Friday, October 20, 2017 9:15:10 AM
The Acrobats: Why the Central-Bank-Driven "Prosperity" MUST Eventually End
http://www.pretzelcharts.com/
"(Editor's Note: Because this article is rather lengthy, the usual update will be published as a separate stand-alone.)
Veteran readers know that it's been a really long time since I've written an article focusing on any sort of "bearish fundamentals."
In fact, the last time I wrote about "bearish fundamentals" was sometime back in 2012. In January of 2013, I wrote an article imploring bears to essentially "forget about bearish things" for a while. In it, I analogized a trip into the future in a time machine (See: A Survival Guide for Bears in a Bulls' World) as a mental trick to help bears forget about being doomsday bearish. And I included this observation:
I do know one thing with certainty: they [the governments of the world] can kick the can a lot farther than most of us imagine is possible. I know this is true because they already have.
I intended that article to "close the book" on long-term bearishness for a while, partially because (as veteran readers also know) by February of 2013, I had decided we were in the midst of one of two possible scenarios: Long-term bullish, or really long-term bullish (remember how outlandish this chart seemed five years ago? SPX to 2170? Unconscionable!).
Point being, to my way of thinking in 2013, "worst case scenario" was not what traders would want to focus on over the coming years, because that type of thinking is completely counterproductive to making money during a bull market.
And we're probably a little early to even start talking about them again now. Time will tell.
But nevertheless, I'm writing such an article now, after a hiatus that has spanned over half a decade (aaaand that just made me feel old), primarily because I have recently become aware that there seems to be an entire generation of new investors who have absolutely no idea what's been going on.
They apparently think the 2009-present bull market was driven by... I don't even know what. Magic fairies or something.
So I don't want everything to come as a complete shock to them when it starts getting real. The time for education isn't in the midst of a crisis, it's beforehand. And again, don't get me wrong, I'm not saying that's going to happen tomorrow. But forewarned is forearmed.
So it's time we opened this discussion again.
First off, let's start with some of the standard yada-yada: Remember that "the trend is your friend." Don’t buck the trend until the market says you should. When the current bull ends, there will be plenty of warning for people who pay attention to the signals. So don’t get so focused “on the end” that you miss all the money to be made “in the middle.”
I know many a trader who’s gone broke shorting too soon in a bull market.
Sorry, that had to be said…
Now, since we're partially addressing "a new generation," it's necessary that we quickly recap some basics, in order address some potential misconceptions among certain investors. Here goes:
Bull markets do not come about because of “good economies” (although they can). Ultimately there is only one thing that drives a bull market:
Liquidity.
When there is extra cash floating around (liquidity), then some of that cash finds its way into the market. That means more buyers. More buyers than sellers means a rising market. Sometimes extra liquidity is the sign of a healthy economy (which is what has led to the thinking that "good economies create bull markets"). But in today's world, sometimes the extra liquidity has nothing to do with the fundamentals of the economy.
To better understand this concept, Americans might consider looking around and asking themselves: “Is the real economy significantly better than it was in, say, 1997?”
Most who lived through that time would answer “No, it’s not.”
Yet the S&P 500 is currently trading at roughly double the highest price of 1997 even after being adjusted for inflation."
"Obviously, inflation can't be the reason for current pricing, since we're trading at double the inflation-adjusted price. And certainly the current economy isn’t twice as strong as it was in 1997. So what gives?
Therein lies your answer: What has driven this bull market higher for the last 8 years was not "economic fundamentals," but liquidity — in this case, provided by the world’s Central Banks (CBs). Essentially, the world’s various CB’s have been running the printing presses almost nonstop since 2009. Much of that excess cash has found its way into the stock market, which has driven prices higher. Some might say “artificially” higher, since the fundamentals of the real economy do not support current pricing (especially in terms of production).
