didn't see all the conditions that would suggest this to be the case but who's to say that the market is going to give you everything you want to see? That is seldom the case. Major trend changes happen by surprise and that by definition means unexpectedly.

 I would call myself market agnostic at this point. The bull case is not dead by any means. What we could be seeing now could be reminiscent of 1994 and 2004 which were periods when the fed was normalizing interest rates which eventually created turbulence as the market became concerned that the fed would go too far. In addition, as rates go up it makes stocks relatively less attractive as a competing asset class and it lowers intrinsic values of equities as the present value of cash flows are discounted at a higher rate and rising rates results in higher borrowing costs. On the flip side, higher rates implies an improving economy and provides higher income for savers and those are positives for stocks and so you get this tug of war action because of these pros and cons.  Ultimately though,  it's rising interest rates that have killed bull markets and so the more the fed hikes the greater the chance that the negatives will outweigh the positives and I think we reached that tipping point in favor of negatives. One of things I think we need to see happen for this rout to ultimately end is when the fed changes its tone and starts hinting at the end of this rate hike cycle or at least a prolonged pause which led to the end of the routs in 1994 and 2004.

The possibility of a full fledged trade war between the US and the rest of the world is also weighing on the market. As of now the tariffs being imposed by all are not significant but the concern is that things could escalate. Last year people feared that Trump would hurt the markets and they were wrong or at least premature in this fear but now it seems that Trump is purposely poking the hornets nest to create attention for himself in some sick way and it's starting to spook investors. As I said a few months ago, political risk could be something that actually matters this year. So, you have a combination of risking interest rates, rising political/trade turmoil coinciding when people have piled into ETF index funds like lemmings at a time when the market was overbought on multiple time frames 9 years into a bull market. Not good! It will take some time but I believe that the lemming stampede into to ETF index funds will get undone and we will see a lemming stampede out of them at some point this year which could crater the market. 

The purpose of the market is to make fools of as many men as possible.

What a February it's been so far.  Bubbles popping galore. Crypto bubble pop, weed bubble pop, short VIX bubble pop and perhaps ETF bubble pop. Markets have taken quite the dive and we got the fabled 10% correction that so many have been calling for since the summer. While there is certainly concern out there, I don't get the sense of doom like in previous corrections and that's a big problem. The message that seems to be out there is "relax it's just a correction the economy is fine". Sorry, but that's not what long term bottoms look like. "Now is a time to hunt for bargains"says Cramer. Not what long term bottoms look like. Fed chief Dudly calling the drop "small potatoes". Not what a long term bottom looks like. Trump calling the drop "a big mistake". Not what a long term bottom looks like. That's what you call complacency. What you need is fear.

Throughout this bull run that began in 2009 there was usually a wall of worry for it to climb upon. There was always some concern, some issue that kept people from fully embracing the market and that wall of worry is what a healthy bull market needs to climb upon because concerns/worries  keep expectations low and as they get resolved the markets adjust by moving higher. Coming into the new year that wall was crumbling as the prevailing consensus was that it was blue skies ahead as the global economy was experiencing synchronized growth. Near the most recent peak, the market got extremely overbought on multiple time frames, sentiment as per AAII and other measures were at extremes and there was a surge in fund flows. So, has this 10% correction cleared out these extremes? Not so, at least not yet. There has been a pullback in bullishensss and there was a decent outflow last week, but I don't think that's enough. If we are to assume that the bull market is still in tact, before it's ready to resume its upward march on a sustainable basis I expect to see the opposite of what we saw at the peak. I expect to see bears outnumber bulls 2:1, major outflows and the permabears coming out of the woodwork claiming that the bull market is dead. Notice that the permabears have been fairly quiet. Where is Roubini? Where is Prechter? Pretty quiet  now after having their asses handed to them for 9 years calling a crash at every turn.

The other question I ask myself is "did we see actually see the bull market peak"?  Not all the signs were there but some were. Most bullish strategists seem  to think ""there's no inverted yield curve and so not to worry about a recession and therefore major decline in the market". As the motto of this blog goes, the purpose of the market is to make fools of as many men as possible. Once there is a consensus about something there will come a point where too many people are positioned the same way and eventually Mr. Market pulls the rug from underneath their feet. Major declines always catch the majority by surprise. So maybe we don't get a recession but we do get a major decline anyways like in 1987. Or we do get a recession and a major decline? Either of these scenarios would catch the herd by surprise.

In the short term the market is oversold enough to have a rebound but I would be very careful in assuming that it's anything but a dead cat bounce  until we have seen the extremes that marked the top get completely reversed. I don't know how long that could take. When you start seeing headlines saying "the bull market is dead" and people are fleeing from stocks that's when you'll know a real bottom is close.

