Tapped Out

Lisa Simpson, "What happened?"
Homer Simpson, "Difficult to say sweetie.  The town blew up, I built our house and you showed up.  All we know for sure is, I'm completely blameless."  
An excerpt from the video game Tapped Out featuring the Simpson's television show characters in which Homer has just blown the town up through his negligence at the nuclear power plant.

Reading about the EUs next attempt to stimulate by printing more money and the Federal Reserve's discussion on possibly moving to negative interest rates it seems that the central bankers of the world are rapidly becoming tapped out.

Looking at Japan it seems that they are finally reaching their breaking point as more monetary stimulus is having no impact other than to make the world start to wonder if they will ever be able to pay back their current debt.  The loss of confidence is not only affecting their currency but is also having a negative impact on their consumers and this is feeding into negative consumption reports.  China too is having limited success mainly due to the fact that large swathes of money that is being forced into the economy is ending up with deadbeat state run companies.

As I have repeatedly written about in this blog, debt does not solve a world's economic woes.  Taking on debt is at best a short term solution that should be used in cases where budgets are temporarily unbalanced or to put a stop gap under a financial crisis but it is not a long term solution.  Piling ever more debt onto an already massive pile does nothing other than sink the economy.  When that economy is large like the United States, it takes a lot of debt weight to sink it however, when it is small like Zimbabwe it does not take much.

One way that countries escape from this burden is to let their currency devalue and this creates opportunities to grow through exports however it also has the effect of creating inflation as global goods like oil become more expensive.  This inflation makes the overall debt level become more manageable assuming that the debt is based in the local currency and not in dollars.  For countries with debt based in dollars this depreciation can be the final death knell as has been witnessed in some South American economies but in developed nations currency depreciation is frequently used.

One way to depreciate a currency is to lower interest rates.  The result of this is that investors leave the country and move their money to countries where currency appreciation is expected along with higher interest rates.  So lowering your interest rate below zero should therefore do the trick however even this is not working as everyone is now playing that game at the expense of savers and investors the world around.  The idea that negative interest rates will stimulate by forcing investors to make their money work or by channeling debt to companies so that they can grow is not having any impact as companies and consumers are either already awash with debt, cannot obtain it or have no place to invest it; so adding more debt is never going to have the impact that the Federal reserve thinks it will.

So if lowering interest rates is not working and adding debt has not worked essentially the world is rapidly waking up to the fact that the central bankers of the world are tapped out.  And while the markets rallied today on the back of the US's stimulus package it is once again false hope.  Until there is some form of global inflation based on capacity constraints due to sustainable global growth as opposed to fictitious growth from monetary stimulus, these market rallies will be short lived and are a sucker bet.

Sell The Rips!

"Buy the dips and sell the rips." - Wall Street trading adage

In a bull market an old trading strategy that is often referred to in the press and on television is to "buy the dips".  This works well when stocks are trending higher as has been the case since 2009.  Each time the market takes a breather buyers step in adding to their positions and profit from the continuation of the bull market rally.

In a bear market the opposite holds true and that is "sell the rips".  That is when the market rallies you take advantage of the rally to either exit more of your long positions or put on new short or put options to take advantage of the next leg lower.  This is not for the faint of heart as most of us are wired to make money when things grow or go higher.  To bet that things will fall in price normally is beyond the scope of most amateur trader's mental capacity so most shun this trade as too risky.  Rather they let their positions lose money with everyone else.  There is comfort in knowing that you are not alone in losing value whereas taking a stand as a bear can be lonely and, if the market runs against you it takes a lot of mental strength to hold your ground.  So selling the rips sounds easy but in reality it is a scary proposition.

That said if past bear markets are anything to go on then this "bear" market is just warming up.  The reason I put "bear" in quotations is that until the market falls more than 20% from its highs it is not an official bear market.  As we have recently rallied back to 2000 on the S&P 500 we are a long way from a bear market but in studying bear market trends most bear markets last roughly 2 years and the vast majority of the bear market collapse happens in the last six months of that time frame.

So the first question is if we have entered a bear market then when did it begin?  If you look at the high back in May 2015 then we are barely beginning this downward cycle however some economists have placed the beginning of the bear market as the last time the Federal Reserve added money into the banking system.  This would take the beginning of the bear market back to November 2014.  If this is correct then the bear market is getting quite long in the tooth and that could mean that the bear claws are about to come out and rip a new hole in the market sending it tumbling lower within the next six months.  As an example the last bear market lasted 17 months and the Dow fell 7700 points, 5000 of which occurred in the last five months!

So why would we be entering a bear market?  There are numerous numbers to look at but I will only mention the 10 most definitive reasons:

1. At the end of bear markets stocks indices are dragged higher by a smaller and smaller number of must have stocks.  This occurred with the FANG stocks (Facebook, Amazon, Netflix and Google).
2. Volume is far lower on days that the market goes up than when it falls.
3. While the oil price might be a benefit to consumers, sovereign wealth funds in oil exporting countries are selling large swathes of stocks to meet obligations at home ($220 billion last year with more than double that expected this year).
4. China has used more than $800 billion of its wealth to support its crumbling economy and more selling is expected.
5. While China has reported economic expansion its economy may not be growing at all if you look at the dismal export numbers reported by their largest trading partners all of whom have seen their export numbers crater.
6. Domestic equity fund outflows have exceeded the level recorded right before the 2008 sell off.
7. Profits at S&P 500 companies declined 12.7% in 2015 the worst decline since 2008 and a further decline is expected in the first quarter of 2016.
8. Warm weather this winter has brought forward economic activity so there will not be an uptick in GDP later in the year as has occurred in previous years.
9. According to Warren Buffet and other leading CEOs, the economic headwinds are stronger than they have experienced in a long time and some have said EVER.
10. The Federal Reserve will not be able to come to the market's rescue until there is a significant sell off as the numbers coming from unemployment and inflation do not warrant stimulus.

For these reasons I believe that the best option that you have right now is to sell the rips, of which we are experiencing one as the market has roared upward more than 10% from the lows.  The next sell off should take out the recent lows and at that stage we could be in to the final capitulation phase of the bear market so get ready and don't say that you haven't been warned!