Just yesterday, we observed that the financial landscape may be changing. It appears that Stocks and other “Risk Assets” were finally, FINALLY ready to enter something that only us old-timers remember: The Ravages of a Bear Market (http://markonomics101.com/2018/06/26/a-cruel-summer-for-equities-the-bear-has-arrived/). That particular argument is not just reflected in the charts, but also is consistent with other indirect data points. All of these indicate a rising possibility of inflation and recession.
As we pointed out in yesterday’s piece, a disproportionate amount of return has been contributed by small group of technology giants, now referred to as the “FAANG”‘s, typically including Apple (AAPL), Amazon (AMZN), Facebook (FB), Netflix (NFLX) and the Googles, which are now also strangely referred to as the “Alphabet” Companies. Their explosion in value coincides with the adoption of the Federal Reserve Policy known as “Quantitative Easing” (QE). QE is the systematic or reliquification of the financial system, following the noted failures of many banks and brokers in 2008-2009, using extreme measures to expand the availability of credit at very low interest rates. The Fed’s sequentially greater QE’s didn’t really stimulate the economy, but instead blew up a series of asset bubbles including Cryptocurrencies, Real Estate, Bonds and Equities.
In the stock markets this tidal wave of monetary stimulus ended up disproportionately benefitting large capitalization multi-national corporations and a handful of technology companies as those that comprise the Standard & Poor’s 500 Index (SPX) as illustrated above.
Compare the appreciation in the SPX to that of the Value Line Geometric Index (XVG), below. The XVG is not capitalization weighted, so every component is considered equally. The appreciation in the XVG is far less magnified since it doesn’t capture the “liquidity tailwind” provided by the Fed.
The piling on of liquidity into the large capitalization issues will not be a one-way street perpetually. The rate with which the Federal Reserve reduces systemic liquidity will replace the tailwind with a substantial “headwind” toward many risk assets as investors seek safety and especially cash. Another sign of diminished systemic liquidity is the reduction in growth of money supply (https://www.zerohedge.com/news/2018-06-28/money-supply-growth-slides-again-falling-3-month-low).
The removal of liquidity is dicey on many levels. For one, it makes commerce more difficult to finance especially across continents. The profitability of Multi-national corporations, which dominate the SPX, is very sensitive to global trade. The amount of trade benefitting these types of companies has been threatened by the “Trade Wars” that have taken center stage on the World Economy. In fact, many believe that major trade partners like China use their Trade policy as a weapon to weaken the US Economy and our equity markets (https://www.zerohedge.com/news/2018-06-28/china-done-playing-tariff-tag-its-now-looking-crash-markets).
The Dow Jones Transportation Index (DJTI) is an excellent barometer of the economy since the companies comprising it move people and goods between states or across oceans. Components of the DJTI include airlines, ocean tankers, truckers and railroads. They are listed here:(https://en.wikipedia.org/wiki/Dow_Jones_Transportation_Average)
The charts of the DJTI shown below indicate the weakening of global commerce and may be signaling recession. This is evident most starkly by the breakdown of the DJTI below major support at the 10,400 level.
The BEAR is showing itself in many ways and investors need to remain aware of the ramifications. In a BEAR, the best strategy is to minimize losses and reduce risk, a strategy that few are accustomed to or are prepared for. Prior Bear markets have been relatively short-lived as the Federal Reserve has taken strong measures to minimize their impact. This may not be possible now as further easing is likely to end up in increased inflation.
“Take Your Money Off The Table Before The Table Takes Money Off of You”.