As I write this, the S&P 500 futures (ES) are flirting with fresh all time highs. Santa has been kind to Wall Street this year. The following is an hourly chart of the December action in ES.
The while oval represents the two hours during which the Federal Open Market Committee released it’s latest economic outlook, along with the press conference of chairwoman Janet Yellen to explain it all to reporters. The biggest story from it all, was a semantics change from the FOMC. With reference to the process of raising rates, the next step on the march to monetary policy normalization, the FOMC pledged it would exert ‘patience’ in carrying out the process, rather than merely keeping rates at zero for a ‘considerable time.’ While Yellen asserted that the change of language meant nothing in terms of a change in action, the markets took off from there. Whether these new attempts at all time highs can be upheld remains to be seen.
One thing about the month so far that has been evident is the difficulty in being a bear at this time. Despite the fact that pre-Yellen, ES had sold off 100 points from the highs of the month, there were sharp rallies of 27, 33, 25 and 50 points which meant that it was extremely difficult to actually make money on the short side. That sort of volatility may actually embolden the bearish case going forward, but for now it seems as though the bears will have to retreat until further notice. A two year view of ES:
Up 33% in 2013, and another 13% in 2014 with 8 days left in the year, with no signs of stopping. So what is the bearish case? That requires the consideration of two factors: time frame, and the adherence to reality. Quite frankly, over the long run I don’t think a bearish case exists for the US stock market, at least in nominal terms. This is because FOMC is fully committed to preventing asset prices from ever falling, and will print infinite dollars to do so if that’s what it takes. The issue is that monetary policy induced perpetual rises in stock prices tend to be divorced from economic reality. See: Argentine and Venezuelan stock market appreciation vs economic realities in those countries.
The creation of more currency does not drive real economic growth, but it can increase stock prices, which ostensibly reflect greater economic growth prospects, creating a discrepancy between real economic prosepcts and the supposed barometer of such. Thus it is possible to have a situation where on one hand, there are shortages of toilet paper, as the stock market makes new all time highs, as it was in Venezuela earlier this year. Or closer to home, last year, the US market making a fresh all time high on the day Detroit, once a symbol of American industrial might, filed for bankruptcy.
What these sort of discrepancies mean is that the bullish case has been, and can continue to be right for the wrong reasons. As being on the right side of the trade is all that really matters in the long term, it’s really hard to argue with the idea that one should just blindly buy and forget about it.
None of this precludes a shorter term attempt by the market to ‘revert to the mean.’ In fact, in order for the long term ultrabullishness to play out, this sort of short term ‘correction’ is necessary, as policy makers won’t flood the market with even more currency unless there is a threat of sustained asset price declines. Thus, the bearish case is really a case of a brief temporary adjustment to economic realities before policymakers step in to resume the voyage to Fantasyland. As I’ve been discussing over the last week, the most likely catalyst for such a short term correction is the oil situation. A long term chart of oil, spanning 20 years:
Based on the rise from $10.65 low in 1999, the current price in the mid 50s still seems ridiculously high. That is until you consider that for the majority of the last 10 years, oil was trading over $50. Most commentators have pegged $40 as the ultimate resting place, which is roughly where it bottomed in 2009 after the crash from the $147 all time high of 2008. Based on chart analysis, specifically the Elliott Wave principle of a three wave correction, I believe that $20-30, rather than $40 will be the ultimate place oil bottoms.
That is, the price action from $147 until now is all part of a longer term correction, after which price will resume higher eventually, ultimately taking out the $147 high nominally. From $147 to $35 in 2008-2009 was the first leg. The second leg was up, from $35 in 2009 until June 2014 (chart below), and the third leg from June 2014 to its ultimate bottom, perhaps in the $20-30 range, which coincides with the last major low before oil prices really took off for the stratosphere in late 2001.
This is consistent with my views above, namely that in the longer term we are going to be in for severe price appreciation, however this will take place after a deflationary event induces the Federal Reserve to go even more ‘all in’ than it already has. Oil seems to be the first domino in that deflationary chain.
Technically speaking, the triangle formation that took about 4 years to form broke in August, as shown in the above chart. On that break, I drew in the support lines pictured. The manner in which price scythed through these levels suggests there is a real force behind this move. In the immediate term, this move lower could be overdone. The penultimate green candle represents last weeks action, and if the low from last week isn’t broken this week, it will portend a slight respite in the decline. Perhaps a move back to $65-80. But the trend is clearly down, and it will take some doing to arrest the decline. Particularly as Yellen and Co. do not see any real threats from the falling oil price at this time, which suggests they will do nothing to arrest it.
The next immediate place to look after the oil domino falls is the Junk Bond space, as a lot of the financing for oil related projects came through junk bonds. The following is the JNK etf action for the last two years:
Despite the market as a whole being up over 10%, junk has diverged, to this point down a little over 3% for the year. Something to keep an eye on in 2015.
As for other areas, US dollar strength continues apace:
The above is the US Dollar Index ($DXY), over the last two years. I mentioned in October that my target for $DXY was 92.5, which seems to be on the cards. This coincides with multi year support on various dollar related currencies, including EUR/USD, GBP/USD, AUD/USD, USD/CHF, USD/JPY, and NZD/USD. With all the sentiment biased in favor of a strong dollar, it wouldn’t be surprising to see at the very least a correction in dollar bullishness, if not a major reversal.