So, the CB’s have been responsible for inflating asset prices by flooding an exorbitant amount of liquidity into the world. One problem with their "free money" approach is that it sends false signals to the market that there is more demand for things than the actual, real market would support.
Let me draw an analogy as to why this is a problem using the following story, titled:
The Acrobats
Imagine you owned a hotel in a small town for the last 10 years. After 10 years, you have a pretty good feel for what the market supports for your business. You have the right number of employees, the correct hours set for them, your income and expenses are well-balanced, etc..
Then one day a large, traveling band of acrobats shows up, and they rent out an entire wing of your hotel. Well, that’s good news, right? You’re pulling in more income than ever!
These acrobats initially book their rooms for a week, so you don’t make any changes whatsoever to your business model. You understand this situation is temporary.
A week goes by, and the acrobats announce that they’ll be staying for another week. Great! Still nothing Earth-shattering — you might have to get a few employees to work longer hours, but again, your business model doesn’t change.
The next week passes, and the acrobats announce to you that they’ve decided to set up shop in your town, so they're going to "move in" for an undetermined amount of time. They are a superstitious lot, and they don't believe in owning land, so they tell you they'll be staying at your hotel for “at least 10 years.” Holy cow! Amazing news!
But... Your hotel is no longer going to be large enough to support its usual customer base, because these acrobats will be “permanently” occupying one whole wing.
This changes your business model.
You decide you need to expand, because after all, the local artist festival this spring is always a full house -- but with the acrobats occupying so much space, you won’t have room for the artists anymore. Same with the Harvest Festival this fall. And over Christmas, there are always a ton of relatives in town, causing the hotel to fill up…
So you decide to build a new wing, similar in size to the wing that is now “permanently occupied” by the acrobats. You also figure it's a good time to remodel, and you decide on a "more upscale" look for the hotel. You can charge higher rates now, because with the acrobats providing a steady source of income, who cares if a small handful of your old customers can no longer afford the stay?
Plus, wow! Interest rates are incredibly low right now, so you might as well finance everything at once. The acrobats will more than cover the payments on a 10-year loan anyway. When they move out, you'll be paid off!
You also hire more employees and expand the hotel’s restaurant.
Business is better than ever, and things are going great!
After a while, your business has not only adapted to "the new normal," but your business model is now, in fact, predicated on it. After a while, "the new normal" is just normal. And you forget what life before the acrobats was like.
But then... sudden tragedy strikes. Only three years after the acrobats told you they’d stay for “at least 10 years,” their star performer suffers a nasty fall and is permanently injured. He and his family leave the hotel. So do his two performance partners.
The rest of the troupe then decides this location is "bad luck." They tell you that despite their long-term promise, they’re not going to stay any longer than they already have. They pack up and leave town.
Your hotel is suddenly very empty. And not only very empty, but very large and empty. You have to lay off half of your workforce immediately, including three-quarters of the Housekeeping staff.
The huge, recently-expanded restaurant starts running specials to attract more customers. At first, it's "Kids eat free on Tuesday and Thursday!"
When that fails to bring in enough business, you try: "Kids eat free on any weeknight!
Then: "Kids eat free every night!"
But to no avail.
And the loan payments! Sheesh, those seemed like a walk in the park when the acrobats were in town. Now you can barely keep up. You slowly begin to realize that you may have to sell the entire hotel... But who's going to buy a huge, fancy hotel that is clearly overbuilt for this Podunk area?
You realize selling is probably not going to work, and for the first time in your ownership, you begin to consider bankruptcy.
As you sit and ponder your fate, you invariably find yourself asking, "How did this happen? How did I let myself get into this position?" And the answer comes almost immediately:
The acrobats sent false signals to the market (which in this case, was you).
How could you know these signals weren't real? You really couldn't. Sure, you could have kept the hotel the same size, but you would have been turning away an awful lot of business if you had. Who can blame you for expanding? Expansion was what the environment seemed to call for."
