Monday, February 19, 2018 12:56:29 PM
Has the Fed Made a New Bear Market possible?.......Continued......
http://www.pretzelcharts.com/
"You can see that pre-2008, the Fed was carrying less than a trillion dollars on their balance sheet. But between then and 2015, their balance sheet more than quadrupled. This is a large part of what bought us that wonderful "can't go wrong" bull market of the past 9 years.
You can also see that their balance sheet has remained largely flat until very recently.
However, in October, they finally began rolling off $10 billion per month. The market initially had no trouble absorbing that drain, in light of the bullishness surrounding the Republican tax cut, foreign capital influxes, and ma and pa investor finally "getting back into stocks" (the market recently saw record levels of mutual fund and ETF inflows -- $58 billion from late December to January 19, for example. This type of thing often happens near market tops.).
In January, the Fed doubled their roll-offs and began draining $20 billion per month from the banking system. And that gave us a 10% drop in the stock market in less than two weeks. The fourth fastest 10% drop in the entire history of the stock market, I might add. The pundits who are treating this as if it's a "normal," healthy run of the mill correction either haven't been paying attention, or don't know their own history. Or both.
And here's the thing: The Fed plans on accelerating the amount they're draining from the banking system each and every month from here on out, until the amount of this "reverse cash flow" reaches $50 billion per month in October 2018. In addition, they seem intent on continuing to raise interest rates.
If a $20 billion drain gives us a 10% "correction," then what will a drain of $50 billion per month give us? A true crash and/or a bear market?
Well... quite possibly.
This will, after all, represent the most aggressive Fed tightening program in history.
The problem is, as I've argued for years, we are in uncharted waters. None of this has ever been attempted before -- so we don't really know how this story ends. The level of Fed intervention from 2009-2014 was unprecedented; so, of course, the drain the Fed is now attempting is likewise unprecedented.
Before I discuss this further, let's look at a chart, because the fundamentals and the technicals seem to be aligning. The chart below is the long-term count I've been operating from over for the past several years. So far, it has played out rather well, having reached (and slightly exceeded) October's target -- which then generated a reversal, exactly as the chart suggested it would.
Here's how the chart looked in October:"
"And here's how it actually played out (basically perfectly -- so far, anyway):
(Note: Chart below is from Feb. 11, when I originally intended to publish this; we've since reached the beginning of the blue projection line, where the market presumably heads lower again.)"
"I'm showing that chart because it's relevant to my thesis on how everything fits together. Below is a basic outline on my Theory of Everything. My thesis is basically the market equivalent of Unified Field Theory:
I have long-argued that, from a technical standpoint, we seemed to need a large fourth and fifth wave to fulfil this wave structure. On the chart above, that fourth wave is represented by Red 4 and 5.
I have also long-argued that the Central Banks (CB's) would likely cause Red 4 -- probably through some mistake or miscalculation (I actually first developed and presented this theory years ago, while QE was still underway). We may be witnessing the beginning of Central Bank action directly causing Red 4 now.
I have likewise argued that the CB's would then also cause the Red 5 recovery rally. Once they realize their mistake, they are likely to overcompensate, and flood the market with liquidity once again. That's how the Fed seems to work, after all: They seem to realize everything on a delay, as if nobody there has the faintest clue how all these puzzle pieces fit together. (They tend to be late in recognizing both recessions and recoveries.)
The same Fed actions that cause the Red 5 rally to new highs (presumably more "easy money" policies) are going to drive us further into the territory of the unprecedented.
Red 5 could even come about via some form of hyperinflation, depending on the Fed's reactions, and the market's reactions to the Fed.
When Red 5 finally ends, we are going to experience a bear market of truly epic proportions, as the massive imbalances created in the system will need to be rectified -- likely destructively. As Friedrich Hayek said: "The curious task of economics is to demonstrate to men how little they really know about what they imagine they can design."
Let's examine a few implications of my thesis. The biggest implication can be boiled down to one simple sentence:
The Fed is already trapped by the monster they created during 2009-2014.
They just don't know it yet.
If they unwind the monster, the market will tank. In fact, several markets will tank -- likely bonds, stocks, and real estate, among others. If they try to salvage the market, then they will drive us further into "bubble" territory, because the only way to keep a bubble expanding is to add more air.
However, there is one way out of the trap they've laid for themselves... but it's one most of us prefer not to consider: Rapid inflation. And/or hyperinflation.
