A Dumb Mechanism

Evidence reveals the financial markets to be ‘dumb’. Long term trends are dictated by demographics (swelling numbers of buyers or sellers) and solar cycles (influencing speculation levels amongst participants). Markets top out when there are no new buyers left and/or no room or appetite for existing buyers to increase debt, and bottom at the opposite. This contrasts with common wisdom that markets are instead dictated by central bank actions, economic indicators, or company fundamentals. They play a role, but the evidence shows that the stock market leads the economy, that central banks are typically behind the curve, and that stocks rise purely on multiple (valuation) expansion if there is either swelling leverage or swelling buyers (or fall vice versa).

Into 2014’s solar maximum we saw a speculative mania in equities akin to the last solar maximum of 2000. But unlike 2000, there was no demographic tailwind, instead a headwind. Without new buyer flows into the market, we have therefore seen equities bid up by (1) existing buyers leveraging up and (2) companies buying back their own shares.

This chart captures the flat money flows as predicted by demographics versus the declining share issuance due to buybacks.

15augu2Source: Business Insider

The effect of buybacks is to increase EPS and decrease P/E. The latest earnings show a blended 1% decline YOY, but without those buybacks the figure would have been closer to -4%. Revenues declined 3.3% YOY and reveal a truer picture of companies performance. Additionally, companies have largely borrowed to buy back their shares, making this market fuel particularly ‘unhealthy’.

Buybacks are likely heading for a new record this year, beating the 2007 record. This may partially account for stocks continuing to levitate despite all-round deterioration in other indicators.

15augu30Source: Bloomberg

The other fuel source has been increasing leverage. We can see that leveraged loans peaked out around last year’s solar maximum:


Source: LeveragedLoan

Whilst margin debt lurched upwards again in 2015 to a current April high.

15augu40Source: D Short

Meanwhile in China margin debt went crazy and can be seen to be wholly accountable for the rise in the Shanghai Composite. This too fits with demographics there: no new buyers, only existing buyers leveraging.

15augu20Source: FX Street

The subsequent collapse in China’s stock market shows what happens when there is no room or appetite for further leverage amongst participants, which brings us back to the top of this post. Then, when leverage starts to unwind, it brings about forced redemptions and thus more selling, as it is effectively a ponzi scheme.

So the question is when leverage in the US and elsewhere starts to unwind. Based on historical evidence, appetite for leverage should wane post solar maximum. We see that in leveraged loans above, but margin debt has rallied further. We know from 1929 that leverage extended a year post solar maximum before collapsing, whilst breadth deteriorated over the same 12+ months. We are again producing that kind of outlier extension, set against a similar ongoing breadth deterioration since the solar max of last year.

Either the sideways range in US stocks in 2015 is the pause that refreshes the bull or it is the topping process that turns into the leverage reversal inspired sharp declines. Solar-aside, there have been so many indicators that this is a market top, sharing characteristics with 2007, 2000 and other major historic peaks, that a bull pause is highly unlikely. But what’s different is that the interest rate, QE and inflation environment, together with commodities relative performance, hasn’t been seen in 50+ years, if this is to mark a top. However, rather than that negating a top, we simply need to look further back in time for reference points. Yet, if the stock market is a dumb mechanism, then we shouldn’t even need to do that.

The solar max produced the stock market mania. Demographic trends meant it has been fuelled by leverage and buybacks. The flat market of 2015 suggests saturation has been reached. Post-solar max, appetite for speculation unwittingly declines. China has broken and all markets are off their peaks. The last several weeks, indicators that have worked for the bulls over the last 2 years haven’t been working. I think the fuel is spent. Buybacks and margin debt are the key here, but both data sets come out with a lag.

Below we see several key indicators peaked out with last year’s solar max whilst a couple of others extended beyond. Now the latter should fall in line with the former. Note how the levels reached have been largely similar to 2000’s saturation levels.

Screen Shot 2015-08-15 at 08.43.03Source: Stockcharts

We are now through the August new moon, heading into the seasonal (geomagnetic) lows of Sept/Oct. I’ve been back on the attack short stocks, with particular emphasis on Biotech.


