Bull Market Peak

US Stocks:dollar, stocks:bonds, junk bonds and volatility (inverted) all peaked out mid-2014 with the solar maximum.

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Source: Stockcharts

Crude oil, put/call, breadth and bullish percent did likewise.

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Sornette’s bubble end flagged then too.

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Source: FinancialCrisisObservatory

Global business activity peaked out at the same time.

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Source: Thenextrecession

And economic surprises.

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Source: Not_Jim_Cramer

So did financial conditions, Europe and US.

Screen Shot 2015-09-22 at 20.28.53 Screen Shot 2015-09-22 at 20.27.06

Source: Bloomberg

And geomagnetism has played a key role in these developments, intensifying since mid-2014.

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With united demographic downtrends in the major nations, solar history suggests markets and economy should tumble down to the next solar minimum.

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Source: NOAA

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Source: Tarassov

Drawing demographics, solar cycles and valuation together we get this:

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It fits all three and that’s what makes it fairly compelling.

The mid-2014 peak we see in many indicators and assets is unrecognised by most. They see the August 2015 drops as the first drop in a topping process or a wave 4 in EW, both meaning we head back up. But the drops into last October fit better with this, with a secondary and final peak then forming in May 2015. The nominal price action has been uniquely confusing in this major peak, but the clues are provided by those under the hood and cross asset indicators.

What resonates with me about Elliott Waves is the waves of mass crowd psychology. We see this phenomenon playing out in solar cycles, lunar oscillation, demographics and valuation. But the weakness of Elliott Waves is that on any chart at any time multiple different counts can be produced and are then refined with time to make the count always ‘right’ with hindsight. I simply don’t see evidence that Elliott Waves are reliable market predictors (emphasis on the reliable), but the general underlying idea is very much in play in overall price action, something like this:

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Source: ProfitF

We all know an up trend rarely ends abruptly but instead typically peaks, reverses a while and next heads back up. Then, typically, the move either fails before the previous peak, double peaks with it, or makes a marginal higher high but on negative divergences, before the trend reversal takes off in earnest. All akin to turning a tanker at sea: it takes some time. Whatsmore, the last move up is typically the stage on which the retail money makes its usual late and painful act.

Between last July and this May we saw smart money flows weaken, dumb money indicators hit new highs, leverage jump to a new record and stock market internals notably diverge. All evidence of a wave 5, a secondary peak, or the terminal rally after the primary distribution, whatever you want to call it:

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That second chance peak is now looking fairly potent on Biotech:

Screen Shot 2015-09-21 at 21.06.18The point is that topping processes share similar characteristics which reflect how humans work. A peak takes time to form with some back and forth, some telltale signs in those leaving early and those joining late, and some health warnings.

Finally, let’s recall that this has been the second biggest mania of all time, as measured by valuations, leverage, allocation and sentiment. The second major error analysts are currently making (to go with the failure to see the topping process began last July) is to see charts like this one as contrarian bullish:

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Source: Yardeni

The jamming of the indicator at record highs last year highlights the mania that was in play. The subsequent crash is the mania bursting. The low reading is bearish, not bullish. It will take some time to recover, maybe even years. Given how ultra saturated the market was in terms of allocations, leverage and sentiment, it is unrealistic to think that the market will now go make new highs. Some of the dumb money was wiped out in the August falls, some more is selling on every move up to get out at break even.

The most bullish outcome is that the market gradually digests the falls and range trades whilst all the excesses of 2014 are gradually mopped up. But, there is no precedent for this in history. From 2014’s valuations, leverage, sentiment and allocations levels we have only seen devastating bear markets in the past. The post solar max and demographic environment add to this likelihood.

Gold looks to be completing its basing. Global stocks are now retesting their August lows. Clearly, if gold takes off here and stocks decisively break down beneath their August lows then the mood will properly change. The most bullish outcome I consider is that stocks range trade and recover some whilst the 200MA gradually arches over, as bear markets often aren’t in a rush, more of a slow bleed. However, written into the record leverage, is a period or periods of panic selling. Biotech is in an ideal technical set up for that to now occur. DAX and RUT look post second chance, which in past major peaks led to waterfall selling. So maybe we fall apart rapidly here – or, my bullish scenario – we hold up (without exceeding the highs) into the end of the year and fall apart in early 2016. Every man and his dog thinks that stocks are going to bottom out and resume bullish in October in line with seasonality so it seems likely that something else occurs. I think actual (rather than seasonal) geomagnetism is likely to play a role in this, so I am watching developments. I favour the falling apart option but you know my positions disclosure. Trades-wise I’ve been increasing shorts and adding to gold on the basing evidence, and adding stops to all of it. I’m going to carry on with this strategy unless the market bounces on positive divergences and shows evidence of a renewed move up for the bulls.

