E The Eye Of The Storm – More Market Pain Is Ahead

The’ eye of the storm’ is being navigated through; with realization no matter how hard one tries to avoid what spins around the ‘zone of calm’, the other side likely features more pain, which may or may not equal or exceed the first phase of violent volatility. In other words; more pain is ahead, though without the shocking impact seen in the first strike, for which so many were unprepared. 

Monday seriously faltered in its rally attempts; as Oils and Financials remained under pressure; even Apple (AAPL) sold-off some. And the ‘eye of the storm’ is roughly defined as a range between Wednesday’s low and actually an area a bit above Monday’s high; to wit further clearance of what I term an ‘accelerated declining tops’ pattern (addressed via video). Things look so sour that even if the FOMC changes language to be more ‘dovish’, it might not matter, for very long at least. Perhaps one can get optimistic now that so many belatedly embrace our views of the world; of Debt; of limited maneuvering room for central bankers, and all. 
 

I think however that while we gave early warnings and stewarded through all of 2015’s ‘distribution’ (the whole year was expected to be distribution, and it was) the reality is a huge (dangerously long-side biased) overhanging supply, along with relatively heavy remaining leverage, is still out there. Though we called this to accelerate down even before the final days of 2015 (as soon as settlement in the new tax year was doable), very few managers seemed to be proactively in a mood to lighten-up. Not to be critical, but maybe that’s why there’s detectable angst from the ETF and other managers all gathered in Hollywood Florida just today. I think they’re unable to console each other; they just sound freaked. 

That tells me being bullish is not being contrarian; because that might be true if the market was very low and historic redemption runs were taking place. This smacks more of selling they can’t explain; so they suggest sovereign funds or a potpourri of other reasons (just Oil mostly). They omit the political winds hinting at change; they don’t want to acknowledge ‘actual earnings’ and multiples are absurdly high for the likely growth path ahead (when we get a new one; still in a declining phase unfortunately); and what that says is they have yet to sell. You might recall my mentioning that ETF’s aren’t necessarily as stable as perceived and that some are leveraged as well. Just something to ponder, but as I see it at this time; the optimists are talking their book, or primarily rationalizing.     
 

We’ve summarized (or anticipated) the vast majority of challenges being faced both by markets, by some key sectors, and even by nations, along with various geopolitical risks. The potential ‘upside’ factors are so limited (that will change I hope within a reasonable time to a true growth US leadership) that it has been inappropriate to dwell on a few tidbits of ‘hope’; as ‘hope is not a strategy’. 

For instance, I’ve mentioned during the entire year just past of distribution (sell the rallies mode) that I’m optimistic and bullish on America in the long-run; as I envision the U.S. (and to a degree Europe) leading the world out of the morass, not so much China (which I’ve suggested would have a harder landing, but to a degree also has discredited their own burgeoning financial markets by virtue of a hard-handed approach taken towards traders, and basically doing what some see in America too; financial-engineering to contain and control markets; which diminishes free markets and the attraction of a market to traders). 
 

This matters, as ironically, the U.S. (and the Fed) usually do the right thing, but too late; thus allowing problems to simmer (it’s sadly true geopolitically as well monetarily); but when they boil-over; at least investors don’t get arrested or are threatened, when they protect themselves. Speaking of that, the inability to get much of a rally going in the U.S. can be viewed as hesitation ahead of a FOMC statement this week, or it can also be lack of buy-side interest once turnaround short-covering, limited buying, and a penetration of the steep declining-tops got accomplished (as suspected since last Wednesday). We’ll have to see if FOMC gives the market more ‘dovish’ signs that can at least stimulate a further rise for selling, not for buying (in our opinion). 

To-sum-up: there are major ongoing concerns which are not alleviated by the basic ‘snap-back’ relief rally (and that’s failed) we’ve had without spirit from the washout hit just shy of breaking the August lows, more dramatically than it did. The S&P as you know fully-filled our projected ‘vacuum’ underlying Nov./Dec. lows; and as it entered what I’ve termed ‘no-man’s-land’ below the August (and Oct. 2014 lows as well), they tried to rescue it; lest a major catastrophe unfold. Now they’re in a pickle, with a potential faltering already. 
 

We believe there is more risk from those ongoing concerns. The correlation of Oil and the S&P continues to result in algorithmic moves (both selling and then buying). Liquidations from sovereign funds remain a factor we’ve warned of (as Russian GDP is downgraded to a several percentage point decline due to Oil, it has impacts that radiate widely too). Earnings reports are often coming-in well below already-lowered consensus estimates; and that is not unnoticed by most professionals who knew the estimates were already conservative. Upgrades in some cases (like Apple last week) are often focused on either the most-shortedor the biggest-capitalization stocks, in-order (it seems) to help revive the Index. 