Gold And Gold Miners

Gold as an investment: not straight forward. It was the original money, valued for its rare, precious and indestructible qualities. Fiat money then took over, but convertible to gold. Now, fiat money is purely a game of confidence, and gold floats freely. Gold is a non-yielding, non-productive asset so comes into favour (jewellery demand aside) only under specific conditions, namely when real interest rates are negative (which can be under inflation or deflation), when fiat money is being diluted (such as by policies of inflation or money-printing), when debt is growing significantly (as this is money borrowed from the future) or when other assets are in decline (which chiefly occurs due to demographic trends).

Right now, real interest rates are borderline negative, public debt is at record levels, QE has been rolled out across the developed world and demographics are united negative (i.e. pro gold) in the major nations. So why isn’t gold going up?

By demographics and solar cycles, gold should be in a secular bull from 2000 through to circa 2025, the next solar max.

3juli10 3juli18Therefore, gold’s bear market from 2011 to 2015 would be a cyclical bear within an ongoing secular bull, similar to as occurred in the mid-70s. Gold has been making a long basing, as evidenced in the TSI below, over the same period that stocks have been making a topping mania. When stocks start to fall in earnest, then I expect gold to take off, in a new cyclical bull within an ongoing secular bull.


Source: Stockcharts

A bear market in equities would, through the wealth effect, tip the fragile economy into a deflationary recession, which should then result in negative real rates, additional fiat dilution by central banks, rising nominal debt levels and cash-flow looking for a safe haven. All favourable for gold.

However, contrast that with the common perception currently, which is that we are in a young secular bull in equities, with the economy early in the cycle and about to start growing strongly, and a trend of increasingly positive real rates ahead. Once this perception is revealed to be a misunderstanding, then the narrow interest in gold will become much broader.

A near term look at gold technicals suggests one more washout to the downside may be needed, as evidenced here in the gold put/call. The short interest is already at contrarian levels.

2juli7 2juli6

Source: The Daily Gold / CFTC

I would see this as fitting with a last rally back up in equities into the mid-July new moon (to a lower high), which was predicted by CPCE and Vix/Vxv as highlighted two posts back. I therefore lightened up my equities shorts and gold longs after this week’s full moon. Earnings season starts next week and properly gets going the week after. With a predicted 4.5% yoy drop in both earnings and sales for Q2, this provides a backdrop for stocks to topple over from that second week in July, and in turn gold to finally wake up. I believe that point will mark the definitive trend change in both and currently see that as the point of max attack.

Gold miners sit between the two asset classes: as both equities and tied to gold. In the last 4 years they have very much sided with the latter, declining in the face of a rising stock market. But notably they have performed much worse than gold, as shown in GDX:GLD below.

2juli1In fact, on the long term view, the miners to gold ratio is the lowest its ever been.

Screen Shot 2015-07-02 at 06.23.49Source: Incrementum

However, the major miners have been diluting their shares, making them not the bargain they initially seem.

2juli10Source: Seeking Alpha

Additionally, there is a question mark over how they might perform under sharp stock market falls. With few historic reference points, we can at best draw on the 1929 experience whereby the gold miners didn’t escape the initial falls but broke away later once the stocks bear was more clearly cemented. For these reasons, I stick with gold itself as the pure play and will pass on the miners.


Charts Update

It’s a picture of a major market top. The ‘real’ peak was mid-2014 at the solar max, as it was at the last solar max of Spring 2000. The supports for price since mid-2014 have been dismantled and evidence suggests the nominal price peak in equities occurred May 2015. Annotated, so no further comments.

Screen Shot 2015-07-01 at 08.55.34 1juli6 1juli4 1juli81juli2 1juli1

Comparison to 2000

The biggest stock market mania of all time peaked out in March 2000, which was the exact month the smoothed solar max of SC23 peaked. Solar cycle 24 appears to have made its smoothed peak in April 2014, into which we experienced another mania in equities.

Below we see put/call (smart to dumb money variants), allocations (Rydex, as a proxy for the wider market), valuation x2 (real SP500, and relative to bonds) and strength (TSI) all displaying similar behaviour to 2000. What’s interesting is the extremes reached in these indicators have hit levels very close to those reached in 2000, as designated by the horizontal arrows.