(Continued, next post)
http://www.pretzelcharts.com/
"(Editor's Note: Because this article is rather lengthy, the usual update will be published as a separate stand-alone.)
Veteran readers know that it's been a really long time since I've written an article focusing on any sort of "bearish fundamentals."
In fact, the last time I wrote about "bearish fundamentals" was sometime back in 2012. In January of 2013, I wrote an article imploring bears to essentially "forget about bearish things" for a while. In it, I analogized a trip into the future in a time machine (See: A Survival Guide for Bears in a Bulls' World) as a mental trick to help bears forget about being doomsday bearish. And I included this observation:
I do know one thing with certainty: they [the governments of the world] can kick the can a lot farther than most of us imagine is possible. I know this is true because they already have.
I intended that article to "close the book" on long-term bearishness for a while, partially because (as veteran readers also know) by February of 2013, I had decided we were in the midst of one of two possible scenarios: Long-term bullish, or really long-term bullish (remember how outlandish this chart seemed five years ago? SPX to 2170? Unconscionable!).
Point being, to my way of thinking in 2013, "worst case scenario" was not what traders would want to focus on over the coming years, because that type of thinking is completely counterproductive to making money during a bull market.
And we're probably a little early to even start talking about them again now. Time will tell.
But nevertheless, I'm writing such an article now, after a hiatus that has spanned over half a decade (aaaand that just made me feel old), primarily because I have recently become aware that there seems to be an entire generation of new investors who have absolutely no idea what's been going on.
They apparently think the 2009-present bull market was driven by... I don't even know what. Magic fairies or something.
So I don't want everything to come as a complete shock to them when it starts getting real. The time for education isn't in the midst of a crisis, it's beforehand. And again, don't get me wrong, I'm not saying that's going to happen tomorrow. But forewarned is forearmed.
So it's time we opened this discussion again.
First off, let's start with some of the standard yada-yada: Remember that "the trend is your friend." Don’t buck the trend until the market says you should. When the current bull ends, there will be plenty of warning for people who pay attention to the signals. So don’t get so focused “on the end” that you miss all the money to be made “in the middle.”
I know many a trader who’s gone broke shorting too soon in a bull market.
Sorry, that had to be said…
Now, since we're partially addressing "a new generation," it's necessary that we quickly recap some basics, in order address some potential misconceptions among certain investors. Here goes:
Bull markets do not come about because of “good economies” (although they can). Ultimately there is only one thing that drives a bull market:
Liquidity.
When there is extra cash floating around (liquidity), then some of that cash finds its way into the market. That means more buyers. More buyers than sellers means a rising market. Sometimes extra liquidity is the sign of a healthy economy (which is what has led to the thinking that "good economies create bull markets"). But in today's world, sometimes the extra liquidity has nothing to do with the fundamentals of the economy.
To better understand this concept, Americans might consider looking around and asking themselves: “Is the real economy significantly better than it was in, say, 1997?”
Most who lived through that time would answer “No, it’s not.”
Yet the S&P 500 is currently trading at roughly double the highest price of 1997 even after being adjusted for inflation."
"Obviously, inflation can't be the reason for current pricing, since we're trading at double the inflation-adjusted price. And certainly the current economy isn’t twice as strong as it was in 1997. So what gives?
Therein lies your answer: What has driven this bull market higher for the last 8 years was not "economic fundamentals," but liquidity — in this case, provided by the world’s Central Banks (CBs). Essentially, the world’s various CB’s have been running the printing presses almost nonstop since 2009. Much of that excess cash has found its way into the stock market, which has driven prices higher. Some might say “artificially” higher, since the fundamentals of the real economy do not support current pricing (especially in terms of production).
So, the CB’s have been responsible for inflating asset prices by flooding an exorbitant amount of liquidity into the world. One problem with their "free money" approach is that it sends false signals to the market that there is more demand for things than the actual, real market would support.
