Alchemy - Bulls Into Bears

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by: Terence Reilly

So much to say and so little space. I guess a chunk will have to wait for my quarterly letter next month.

Some of the most visible market pundits that I term as permanent bulls have turned bearish of late. In fact, in my almost 30 years of doing this, these are people that I have never seen anywhere remotely close to bearish - so this is news. Perhaps it just has to do with how late we are in the cycle, but I couldn't help but notice. Prof. Jeremy Siegal, Abby Joseph Cohen, Leon Cooperman and now Ben Bernanke have all turned bearish in the last few weeks, and they all seem to be pointing to how difficult 2019 is going to be. To us, that means the trouble could start as early as July of 2018 in anticipation of a tough 2019.

From Jeremy Siegal:

Caution is going to be the word here.

This is a great year for earnings, no one argues with that. But the tax cut is front-loaded which means that the write-offs on capital equipment are going to accrue to 2018 and not nearly as much in 2019.

The major threat of the market is higher interest rates going forward. Too many people read the FOMC minutes as being too dovish. - Prof. Jeremy Siegal

From Leon Cooperman:

I would be a reducer on strength, not a buyer on strength. I think the market is adequately valued.

I'm sympathetic to the idea that sometime in the next 12 to 24 months, there will be events that will catch the market. In other words … I think that inflation and interest rates will catch up to the market as we normalize. - Leon Cooperman Omega Advisors

From the Did He Really Say That Dept?

The stimulus "is going to hit the economy in a big way this year and next year, and then in 2020 Wile E. Coyote is going to go off the cliff,"
- Ben Bernanke, former Fed Chairman, June 7

While not a perma-bull, the most direct and information laden warning came from the largest hedge fund in the world - Bridgewater Associates.

2019 is setting up to be a dangerous year, as the fiscal stimulus rolls off while the impact of the Fed's tightening will be peaking.

We are bearish on financial assets as the US economy progresses toward the late cycle, liquidity has been removed, and the markets are pricing in a continuation of recent conditions despite the changing backdrop. ­- Daily Observations co-CIO Greg Jensen Bridgewater Associates

The Fed is pulling back on liquidity as it is the right thing to do, however, there are many that don't share that view. In particular, emerging markets that are beginning to submerge from Argentina to Turkey to Brazil, and the ripples across the pond are becoming waves. Those waves will eventually hit these shores and the Fed will have to slow its tightening cycle. There are no problems only opportunities. We are loath to enter the emerging markets but see commodities as a place to hide as inflation rears its ugly head as a handcuffed Fed is forced to slow rate hikes by Congress and external international pressure. We are already starting to see wage pressures in trucking and the oil patch. Markets are pricing in a goldilocks scenario that is ever elusive and fleeting. Change is the only constant.

We are also more bullish on the US than Europe. We are currently seeing Europe's economy slow down while the US speeds up. Why? The US and Europe both have QE and are buying assets in the real market. The difference is interest rates. The US is raising interest rates, which is creating demand. People are saying hey, interest rates are going up I better, fill in the blank, buy that house, that car, or build that factory. Jobs are getting more plentiful. People can get raises, get better jobs, move, spend money. Europe is not raising rates, and therefore there is no impetus or motivation for people to spend. Spending leads to more jobs with healthier pay which leads to people moving for better jobs which creates jobs and more spending. You get the picture.

QE is the kindling. Interest rates are the match. Europe just keeps pouring more gas on the fire without lighting the match. It took the US several tries before the market and economy gained confidence and then believed the Fed would continue to raise interest rates. Trump's fiscal and tax polices helped give the Fed cover and made its story more believable. Europe needs the same. Light the match. Having said this, the fire will only burn so long. What comes next? Commodity prices will rise along with inflation here in the US. The Fed will try to continue to raise rates, but the question remains will they end up behind the curve while feeding inflation? We think they will.

The market can continue to chug along to higher prices, but that will become more difficult as we head into 2019 with less fiscal/tax stimulus and more QT around the world. To be sure, Cooperman cautioned that while trouble could be ahead for late next year, he isn't ready to head to the exits just yet, saying "the conditions normally associated with a big decline are not yet present." We agree.

Small caps continue to lead while the trade wars stay on the front burner. Keep an eye on the banks. Markets won't get far without them. You'll find us in the commodity space. You won't find us in emerging markets. That's where the trouble will surface.

We have been telling you to keep an eye on Bitcoin. It bounced slightly this week to close on Friday at $7,660.66. It still has our attention. $6,777 is important support for bitcoin.

The S&P closed the week at 2,779 or up about 1.6% but still near our fulcrum of 2,666. 2,800 is resistance. Small caps and the Russell are holding their recent new highs but look a bit overbought and could use a rest. We are headed to NY/NJ to see clients and had considered taking the whole week out of the office. We think that is sufficient to confuse the trading gods and expect next week to be an active one. Whenever we are out of the office, the trading gods seem to knock the hell out of the market. Next week is a busy one with summits and central bankers galore. Keep your helmets on. The bulls are still in charge and looking for a knockout punch.