Screen Shot 2015-06-19 at 08.12.38 19junn4Source: Stockcharts

And we can add margin debt to GDP for one more:


Source: Octafinance

In all the indicators, we see the intermittent 2007 stock market peak printed lower or milder. The difference? No solar max to drive speculation.

In short, various measures and indicators reveal a close mirror of 2000, both in behaviour and level. The question is whether those levels represent ceilings or whether we go on to see all new extremes. So back to the opening comment: 2000 was the biggest stock market mania of all time, and in various ways we are matching it. Wow, no? This is despite a demographic headwind (rather than tailwind into 2000) and despite a weak world economy (versus strong growth into 2000). Can we really go higher?

Timewise, equities are on borrowed time since the solar max of mid-2014. Although nominally they have not topped out, various measures under the hood (see previous posts) reveal a peak back then, and the divergences remain. The TSI divergence back at the SC23 peak lasted from mid-1998 to the top in 2000; the current TSI divergence began in mid-2013, making for a similar duration. Drawing it all together, I maintain the likelihood of a mid-2015 switch into an equities bear and I am staying on the attack.


Comparison to 1929

Hat tips to Mark, John Li and Chien Jen.

So what’s similar to 1929?

A stock market mania to extreme valuations.


Source: D Short

A similar low intensity solar cycle.

17junn1Source: Chien Jen

Stock market breadth peaked very close to the smoothed solar maximum (May 1928 vs April 1928, Mar/Jul 2014 vs April 2014) whilst stock index prices didn’t peak until at least a year later.


Source: RW Nelson17junn6Source: Stockcharts

Maybe stock prices are following a similar technical pattern.

17junn8 17junn9

The timings within the year fairly closely match too. 1929 began with a range. The final push was June to Sept. Therefore, the onus is on the bulls here to push prices back up into the range and out, to prevent the breakdown from the current position.

Now what’s not similar.

Economic growth was stronger in the 1920s.

The fed funds rate was around 4-5% in 1928/9 versus zero now.

It was a demographic climax produced by peak immigration at the start of the century of the age bracket that would buy the stock market in the 1920s.

17junn20Leverage reached 12% of GDP by the peak, versus 3% now.

All things considered, I believe 1929 has more in common with 2000, which was a demographic climax following strong economic growth with fed funds rate similarly around 5%. Post 1929 we saw the Great Depression, post 2000 the Great Recession, then following both we experienced a valuations-led stock market mania into the next solar max set against easy money conditions. Hence 1937 is a better all round fit to now (see HERE for details).

However, what’s common with 1929 is important, specifically that breadth peaked out 16 months before prices, and that is was ultimately leverage that delivered the craziness into the peak. Here in 2015 margin debt is hitting new highs so maybe the game isn’t over yet.

There was always a question mark over why prices didn’t peak with the 1928 solar max but made the anomalous extension into 1929. However, now we can see that breadth peaked at the 1928 solar max, like it has at the mid-2014 solar max, so in both cases marking some kind of speculation peak. The majority of other solar maxima delivered peaks in both breadth and prices close to the sunspot peak. Assuming prices peak out within the next several months (and don’t keep going, new secular bull style) then we are again producing that kind of anomaly that we saw in 1929, namely a fairly long period of degrading internals whilst prices continue to levitate or rise. Why? It’s leverage. Saturation levels in sentiment, allocations and valuations have been in place since the start of 2014. Buybacks were significant for much of last year but now it is leverage which is left holding things up.

So what stopped it in 1929? Answer: nothing in particular. One day the market topped out without any notable trigger, like most tops. Ultimately it was a combination of the fuel for higher prices being spent, leverage at unsustainable levels, prices for stocks being fairly unpalatable, and the whole thing having become a ponzi scheme. Then I would argue that the twin downward pressures of post solar max and the geomagnetic seasonal lows of Sept/Oct produced the timing.

Which brings us to today. What’s to stop prices making a final major leg up like in June-Sept 1929? Nothing, if leverage can keep rising, and the appetite amongst participants is there. However, that ‘appetite’ is under threat due to our positioning post smoothed solar max and the seasonal downtrend from July to October.

