Mind The Gaps

This is a syndicated repost courtesy of NorthmanTrader. To view original, click here. Reposted with permission.

The economy is not the stock market, the stock market is not the economy. The stock market of 2019 is dovish central banks, buybacks and China trade deal jawboning.

Liquidity moves markets!

Follow the money. Find the profits! 

In process of all the jubilation and cheering for new highs to come investors brush aside all the big lessons from 2018. The biggest and most ominous being: The world can’t handle higher rates. At all. 2018’s rise in yields precipitated the 20% decline in markets. Yield scare. Fed scare. No rising rates please. We can’t handle it. And the Fed gladly obliged.

And for good reason:

“By one measure, the amount of investment-grade bonds has doubled to $52 trillion since the financial crisis. And yields have, on average, fallen to roughly 1.8 percent, less than half the level in 2007. If they were to rise by a mere half-percentage point, investors could be looking at almost $2 trillion in losses.

“This is an element of hidden leverage that is not appreciated,” says Jeffrey Snider, global head of research at Alhambra Investments. “We are eventually going to have a shock.”

The current situation is a legacy of the easy-money polices enacted by central banks following the financial crisis. With interest rates at or near zero, governments and corporations went on a historic borrowing binge — and investors gorged on debt that yielded little in return.

These worries aren’t new, of course, but they’ve attracted fresh attention as the amount of negative-yielding debt has climbed past $10 trillion. To some, it’s a sign investors have gotten a little too complacent and could easily get blindsided once growth and inflation start to pick up.

The debt load in the world is so high now that it can’t withstand any historically-normal size of interest rate increases anymore,” says Stephen Jen, chief executive officer of Eurizon SLJ Capital”.

The world is trapped in debt. Central bankers are trapped by the very construct they helped enable. And now, after a torrent 16% rally in the first 3.5 months of 2019 investors are finally turning bullish. The chase is on.

See any signs of unidirectional chasing?

Look no further than high yield:

Speaking of unidirectional chasing: Stocks go up forever now, don’t you know?

As outlined in Icarus Warning, it is precisely at these points of historic disconnects, courtesy forever dovish central banks, that investors are embracing complacency once again with the $VIX back at 12. The $VIX on Friday filling the open gap left on the heels of the October swoon when people were saying a low $VIX is bullish:

..while markets are running from open gap to open gap:

While markets are ignoring these gaps now they represent target zones for when volatility reawakens from its compressed slumber. It is precisely these open gaps that represent the achilles heel of this levitating market as they will become magnets for a future market seeking to find balance.

But as long as momentum drives price investor psychology will seek to dismiss all negatives and warning signs.

Case in point: The yield curve “scare” a few weeks ago? Already long forgotten:

The “scare” was barely worth a dip in markets. With all negatives ignored it is precisely the type of environment that could lead to the blowing off top scenario I described in Combustion.

Yet memories are short and dismissive. In an environment where people either barely remember bear markets or have never experienced them before (almost 70% of Goldman Sach’s workforce is under 35) all the reasons for the 20% market drop in Q4 are long forgotten. The Fed has our backs once again is the mantra.

But because memories are short it may be worth keeping an eye on the lessons of history. That short yield curve inversion that is being dismissed as a false positive?

That has happened before as well:

Note that little “false signal” in April 2000?  Dismissed as a false positive for 3 months. The yield curve then inverted again and the recession hit a mere 11 months following the original signal.

The gaps in narratives and in price action are becoming ever more plentiful and they will have to be reconciled.

Mind the gaps.

Some of these charts and many others discussed in more depth in the video below:

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Wall Street Examiner Disclosure:Lee Adler, The Wall Street Examiner reposts third party content with the permission of the publisher. I curate posts here on the basis of whether they represent an interesting and logical point of view, that may or may not agree with my own views. Some of the content includes the original publisher's promotional messages. I may receive promotional consideration on a contingent basis, when paid subscriptions result. The opinions expressed in these reposts are not those of the Wall Street Examiner or Lee Adler, unless authored by me, under my byline. No endorsement of third party content is either expressed or implied by posting the content. Do your own due diligence when considering the offerings of information providers.

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