Fundamentals And Technicals Call For Correction

|
 |  Includes: DIA, GLD, SPY
by: Seth Walters

For a few weeks now, I have had a feeling of awful unease about the equity markets. I'm not sure exactly why, specifically, except to say that the more I have learned about the fundamental and technical signs of our economy, the more and more concerned I have grown. Over the last several months, I've been assimilating as much knowledge as I can about the general state and direction of our economy, and what I have learned gives me some cause for concern. I've chosen to use this article as a platform to share the aggregated fundamental concerns that face the world economy and some troubling technical patterns I have noticed in the indices.

If you're reading this article, chances are that you already know about all of the challenges that face the market going forward. U.S. CEO's have been generally negative with earnings guidance going forward. Revenue misses have been ubiquitous - and when earnings are based on margin compression at a time of historically high margins, that is not the kind of thing that predicts future growth. U.S. corporations are sitting on a pile of $1.5 trillion in cash rather than investing it. China has been slowing down, and where growth will stabilize and what the new leadership (appointed in November) will do to stimulate the Chinese economy, if anything, remains uncertain. The U.S. fiscal cliff looms, with the very real possibility of large government budget cuts and a new ensuing recession. Europe is in crisis. Greece seems ready to default and exit the European Union at any moment, while Spain and others have truly immense unemployment and serious social unrest. Others have spoken of Argentina possibly defaulting as well. Much of the world is in serious economic danger, in my opinion. These are not new ideas, and several other contributors have provided excellent coverage of them, so I will not discuss them in detail.

The way we got here is not really so hard to understand. It seems to have worked the same in almost every country from what I can understand. First, we started with a bull market that lasted roughly from 1982 to 2000. Below is a chart of the Dow Jones Industrial Average that covers this period of time. Economic growth was strong, and note the sharp inflection point in 1995, when the World Wide Web really started to take off. The Internet was a truly transformative innovation that was well worthy of investment, but as is often the case, the investment activity grew too fast, and it created a bubble. The bubble broke, and the bull market was over.

Click to enlarge
(Click to enlarge)

Or was it? Alan Greenspan and the rest of the world's central bankers didn't want to let the economy fall. Various things were done to stimulate the housing market and boost asset prices through the roof. The bull market was back! Thus, we had a credit and housing bubble replace the tech bubble of the late 1990s. Undoubtedly, the central bankers of the time thought that they were buying time for the real economy to catch up and were doing great work. It was a bold gamble, a risky gamble, to try to replace one bubble economy with another.

But it failed. The financial crisis came.

But the central bankers did not give up. What better to bolster a twice failed bubble economy than to inflate yet another bubble? The first bubble was technology, the second was consumer credit and inflated housing asset prices, and the third is fiscal and monetary stimulus and inflated financial asset prices. The first two bubbles have broken, and I believe that the third will break quite soon as well. As nice as the time is that the central bankers have bought us, money printing and deficit spending cannot simply go on forever in every country in the world without the scheme eventually falling apart. I have discovered an interesting pattern in the Dow Jones Industrial Average, and I believe you can see the same thing in the S&P 500 and probably other risk asset indices.

Click to enlarge
(Click to enlarge)

This pattern is called a rising wedge, and it extends all the way back to 2008. As the period from the year 2000 on is often characterized as a secular bear market, this 4 year long rising wedge occurring within this context is a bearish development, and may well portend a significant break to the downside. I expect this to happen before next April to be sure, but probably much sooner. It is even possible it has already begun.

My gut feeling is that central bankers are basically well meaning. I believe that the measures they have taken to keep the world economy boosted has been intended to buy time for the real economy to catch up and support the growth. However, the world faces extremely serious economic challenges in the decades ahead. Technology has thus far proved better at replacing workers via efficiency boosting innovation than empowering workers by transformative innovation. For example, entire factories can now be run by robots. A declining worker base that is required for the global engines of capital ultimately means that revenues are destined to fall, as those who no longer have jobs will find it considerably more difficult to be customers. In my opinion, this problem looms even larger than the more immediate problem of overleverage and increasing wealth inequality, both of which have been causing revenue hits for many years already. The world's central bankers have bought the world economy time, but the world's governments and corporations have thus far failed to deliver the correct long-term solution to our problems.

Business enterprises will continue to be the best investments for relatively quick return on capital for the foreseeable future. In the longer term, my opinion is that investment in scientific and other technical research is the best that we can make. While this perspective is not being adhered to very well by the world's economic systems or governments, I and many others will continue to pursue it on a personal level in the hope of delivering the transformative innovations for the future that private enterprise is by its nature incapable of delivering. Because without this sort of transformative innovation, all of the central banking tricks in the world are nothing more than chicanery and hucksterism designed to mask the fact that the economic engines have stalled and without deficit spending we'd be falling from the sky.

Given the facts as they currently stand, I recommend exiting long positions and standing pat or entering short positions. I am bearish on gold and continue to advocate avoiding or shorting it at these levels. It has fallen approximately -5.5% since my last article on it, written early in October. The traditional lifeboats of safety have already been overcrowded and are starting to sink under their weight in the heavy seas. There is no safety to be found in any one thing all of the time, but sound judgment and careful weighing of options is required at all times.

The faint improvements that we've seen in the economy have been created on the back of unsustainable stimulus and huge budget deficits. They are nice, but they are not real. As such, I do not think there is anything at all to push the stock market higher, and expect that the large rising wedge I have discovered will break to the downside in due course. Good luck to everyone with their trades and investments.

Disclosure: I 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. I will most likely initiate a short position in U.S. equities within the very near future.