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What Causes Bear Markets And Recessions?

Firstly, the definitions of a bear market (20% decline) and a recession (two consecutive quarters of negative growth) are arbitrary, but a line has to be drawn somewhere. Secondly, there is a lot of misinformation spread about this question, so let the evidence speak.

This chart shows US bear market and recessions. Mainly they occurred together but we can see a couple of recessions without stocks bears and a handful of stocks bears without recessions.

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Source: Ritholz

The deep recessions always correlated with a stocks bear and the deep bear markets always went hand in hand with a recession.

You’ll hear a lot that recessions cause bear markets, but quarterly GDP prints at bull market peaks say otherwise.

US quarterly GDP growth at past major stock market peaks:

Q4 2007 4.4%
Q1 2000 6.18%
Q3 1987 6.08%
Q1 1973 11.91%
Q4 1968 9.84%

Leading indicators can help us identify the onset of recessions ahead of time. The way it works is the economy does not roll over all at once. Certain activities peak first and others lag (e.g. firing and hiring is one of the last processes). These leading indicator indices identify manufacturing new orders, money supply and interest rate spreads amongst those first to diverge.

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In the chart above we can see that CB and ECRI leading indicators have recently diverged from one another. CB is fairly benign currently whereas ECRI has turned negative.

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The complete list of differences isn’t published. However, there are two important things to note. First of all, both use the stock market as one of their leading indicators: further evidence that it isn’t the economy that leads the stock market but the other way round. Secondly, all they are doing is identifying the first dominos to fall in a recession, therefore they flag only when the economy and stock market are already flagging in certain ways. So useful, but not a stand alone predictor.

Related to leading indicators are recession models. They too try to pick out the leading variables and typically include the likes of real income, trade sales and industrial production. Once again they flag as these first parts of the economy roll over, so cannot be considered as ‘predictors’.

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Next, you’ll hear a lot that tightening, either through oil prices or interest rates, are the typical causes of tipping the economy into recession. The two charts below appear to echo that.

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However, we see that further back in time crude wasn’t a major factor in recessions and Japan provides a useful example of recessions occurring despite ultra low rates.

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Source: ETF Guide

Associated with the latter is the interest rate spread. The yield curve is perceived to be a reliable recession predictor: when it turns negative recession is looming.

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The reasoning is that buyers would rather take up a 10 year bond at meagre rates because they have such little confidence in the economy ahead. If that is so then it is the market leading the economy again.

However, the Japan experience shows that we can have recessions without an inverted yield curve, and again looking further back in time at the US we can see the same occurred there too.

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Below we can see the relationship between inflation (with oil prices being a key factor) and interest rates.

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Source: Yellowstone Partners

And here the rise of deflation.
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Accordingly, our current circumstances have more in common with the 1930s when low oil prices, low rates and non-inverted yield curves were in play and notably were not recession triggers.

The supposed ‘mistake of 1937’ alludes to the central bank tightening to early and bringing on a recession. This is part of the wider misinformation that central bank actions lead us into and out of recession. Once again the example of Japan in the 90s and 00s show us that despite QE and ultra low rates, both bear markets and recessions still took place. Now we see that repeating but on a global scale. The US may have ended QE but it continues in the UK, Europe and Japan, whilst ZIRP is the norm around the developed world and there have been many fresh cuts and easing measures in 2015. Despite all this the world is quietly slipping into recession. Below are the real indicators of China’s economy, notably diverging from the ‘official’ GDP.

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And here we see US economic indicator surprises have stayed negative all year.Screen Shot 2015-09-19 at 06.27.32

Negative leading indicators (ECRI) and negative coincident indicators (above). No surprise then the Fed left rates at zero. This is going to help with the myth debunking. If we are now in a bear market and tipping into a global recession, as I believe, then central bank ‘tightening’ can’t be fingered.

