Bear Market Melt Up
The market rallied smartly at the start of the week, fueled by Friday’s “this time for sure” Fed pivot hopes.
Concierge readers got the full breakdown in Monday’s mail. We pointed out that nothing has really changed in the fundamental picture, but we took note of the shift in investor sentiment due to news the Fed might be considering a retreat from its current hawkish stance.
Here’s what we said on Monday:
With global markets temporarily settled after the British Gilt shock from the previous
week and rumors of Credit Suisse and Deutsche Bank already baked into prices, there
may not a lot of news to move the US equities markets this week.
We expect the market to remain buoyant in the week ahead, absent any sudden, unexpected shock. As [Jim] Rickards observed, bad economic news is now being traded as good news, so it’s unlikely any negative data this week will upset Mr. Market.
In other words, our readers were alerted to the possibility of a relief rally this week. We even shared a chart showing how much room the Index had to run without threatening the down trend.
That grey box extends to 4150, so even after Tuesday’s close at 3859, the S&P has another 8% to go before taking out the trend line off the Aug. 16 cycle high.
That downtrend line actually extends back to the all-time high of January 3, and marks the trajectory of the entire bear market. A continued rally past 4150 would at least give bulls a reason to argue a technical reversal is at hand. But are we likely to see this run continue to that point?
Everything we’ve been discussing here for months argues no. Fundamental weakness in the economy and multiple threats of a shock from outside the system continue to pose dire structural challenges to the economy, and the markets.
Despite enthusiasm for an eventual reversal in interest rate hikes, optimism about the chances of a pro-business shift in Congress with the mid-term elections, and the massive liquidity still available for stock investment, all of which could continue to take us higher in the near-term, our overall outlook remains bearish.
Here’s what this week’s upturn looks like on the same chart we just viewed:
What we see is even with the strong surge from Monday and Tuesday, prices have a long way to go to break the downtrend. After September’s big drop, prices remain below the 13-day moving average (we use Fibonacci numbers; the 10-day average was breached on Tuesday). Even if the buyers hold serve for the rest of the week – which we expect they will, again, barring an unexpected development – we are not on the brink of a long-term reversal.
In other words, what we are seeing unfold now could be the “bear market melt up”… the final rally before the big leg down which will put an end to any false hopes for a quick recovery.
Not that we wouldn’t like to see things get better soon. It’s just the conditions for an end to this bear market are still nowhere in sight.
About that Liquidity
Paradigm Press’ Zach Scheidt had an interesting observation in Tuesday’s 5 Minute Forecast regarding investment capital currently on the sidelines:
“We all know we’re in a bear market,” says [the 5’s] retirement-and-income expert Zach Scheidt. “As I write this, the S&P 500 Index is down roughly 21% on the year.
“After nearly 10 months of selling,” he adds, “chances are you’ve made some adjustments to help reduce your risk. Fund managers are in the same boat…”
“The research I’ve seen shows a lot of dry powder (or uninvested cash) that institutional investors are sitting on,” says Zach.
“As the U.S. stock market starts to rally, holding cash becomes a ‘career killer’ move for institutional investors. Imagine telling your clients you missed a fourth-quarter rally because you were trying to be careful.”
“So for now, we’re in a situation where any rebound in the market could trigger a tsunami of buy orders from professional investors,” he says. “Not necessarily because they think stocks are a great buy… but because they know they’ll lose their jobs if they don’t participate in a rally!”
“Don’t be surprised if we get a sharp rally over the next few weeks fueled by scared institutional investors piling into the market as fast as they can.”
A tsunami of managed assets pouring into equities could certainly drive prices significantly higher. This is one reason why 4th quarter seasonality often favors the bulls… professional money managers don’t want to be seen as sitting on their hands when year-end reports go out to investors.
But there’s another side to the liquidity question, one which holds much more profound questions for investors, traders, and in fact for the entire global financial system.
This is something we also discussed in Monday’s Concierge letter.
The question is, how close are we to “disaster,” and what exactly will it take to force the kind of reversal in interest rate direction the stock market is betting on.
One possible answer to that question is provided by former Fed analyst and current Head of US Rates Strategy at Global Research at B of A, Mark Cabana.
Cabana sent this note on Friday:
“…thin UST [United States Treasuries] liquidity conditions combined with weak UST demand & elevated investor risk aversion have contributed to fragile market conditions. Fragile things can break easily. We are concerned the UST market may be one shock away from market functioning challenges.”
The risks of a liquidity crisis, where the credit needed to grease the wheels of the financial system is no longer available, are considerable. And the consequences would almost certainly meet anyone’s definition of disaster.
The idea we are “one shock away” from a major breakdown in the world’s financial system is not something the stock market is “pricing in.” This despite:
- An ongoing crisis in the yen
- The Bank of England fiasco over the past month that led to the farce of Liz Truss’ ouster from the Prime Minister seat after only 49 days
- Ongoing concerns about the situation at Credit Suisse
- Escalating threats of nuclear war in Europe
- A continuing energy shortage and the politicization of oil and gas supplies
- The trailing effects of interest rate hikes on corporate and public debt instruments
- And new anti-free market developments in China, coupled with U.S. moves to cripple the Chinese semiconductor industry
…to name only the most pressing issues.
We often point out as investors and as traders, it is imperative to look beyond the superficial considerations of stock prices.
Yes, what’s going on in the markets is important to our portfolios and our overall financial health. But there are serious, potentially world-changing forces in motion…and our ability to anticipate what these might bring could be a matter of financial survival.