The Federal Reserve and Treasury both love inflation. In fact, they need inflation. Because inflation lets you pay back yesterday's debt for much less money, by using today's dollars. For example, $1 in 1980 currency is equal to about $3 today -- so for every dollar you borrowed then, you'd only need to pay back the equivalent of 33 cents today. Thus, if the Fed had a $4 trillion balance sheet back in 1980 and had done absolutely nothing since, then that balance sheet would have already shrunk by $2.66 trillion in relative terms. They would really only need $1.33 trillion-worth of 1980 currency ($4 trilling in today's dollars) to clear it entirely. ("Only," he says.)
In other words, they would have basically gained $8 trillion for "free" ($4 trillion spent in 1980 is equal to $12 trillion spent today) -- through The Miracle of Inflation.
Except it's not free. It's paid for by the American people.
See, inflation is a silent tax on We, the People. Each time the Fed prints more money, that money gains its value in part by stealing value from all the other money in circulation. In other words: Every time inflation ticks upwards, your liquid net worth ticks downwards. Some of your money was just stolen from you, courtesy of the Federal Reserve's printing press.
But there's no new Boston Tea Party for this silent "taxation without representation," because most people don't realize what's going on.
So there's the whammy. And that might be what brings us Wave 5 -- above average levels of inflation, courtesy of some new "emergency, one-time program" the Federal Reserve will create near the bottom of Wave 4, the way they created Quantitative Easing near the bottom of Wave 1 (the bottom was March 2009 at 666 SPX -- which has always struck me as an oddly-coincidental price point).
But Wave 5, if it goes this route, will just drive us higher into the already-rarefied air -- which means we'll have that much farther to fall when it finally ends. And it must eventually end, for reasons I discussed in The Acrobats article.
The amazing thing is: We may be witnessing my long-time thesis unfold, both technically and fundamentally, starting right here and now.
But this is the trickiest part. Finding the beginning was easy, because the Fed shouted from the rooftops that it was going to print money for however long it took (hence my term "QE Infinity") to reflate the stock market bubble, and they did exactly that.
Finding the end is a little tougher, because there are factors such as foreign capital influx and so forth that could help markets absorb the current liquidity drain, or at least cushion it.
I suspect my thesis is correct (obviously, or I wouldn't have formed it!), but I'm not 100% certain on the "starting right here and now" part. Perhaps they can kick the can a bit farther down the road.
Hence, now I'm going to play Devil's Advocate against myself, and rain all over the idea that it's already begun -- because one thing I try to avoid is complacency in my own theories. I learned long ago that getting tunnel vision as a trader is a sure-fire way to go broke. Confirmation bias is one of worst potential enemies in market analysis, so we must always strive not to merely "see what we want to see" in all the ways that agree with us, but to instead see what's really there.
The first thing we need to be aware of is that, from a technical standpoint, this drop has done nothing more than back-test the prior breakout. On the chart above, the upper red trend line represents the long-term bull market that (in the Nasdaq, anyway) began in 2002.
All the decline has done so far is drop back down to test that trend line -- and so far, that test has held. That's all that's "really there" right now. And it's not even an unusual thing to see.
So we need to be aware that if that trend line continues to hold, then that would actually be a bullish signal, not a bearish signal.
There are similar breakout patterns on other major indices (the Dow Jones, the S&P), and they've all done essentially the same thing (back-test their breakouts -- but not whipsaw their breakouts... yet, anyway).
In other words, it's a little premature to know yet if Red 4 has actually begun or not. There is room in the charts for this to be a lesser degree fourth wave, so perhaps Red 4 gets delayed a while longer. The market often has a way of pushing things out just a little farther than you sometimes think (although, it's already done that to most people, and maybe that's enough -- we happened to be on top of the last rally and turn, so it didn't run farther than we thought... yet.).
Anyway, I can't entirely rule out the possibility that this back-test will hold, which could lead to a rally back up to new highs. All the evidence points to the idea that it won't, but market analysis is never 100% clear-cut.
The best we can do in market analysis is try to parse probabilities. There are no guarantees, ever.
I am inclined to think that the probabilities favor the idea that Red 4 has indeed begun (or is very close to beginning) -- but I can in no way guarantee that yet. Despite the huge and fast drop we just experienced, from the perspective of the pattern itself, we are (at best) still in the early stages of a turn, and there's just not much to go off of yet. If we are instead witnessing a fourth wave at a lesser wave degree, then that could represent what Wall Street calls "a correction" as opposed to "a bear market."
Depending on what the market does next, I should be able to assign additional probability to either scenario.