Moving on, high valuations are considered a bear market trigger. The chart below reveals this may be so, but with a notable outlier in 2000. Much like the charts of interest rates and crude oil above, if there is a relationship then it doesn’t tell us at what level (oil price, interest rate or equities valuation) or at what point in time the economy or stock market will tumble over. However, high levels in any of the three would represent notable flags that a reversal lies ahead.
19sepe9Similarly, high sentiment, allocations and leverage are flags for a stock market peak. But again they don’t tell us when or at what level the reversals will occur. They are warning signs that mania is taking place, but what causes that mania?

On the chart above are labelled what I consider the real predictors: solar cycles. They enable us to time the market peaks on a longer term view, with the major lows above equating to major peaks in commodities. Below we see that the influence extends to the economy with relations to unemployment and recessions.
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But not all bear markets and recessions can be associated to sunspot peaks, which brings us to the other main cause: demographics.

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This is the overarching reason why the global economy is in trouble: the collective negative demographic trends in the major economies. Again, demographics influence both the markets and the economy, and as they are to a large degree set into the future we can predict what lies ahead. As the chart above shows, that would be ‘trouble’.

Demographics and solar cycles are related, with the latter influencing the former, and as we can identify their influence in tipping the market and economy over, we can likewise see how they bring about manias in both into demographic and solar peaks. Therefore into both types of peak, it is normal that oil prices may rise, unemployment may fall, stocks may boom and rates may be tightened.

The major peaks in 2000 and 2014/5 were solar. The major peaks in 2000, 2007 and 2011 were demographic. Perhaps we then we can see why 2000 was so outsized: it was both solar and demographic together.

To summarise, demographics and solar cycles are the main causes of bear markets and recessions. Within that, we can identify those indicators that lead in the economic downturn, which make up the leading indicator and recession probability model components. Notably, these include the stock market. The yield curve, interest rates and oil prices can also be useful such flags but there are circumstances when they don’t apply. Those circumstances are demographic, and that non-application is in play now, as it was in 90s Japan or 30s US. So, should we now be tipping into a bear and recession, that will help invalidate some of the misinformation spread.

There are no dead certs in the economy or markets. The best way to phrase it is that typically stocks bears and recessions occur together, normally the former leads into the latter, usually the cause is either demographic solar or both, and that often we see flags being raised by several of the following: valuations, sentiment, leverage, allocations, oil prices, inflation and interest rates.

Turning to the short term markets briefly to close, the recovery rally in stocks has been enough to neutralise several of those indicators that had turned excessively bearish. Gold has been able to make a higher low last week and the next confirmation would be a higher high. I expect stocks to break downwards again in due course and I maintain the bear kicked off in earnest in May, with the topping process having showed clearly as starting in 2014 at the solar max.

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Stock Market, Sunspots And Geomagnetism

The smoothed solar maximum was April 2014. Geomagnetism intensified as of August 2014. This is normal progression: positive pressure up into the sunspot peak, then negative pressure as both sunspots wane and geomagnetism ramps up in the following window. The influence on financial markets is captured here:

Screen Shot 2015-09-11 at 16.29.43

We can see that the solar-inspired speculative mania effectively ended in that window of mid-year 2014, with stocks making a topping process between then and May 2015.

Daily geomagnetism reveals an intensification in recent months.

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Something similar happened in 2000.

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Stocks were led into a 2 year bear.

Back to the current, the overdue snap in equities in August 2015 changed the picture. No V-bounce like in 2013-2014, plus a sharp escalation in complacent indictors. This is not like those 2013-4 corrections.

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Various indicators which were stuck at bullish extremes in 2014 have now not only mean reverted but have moved all the way to bearish extremes. Amongst these are Investors Intelligence bulls, US equity outflows, capitulative breadth, Trin and a cluster of 90% down volume days. Collectively they represent bear market bottom readings, leading some analysts to call time on the current the correction in equities and predict a bull market resumption.

In that scenario we need to square why stocks only corrected 10%. In the first chart at the top we can see a year long stealth bear in progress, more apparent in some markets and indicators than others. So did stocks correct in time rather than price? Proponents of that option then have a problem with big picture indicators, in that both valuations and leverage are still a long way from mean reversion.

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29augu10Source: DShort

Due to the lack of demographic tailwind, the bull mania was fuelled by debt: traders leveraging up and companies leveraging up to make buybacks. For the bull market to continue, both those would need to rise to new record highs. Given the sharp snap in equities in August, the appetite for that is likely absent, at least for some time.

