Pickles, And How Risk-On Might End

[Note: Hi everyone, Papa_Boule here. AlbertaRocks has graciously extended an invitation to me to post articles here occasionally. I take that as a great compliment, so thanks AR, from the bottom of my heart. AR even suggested that I simply repost my comment from a couple of days ago as my first article -- with a few edits for clarity of course. So here it is:]

AlbertaRocks and GregInBaltimore posed a couple of questions in comments a few days ago. AlbertaRocks mused:

"What a pickle. I wonder if it's realistic to consider that the Fed [in its ongoing easing operations] is actually, and fatally, trapped?"

It is a great question. There can't be a resolution to the current economic problems without reform, and there's no political will to reform. And the Fed can't continue what it is doing without consequences, and can't stop without consequences. "Pickle" is right.

And GregInBaltimore's question that started the little discussion was great too: "How will risk-on end?"

The conventional way bull markets end is on the highest of high notes. That's why no amount of technical analysis or Elliott Wave theory can pick a top. Bears give up, even shut down their blogs, everyone's bullish. The benchmarks point to more up side, and a lot of it. There's often a blow-off move and the news and outlooks are great. Exuberance abounds. And every major top over the last few years has come with an "unfinished" Elliott Wave count -- an expected next move up that never comes.

But this isn't a conventional bull market. I often wonder where the markets would be without intervention. This is what blows holes in the theory that the market is an accurate reflection of social mood. The reason they are intervening in the first place is to prevent the markets from organically moving downward with social mood, and to levitate them upward in opposition to it. Because of the incomprehensible amount of money they were loaned (interest free) to play with, they have succeeded. The investing going on isn't "organic." And retail investing -- where you would think most of the actual social mood is -- is still largely on the sidelines.

Algos bid the market up on every bit of good news (or bad news spun positively) in the expectation or hope that retail will respond to the news (and the upward ticker move itself) and come back into the market. But retail stays on the sidelines, and most all the action is just algos bidding the market up against each other using the free money.

It's an unsustainable game for several reasons. One of which is the one-sided inflation it causes: prices of goods/commodities rise while wages do not, so the cost of living goes up, and the standard of living and percent of disposable income for the middle and lower classes go down. Less spending means even more negative pressure on the economy.

Another reason it is unsustainable is: What is the second part of the plan once retail re-enters the market -- if it ever does? What then? Do all the big boys sell to retail and get out? That's not good, because that just means crash. Or do they then magically find the will to reverse NAFTA and restore Glass-Steagall and start real reform and break up TBTF banks? Is there an actual plan to end outsourcing and bring jobs and manufacturing back? Is wealth going to be "un-concentrated" now that it has been concentrated? Is there any will to do any of this?

Of course none of this is going to happen, not the way things are. And a lot of people sense there's no sunshiny outcome at the end of this.

So this one could end on some sort of "bad" news -- something forced by the consequences of intervention, perhaps -- that pops the illusion or shakes the confidence and brings more reality into awareness.

So, what exactly? My gut says some new scandal or financial crisis in some sector becomes the Black Swan event. But it may be more mundane. As GregInBaltimore suggests in his comment, maybe just rising interest rates will trigger it. He may be onto something there. 

Looking at the last two major peaks (the dot com and housing bubbles) as analogs may be really appropriate since this is the third of what looks like a triple top. So it may be a fractal in several different ways.

The dot com bubble ended fairly quietly without a discrete event, but with several interest rate hikes and with a court case finding that Microsoft was a monopoly.

The housing bubble was more of a case of playing itself out, prices overextending and collapsing, foreclosures increasing, culminating with the mortgage/financial crisis.

Here's an interesting possibility: It may be that these three bubbles are more than just a fractal. They may be directly related. The housing bubble may have been a lagging offshoot of the dot com bubble (when exuberance from the first led to an exuberant housing market). The housing bubble is credited with avoiding a full blown recession after the dot com bubble. Then the current QE bubble is a direct offshoot of those -- an aggressive intervention peak, to avoid a full blown recession after the housing bubble. So three peaks makes sense -- one led to the other and to the other.

And since the QE peak is not "natural," but an intervention peak, it makes sense that there won't be a fourth peak, but instead a big overdue correction. One that could start on a tiny little event, like an interest rate increase, as GregInBaltimore suggests.

I'm going to repost that simple, elegant, and eloquent chart by The Green Prince that AlbertaRocks posted, because it deserves a second look -- and even a third one. The S&P100 peaks and bottoms average about half the value levels of the S&P500. So, extending the channel to the right a bit, a slide to the bottom of the channel would take the S&P100 down to about 275. That would be under 600 for the S&P500, or even lower if the channel doesn't hold, which I think is a strong possibility -- even a likelihood, if the dominos start tumbling with this next burst bubble.

And remember, as Aunt_Pittypat says, if things get ugly, don't get ugly too. Make up your mind to stay pretty.

Click the chart for a nice full blown view

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"Aaand... it's gone"