Combining technical and fundamental factors can be very powerful. Far too often, analysts place too much weight on one or the other. The 9 risks below combine both fundamental and technical perspectives to show the bulls are ignoring a wide spectrum of information. This information, as a whole, indicates risk assets, particularly stock markets, will head lower, nationally and globally.
The bulls may ignore one factor, perhaps a few. However, ignoring a whole range of factors is risky.
DI1 | DI3 | |
Jan-16 | 74 | 76 |
Feb-16 | 68 | 76 |
Mar-16 | 70 | 78 |
Apr-16 | 62 | 72 |
May-16 | 60 | 70 |
The bulls have been trained to "buy-on-the-dip." The market has reinforced this by not severely re-pricing in many years. It is no surprise, in light of the above, bulls are continuing to buy. They are ignoring these risks, as a whole.
One of the primary arguments I am seeing in the Seeking Alpha comments is the Fed will save the market.
1. The Fed has not always "saved the market" in the past. Recessions do occur. According to Wikipedia, we have had 47 recessions in U.S. history, and the bulls seem to think another is unlikely. History would suggest otherwise. We have had 14 since the Fed was created.
2. Many contend helicopter money or additional stimulus will be next. This is not assured. It is only speculation at this time. Furthermore, President Bush gave $600 as a tax refund to many citizens at the start of the Great Recession. It did not prevent recession. Why would similar measures prevent it now?
More on European Destabilization
These are fairly significant words coming from the Financial Times:
Brexit will increase Germany's political and economic supremacy in the EU - a prospect neither Berlin nor its partners welcome.
Brexit will harm the EU's cohesion, confidence and international reputation. The biggest consequence of all, therefore, is that Brexit will undermine the liberal political and economic order for which Britain, the EU and their allies and friends around the world stand."
The European situation seems to be highly polarized right now. Is the above anti-EU statement merely propaganda or reality? There appears to still be strong EU support among the member nations. However, is this really true? Will tumult boil to the surface? The bold quote above is either an incorrect assessment by the Financial Times, or it really is accurate, and cohesion in the EU is about to unravel, as German supremacy begins to rule heavy-handedly.
More on Japan
To summarize, negative interest rates on deposits are driving money out of Japan. Depositors are converting their currency, particularly to the U.S. dollar. Those that are stuck with the converted Yen are then buying Japanese bonds. This is why the Japanese Yen is strengthening, even in the face of BrExit. Negative interest rates on depositors is deflationary due to the flight from assets and the eventual purchase of bonds. When there is less demand on assets, deflation is created. A higher demand in treasuries is generally seen as deflationary as well. This is because it is evidence that money is not flowing into risk assets, and less demand in assets is deflationary.
See the 6/23 Nikkei Flash Japan Manufacturing PMI from Markit. Manufacturing in Japan is contracting, and the contraction in production is accelerating. Usually, stronger currencies encourage exports. However, in the case of Japen, their manufacturing sector is contracting in the face of a stronger currency.
Japan has not indicated it will reverse policy. Deflation will continue, and it will weigh on credit. As loans come under more pressure, people will find they owe more than they realized. Pressure on credit causes bankruptcies. For these reasons and other deflationary factors, the Japanese economy will suffer until something severely breaks, forcing policy to reverse.
Here is the Wall Street Journal article from April explaining the deflationary effects of negative interest rates on depositors in detail:
...the amount foreign financial institutions can charge to lend greenbacks to Japanese investors has surged. The premium for a three-month contract to exchange yen for dollars is now at ¥0.298, almost twice what it was a year ago.Foreign investors have been recycling the yen they get back into Japanese government bonds, traders say, even though yields on a range of these bonds have turned negative in recent weeks-meaning investors who buy them end up paying money to Japan's government. But the fee foreign institutions can charge to lend dollars is now so high that it outweighs the cost of holding negative-yield-bearing bonds, which remain the safest place for investors to park their yen."
There is a big difference in effect between negative interest rates on depositors and negative interest rates on treasuries. I see many comments on Seeking Alpha assuming the effects of both are the same. They are not. When depositors are charged, they move their money to avoid losing capital, plain and simple.
Conclusion
9 risks stack up. Ignoring the 9 issues listed is riskier than ignoring one or a couple of factors. As the weeks and months progress, we should see these factors weigh on the markets considerably, especially if comprehensive indicators such as the CFNAI and State Coincidences index worsen. Consequently, it would be wise to anticipate such a situation. I have been building a position in puts since 5/10.
This article is relevant to the S&P 500 (SPY), Russell 2000 (IWM), and any other index-like product (QQQ), (IVV), (VO), (VTV), etc.
Disclosure: I am/we are long PUTS ON THE RUSSELL 2000 AND DISH.