The world economy is currently in trouble, showing both recessionary and deflationary coincident data:
Given these, the resilience of equity markets has been pretty amazing, even more so as we are now a year post-solar maximum:
In fact, under such extreme levels of valuation, allocations, leverage and sentiment, together with growth, ‘flation, and earnings all rolling over negative as well as the speculation peak of the solar maximum through, the case was extremely strong for 2014’s October sell-off to launch a fully-blown bear market. The weakening economy over the subsequent 6 months and the wealth-reduction effect of the declining stock market would then have fed off each other to create fairly significant devastation.
But it didn’t happen. Stocks were somehow saved. However, as pre previous posts, we see a lot of degradation in internals and cross-referenced data since mid last year, giving the potential for price action since then to be ‘last-gasps’. Below is the Dow Jones World stock index which reveals a similar higher high against weakening strength to the last 3 previous major tops.
Plus, we have seen a sell-off in recent weeks, making that higher high maybe a fake-out high. We still see saturation levels in valuations, allocations, sentiment and leverage and many negative divergences that all support the bear case.
However, set against this, we have recently seen a turn up in leading indicators and what maybe a bottoming in coincident data.
At the same time we have seen some money exiting bonds and inflation expectations recovering, suggesting some of the expected pick-up being priced in by market participants.
However, real money leading indicators predict this to be another non-sustained pick up in global growth, i.e. still not the move to sustainable strong growth that leads to central banks starting to raise rates. Rather, they predict the growth to peak by October this year and then give way to weakness again.
The key question, therefore, is whether equities can now rally again and keep the bull market going over the next few months against a backdrop of improving economic surprises. If so, then we would need to see stocks repairing this kind of bearish set-up of fake-out plus divergences:
If stocks can do that, then an obvious reference point would then be 1929, with a potential Autumn/Fall peak, a similar length of time post-solar maximum, at similar extremes of valuation and leverage. Anything beyond that and there would be no further reference points. This really would be unchartered territory for world markets, whereby the ‘old rules’ no longer apply.
Here’s a look at China’s stock market. The divergence from GDP is extreme and as such valuations are now at a new record.
The rise in margin debt in China has rocketed. Leveraged-based stock rallies are ponzi-schemes, making for a risk of a major unwind at any point. The leverage situation around the world is similarly flagging that risk.
In summary, I believe this is where we find out what really moves the markets. My position on that: dumb forces. Demographics, solar cycles and simply running out of buyers. By the latter I refer to saturation in valuation, leverage, sentiment and allocations: everyone on one side of the boat and borrowed up to the max. We can see additional clues to the fuel drying up in divergences in breadth and other indicators.
June/July is the seasonal geomagnetic peak, so I don’t rule out the possibility of a short rally back up here in stocks. But unless all those under-the-hood July 2014 peaks are repaired, together with the bearish technical set-ups and negative divergences, then I expect leading indicators to be disregarded here, in the same way negative leading indicators were disregarded several months back. The fact that the market has risen against both positive and negative leading and coincident economic data the past 2 years is a clue that economic indicators aren’t the driver. So is central banks? I refer you back to the top two charts. After billions spent on QE and ultra suppressed rates, we still have a world economy on its knees.