The First of Three Triggers
and Three Breaks
In a week that saw more Trade War fears, Russia lash out against sanctions, the risk of Turkish contagion, US election jitters and US inflation failed to ignite, US stock indices at least remained remarkably stable and the USD strengthen (in a clear pair sequence). Indeed the Dollar Index broke to new highs.
We also saw further calls for a stock market crash. Curious you may think given the Cinderella US economy with strong earnings, benign inflation and therefore ramping stock prices.
But most historical comparisons and calls for a crash are based on price (technical). And yet these ignore the drivers of the uptrend that define price; namely fundamentals, intermarket relationships and above all sentiment. Understanding all four of these pillars is the key to trading one of the most momentous stock markets of our lifetime and the subsequent fallout in stocks, currencies, bonds and commodities.
In previous weeks we have explained previously the economy does not need to turn down into a recession for markets to turn. There may be indicators of a forthcoming recession but they are neither sufficient nor necessary. It is a deterioration in the rate of economic improvement that holds the fundamental key. Last week we outlined how the fundamental milestones of the 1920s and 1980s style uptrends have now been met bar two key indicators. The of US economic growth and not GDP needs to turn down although this may only be known after the fact or indeed a stock market top. But perhaps more importantly the set of fundamental plus price indicators (dividend yields, PE ratios and therefore earnings) need still to meet their targets. This in itself implies we need a further an aggressive blowout IN PRICE before the market can turn and indeed stop the current uptrend in the USD and yields.
The question and the subject of today’s newsletter is the first of three triggers we expect into the end of 2018 or breaks if you like: what will cause the final blowout/break to new highs. The second is what will cause the top. And the third is the trigger for a crash.
Markets and trends are fractal. Uptrends start with negative sentiment until positive fundamental reasons drive prices higher until a technical correction heralds the end of a fundamental uptrend with breadth and justification. Thereafter sentiment takes over leaving fundamentals behind to a point of euphoria where the rise can no longer be sustained and therefore reverses. So what typically causes the final rally (the pink line) where the gap between expectation and reality (the underlying fundamental) grows to an extreme? Sentiment.
And what causes the euphoria? Nothing necessarily as it often follows either a dissipation of previously bullish sentiment as we have seen in the first half of 2018 or indeed in 1987 when there appeared to be an easing of international trade tension into the third quarter. Sometimes there are negative negative reasons as we saw in the North Korea scare correction where a weekend fear failed to materialise prompting the short covering break to new highs. Frequently this happens where an over-compensation of previously bearish sentiment is unwound into new highs as we saw successively last year with Russiagate stories. Interestingly in 1929 the market broke higher in June following the passing of the Smoot Hawley tariff bill in the House of Representatives in May which caused the market to dump and then ramp to new highs in a squeeze fuelled by the inflationary aspects of protectionism. Wheat prices soared. Could an uptick in inflation now due to tariffs and (as we saw last week typical of the blowout) be the driver of the final leg? Certainly there appears to be tariff creep in Average Hourly earnings. Indeed both the 1999 and 2007 breaks to new highs were prompted by positive inflationary reasons – two strong job reports.
It is easy and often wrong to find reasons in advance why markets may move suddenly in the anticipated direction. They move frequently because of existing positions (Sentiment) and underlying fundamentals but not necessarily. Sometimes the move is triggered by other related markets. We have shown the importance of the bond markets to the 1987 and current blowouts and how they triggered the ramp and top. If protectionist inflation is the trigger this time round perhaps aided and abetted by a compenstaion of current Turkish contagion fears, then the market and the USD will focus increasingly on 2 year yields rather than 10 years. That was the trigger in 1987
And just maybe Paul Tudor Jones is right.
You can watch this video yourself, and also hear Paul’s views in conversation with ex-Goldman’s CEO Lloyd Blankfein in this Youtube interview.
The Next Recession Will Be Frightening
Here’s to making the very best.
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