After digging through the dirt on our markets and writing the SA article "The Debt Cycle And Rhymes Of Lehman Brothers" back in October, I've been trying to be optimistic about 2016. As I pointed out, a bad down cycle in debt does not always result in a corresponding down stock market. I pointed out that 1994 and 1980 saw bad debt developments with no bear stock markets. And there are similarities between now and 1980:
- We don't really have a boom/bust cycle in stocks as the weak, recession ridden economy of the '70s produced no shock as we entered the bad '80-'82 recession. And now we have had an economy barely treading water just above official recession levels even with politically distorted numbers
- Commodities crashing were all the rage in 1980, just as they are now
- We had monetary instability in 1980 with inflation seemingly out of control. Now we have global money printing seemingly out of control with deflation threatening despite the money flood
- 1980 was an election year as is 2016. Political forces often do arm twisting on monetary and other individuals to induce a stock market for incumbents to run on
Ahh to have the peaceful stock market of 1980. But I'm afraid more powerful factors are going to make for a bad 2016. For starters, margin debt is going through a reversal pattern that has precisely presaged the last two bear market turns: (click on images to enlarge)
This chart from Doug Short's Advisor Perspectives shows an inflation adjusted pairing of margin debt and stocks. I have added in purple the topping pattern notation where you get a sharp blow-off peak in the debt followed by a surge going into the downside of a rollover pattern in stocks. We won't know margin debt figures for January for several weeks, but it's safe to assume that the severe sell-down this month induced a move down in the margin debt chart, completing the topping pattern. The margin debt has been criticized as a market predictor because only about 3% of the market cap is bought with margin. That's not all that unstable, and this debt is just a reflection of the health of the market. Doug Short comments on these charts he keeps by saying that there are not enough ups and downs to rely on just this as a predictor. But over these last two bear turns, the 3% seems to be a canary in the mine showing the aggression/defense behavior of the non-margin masses, and that behavior seems to follow a pattern.
I actually find the technical rollover pattern in stocks a more prescient indicator of danger ahead. The failure of successive rallies to make new highs says something important about the trend in question. It said something important in 2000 and 2007:
I watch the moving average pair of the 140 day and the 200 day as this is about the best divider of major bull and bear moves I have found. Here we see that this pair divided the bull from the bear quite clearly, and when they cross, it is a critical change of trend. This all happened in the above chart in 2000 and again in 2007:
Keep in mind that the blow-off peak in margin debt transpired months before the top of the curve and the cross in each of these cases. And what's doing now?:
The margin peak was back in April and, after a struggle, the moving average cross now appears inevitable. For awhile, I was thinking maybe we would be fortunate and repeat the 2011 "analog" with a continued bull market as Jim Cramer was predicting back in September. We were putting in a facsimile of the inverse head and shoulders bottom to the Greece Contagion smack down in the Russell, one of the lead indexes for major turns. Also, the above chart shows how we refused to do the negative moving average cross after August, and even went back above the pair with a positive slope! But that has all violently changed now. The analog is all but dead. And what is the lead Russell doing now?
Not good. The crossover was clear 3 months ago. But the Russell isn't the only critical lead group we should be watching. Another is the other small cap index, the Nasdaq composite. This has been leading the broad market for years now. In the 2011 melee, it did not do a negative 140/200 crossover as the broad market did, and going into our new year now, it was still wanting to lead up:
Another noteworthy lead group, ever since 2001 really, has been a measure of consumer health, the RLX big box retail group. In our de-industrialized American economy, where consumer spending has become about 60% of the economy, this matters. In 2011, the RLX came nowhere near doing a negative crossover, and is still wanting to strongly lead a bull market:
But the American consumer appears to be the last general standing in the bull/bear battlefield. And his position looks precarious at best. There is always the hope of monetary intervention, as in 2008 and again in 2011, but the Fed and all major central banks have spent a lot of valuable ammunition. Has it put us on a new path of economic growth? No, but it has accomplished a great erosion in investor confidence in their ability to really fix things. It is almost comical the way the Fed has raised rates and is projecting four more this year with money velocity plummeting to 1930s levels. What are they smoking with a nearly a quarter of the population on food stamps - some rolled up printed money bills perhaps?
The Fed could take all four hikes off the table, repeal the one just done, and QE some more, and after a knee jerk rally, we probably would still be saddled with a bear market. You hear commentators saying this is not 2008 because there is not the leverage in the system now. Yes, that's true - of the big banks. Their balance sheets are immaculate for the most part. There is, however, mammoth leverage in about everything else, especially all things commodity related. The "weapons of mass destruction " in finance, as Warren Buffett called them, derivatives, have grown well past 2007 levels. And this includes many banks such as Deutsche Bank, the biggest bank in Europe's economic leader, Germany. If you check their stock chart, it looks very similar to the CRB. How much systemic risk this presents only time will tell.
What makes this turn even more worrisome can be seen in another of Doug's charts - the credit balances:
There is a mad dash to the green at each bear turn, and we seem to be further in the red and more behind the curve to the green at this point.
As we know, all this trouble is largely being precipitated by the commodities slide. I went over the commodities problems in my Debt Cycle article and showed a chart for what appears to be a new measure by the Fed for backstopping commodity price induced debt blowups. CNBC is now talking at length about the commodity debt problems, going over projected bankruptcies amongst the oils in particular. As I discussed in the article, Glencore (GLEN.L) is a lot like the Lehman of this cycle. CNBC's Brian Sullivan just the other day, featured "the most important stock in the world" in his show, which was Noble Group of the Hong Kong market, saying that it is their version of Glencore. He said that these two stocks were the ones to watch as this mess continues. In my article, I showed the Fed's repo chart and mentioned the take of Investment Research Dynamics by Dave Kranzler, "Something Blew Up In The Global Financial System", regarding the repo spike in September. Well I have an update to add to that as something else seems to have "blown up" just now:
The most recent sharp move down in commodities "C" may have sprung another major leak in the debt dike I pictured in the other article.
All this darkness may blow over and be resolved without a bear market. But I don't think I am going to be comfortable being anything but defensive until the whole technical pattern morphs into something not so disturbing.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.