Thus, if you take away nothing else from this, at least take away this much: I suspect Red 4 has begun, but I can only assign a probability of maybe 55-60% to that at this early stage in the game. The red trend line on the chart above is important to the bull case. If the market sustains a breakdown below that trend line, then that will suggest a whipsaw of the breakout. And whipsaws can be very bearish.
If it doesn't -- well, we just discussed that.
Thus, a sustained breakdown of the upper red trend line is the first signal we'd like to see, to help confirm the intermediate-term bear case.
In early favor of the bear case is an apparent impulsive decline from the all-time highs. That impulse suggests the market needs at least one more impulse to new lows, ideally to break the min-crash's low. Typically that second impulse is at least equal in length to the first impulse, which (if we peak near current levels) would send the SPX down toward 2400.
A standard Fibonacci extension of 1.618 would send it down to the low 2200's -- and all that can still happen within the context of a lesser degree fourth wave (although at that point, Wall Street would call it a "bear market").
A true new bear market by my definition (an intermediate or long-term downtrend) could see the market ultimately trim most (or all) of the gains we've had over the past two years, and possibly more.
So, all that said, we always need to know our exit. In the event the market sustains a breakout over the all-time highs from here, then we would have to rethink the timing of all of this. I'm favoring the idea that it won't do that, and, as discussed, believe there will be at least one more "mini-crash" type wave down of at least equal or greater length to the first drop.
Incidentally, I didn't use as much Fed data as I initially thought I would when I began this article -- had I done so, I would have drawn heavily from the work of a friend of mine named Lee Adler. (Prior to beginning this article, I emailed Lee to ask his permission to reprint some of his data -- which I never did -- but I feel obligated to give him a shout-out anyway!) If you're looking for detailed data on what the Federal Reserve is doing week in and week out, then no one tracks that better than Lee. I would recommend checking out his site (The Wall Street Examiner) if you're interested in learning more.
In conclusion, we may be witnessing the early stages of a decent bear move, and the fundamentals support the charts in this regard. If we're not, then we have a fairly clear line in the sand to watch -- a brief break of the all-time highs would be okay, but a sustained breakout would suggest bears need to move back into "watch and wait" mode. I am currently favoring the idea that this decline has farther to run -- but I'm far from infallible, and this market has behaved as an oulier both on the way up and on the way down, so there are no easy calls here. Thus I will continue watching for any signals that could prove my preferred outlook to be wrong. Trade safe."
http://www.pretzelcharts.com/
"You can see that pre-2008, the Fed was carrying less than a trillion dollars on their balance sheet. But between then and 2015, their balance sheet more than quadrupled. This is a large part of what bought us that wonderful "can't go wrong" bull market of the past 9 years.
You can also see that their balance sheet has remained largely flat until very recently.
However, in October, they finally began rolling off $10 billion per month. The market initially had no trouble absorbing that drain, in light of the bullishness surrounding the Republican tax cut, foreign capital influxes, and ma and pa investor finally "getting back into stocks" (the market recently saw record levels of mutual fund and ETF inflows -- $58 billion from late December to January 19, for example. This type of thing often happens near market tops.).
In January, the Fed doubled their roll-offs and began draining $20 billion per month from the banking system. And that gave us a 10% drop in the stock market in less than two weeks. The fourth fastest 10% drop in the entire history of the stock market, I might add. The pundits who are treating this as if it's a "normal," healthy run of the mill correction either haven't been paying attention, or don't know their own history. Or both.
And here's the thing: The Fed plans on accelerating the amount they're draining from the banking system each and every month from here on out, until the amount of this "reverse cash flow" reaches $50 billion per month in October 2018. In addition, they seem intent on continuing to raise interest rates.
If a $20 billion drain gives us a 10% "correction," then what will a drain of $50 billion per month give us? A true crash and/or a bear market?
Well... quite possibly.
This will, after all, represent the most aggressive Fed tightening program in history.
The problem is, as I've argued for years, we are in uncharted waters. None of this has ever been attempted before -- so we don't really know how this story ends. The level of Fed intervention from 2009-2014 was unprecedented; so, of course, the drain the Fed is now attempting is likewise unprecedented.
Before I discuss this further, let's look at a chart, because the fundamentals and the technicals seem to be aligning. The chart below is the long-term count I've been operating from over for the past several years. So far, it has played out rather well, having reached (and slightly exceeded) October's target -- which then generated a reversal, exactly as the chart suggested it would.
Here's how the chart looked in October:"
"And here's how it actually played out (basically perfectly -- so far, anyway):
(Note: Chart below is from Feb. 11, when I originally intended to publish this; we've since reached the beginning of the blue projection line, where the market presumably heads lower again.)"