Solar cycle 16 had a sting its tail with a final surge in sunspots from September to December 1929. As this rather fits with the declines than the final run up in prices, I don’t think it’s relevant as a cause of the last leg up.

I would summarise that stocks are on borrowed time since the solar max of mid-2014. Breadth, volatility (inverted) and various risk measures all peaked out then. Buybacks also peaked out around then, leaving leverage as the key driver. This kind of anomalous extension post solar max was only seen before in 1929. Given most things in the world are now ‘bigger, better, faster, more’ than back in the 1920s, what’s to stop us blowing that reference point out of the water with an even dizzier anomaly now? Well, I would argue that in the context of negative demographic trends we already have.

A common historic technical topping pattern looks like this.


Bottom right is a chart from last year when it appeared to have formed into early 2014, but was a red herring. Drawing together several indices from around the world we could argue it is there again, with the primary distribution across last year and the final leg up in 2015.

17junn50Or we could argue the final leg needs to go higher yet, or has to happen yet on the main US indices. Not easy to call.

So if we stick to what we know, I suggest it’s this. Stocks are on borrowed time since mid-2014 as divergences continue to grow. The geomagnetic downtrend from July to October 2015 together with the post-solar-max downward pressure has a strong chance of killing the bull. The two things to watch are these. Can prices be bid back up into the 2015 range and out of the top? If so, a final leg up would gain weight. And can leverage keep rising? It needs to, if another leg up is to happen.


The Conundrum Of Our Times Part 2

Let’s now draw in the solar cycle. Here are US equity valuations by Q ratio versus solar maxima over the last century. A relation becomes apparent with secular lows and highs.


Source: D Short

We can see three that don’t fit so well. The 1929 stocks peak extended over a year beyond the SC16 peak, stocks sailed through the 1957 solar max and whilst the SC22 peak wasn’t so significant for US stocks it turned out the secular peak for the Nikkei.

Now for the three secular ‘lows’ on the above chart (SC15, 18 and 21) we can cross reference to long term commodity prices and see that they instead marked secular highs in hard assets. Similarly, the secular stocks highs of SC23 and SC20 maxima marked secular commodities lows.

15junn3Solar science reveals peaks in human excitement at solar maxima (e.g. clusters of war). In the financial markets this appears to translate as peaks in speculation (and in the economy in peak activity). Therefore, it appears that the asset in favour at the time is bid up to a secular peak and subsequent pop around the solar max (with the rare exception, as with any indicator or discipline). So what would make the favoured asset stocks rather than commodities or vice versa?

The evidence suggests it is demographics, namely that secular = demographic. The chart below reveals equity valuations tracking US demographics and gold moving in opposite directions. Therefore we see a secular peak in gold at the demographic low and a secular peak in stocks at the demographic high.


The picture is enhanced when we discover that solar cycles influence birth rates, which may account for why demographic peaks often tie in with solar peaks.

The chart below shows how Japanese demographics peaked out first in the late 1980s, which explains why Japanese equities made their secular peak at the 1989 solar max whilst other major nation stock markets continued to advance under positive demographics.


The current relevance of the chart is that the global demographic composite is definitively negative, and this is echoed in other demographic variants. Together they spell recessionary and deflationary pressures, which we are seeing in reality. But they also should be sinking equities and launching gold, which we are not (currently) seeing. More on that shortly.


Solar cycles are long cycles, but armed with the above information we got the chance for a real time test with the SC24 max, which now appears to have been centred around April 2014 (smoothed max).

Two things were anomalous about the SC24 max. It was lower intensity (less sunspots overall) and it took longer to form (including a higher second peak).


The average duration between solar maxima is 11 years 1 month, but the SC24 max didn’t form until 14 years 1 month after the SC23 max, which makes it an outlier. Is this relevant? Well, a major commodities peak occurred in April 2011, exactly 11 years 1 month after the SC23 max.

Tangent for a moment. Here is the influence of the lunar phase cycle on the markets: it makes for a fortnightly oscillation with distinct measurable returns over time.


