Is This the Crash?
We have the Marker!
In a week that we said farewell to Janet Yellen, the markets finally produced a sharp stock sell off to reverse the January blow out and end an historic run. The SPX fell by over 4% last week, bringing the record 17-month run without a 3% correction to an end.
However, as of Friday’s close, the S&P 500 (cash) is yet to break the longest (407 day) run without a 5% correction which started after the Brexit vote. But it won’t be long.
In a special edition for subscribers this week we explain the importance of this ‘marker’ as a guide for the rest of the year with a further new set of criteria to help fine tune each and every move in an increasing two way volatile market.
Is this the start of the 1929 and 1987 style crash?
Technically no. The crash itself was a three legged affair. The more important question is whether this is the top before a crash that lasted 23 days in 1929 and 12 days in 1987 and fell 43.7% and 39.05% respectively but not respectfully. We have waited a long time it seems for a drop of this magnitude to provide potential definition to the blowout and turn into a crash.
All our FITS (Fundamental, Intermarket, Technical, Sentiment) criteria have been satisfied for the US stock market.
Economic growth has stopped increasing. Low inflation remains a ‘mystery’ in a 2010s context but not by comparison to the disinflationary 1920s and 1980s. PE ratios (cyclically adjusted or otherwise) have hit their targets. And the most important fundamental milestone, because it it’s the last, dividend yields have collapsed below 1.75%. A timely exit then for Janet Yellen.
Wednesday was Janet Yellen’s last meeting as the Federal Reserve Chair. There was no press conference to say goodbye but her achievements speak for themselves.
As the first woman to lead the Fed, Janet Yellen took over from Ben Bernanke in February 2014 when quantitative easing was in full swing. Not only did she successfully manage a non-disruptive tapering of this programme she raised rates for the first time in seven years. Her achievements as of January 31st 2018 are fivefold.
Managing a Non-Disruptive End to QE
Janet Yellen skilfully started to reduce the Fed’s $4.5tn stockpile of bonds last year by clear forward guidance, unlike her predecessor, Ben Bernanke who sent the markets into chaos when he first introduced the idea in 2013. By raising rates and reducing bond purchases, this now gives the Fed greater flexibility for any future shocks as they can now lower rates or restore QE.
Safer financial system
Yellen helped introduce new rules (the Dodd-Frank reforms) to make US banks safer following the 2008 crisis, and ironically (?) to make banks more resilient to downturns. She has argued that the reforms have not caused any major restrictions in loan availability, and resisted Trump’s moves to weaken them, a position which may have cost her the Fed chair.
Yellen leaves the Fed having steered the economy into maximum employment, a key economic target given to the central bank by Congress. Unemployment has fallen by more than a third over the past four years from 6.7% to 4.1% last month – the lowest since 2000.
Yellen has also fulfilled the second objective set by Congress, to keep inflation within a slow and steady range, by maintaining price levels close to its 2% target. Even though CPI dipped preciously close to deflation in 2015 price rises recovered without as yet spiralling out of control. The CPI figure for December was 2.1% (1.8% ex Food and Energy), pretty much exactly on target.
Rising Stock Market
Yellen has presided over a consistent bull market, putting on an impressive 70.12 % during her 1000 trading day tenure. Alan Greenspan saw a much larger increase during his term, but he held the chair for nearly 20 years. Her policy of giving clear indications of future actions and timing (“forward guidance”) has now become standard Central Bank policy worldwide, and has until recently at least helped to reduce the unhelpful equity market volatility we saw in earlier decades. But has she left a healthy stock market that has rose as high as 22.48% in her last 100 trading days?
Her record cannot be judged now.
It could be argued her success was largely due to the solid foundation that her predecessor created, following the financial meltdown in 2009, and that she was lucky to have reaped its benefits. Moreover, following the election of Donald Trump in November 2016, the almost euphoric expectation of fiscal expansion has fuelled one of the most dramatic rallies in stock market history. Perhaps her greatest achievement is that, despite the promise of inflationary growth that has driven the stock market higher, economic growth has remained stable and inflation still a ‘mystery’ just below target rate. This is what she will be judged on, Ben Bernanke’s legacy and Donald Trump’s promise. Her successor’s record will, however, be based on President Trump’s actual achievement and Janet Yellen’s legacy. Jerome Powell has a hard and dangerous act to follow and one he may have little control over as markets and consequently the economy continue down an increasingly unstable historic path.
The almost unique intermarket framework of rampant stocks, falling dollar and rising yields and commodities is still following the only other precedents of 1929 and 1987. The currency markets have been front running the crash template for some time with an ominously falling Dollar. This fits neatly with our other USD templates from 2003 (Pandora’s Box).
Both of these templates and Dollar received a boost from Friday’s NFP. This confirmed last week’s analogy to February 1987’s Louvre accord that tried and failed to keep the Dollar range bound. The templates for all 23 of the currency pairs we cover will be also be emailed to subscribers this week. And there are some stunning matches with some surprising outcomes.
EURCHF remains a notable exception due to SNB manipulation but other safe haven/risk aversion pairs such as EURJPY and GBPJPY are not. Even though they are making ‘catch up’ yield driven new highs as stocks sold off this week, this presents an excellent opportunity to catch up—the other way.
If this largest weekly stock decline since November 2016 is the marker, then the projected 1987 style ramp in bond yields has been the script.
This week’s liquidation was more than just month end rebalancing of over long stock exposures although this was significant.
The continued liquidation into February stemmed at least from talk of funds becoming increasingly uneasy about the current stock market levels with yields pushing higher. It was interesting that month end rebalancing sales of Dollar (to hedge increased stock portfolio values) was not as pronounced as it might have been given January’s stellar stock performance.This suggests funds may have liquidated more stock longs than necessary to rebalance their portfolios.
This only leaves the interaction of sentiment with technicals. Sentiment and its impact can be aggressive as evidenced by the lack of definition to the last 3 month parabolic rise. Bullish readings remain at historic highs.
And yet it can be fickle as seen by this week’s capitulation. When this is reflected in price action it provides definition to an almost elusive beast. A one way VIX driven market can be oppressive. But when VIX’s stranglehold is broken it allows the market to move not only wildly but cleanly and with greater clarity.
Now we have the marker and the technical criteria by which to monitor the next few days, we have a clear guide for the next few weeks. Farewell Janet, Hello increasing two-way volatility and Good Luck Jay Powell.