"I'm showing that chart because it's relevant to my thesis on how everything fits together. Below is a basic outline on my Theory of Everything. My thesis is basically the market equivalent of Unified Field Theory:
I have long-argued that, from a technical standpoint, we seemed to need a large fourth and fifth wave to fulfil this wave structure. On the chart above, that fourth wave is represented by Red 4 and 5.
I have also long-argued that the Central Banks (CB's) would likely cause Red 4 -- probably through some mistake or miscalculation (I actually first developed and presented this theory years ago, while QE was still underway). We may be witnessing the beginning of Central Bank action directly causing Red 4 now.
I have likewise argued that the CB's would then also cause the Red 5 recovery rally. Once they realize their mistake, they are likely to overcompensate, and flood the market with liquidity once again. That's how the Fed seems to work, after all: They seem to realize everything on a delay, as if nobody there has the faintest clue how all these puzzle pieces fit together. (They tend to be late in recognizing both recessions and recoveries.)
The same Fed actions that cause the Red 5 rally to new highs (presumably more "easy money" policies) are going to drive us further into the territory of the unprecedented.
Red 5 could even come about via some form of hyperinflation, depending on the Fed's reactions, and the market's reactions to the Fed.
When Red 5 finally ends, we are going to experience a bear market of truly epic proportions, as the massive imbalances created in the system will need to be rectified -- likely destructively. As Friedrich Hayek said: "The curious task of economics is to demonstrate to men how little they really know about what they imagine they can design."
Let's examine a few implications of my thesis. The biggest implication can be boiled down to one simple sentence:
The Fed is already trapped by the monster they created during 2009-2014.
They just don't know it yet.
If they unwind the monster, the market will tank. In fact, several markets will tank -- likely bonds, stocks, and real estate, among others. If they try to salvage the market, then they will drive us further into "bubble" territory, because the only way to keep a bubble expanding is to add more air.
However, there is one way out of the trap they've laid for themselves... but it's one most of us prefer not to consider: Rapid inflation. And/or hyperinflation.
The Federal Reserve and Treasury both love inflation. In fact, they need inflation. Because inflation lets you pay back yesterday's debt for much less money, by using today's dollars. For example, $1 in 1980 currency is equal to about $3 today -- so for every dollar you borrowed then, you'd only need to pay back the equivalent of 33 cents today. Thus, if the Fed had a $4 trillion balance sheet back in 1980 and had done absolutely nothing since, then that balance sheet would have already shrunk by $2.66 trillion in relative terms. They would really only need $1.33 trillion-worth of 1980 currency ($4 trilling in today's dollars) to clear it entirely. ("Only," he says.)
In other words, they would have basically gained $8 trillion for "free" ($4 trillion spent in 1980 is equal to $12 trillion spent today) -- through The Miracle of Inflation.
Except it's not free. It's paid for by the American people.
See, inflation is a silent tax on We, the People. Each time the Fed prints more money, that money gains its value in part by stealing value from all the other money in circulation. In other words: Every time inflation ticks upwards, your liquid net worth ticks downwards. Some of your money was just stolen from you, courtesy of the Federal Reserve's printing press.
But there's no new Boston Tea Party for this silent "taxation without representation," because most people don't realize what's going on.
So there's the whammy. And that might be what brings us Wave 5 -- above average levels of inflation, courtesy of some new "emergency, one-time program" the Federal Reserve will create near the bottom of Wave 4, the way they created Quantitative Easing near the bottom of Wave 1 (the bottom was March 2009 at 666 SPX -- which has always struck me as an oddly-coincidental price point).
But Wave 5, if it goes this route, will just drive us higher into the already-rarefied air -- which means we'll have that much farther to fall when it finally ends. And it must eventually end, for reasons I discussed in The Acrobats article.
The amazing thing is: We may be witnessing my long-time thesis unfold, both technically and fundamentally, starting right here and now.
But this is the trickiest part. Finding the beginning was easy, because the Fed shouted from the rooftops that it was going to print money for however long it took (hence my term "QE Infinity") to reflate the stock market bubble, and they did exactly that.
Finding the end is a little tougher, because there are factors such as foreign capital influx and so forth that could help markets absorb the current liquidity drain, or at least cushion it.
I suspect my thesis is correct (obviously, or I wouldn't have formed it!), but I'm not 100% certain on the "starting right here and now" part. Perhaps they can kick the can a bit farther down the road.