The most plausible explanation is the influence of nocturnal illumination levels on evolving humans. Yet, the influence is still present despite living under artificial lighting for several generations. Therefore it would appear to be hardcoded to some degree: we oscillate internally with the moon cycle, to some extent. Might the solar cycle also be to some degree hardcoded? If so, that could be a factor in the major speculative commodities peak (and associated major stocks low) in 2011, i.e. human excitement to some degree peaked into the anticipated/internalised solar max.


Source: Stockcharts

The case for that increases if we look at ‘leveraged’ commodity silver. The same kind of parabolic blow off as in 1980 occurred.


It would make the secular commodities bull 2000-2011 a mirror of the 1968-1980 bull, namely one solar cycle in length and set against a secular stocks bear, and both in keeping with demographic trends of the time. The implication would then be that commodities are now in a secular bear and stocks are in a new secular bull.

But let’s now look at the real experienced solar max of April 2014. From 2011 to 2014 stocks rallied strongly and since the start of 2013 displayed characteristics of a mania. A snapshot at April 2014 reveals many typical signs of a major market peak: extremes in valuation, sentiment, allocations and leverage; record negative earnings guidance and economic surprises all negative in the major nations; divergences in money flows and various risk-off measures; outperformance of defensive sectors and bonds; etc. At the time I gathered together 40 indicators all with different angles on a telltale top in stocks. Really, the evidence could not have been better for a speculative mania into the solar max.

However, as we passed through the real solar max, it was commodities that fell again, rather than stocks. An oil-heavy commodity index, used for emphasis, shown here:


Source: Stockcharts

Indeed, by the end of March 2014 large speculators had amassed an all-time record long position in the CRB commodities index, suspiciously right at the solar max. So we have a potential case here for commodities to have effectively made a double secular peak between the ‘average’ and ‘real’ solar maxima.

But… things get more complicated when we look under the hood at equities. Stocks:dollar, stocks:bonds, volatility, breadth and various other measures not only resemble previous major peaks but occurred together very close to the real solar max.


We are now waiting to see whether these will be repaired or whether nominal equity prices now fall in line. If the latter, then we have the evidence that speculation in equities peaked at the real solar max. At the same time, gold has been forming a technical bottom in recent months together supported by washout sentiment and allocation levels, which after a 4 year bear suggest it is ripe to break into a new bull. Which brings us back to demographic trends being aligned to stocks declining and gold rising: this angle on what happened would argue that the anomaly in hardcoded/real solar max produced a second speculative peak against demographic trends and in stocks, only for demographic trends to now reassert themselves (stocks complete the secular bear, as suggested in the last post, whilst gold goes to new highs).

As alluded to in the last post, the closest fit historically to the current time was the peak of 1937: a solar maximum and speculative peak against a backdrop of low rates and easy conditions. Equities peaked out at high valuation (see Q ratio chart at top of page for SC17), following a front-running of prices to an expected return to normal growth that didn’t materialise. If there was any doubt this isn’t being repeated today, take a look at how analysts continually expected bond yields to rise over the last several years. Reality (demographics) has persistently denied them.

15junn32Source: Mike Sankowski

In 1937, both equities and commodities rallied into the solar max of April and both topped out around then, falling sharply for the next 12 months with both deflation and recession occurring.



Stocks didn’t make a real (inflation adjusted or valuation) bottom until 5 years later.

Which brings me back to the unfinished business in equities and the prediction by both demographics and valuations:


In summary, from all the topping indicators in equities, stocks should now break into a bear market, tipping the fragile world economy fully into both deflation and recession. There should be a feedback looping between the two, taking stocks down to much more appropriate washout valuation levels, whilst crises breed crises again in the economy. As in 1937, it should kick off under easy monetary conditions, limiting the toolkit of central banks, but also as then, central banks will likely resort to unorthodox (and probably ruthless) tactics. Systemic breakdown is a real risk again, with debt levels greater than in the Great Recession (hat tip Sinuhet).