These types of maneuvers (or upgrades, and we like Apple as always but very long-term) are about marketing and hand-holding it seems; more than analysis. I think that’s proven by how most official macro-economic data-points last year were interpreted optimistically by most institutions; while they clearly were poor and likely to be revised downward (part of what we did in calling distribution on all the rallies triggered by some sort of spin of data reports all last year). Most currently; some pundits express puzzlement about ‘Financials’ not participating much in the snap-back of the past couple days. Well; inadequate loan-loss due in large-part to Oil and Energy sector loans that face some default risk could be a logical reason. The Financials should not surprise anyone. Regional banks in fact are stronger normally; but many of them have energy loans out there too. 
 

Perhaps that’s one reason where balance sheets and trailing earnings mean so little. You have an economy contracting; net-interest-margins contracting; and a reticence for businesses to engage in CapEx (capital expenditures); all of which retards economic growth. Now; sure, we’ll get to a point where cheap energy in an exhausted downside will spur a rapid catch-up to meet demand (not just oil but other areas); however, that’s not something that’s visible yet. The market is a discounting mechanism; but it tends to anticipate 3-6 months ahead of time; not much longer than that, unless it’s a manipulated stimulus-based advance of little relevance to what’s really going on. 
 

That matters too. Because the most bullish thing the Fed can do is stay out of it for now; they’ve done enough damage, and delayed the real recovery by virtue of facilitating financial assets going way to high for too long. Yes we caught the key shakeouts all last year; that’s not the point. The point is they endanger the limited recovery fostered, because it allowed the ‘spread’ to widen between PE realities and where the S&P went (for instance). So you get to ‘peak-stocks; to ‘peak-auto’; to ‘peak-housing’; to ‘peak retail’, and the adjustment due to money printing elevating stocks, plus China and everything else, means you can get a shock to the system that causes every Americans not in the market to detect a problem, and curtail discretionary spending. 
 

If the latter occurs (I have believed that a new recession phase will track back to last July as you know, the point from which we called for market erosion and sluggish business, downgraded earnings and GDP etc.); then the trough is not here presently for the stock market, as it has to discount yet-seen negativity. If it’s otherwise I’ll be delighted; but so far don’t see that broadly other than a few areas like Germany. (Areas as in Europe, aside immigrant-invasion-chaos and effort to reclaim society that is threatened to be undermined, not so much by normal refugees but by those who intend reshaping the host countries rather than assimilating and adopting the traditional culture of the nations, are fairly stable and profiting from the lower Euro we’ve projected since near 1.40 over 3 years now). 
 

Now; as to Emerging (I call them submerging) Markets; it remains fairly dire at worst, or simply staying repressed at-best. As to High Yield, some have hung-in where investors don’t anticipate dividend cuts; but generally they trade off of oil and the terrible correlation there or being pretty-wide versus Treasuries; means we were correct in forecasting the Fed ‘would’ hike rates; but it would backfire. 

The economic outlook from the Fed was we said absurd; and based on a global view, not a domestic one (where they appear to be blindsided to everything); as they tried to get out of the corner I’ve said they were painting themselves into in all of the last year or more. It wasn’t a dour mood on my part; it was reality, and a call for the Fed to move even soon to ‘normalize’, which might have mitigated the impact on the markets; and actually helped the general economy to revive. 
 

Bottom-line: fundamentally we have liquidity mismatches; bank-loan or energy master partnerships (and more) actually in deeper trouble than what we saw in our ‘Epic Debacle’ call of 2007-2008. That was ‘derivatives based’, and harder for most analysts to pick-up on. This is pretty visible to everyone, as ballooning debt and default risk could add to volatility, as most managers and investors for now have not adequately protected themselves. Hence support of what we had or might get (depending on earnings and the Fed) suggested and still suggests it being nothing more than ‘relief rallies’ (barely that); before a rocky evolution to seek an ultimate low later for the S&P, regardless of near-term action. 

And, if we do ‘crash’ (which is rare but barring exogenous events always occurs from oversold, not overbought, conditions), beyond what I called a ‘process’ of ‘walking the dog’ down as it’s said; ‘banks & counterparties’ will be at-risk due to current structures in such a ‘liquidation’. What we have had wasn’t truly a full liquidation; and that’s disconcerting to optimists. Perhaps that may also be part of the Financial weakness nobody dares ignore.