Rather, in my opinion, that was the point at which the mania popped, at which record complacency and froth was finally shot down. The bear market bottom readings in certain indicators are indeed a sign of a bear market: a pause in the downdraft. These indicators show selling and fear and are only bullish if they revert. Case in point: in 2014 they were stuck at extreme bullish and did not revert, hence stocks continued to edge up. The question is why they were stuck at record bullish extremes, and the answer is the hidden force of the solar maximum. Now we have the twin powers of waning sunspots and intense geomagnetism, which are likely to keep these indicators bearish.

There is a common misperception that the economy (i.e. recession) causes bear markets, but the data in fact shows that the stock market leads the economy.

US quarterly GDP at past major stock market peaks:

Q4 2007 4.4%
Q1 2000 6.18%
Q3 1987 6.08%
Q1 1973 11.91%
Q4 1968 9.84%

Rather it works like this: demographics and sunspot cycles bring about the major peaks and troughs. In our current case, the rise into the mid-2014 solar max caused the speculative mania in the markets, identified by extremes in valuations, sentiment, allocations and leverage. Then the wane from the solar max and associated intensification in geomagnetism have brought about the burst. That burst isn’t complete until valuations and leverage have reverted sub-mean, a process that is already fixed in demographic and solar trends right ahead.

October is the seasonal peak intensity for geomagnetism. This is the reason for a cluster of major historic drops to lows in October. We are finely poised leading into it. Stocks have made a triangle consolidation following the August drops. Gold has a weak higher low, as a tentative basing. For equities a retest of the August lows would be historically normal following such sharp drops, whether bull or bear bigger trend. But, various indicators are already at bearish extremes, i.e. contrarian bullish, so we could move further sideways or upwards before heading down again. Friday was the new moon, so we are now tipping over again into negative pressure, and this is assisted by current raging geomagnetism. FOMC and OpX this week.

My view. Stocks are in a bear since May 2015. That means no new highs and another lurch down lies ahead. Given the collective shock at the August drop in equities – despite 40+ topping indicators forming last year – another leg down to lower lows would have a major effect on the masses. If indicators can’t pull up now from their current extreme bearish readings, then that’s the recipe for another sharp break downwards in the current geomagnetic environment. Odds are this can transpire as we move into October. Invalidation would be stocks holding up through this window, gold breaking down, and equities indicators pulling away from bearish levels.

The Big Picture

Financial markets are the function of swells and shrinkages in buyers and leverage, brought about principally by demographics and sunspot cycles, additionally with the latter influencing the former.

The big theme in demographics over the last half century has been that the major nations have largely experienced similar swells and shrinkages in key age groups due to the post WW2 baby boom. As a swell of young adults they produced inflation in the 60s and 70s, which then turned into a middle-aged swell producing stock market and real estate booms post 1980.

This chart shows the ratio of middle-aged to all population in the major nations. This ratio experienced a major peak in each of the countries between 1989 and 2011 producing the according stock market and commodity major peaks.

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First Japan’s demographics peaked out, producing the Nikkei and Japanese real estate tops. Then the US peaked in 2000 with the resultant biggest ever stock market mania. Next UK and Germany peaked out with the 2007 stock market and real estate peak. Finally, China peaked out and as the world’s biggest consumer of commodities, the commodities index accordingly delivered a major top.

Since then demographics are united in a downtrend, which is the main reason why 6 years post financial crisis we still have ZIRP, QE and easing as the dominant central bank policies worldwide, and why the world economy is under such deflationary and recessionary pressures. Ultra low rates helped give rise to the stock market mania of 2013-2015, but otherwise we have to turn to solar cycles not demographics for the driver.

Each of the sunspot maxima in the era of globalised, free markets produced a peak speculative mania. Between July 2014 and May 2015 we saw commodities, junk bonds, leverage, breadth and stocks peak out, following the smoothed solar max of April 2014.

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That lag is not dissimilar to that in 1929: a slight overthrow beyond the solar max. In both instances breadth peaked out at the same time as the solar max but nominal stock prices didn’t top out until a year later.

Drawing on Q ratio valuation for the big picture we can see that solar maxima typically produced high extremes in valuation which then mean reverted. Meanwhile, low extremes corresponded to major commodity or gold peaks.