Let me draw an analogy as to why this is a problem using the following story, titled:
The Acrobats
Imagine you owned a hotel in a small town for the last 10 years. After 10 years, you have a pretty good feel for what the market supports for your business. You have the right number of employees, the correct hours set for them, your income and expenses are well-balanced, etc..
Then one day a large, traveling band of acrobats shows up, and they rent out an entire wing of your hotel. Well, that’s good news, right? You’re pulling in more income than ever!
These acrobats initially book their rooms for a week, so you don’t make any changes whatsoever to your business model. You understand this situation is temporary.
A week goes by, and the acrobats announce that they’ll be staying for another week. Great! Still nothing Earth-shattering — you might have to get a few employees to work longer hours, but again, your business model doesn’t change.
The next week passes, and the acrobats announce to you that they’ve decided to set up shop in your town, so they're going to "move in" for an undetermined amount of time. They are a superstitious lot, and they don't believe in owning land, so they tell you they'll be staying at your hotel for “at least 10 years.” Holy cow! Amazing news!
But... Your hotel is no longer going to be large enough to support its usual customer base, because these acrobats will be “permanently” occupying one whole wing.
This changes your business model.
You decide you need to expand, because after all, the local artist festival this spring is always a full house -- but with the acrobats occupying so much space, you won’t have room for the artists anymore. Same with the Harvest Festival this fall. And over Christmas, there are always a ton of relatives in town, causing the hotel to fill up…
So you decide to build a new wing, similar in size to the wing that is now “permanently occupied” by the acrobats. You also figure it's a good time to remodel, and you decide on a "more upscale" look for the hotel. You can charge higher rates now, because with the acrobats providing a steady source of income, who cares if a small handful of your old customers can no longer afford the stay?
Plus, wow! Interest rates are incredibly low right now, so you might as well finance everything at once. The acrobats will more than cover the payments on a 10-year loan anyway. When they move out, you'll be paid off!
You also hire more employees and expand the hotel’s restaurant.
Business is better than ever, and things are going great!
After a while, your business has not only adapted to "the new normal," but your business model is now, in fact, predicated on it. After a while, "the new normal" is just normal. And you forget what life before the acrobats was like.
But then... sudden tragedy strikes. Only three years after the acrobats told you they’d stay for “at least 10 years,” their star performer suffers a nasty fall and is permanently injured. He and his family leave the hotel. So do his two performance partners.
The rest of the troupe then decides this location is "bad luck." They tell you that despite their long-term promise, they’re not going to stay any longer than they already have. They pack up and leave town.
Your hotel is suddenly very empty. And not only very empty, but very large and empty. You have to lay off half of your workforce immediately, including three-quarters of the Housekeeping staff.
The huge, recently-expanded restaurant starts running specials to attract more customers. At first, it's "Kids eat free on Tuesday and Thursday!"
When that fails to bring in enough business, you try: "Kids eat free on any weeknight!
Then: "Kids eat free every night!"
But to no avail.
And the loan payments! Sheesh, those seemed like a walk in the park when the acrobats were in town. Now you can barely keep up. You slowly begin to realize that you may have to sell the entire hotel... But who's going to buy a huge, fancy hotel that is clearly overbuilt for this Podunk area?
You realize selling is probably not going to work, and for the first time in your ownership, you begin to consider bankruptcy.
As you sit and ponder your fate, you invariably find yourself asking, "How did this happen? How did I let myself get into this position?" And the answer comes almost immediately:
The acrobats sent false signals to the market (which in this case, was you).
How could you know these signals weren't real? You really couldn't. Sure, you could have kept the hotel the same size, but you would have been turning away an awful lot of business if you had. Who can blame you for expanding? Expansion was what the environment seemed to call for."
(Continued, next post)
Join the InvestorsHub Community
Register for free to join our community of investors and share your ideas. You will also get access to streaming quotes, interactive charts, trades, portfolio, live options flow and more tools.
