The U.S. Federal Reserve Bank and the Bank of Japan made dual announcements about their respective monetary policies, within hours of each other, to what seemed to be the breathless global masses — then, nothing. Yes, both equities and gold rose (1.2% and 1.8%, respectively), but the less-than-energetic move hasn't changed the trajectory or the pattern for either asset.
The patterns we have been following remain in play; the move in the S&P 500 (NYSEARCA:SPY) was within the range of the pattern. The chart below shows the topping patterns in all four sentiment indicators: bull and bear investor sentiment, and Rydex bull and bear fund assets. The SPX is pushing up against the upper boundary of the down channel, so the index could go in either direction or stay at this level (the question mark on the chart). We expect the former.
It has been awhile since we last displayed the topping pattern of the bull and bear investor sentiment indicators. The chart below shows that bull sentiment spikes (pink vertical lines) one to six weeks ahead of the SPX topping-out (blue vertical lines). This pattern is pointing to continued downward pricing for the next several weeks (see red arrows.)
These two charts approached the problem from a topping perspective, and the patterns that emerged indicated a downward bias. What happens if we approach it from a bottoming perspective?
The graph below shows the local bottoms (blue horizontal lines) and the pattern that is visible in the indicators: Rydex bear-to-bull ratio, Rydex bull assets, bull and bear investor sentiment. Notice that when the SPX corrects (red arrows on the SPX), the indicators respond in a very similar way every time the SPX correct. The indicators "sweep" into the bottom-indicating horizontal blue lines as the SPX corrects.
The pattern at this time is pointing to further corrective action, at least in the shorter-term.
It turns out both approaches give the same probabilities and are in agreement about a downward bias, but both approaches only look at short-to-medium time frames.
The long-term picture is different: The Rydex bear/bull asset ratio is indicating a higher market in the works (red circles on the chart below).
The long-term RSI, MACD, and 8- and 12-month moving averages are also indicating a potential bull move in the S&P 500 (see below):
It could be that the downside, predicted by the short- to medium-term patterns, will not last beyond a few weeks. There seems to be more upside coming.
What could possibly justify higher equity valuations when: the PE ratio has rarely been higher than it is at the moment; home ownership is down; the Fed is "generally pleased" with the U.S. economy, although the GDP estimate is only 1.8% (lowered from 2.0%); business earnings growth has been negative for five quarters; and much more?
All those reasons for the market not to go up are well known, if not obvious. Yet prices continue to rise. That smells like a bull market. A mature bull, we have to admit, but a bull nonetheless. Valuations at the later stages of past bull markets were just as hard to rationalize as today's market valuations, but they went on to defy gravity anyway. The same may be happening now.
Climbing a wall of worry makes the market behave irrationally -or does it?
What if the market is betting that, even though monetary policy by itself has not been able to stimulate the real economy, the governments of the world will not allow the economy to be starved beyond what the people will tolerate?
Intolerable inequity has always resulted in revolution. Maybe the market is betting governments will act to reverse the inequity.
In the U.S., both presidential candidates intend to use fiscal policy to get the ship sailing. And they are going to build infrastructure and go further into debt in order to do it. But wait, isn't high government spending and debt the reason for this economic mess in the first place? By that logic, more spending and debt would only make things worse, or even cause a depression.
But what if that logic is wrong (as we continue to maintain)? What if governments borrow at the lowest interest rates ever and use this debt to rebuild and extend airports, bridges, highways, renewable energy infrastructure, and especially education and healthcare (because AI robots will do the less-technical work, leaving the less-educated out of the workforce)? What might happen then?
Business - and hence the real economy - needs the consumer to increase the velocity of money, and the consumer, in turn, needs business to provide the money (create wealth). The consumer cannot start increasing money-velocity on their own, and business is too busy flipping their own shares at the moment to actually bother growing a business.
Unlike QE money, which has never made it past the financial industry, fiscal expenditures on infrastructure will have relatively unfettered access to the consumer. Every dollar in the hands of labour will be circulated in the economy, while another billion dollars in the hands of the already-rich corporations or individuals, will simply gather dust in a tax haven somewhere.
Business will then have to respond to the demand and opportunity that is created by consumers spending money. In other words, corporations will have to stop their share buyback programs, which are nothing more than financial self-congratulation, and actually invest in growing their businesses.
The debt is like a very large and long-dated mortgage that carries almost no interest. The higher revenues arising from the increased business activity will easily handle the mortgage payments.
This could turn company profits around and lower the PE ratio, while simultaneously increasing equity valuations. This will only happen after the election, but the market is a futures market, so maybe any correction could be short-lived, since it looks ahead six months.
If Trump is elected, we might find that some of that infrastructure debt is used to build a yuuge, beautiful wall. Since we really don't expect another country will buy us this yuuge wall, we are resigned to the fact that we will be paying this particular tab.
In conclusion, there is still much uncertainty in the equities market, so we will continue to maintain our hedged positions.
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. I have no business relationship with any company whose stock is mentioned in this article.