Hence, now I'm going to play Devil's Advocate against myself, and rain all over the idea that it's already begun -- because one thing I try to avoid is complacency in my own theories. I learned long ago that getting tunnel vision as a trader is a sure-fire way to go broke. Confirmation bias is one of worst potential enemies in market analysis, so we must always strive not to merely "see what we want to see" in all the ways that agree with us, but to instead see what's really there.
The first thing we need to be aware of is that, from a technical standpoint, this drop has done nothing more than back-test the prior breakout. On the chart above, the upper red trend line represents the long-term bull market that (in the Nasdaq, anyway) began in 2002.
All the decline has done so far is drop back down to test that trend line -- and so far, that test has held. That's all that's "really there" right now. And it's not even an unusual thing to see.
So we need to be aware that if that trend line continues to hold, then that would actually be a bullish signal, not a bearish signal.
There are similar breakout patterns on other major indices (the Dow Jones, the S&P), and they've all done essentially the same thing (back-test their breakouts -- but not whipsaw their breakouts... yet, anyway).
In other words, it's a little premature to know yet if Red 4 has actually begun or not. There is room in the charts for this to be a lesser degree fourth wave, so perhaps Red 4 gets delayed a while longer. The market often has a way of pushing things out just a little farther than you sometimes think (although, it's already done that to most people, and maybe that's enough -- we happened to be on top of the last rally and turn, so it didn't run farther than we thought... yet.).
Anyway, I can't entirely rule out the possibility that this back-test will hold, which could lead to a rally back up to new highs. All the evidence points to the idea that it won't, but market analysis is never 100% clear-cut.
The best we can do in market analysis is try to parse probabilities. There are no guarantees, ever.
I am inclined to think that the probabilities favor the idea that Red 4 has indeed begun (or is very close to beginning) -- but I can in no way guarantee that yet. Despite the huge and fast drop we just experienced, from the perspective of the pattern itself, we are (at best) still in the early stages of a turn, and there's just not much to go off of yet. If we are instead witnessing a fourth wave at a lesser wave degree, then that could represent what Wall Street calls "a correction" as opposed to "a bear market."
Depending on what the market does next, I should be able to assign additional probability to either scenario.
Thus, if you take away nothing else from this, at least take away this much: I suspect Red 4 has begun, but I can only assign a probability of maybe 55-60% to that at this early stage in the game. The red trend line on the chart above is important to the bull case. If the market sustains a breakdown below that trend line, then that will suggest a whipsaw of the breakout. And whipsaws can be very bearish.
If it doesn't -- well, we just discussed that.
Thus, a sustained breakdown of the upper red trend line is the first signal we'd like to see, to help confirm the intermediate-term bear case.
In early favor of the bear case is an apparent impulsive decline from the all-time highs. That impulse suggests the market needs at least one more impulse to new lows, ideally to break the min-crash's low. Typically that second impulse is at least equal in length to the first impulse, which (if we peak near current levels) would send the SPX down toward 2400.
A standard Fibonacci extension of 1.618 would send it down to the low 2200's -- and all that can still happen within the context of a lesser degree fourth wave (although at that point, Wall Street would call it a "bear market").
A true new bear market by my definition (an intermediate or long-term downtrend) could see the market ultimately trim most (or all) of the gains we've had over the past two years, and possibly more.
So, all that said, we always need to know our exit. In the event the market sustains a breakout over the all-time highs from here, then we would have to rethink the timing of all of this. I'm favoring the idea that it won't do that, and, as discussed, believe there will be at least one more "mini-crash" type wave down of at least equal or greater length to the first drop.
Incidentally, I didn't use as much Fed data as I initially thought I would when I began this article -- had I done so, I would have drawn heavily from the work of a friend of mine named Lee Adler. (Prior to beginning this article, I emailed Lee to ask his permission to reprint some of his data -- which I never did -- but I feel obligated to give him a shout-out anyway!) If you're looking for detailed data on what the Federal Reserve is doing week in and week out, then no one tracks that better than Lee. I would recommend checking out his site (The Wall Street Examiner) if you're interested in learning more.
In conclusion, we may be witnessing the early stages of a decent bear move, and the fundamentals support the charts in this regard. If we're not, then we have a fairly clear line in the sand to watch -- a brief break of the all-time highs would be okay, but a sustained breakout would suggest bears need to move back into "watch and wait" mode. I am currently favoring the idea that this decline has farther to run -- but I'm far from infallible, and this market has behaved as an oulier both on the way up and on the way down, so there are no easy calls here. Thus I will continue watching for any signals that could prove my preferred outlook to be wrong. Trade safe."
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