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Draw together both the solar cycles and demographics above and we get the projection of the black arrow, namely that stocks should wash out to undervaluation levels by around 2025, the next solar max, and gold should rise into a major peak then. What’s key is that there is no demographic relief in any of the major nations between now and 2025 nor a solar maximum (they are roughly every 11 years). Therefore, I expect a long bear market in stocks in this window, like these examples from history:

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If I was to narrow the projection a little further, then the solar minimum of around 2018-19 is likely to mark the first major bottom within that. That means a bear from now of around 3 years, similar to those historic cases above. After that stocks ought to continue to languish, perhaps sideways Japan-1990s-style, whilst gold rises to dizzying heights to a peak circa 2025. But that time frame is a little to long to be anything more than speculative, so let’s keep the focus on the first major cyclical move, which I consider to be a bear from May this year to last some time and take valuations sub-mean.

The question mark is over central bank response. They won’t stand by and watch this occur but are likely to turn to increasingly unorthodox measures. The reason demographics and solar cycles work is because the markets are globalised, free, instant voting machines that therefore capture major collective trends. If central banks ban shorting, restrict capital flows out of the country, penalise people for not investing in government bonds, penalise savings, or other such policies then the markets environment will become more distorted and we will have to adjust accordingly. So far, however, central bank distortive measures haven’t been able to override the collective demographic trends, as evidenced here in global inflation and economic trade.

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Source: Gavekal5sept5

All that stands between outright global deflation and recession is the wealth effect of the stock market. So let’s turn to that.

In 2014 we saw around 40 different topping indicators aggregate in the US stock market. From mid-2014 we saw multiple divergences in breadth and risk, whilst commodities and emerging markets broke down. In 2015 developed nation stock prices arched over, topped in May and snapped in August. Now, we see washout levels in commodities, emerging markets and various stock market measures such as sentiment, breadth and risk.

In the big picture, US stock market valuations have declined from their peak but are still highly levitated.

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II sentiment and Rydex allocations either show a major unrepairable pop of the stock market bubble, or a healthy washout from which stocks can now in due course resume bullishly.

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Source: Yardeni5sept51

It’s clear that the mania or the last 2 years depicted in these two indicators is about as crazy as it gets and odds are much higher that that recent bursting of the bubble is likely to have ushered in a period of mean reversion. Effectively it has broken the collective complacency and the record leverage deployed in the markets is now likely to shy away from its peak. Without the demographic tailwind, leverage has been the main fuel for this bull, through both margin debt and buybacks-via-borrowing.

Regarding buybacks, this fuel source is likely to continue through the end of this year as companies execute their purchase plans. We can see how something similar transpired in 2007.

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At some point, the leverage in the system will unwind in a disorderly way, producing a crash. What I am wondering is whether this may occur again once both buybacks and margin debt are declining in a more united way together (like in 2008), which would likely be once 2016 hits. Just speculation.

In the meantime, the August breakdown in stocks has likely done enough damage to cement the bear and kick off the negative feedback looping that will produce escalating trouble from here on. ECRI leading indicators and Bloomberg financial conditions have both slipped negative.

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Source: Bloomberg

Turning to the near term, this is how the SP500 looks:

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Prices are consolidating after the August drop. Breadth, Trin and volatility show similar washout readings to 2011. Nonetheless, the historic pattern is that stocks ought to retest the August lows and at that point bulls should be looking for positive divergences. An absence thereof likely spells lower prices which in turn increases the odds we are in a bear market.

If we are in a bear market then this doesn’t prevent ripping rallies. In fact they are common. What’s important is to see a pattern of lower highs and lower lows. So, should we push upwards from the current oversold/overbearish short term readings then we should stop short of the August breakdown point. Should we break downwards we should take out the October low and initiate the lower low pattern. On a longer term view, the bear market should very gradually eliminate the dip buyers, until all hope is truly lost.

My tactics then are: hold short (Biotech, R2K, Dow), add short if we go higher, wait for August lows retest, check for positive divergences and bottoming pattern to judge whether to take profits. Cross market to gold, I am long and holding, looking for gold to cement its higher low than July and build out its rally. Were gold to break down to new lows, then it would be a warning.

Lastly, a note on washed out emerging market stocks and non-precious metal commodities. Oil has dropped from $100 to sub $40 in a short time and emerging market equity valuations are historically very low. Are they a buy?

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My perspective is that we have experienced something similar to 2006-8 whereby markets crumbled in order. Then, real estate fell first, then equities then commodities. This time, commodities and emerging markets fell earlier than developed equities. When developed equities have eventually truly washed out then there may be attractive risk-reward on emerging and commodities. But between now and then I expect a bear market and global recession, which would keep the pressure on both asset classes.