Screen Shot 2015-06-15 at 08.57.23

Source: McKinsey

Commodities (particularly industrial) should sink again too, but likely for shorter and shallower (in line with demographic pressures, as per 1937, and understanding their existing slide since 2011). However, I expect gold to break away and rally as real money. It’s not an easy call due to the limited history of gold free-floating and performing under deflationary conditions. But ultimately I maintain it is the anti-demographic ultimate safe haven, and should regain favour particularly as central banks are currently doing their best to corrupt the money mechanism with QE and ZIRP.

If I’m wrong? Well, this is where we get to the ultimate conundrum. If stocks are instead in a new secular bull (and commodities made their secular peak in 2011, doubled down in 2014) then the appropriate investments/trades are really the opposite of if they are on the cusp of a new devastating bear in an ongoing secular bear. Long stocks and short gold versus short stocks and long gold. I have been able to make cases for both in the last two posts, but I have also shown the flaws in both.

Ultimately it’s a game of probabilities. When all crunched together I see it as most likely that 40 topping indicators and an under-the-hood peak around the smoothed solar max of last year should produce an imminent meaningful correction in stocks unless those divergences start to be repaired. That would be the telling clue. Fitting with that I see gold’s technical basing as likely to produce a meaningful rally. From there I would expect to see serious troublespots emerging in the global economy (defaults, etc) and the meaningful correction in equities turn into a fully fledged bear. However, if the secular stocks bull scenario were to turn out true, then indicators should point to a recovery in equities before we hit such problems.

I have to end on a sobering note. If we do see a global bear market and recession here, then the damage will be immense. No capacity to reduce rates, QE proven to be a failure, record debt levels and increasing under deflation, and no demographic upturn in sight for some time. Accordingly, central bank response would have to get tough, such as penalising any saving, imposing capital flow controls or protectionism. The potential for civil unrest, war or systemic breakdown would increase. The outlook would be very uncertain but surely bleak for the majority of people for the period ahead. It would really be in mankind’s interest for the new secular stocks bull scenario to be true. However, both the debt and demographic problems that we now face can both be traced back to the second world war. They have been a long time growing and attempts to conceal or water down their impact cannot go on indefinitely. Printing money to buy your own debt is normally the end game, so it’s not realistic to expect ‘muddle through’ can keep going. It comes down to the complications of gauging how the end game plays out.

Global Economy

The world economy is currently in trouble, showing both recessionary and deflationary coincident data:


Source: Ned Davis10junn3Source: GaveKal

Given these, the resilience of equity markets has been pretty amazing, even more so as we are now a year post-solar maximum:

10junn12The last six months has been particularly weak economically, and normally historically stocks would have sold off leading into this, with stocks typically leading the economy.

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.

10junn10Source: Stockcharts

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.


Source: Stockcharts

However, set against this, we have recently seen a turn up in leading indicators and what maybe a bottoming in coincident data.


10junn4Source: FT


10junn2Source: Goldman Sachs

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:


Source: Stockcharts

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.

10junn6 10junn8Source: Sober Look

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.


Source: DShort

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.

The Influence Of The Solar Maximum

The smoothed solar maximum occurred mid-2014.

Screen Shot 2015-06-03 at 08.13.32

Source: Solen

Financial Conditions peaked mid-2014.

Screen Shot 2015-06-03 at 07.35.01Source: Bloomberg

World earnings peaked mid-2014.

Screen Shot 2015-06-03 at 08.12.29

Source: Schwab

US IPOs peaked then.

3junn2Source: Marketwatch

Buybacks peaked then.

Screen Shot 2015-06-03 at 08.23.52Source: Factset

US stocks:dollar, stocks:bonds, volatility (inverted) and breadth all peaked mid-2014.


Source: Stockcharts

Junk bonds, commodities and FX all changed course then. European stock indices have since risen in nominal terms, but if we net out the Euro’s decline from the picture then they too peaked mid-2014.

3junn10Various economic data measures peaked out then.


Source: Alhambra

This all fits with the theory of peak human excitement at the solar maximum, translating as peak speculation and risk-taking in the markets and peak activity in the economy. However, we need to continue to see further all-round degradation as the sun moves further away from its peak over the rest of 2015, and not least, we need to see the nominal falls in equities now come to pass.







