Saturday, December 14, 2019

The Crack Up Boom And Bust

Historians will say this was all just a liquidity driven delusion. Record borrowed money conjoined with record printed money. Trump was the Harry Houdini of fake recoveries. He was a master market manipulator who took a late cycle economy and put it on fiscal and monetary steroids. For a time he preempted recession, however, the end result was a mega bubble that collapsed into depression. Those who warned this would all end extraordinarily badly were assiduously ignored. The economists of the day having long ago sold themselves out to central bank alchemy. Disney markets and simulated prosperity.

One thing we've learned for certain over this past decade, is that in a Super Idiocracy facts and logic can't compete with easy money. 

2019 is the Idiocracy's official year of easy money

This is for the historians. And for those of us who prefer rationality over denial. 

By the summer of 2015, U.S. GDP growth was at a cycle high along with the U.S. stock market. Commodities and oil had peaked a year earlier in 2014. The Fed was positioned for the first interest rate increase in a decade. Global deflation was accelerating to the downside into the planned (September) rate hike. EM currencies were collapsing. In early August 2015, China devalued the Yuan, which set off a chain reaction RISK OFF across global asset markets. In late August global markets crashed.The Fed postponed the rate hike.

By December 2015, global markets had stabilized. The Fed raised interest rates by a quarter point for the first time in almost a decade. Global markets exploded in January 2016. WTI crude oil hit $26 per barrel at the low point.

Central banks got together in early 2016 and formulated the global coordinated monetary expansion dubbed "The Shanghai Accord". Risk markets were bid.

The rally continued for several months and then got choppy ahead of the Brexit vote as the polls swung back and forth ahead of the vote. Still, the "remain" camp was expected to carry the day. We know who won. Global markets tanked. The S&P futures were limit down. However, once again central banks quickly coordinated a bailout. Markets stabilized.

Ahead of the U.S. election, things were getting dicey again. Trump famously warned in late September during a debate against Hillary Clinton, that this was the worst recovery since the Great Depression. He called the stock market a massive bubble. He said the Yellen Fed was being political by keeping interest rates too low this late into recovery.

Markets sagged into the election even though a Clinton win was widely expected. The latest central bank bailout was running on glue fumes. Trump won, and global markets imploded overnight. However, by noon the next day, Trump had talked markets green, from there they exploded higher. The business friendly president was large and in charge. Word spread like wildfire throughout the business community: de-regulation of everything was coming. Capital moved back into risk markets on a cycle-large scale.

2017 was a one-way melt-up in global risk markets, as Trump's tax cut plan was formulated. The lowest volatility year in decades. The Fed viewed this as their opportunity to begin balance sheet rolloff, which started incrementally in October 2017, and then grew in size quarter by quarter until October 2018. 

The tax cut melt-up went vertical in January 2018. In early February, right as the tax cut came into effect, markets exploded vertical down into the now-famous "VixPlosion". It turns out that the low volatility condition that had attended the tax cut rally had generated mass complacency and over-leveraged positioning among volatility speculators.

Markets stabilized, however with the tax cut stimulus now in place, Trump started the China trade war in the Spring of 2018. U.S. GDP peaked in the third quarter of 2018 along with the U.S. stock market. The Fed had raised interest rates eight times over the two years since the 2016 election. Their last rate hike came in December 2018 which imploded global markets. The S&P 500 was down -20% from peak to trough.

Trump was not happy. He blamed the Fed for imploding the stock market. The Fed quickly "pivoted" in early 2019. Global central banks orchestrated another bailout - the largest since 2009. Global markets exploded higher. The first quarter was the best start to a year for U.S. stocks since 1987. The first half of 2019 was the best six months for U.S. stocks since 1997.

Now we get to recent history.

Into the summer of 2019, the U.S. expansion had now become the longest on record. At that time the Fed - coerced incessantly by Trump - ceased balance sheet rolloff and telegraphed three interest rate cuts, the first cuts since 2009. Fed chief Jerome Powell called this the "mid-cycle adjustment", coming at the milestone mark of the longest expansion in U.S. history. 

The newfound monetary accommodation was all going well until August 2019, when a "debt deal" in Congress allowed Treasury to massively increase their cash holdings to finance the deficit, by issuing unprecedented amounts of new Treasury bonds. Traders warned in August 2019 that this amount of issuance was collapsing liquidity. They specifically warned about the overnight inter-bank lending "repo" market.

In mid-September 2019, as predicted, the overnight repo market imploded, as overnight lending rates sky-rocketed. Fingers were pointed in every direction. The Fed orchestrated another bailout - the largest balance sheet expansion since 2009. A tsunami of new cash flooded the markets. Reflation expectations exploded higher, along with long-term bond yields. The Fed had reverse-engineered a reflation rally, using excess liquidity.

The Fed has been pushing gamblers out of bonds into stocks all year. This latest "reflation" rally has lasted four months:

Which gets us to now, December 14th, 2019.

The S&P 500 is up 35% since the low of December 2018. The Fed and global central banks have done a fantastic job of lubricating risk markets. Here we see social mood as exhibited via the rest of the world. The decline from Feb. 2018 to December 2018 lasted 11 months. The subsequent retracement has lasted just over 11 months and recovered slightly more than 61.8% Fibo. As we see global central bank coordination has tightened correlation among global risk assets.

U.S. cyclicals are following the world pattern

What comes next is called third wave down in Elliott Wave parlance.

It means brick-shitting panic. Worldwide.

Meanwhile, some traders are STILL warning that the Fed has not fixed the repo market, which is expected to tighten again substantially into year-end. Which is "now". The problem at a high level is that the Fed is treating the symptom of short-term lending, whereas the problem is the lack of liquidity in long-term lending markets. Which is where most of the Federal deficit is taking out liquidity. It's a duration mismatch. 

Nevertheless, according to this past week's post-FOMC press conference, this is all well under control. As of their December 12th press release, the Fed are now planning for record short-term stimulus through January. What we know for certain is that risk markets are absolutely convinced this is all under control. Furthermore, the prevailing view is that this much additional stimulus, combined with the "trade deal", and Brexit resolutions, can only lead to higher asset prices. In other words, the repo bailout rally was an acceleration of the rate cut bailout rally, and now the Santa rally will merely be tacked onto the melt-up that began two and a half months ago. From what we are told. The Fed's only verifiable "success" to date can be measured in an Extreme Greed reading the highest since the tax cut melt-up, and the most extreme short volatility futures position in U.S. history (see below).

November 27th, 2019:
"...Asset managers have pushed exposure in U.S. equities through the futures market just above their positioning in July 2019, September 2018, January 2018 and 2007 highs. All of those dates marked “major” peaks in the American stock market"

In other words, speculators have become very adept at front-running central banks. Those who believe the Fed will be successful in keeping vertical markets vertical, have already taken a position on this matter. Therefore, what this all comes down to believing is whether or not central bank drip liquidity measured in the billions per day can control a stampede of RISK OFF capital measured in the hundreds of trillions overnight.

As I see it now, there is no way out:  a) Either the liquidity crisis arrives as some expect, and hammers risk markets OR  b) the ludicrous amount of liquidity injected into risk markets to avoid the liquidity crisis artificially ramps markets to unsustainable levels creating an inevitable crash. The scenario taking place right now.

However, the MOST LIKELY scenario is c) All of the above

This blow-off top and leveraged mass complacency triggers VixPlosion 2.0 at which point the liquidity crisis explodes out of central bank control. Bringing a very unexpected ending to the widely believed and beloved era of easy money.

"Getting in was easy"