The good news about the crytpo bubble bursting

It's clearly game over for crypto. I said before that the sooner the crypto bubble pops the better. News about crypto ETFs being pulled and credit card companies beginning to ban it is a GOOD thing (although I was hoping for  an ETF rollout so that I could buy puts on it). The longer this crypto mania would have continued the greater it would have infected the general economy when the inevitable collapse happened. Hopefully the fallout to the economy will be minimal although it's tough to say at this point how much unwinding of leverage and capital destruction this will result in. I for one will NOT take this fallout lightly. I really need to find out what kind of damage this has resulted in.

If that was the bull market peak...

Major selloff this week. So, was that it? Did we just witness a blow-off top to cap this 9 year bull run? Well, I've been saying repeatedly on this blog: Bull market peaks are made when there is tight money and euphoria/greed. There was definitely flashes of the latter with the bitcoin craze and weed craze which I think are over, but we didn't see tight money because inflation, although picking up, is not a problem at this time.  The yield curve did not invert and therefore, no recession would appear on the horizon and that's what ends bull markets. In 1987 there was a similar situation where the market had been soaring for months, greed was in the air and there ended up being a 25% crash. It's debatable as to whether you can call the 87 crash a bear market. To me, I look at it as a major pullback in the bull market that began in 1982 because the drop was swift and short lived.  Be prepared for the possibility of this type of drop because the markets have simply gone up in a straight line for a year. The trigger of the 87 crash was arguably rising bond yields in the face of a market that had been so strong for months and that made people start to get jittery. Then a bill got passed that made mergers & acquisitions less appealing (M&A was in a frenzy at the time) which created more selling pressure and then there was the popular use of portfolio insurance, which arguably was the straw the broke the camels back and was largely responsible for creating the biggest one day market collapse in history. This time around we have rising bond yields. We don't have portfolio insurance but what we do have is a mindless amount of ETF buying that took place during the past couple years. If sentiment turns negative let's see how how the appeal of low fees holds up during a  meltdown whereby ETF holders have no escape as they are held hostage to the indicies. ETF selling could exacerbate a correction into a full blown panic especially if there is leverage behind these purchases.

Be very careful at this junction. Markets could have ST bounce but I suspect that we are going to see a much larger correction at some point to clear out the excesses that have accumulated. I expect to see YTD gains wiped out at the very least. So, bottom line I don't believe we are entering a bear market but it may feel like one soon enough.

Optimism Phase with flashes of Euphoria via weed and blockchain stocks

The market has gotten off to a rip roaring start up about 4%. It's been a breathtaking move these past 5 months. I've read somewhere that the Dow Jones is the most overbought in its history which spans over 100 years! I remember back in the depths of the 2008 meltdown how insanely oversold the market got in November of that year. Overbought markets are not necessarily a sign of a top, it can often signal a long term breakout but even in such cases, a resting phase tends to follow where the market consolidates. That has to happen at some point. Many have been calling for a 10% correction since at least September and have been made to look the fool. That's the thing about trying to play a correction in a bull market. It's very, very difficult to time and even if you get the timing right, the correction often doesn't go as deep as you were expecting.  Now, having said all this, if was was ever a time to be on the lookout for at least a consolidation it would have to be about now given the sentiment surveys and signs of excess with the weed and blockchain sectors. We are clearly in the optimism phase of the bull market with flashes of euphoria.

People are blindly piling into these 2 hot sectors despite the likelihood that most of these companies will never be profitable. I've been around long enough to know that investing on hype in the long term is a guaranteed loser however in the short to medium term if you are a nimble trader you could do well. At this point however, if you get in  you'd be arriving late to the party. I overheard an adviser at a conference the other day talking to his client about ways to play the weed sector. The average retail investor is very keen on this sector and bitcoin/blockchain too and that to me says stay away. Sure, they can go higher but I'm always looking to be one of the first people at a party, not the last. You jump in now, you need to be a trader, not an investor and have one foot out the door. That's not my style. That's essentially gambling.

The interesting thing about the bitcoin mania is that there is also no shortage of warnings about it being a bubble with a crash being immanent. Warren Buffet recently chiming in that he's certain crypto will end badly one day. If we go by the motto of this blog it would suggest that if a crash were to happen, it won't be just yet. It suggests that the market will first frustrate and shake out a lot of the skeptics just like it did in 1999 with the tech bubble and 2006 with the subprime bubble and then the rug will be pulled out from underneath everyone. So, we could very well see a lot of chopping and flopping with the price of bitcoin  before it rolls over perhaps later in the year.  As such, I'm staying away from this sector but I do want to bet against it one day as I agree with Buffet and don't ever try to write this guy off as being old and irrelevant. Nobody is infallible but this guy has been right far more times than wrong and you don't get labeled as one of the greatest investors of all time for nothing.