Debt And Demographics Dictating

Ever since 2009 analysts in the developed world have largely expected a return to ‘normal’ economic growth and inflation, the kind that necessitates a gradual tightening of interest rates to keep overheating in check. This is based on patterns over the last 50 years following recessions. Yet, as the US chart below shows, something has gone wrong this time, with rates at zero, six years on.

Screen Shot 2015-05-30 at 06.31.59

Source: Fred

Not only that but central banks are still generally easing around the world:

30mays1Source: Charlie Bilello

There are two reasons why global economic growth and inflation aren’t normalising: debt and demographics in the developed nations where world GDP is concentrated. When debt gets too large, too much capital has to be deployed on servicing the debt, redirected away from productive uses. When demographic trends aren’t favourable they can make for deflationary, recessionary pressures, and what is so potent about the current period is that demographics are united negative in the major nations, as per this sobering composite:

30mays2Consequently, central banks are battling to prevent recession and deflation. What does this mean for equities? The stock market has front-run a return to normal growth. As normal growth hasn’t happened, equities are now right at the top end of historic valuations. Each year since 2009 analysts have laid out their predictions for 10% earnings growth and over 3% GDP growth (US), only to see the reality fall short each time. But, the reality hasn’t yet been too dire either, and some would call this a goldilocks scenario for stocks: disinflation but no deflation, meagre growth but positive, monetary conditions kept easy and supportive. So the question going forward is whether this can be maintained.

Last year Q1 US GDP came in negative but the rest of the year recovered. This year the same has happened and whilst there is a question mark against Q2, leading indicators predict a recovery later in the year for the US and for improvement in Europe. However, there was an additional major factor last year: the solar maximum. Speculation and economic activity typically rise into the solar max and recede afterwards.

Currently, the stock market is holding things together due to its wealth effect. A stocks bear would tip the fragile global economy into outright recession and deflation. There is a yawning gap between equity valuations and economic reality, but the common view amongst analysts remains that central bank actions and the ‘normal’ business cycle of the last 50 years will yet produce the return to economic growth and inflation and that we have both a series of rate rises and problematic commodity prices to the upside to go through yet before stocks are in danger.

However, if we look back to the 1930s US or 1990s Japan then we see evidence of a different ‘normal’ in which deflationary recessions and stock bears did occur despite easy conditions in place by central banks. In both cases the yawning gap between equity valuations and persisting economic trouble was ultimately closed. The recent collapse in oil prices and cash flows into increasingly negative yielding bonds reflect bad economic realities, to which the stock market appears to be the last to catch on.

What are the odds of the stock market catching on by range trading sideways for a long period, as it has for much of 2015 so far? The answer is slim. Similar instances in the past of post solar max extreme valuation, sentiment, leverage and allocations, were not only resolved by bear markets, but by the worst bear markets in history. Here is another angle on that:

30mays4Source: Nautilus 

We also see the evidence under-the-hood that the solar max of last year was indeed the game-changer in equities:

15maya22Whilst economic data is disappointing to the downside in the period since too.

We have reached the geomagnetic seasonal mid-year point which has been a typical high marker in equities historically:

30mays5And technically we have seen a narrowing price range on waning strength and breadth.

15maya30Source: Stockcharts

Plus we see compressed volatility and gold making a long bottoming pattern on increasing strength.

In short, I’m going to continue to attack here (short equities, long gold) because the case is strong. The main concern I have is the upturn in leading indicators (real money, ECRI), because I can’t rule out the possibility that once economic surprises start to improve again then the ageing bull gets a little refuel. However, real money leading indicators again predict this to be a transient improvement, still not the return to ‘normal’ growth, and at some point that belated realisation that normal growth isn’t coming back is going to make the max-leverage, max-bullish, max valuation stock market a house of cards, due to the exceptional skewing and distortion. Odds are this is the time, given (1) the under-the-hood peaking in indicators at the solar max of last year, (2) the current strength/breadth divergences like in 2011, (3) the mid-year seasonal geomagnetic peak, and (4) the likely disappointing data still to come out over the next few weeks. A sharp drop in equities would negate the leading indicator improvement ahead, so that’s what has to be delivered here, to give the bear case the decisive control.