Don't Mistake Monday's Brexit Relief For A Real Rally

Includes: DIA, IEV, IWM, QQQ, SPY
by: Orange Peel Investments


Futures have the markets pointing much higher at the open on Monday.

This follows strong performance from European and Asian equities overnight.

Don't confuse this Brexit relief for a real rally. We still think we head much lower.

By Parke Shall

The futures market is indicating an intensely green open this morning. No doubt this is going to have the financial media talking about whether or not we have seen the worst and whether or not the Dow will soon be again pressing new highs. On a day like today, the media focuses as intensely as they can on the market rally because it is the best narrative for the public to hear and it's great for ratings.

We don't adhere to the ratings here, so we'd like to offer up a "counterpoint" dosage of what we believe to be reality. We wanted to just write a short article this morning talking about why futures are rallying so intensely and also why we think today's "relief rally" probably won't last more than a couple of days.

The one item that really scared investors last week was the possibility of Britain exiting the European Union. As poll results came in over the last few weeks that seemed to suggest more and more that Britain may leave the European Union, markets sold off accordingly. The idea of Britain leaving the European Union would cause an extremely volatile shockwave not only in equity markets and companies doing business in Britain, but also in currency and commodity markets. Britain leaving the European Union has the potential to be a catastrophic event if the markets are not prepared accordingly for it. In one of our last articles that we wrote just days ago, we suggested that nobody paying attention to a possible Britain exit could blindside investors and throw global markets into turmoil.

New polls released over the weekend seem to show overwhelmingly that Britain's favor remaining in the European Union, and by large margins as well all of a sudden. Previously, it looked as though there was a real chance of Britain leaving. In a matter of just days, much of that has changed.

With this new data in hand, global markets rallied overnight and U.S. equity futures followed suit, pushing higher and higher overnight in the US while active futures traders continued to bet on a rally moving forward from here.

However, this does not address our main concerns about the US economy and the markets overall. For those that have been reading us over the last six months, you know that we still expect a 10% to 15% correction in all of our indices over the course of the next 6 to 12 months. We have-based that on several factors.

First, we are starting to see bubbles in areas like high-yield corporate bonds and the auto financing market. We have suggested that these bubbles, which are relatively tiny compared to 2008, do you need to burst a little bit and "let the air out of the tire".

Mohamed El-Erian nailed it last week,

"The collateral damage and unintended consequences of this prolonged experiment with very low interest rates [and] very big balance sheets are starting to have a meaningful [negative] effect on the economy," El-Erian told CNBC's "Squawk Box."

Without a clear idea for the future of growth, the Fed has become "overly data-dependent," El-Erian said, arguing that such an approach has been sending "conflicting signals over time."

We also noted that the Federal Reserve's indecisiveness could be cause for a much bigger correction, as the Fed has clearly dropped the ball on its responsibility to maintain interest rates in conjunction with the health of the overall market. Instead of being clinical and raising rates according to their schedule, the Fed remains spineless and unable to put even the slightest bit of pressure on equity markets for fear of backlash from the public and their constituency.

We have argued that this inaction may turn out to be gross negligence when we look at it years in the future. We believe that failing to raise rates when it was appropriate to do so is going to lead to a much larger bubble that the Federal Reserve is going to be wholly responsible for. We have often asked the question of what would happen when quantitative eating simply doesn't work and the public loses confidence in the entire game.

With the rest of the globe embracing negative interest rates, we don't think that we are that far off from a situation like this happening. What we predict will happen is that we will see a bunch of smaller bubbles burst here in the US first, we will see volatility from the upcoming election, we will see employment macroeconomic data not get better from here, and we continue to see all the recipes for a 10% to 15% correction in the overall markets.

We wanted to write this article to let investors know that while the relief rally should be enjoyed today, we still see it as a small pop on a much larger scale of market performance that we expect to continue to decline from here. We do not think markets will again breach new highs, and we will remain exposed to numerous companies via our short book for several quarters to come.

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.