Don't get faked out !
The equity markets are continuing their run up again today all over the world. After a run from 7100 on the DOW to a now 8700 many bears are concerned that we may be entering a new bull market while many bulls are feeling validated.
As I wrote about last week the guests on the Cavuto show two Sundays ago unanimously predicted that we are entering a new secular, long term, fundamental, Bull market.
The probability of this being true is almost zero, in my opinion.
Remember, equity markets are not self validating. Equity markets do not determine economic viability. In the long run they will always reflect economic reality.
Bond and lending markets on the other hand are not only self validating they are the economy.
This is one of the key reasons the Central Banks manipulate loan rates versus equity valuations.
The equities in the US have been increasing recently not because of preemptive, forward looking, predictions of an economic resurgence in 6-12 months.
They have been increasing because of a series of successive short term positive financial market technical indicators in the face of increasingly negative economic indicators all over the world. In other words the near term technical indicators are leading to the erroneous perception that the equity markets are predicting an econimic resurgence rathan than simply reflecting the successive nature of these technical indicators.
If the indicators were connected the story may be different; but they are not.
We experienced a swift downward correction in equity valuations from which they technically bounced off of a few weeks ago. Before that bounce had run its course increasingly bad economic news out of both Asia and Europe led to a migration out of their markets which the US capital markets benefited from. Then we had the consumer confidence numbers plunge leading to concern about consumption in the US which drove the migration out of Europe and Asia even greater; again benefitting the US equity markets. As this occurred the short sellers in US equities have been forced to cover. And now we have expectations of coordinated rate cuts in the US and Europe leading to a bounce up in equities all over the world.
Unless you think the succession of this type of news will continue the risks of investing in US equities outweigh the rewards in the near term.
So what is happening.
I have a swimming pool in my back yard. My home is also known as "Club Roget". During the warm months there is a cook out at my house about 5 times a week that is attended by between 12 and 25 people, half of whom are children.
I have many water toys and rafts and the kids love'em. They also get holes in them on a regular basis that need to be patched; the floats that is.
In most cases the holes start out small and I don't bother fixing them. It's easier to simply pump more air into the float with my handy dandy electric pump.
As the holes get bigger though I eventually have to repair the float before wasting any more time, energy and money pumping it up just to watch it deflate after a couple of minutes of child use.
The same is true of the relationship between financial markets and economic fundamentals.
There have been a series of technical indicators perceived as positives for the US and world equity markets recently. These technical indicators and the associated positive aspects of them are greater in the very near term than the fundamental economic news which is getting worse by the day.
So, if you think of the word financial markets as a float; the capital is being pumped into the float right now at a faster rate than the capital is escaping through the growing economic rift.
Sounds simple doesn't it? It is. And every major trader understands this. They all have their fingers on the sell trigger waiting for one of two things to occur.
Either the good technical news stops or the bad fundamental news becomes greater than the good technical news.
This is not a new phenomenon by the way either. We have experienced this in the US 3 times this year. It has been experienced in the Japanese markets repeatedly for the past decade. It is beginning to be felt in Europe now.
Sometimes these things occur and traders can take advantage of them. And so can you and I. But do not get fooled into believing that because a series of short term technical indicators is temporarily outweighing the long term economic fundamentals that a new world wide equity bull market is back.
Finally, and this where it gets a little tricky. There is a possibility that the equity run could alleviate some of the economic fundamentals if it results principally in a reduction in borrowing costs to corporate America which in turn causes an increase in capital borrowing, spending, and investing.
In order for this to occur we would first have to see a reduction in corporate bond spreads. But, this is not happening. Which means that although the equity markets have been running higher the bond markets have not concurred with the assessment that this is the beginning of a new secular bull market.
So, why doesn't the bond market agree with the equity market? Which one is right?
The bond market is focusing on the economic fundamentals which determine in the long term what the potential is for bond loans to be repaid by the borrowers to the lenders while the equity markets are focusing on the near term technical.
In order for the equity market to be accurately predicting the beginning of a new secular bull market the bond market MUST concur and validate the equity run with falling bond spreads. This would be an indication that the bond traders are becoming less risk averse or concerned about losing money and more upbeat on the financial capacity of corporate America to repay the money it borrows through increased sales, revenue and earnings.
This is not happening. Could the bond market be wrong. Sure, anything is possible. But the probability is much greater than the bond market is not wrong and that unless there is a continuation of successive and increasingly good technical information becoming available to offset the increasingly negative fundamental news worldwide the equity markets in the US and the rest of the world are simply setting themselves up for another correction to the mean or correction to economic reality.
We'll see what happens.
myhomelender.com |
