Monday, September 9, 2019

Last Night's Log Entry: Treading Uncharted Flood Waters

9/8/19 Sunday

Weighing the present bull case against the bear case, while perhaps not (yet) overwhelming, clearly, the bears have the edge.

Nevertheless, and paradoxically, I now place odds that the S&P notches yet another all-time high in the very near future – before a notable correction (if not a full-on bear market) sets in – at better than 50/50.

Ironically, the phenomenon that largely explains what has been a roughly 20-month deterioration in the market’s fundamental and technical underpinnings is what largely (along with central bankers) keeps the bears hostage, and sets the stage for a near-term rally to new highs.

In essence, as long as there remains hope that the U.S. and China can strike a trade deal – which would absolutely send stocks soaring – there’ll be a bid underneath the market; particularly given that the Fed, and, for that matter, every other central bank on planet Earth, stands ready to flood their respective economies with money on every hint that confirms the inevitable. The inevitable being the simple fact that the global economy will not expand for long amid what appears to be a global surge in protectionism (US/China truce or not). Of course, protectionism or not, we are now treading uncharted water, as the present expansion is now the longest in history; i.e., it can’t last forever anyway, it’s just that the trade war is speeding up the clock.

Central bankers, bless their hearts, find themselves utterly stranded; they have to strive to fulfill their respective mandates, which, in a nutshell, are to keep their economies floating while maintaining a reasonable rate of inflation. Problem being, and my how we’ve been here before, pouring money onto problems that easy money can’t solve serves only to make matters far worse when the inevitable occurs.

Yes, in a world of record low interest rates (negative in many places), lowering them further, printing money and freeing up bank reserves can only, at best, inflate asset prices while stretching the divide between the haves and the have-nots. I.e., blowing up bubbles and emboldening the populist think that got us here (sped up the clock) in the first place.

But, alas, and again, that’s precisely what they’re doing: Here’s Bloomberg Asia market reporter Kyoungwha Kim this evening (of course this feeds the short-term bullish case):

“The PBOC's move late Friday to lower banks' reserve ratios should be a shot in the arm for Asian stocks.

The 50bp reduction, effective Sept. 16, will add 900 bln yuan in liquidity to the financial system. That, together with extra 50 bp cuts for some banks, aims to help lower financial costs for companies. The move came before weekend trade data showing exports shrank last month. We also have August's money data coming this week, amid concerns that those figures may also disappoint.

Central banks around the globe look to be doing their bit to buoy sentiment as investors wait anxiously to see if U.S.-China trade talks can make progress toward a resolution.
All eyes will be on the ECB Thursday to see if it resumes QE. And the Fed is expected to take the baton next week and lower borrowing costs after Powell indicated he is committed to sustain the U.S. expansion.”
And here, from a CNBC interview last Friday, is Allianz economist and former Pimco CEO Mohamed El-Erian echoing the point we’ve been making; that the fundamentals and current stock prices are a bit out of whack:
"...recent record highs in the U.S. needed to be validated by fundamentals and suggested that we could be approaching a point when both stocks and bonds are too expensive." 
Make no mistake, aggressive monetary easing at this juncture can only exacerbate the disconnect between stock prices and fundamentals.

Bottom line: While I see real potential for some near-term upside, the current risk/reward trade-off – and the debt market ramifications of the next recession – demands that we tread cautiously.

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