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Stock Market 2015 Parabolic Blow off Mania or Crash?

Stock-Markets / Stock Markets 2014 Nov 16, 2014 - 07:01 PM GMT

By: Submissions

François Lenôtre writes: Since June, some financial markets pundits have been vociferously calling for a market top or even a crash. We eventually witnessed a sharp but brief correction in October, which led to one of the most astonishing upside acceleration on record. We are now reaching new highs on a daily basis and, more than ever, we hear words of caution about an impending market catastrophe.

The basis for calling a market top is well documented:

1. Elevated PERs
2. A slowing global economy
3. Artificially inflated markets through CBs manipulations
4. An aging bull in its terminal stage which saw the S&P triple from its 2009 low
5. Companies leveraging their balance sheet to buy back their stocks
6. A bull / bear ratio characteristic of previous pre-crash environments
7. A deteriorating geopolitical situation

I could go on forever.

If you are a commentator or an analyst, you can take the moral high ground and denounce the monetary follies.
If you are an investor you can choose not to participate knowing that you won’t have the reactivity to leave the party as, some day, we will wake up with S&P futures limit down and, if the market opens, ETF managers and institutional investors will try to unwind their holdings in the mother of all stampede.
But, if you are a speculator, you can’t afford to comfortably enjoy the show, as you need to earn your bread and butter from the market.

The million-dollar question (quite literally) is, to put it in simple analogous terms: are we in March 2000 or somewhere between October 1998 and May 1999?
I could have used many parallels; 1929 and 2007 also come to mind. However, I chose to use the NDX as, between October 1998 and March 2000, in the span of a mere 17 months, this index bottomed at 1063 and proceeded to top at 4816; About 453%!!
AT the time, the catalyst was the Internet revolution and the public wanted to participate in the new economy rather than be left behind. The same psychological environment occurred with railroads in the 19th century and the birth of consumerism in the 1920s.
More recently, in the 70s, commodities (including Gold, Silver and oil) were at the center of a speculative mania of epic proportions based on inflation and geopolitical fears.

These examples can teach us at least one central point as far as speculation is concerned: there is usually a nasty episode of mean reversion at the end of the hill but no one can tell at which point it will strike. Valuations can reach levels with no relationship to reality and many professional market players die financially in the process, trying to time the return to rationality.

The situation can be even worse: Weimar Germany, bankrupted Argentina and socialist paradise Venezuela, to name a few, never saw any mean reversion. The market either kept going up or the currency was destroyed. Those who sold ended up with worthless paper; those who didn’t ended up with a few survivors. Some rode the bull and exited, making fortunes in the meantime by converting their soon to be useless paper into hard assets.

In this context, if you are an investor, not a market timer, you are better off with hard assets right from the start. Although the market went up millions of % in 1923 Weimar Germany, in dollar terms, it was down more than 80%.

However, if you are a speculator, fortunes can be made or lost. Riding the stock bull and switching to precious metals at the end of the mania will be the trade of the century. The problem is one of timing. Gold bugs will eventually be right but if you remember 1999 (250$ Gold after having seen 800$ in 1980), you don’t want to be right too soon as there is no telling how low scared miners will carry the gold price with their forward hedges, before PMs can take off again for good. This is probably the 2016 story. My own opinion is that we are about one year from seeing the bottom in precious metals. The Swiss referendum, if it’s positive, will be a shorting opportunity for hedgers and the diehards will see their beloved metal subsequently reach new lows with utter disbelief.

This brings us back to our question: are we on the verge of a crash which will make 2008 look like a garden party or are we about to see one of the tremendous mania which bring fortune to the astute?

I believe the answer lies in an analysis of the price action and conditions.

The world is scared.
The Chinese fear a government crackdown on ill gotten gains; the Japanese fear the Chinese; the Russians fear NATO; the Europeans fear the Russians; investors fear a global slowdown, especially in Europe, and an emerging market crash; The Islamic State is scaring the Middle East; the list is endless.
The RELATIVE bright spot is the US.

Foreign banks excess reserves at the FED are skyrocketing for a good reason. Everyone from abroad is buying dollars for protection. The dollar is a liquid claim on US assets. Some think gold should be the currency of choice but the market psychology is not just yet ready. After all, aren’t central bankers cleverly justifying their actions with a deflation scare?
Some of that money flow coming from abroad is finding its way into US equities. It’s exactly the same phenomenon as the 1920s when Europeans were buying dollars following the communist revolutions and WWI and parking it in US corporate bonds and shares.

Central bankers are scared.
They have ignited the mother of all financial bubbles and don’t know how to normalize the situation. For a good reason: it’s impossible without a return to the middle age, so to speak.
They also have a more pressing problem most people are not aware of: they (as well as sovereign funds and public sector institutions) sit on 33 trillions dollars and government bonds offer such paltry returns that they have to chase returns.
This is why they are investing in equity markets with the subtlety of an elephant in a china shop. The SNB is even venturing in small and midcaps and, as per their last quarterly report, sold back some of their AAPL longs.

The US investing public is starting to be scared.
The equity bull since 2009 is probably the most hated bull in the history of the stock market. In their wisdom, individual investors know that this is a manipulated market, disconnected from fundamentals. They have been expecting the “BIG ONE”. The crash which will enable them to enter the market at the “right” and comfortable level. For 5 long years they have been suffering. Individual investor’s participation in the market has never been so low. CNBC’s audience has collapsed by 80%. It’s not that people don’t want to see the S&P’s closing level; they just don’t want the constant reminder of missing one of the biggest bull markets in history.

I was speaking of price action; well, maybe you noticed, at least those who know how to read the tape; this market is acting as if there were a lot of shorts. Every retracement is bought with incredible fury. And, yes, the entire world is short equities. They didn’t sell short the S&P futures, but they wanted to buy and they still haven’t or they need to buy and are chasing the market.

Add to that 600 bln of corporate buybacks next year and you have the recipe for a mania worthy of 1999. Trillions of dollars are parked in money market funds earning next to nothing for the foreseeable future while real inflation is destroying their purchasing power. These trillions are about to be unleashed, as the public can’t take it anymore. Since the low of October, we entered the mania phase. There will be wild swings. 10 % corrections will be possible. But, 10 months from now, we will look back and say: who could have guessed?

By françois Lenôtre

Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisors.

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