I remember when Buffet came out with his bullish "buy America" call on October 18, 2008 when the S&P was about 945, obviously a great call in the long run but in the 5 months that followed the S&P went down another 30% and I bet a lot of people thought he was a fool and lost his mojo.  The skeptics of crypto may have to go though a similar baptism of fire with many of them capitulating or least becoming silent. We'll see how this plays out...

Outlook for 2018: Curb your enthusiasm

Unless something happens by end the end of the year, 2017 will be characterized as a one way upward street. The biggest corrections we saw were about 3% and there weren't many of them. I've read many market outlooks from the major investment firms and the consensus view is one of optimism and somewhat complacency. They are basically saying this:

"the markets should benefit from global synchronized growth with international markets, Emerging Markets, being the more attractive. There is little risk of recession as the yield curve is not inverted. The major risk is that the fed ends up tightening more than expected if inflation flares up".

Last year at the time, the consensus from these "experts" was far more cautious as there was concerns about political risks and valuations. Those concerns aren't as prevalent today, yet I would say now would be the time to be more concerned about political risk and valuation! Instead I have seen more strategists justifying current valuations saying that they are fair given interest rates or some other reason. Remember all the hoopla about the high CAPE ratio? Seems like this is being more ignored now (but not entirely).

As a bull market rise in stocks or any asset class (such as bitcoin which I will discuss shortly) progresses it's not surprising to see people make justifications for it as they finally throw in their bearish towel and embrace it. Towards the end of a bull run the gains will accelerate and so too do the justifications which at that point become very weak. I've said before many times that this has been the most hated bull market I have ever seen.... I am now seeing some love for this market...but it only took 9 years! Where the fuck were all you bullish strategists when the S&P was at 1400? lol 

So, now that there appears to be optimism and quite frankly some complacency heading into 2018 does this mean the end of the bull market is nigh? Well, like I said before, euphoria/complacency and tight money is the killer of bull markets. What we are seeing now can be categorized more as optimism with a splash of complacency, but money is not yet tight as the yield curve is not inverted. However, I will say this, I'm seeing that the "experts" have also been pointing to the non-inverted yield curve as a reason to remain bullish and that makes me uncomfortable.  Again, where the fuck were all of you in 2011, 2012, 2013, 2014, 2015, 2016 ? How come no mention of the yield curve then?  Remember the motto of this blog. If too many people become complacent because of the yield curve or for some other reasons, the market will find a way to surprise and punish the masses. Either that indicator won't work this time or there will be some other unexpected thing that happens. I remember in 2001 when the fed did a surprise interest rate cut there was all this bullish hoopla because of a statistic which showed that the market was always up every time 12 months after the fed cuts interest rates - except for 1929. Well, guess where was the market was 12 months later....  

So, here's what I feel. I still believe the bull market is in tact but I'm a lot more cautious than I have been in some time and I won't hesitate to change my stance depending on how things unfold. I believe there is a very high chance of a major correction in the first half 2018 to wring out the complacency I see right now. If the market simply keeps on chugging along then we would likely enter the euphoria/ blow off phase of this bull market.

Speaking of euphoria, let's switch to bitcoin and cryptocurrencies. This is a classic bubble which is so crystal clear to me having witnessed other bubbles: The parabolic rise in prices, the hundreds of spin off coins that have popped up,  adding "blockchain" to your company name or any involvement in blockchain results in  an instant 300%+ gain in the stock price, all the mainstream media attention with celebrities like Katy Perry asking about it (dumb money),  the inquiries I'm getting from friends and co-workers (dumb money), reports of people borrowing money to buy bitcoin, outlandish forecasts for much higher prices after prices have already skyrocketed. These are all major red flags, and this will clearly end badly. Yes, I know many skeptics were calling bitcoin a bubble when it was at a much lower price and they got made to look foolish, but the same thing happened with the dot com skeptics of 1999 - they were right, but early. Bitcoin is 100% in a bubble and I think there's a good chance that it has already began to implode.  I lived through the dot com bust and I will say it again, all the signs for a peak to this frenzy are there and all manias end BADLY. 

If you want to talk about a risk to the market that's not really being discounted I would say it's the implosion of cypto currencies. The fact that there are reports of people borrowing money to buy bitcoin and the introduction of bitcoin futures pose a dangerous threat to the general economy if the mania continues. I'm not sure of the extent of leverage behind bitcoin but it's there and the longer this mania continues the greater the contagion effect will be. We saw that happen with the dot com bust and the sub prime mortgage bust. If the cypto-currency bubble has indeed popped which I think it probably has, it would be for the best as the fallout shouldn't be too bad at this point, but I can't really say that with confidence at this point.... I need to investigate this.