Note: This post is originally from FleckensteinCapital.com, posted on August 21, 2015. My dad is in the investment business and has a subscription site where he comments on market action and has an active community and conversation built around “#AskFleck,” his Q&A that I edit daily. He asked that I post this piece from Friday here so as to make his insights available because he wants people to hear “the facts and not the Bubblvision hype.” (Bubblevision is CNBC.)
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China led the charge lower last night, losing 4% to 5%, with Japan off 3%, and Europe down 2% as well. In talking to the guys I speak to every day, I have been discussing the potential for a real trashing this week (but especially today), for reasons that I have articulated in the past, but also because I kept reading in so many places that the market had to rally this week because of option expiration.
What’s Past Is Prolonged
A lot of people actually put up real money on that notion simply because that has been the market’s tendency. However, the Friday before Black Monday in 1987 was also an option expiration that unwound to the downside instead of the upside. (I managed money back then, was very bearish, and was heavily short in the couple of accounts where I could be.) I felt that this week had a chance to be nasty, as the possibility (and precedent) existed for something like what we saw this morning, where the market was weak early on, tried to bounce, then fell quickly as the S&P took out 2,000, at which point the indices were about 2% lower on the day, and it looked like anything was possible.
The moral of this tale is that sentiment and mechanical concepts work a lot of the time, but you never know when they won’t, and when they don’t, the pain can be quite severe, especially if those concepts have been working, which has been the case for the last several years.
Turning back to the action, several rallies were attempted, but they didn’t stick and the market kept falling and finished on the lows, down 3%(!). Meanwhile, beneath the surface, momentum ideas of all stripes (e.g., Facebook, Netflix, Tesla, Priceline, etc.) were hammered. Be forewarned: Monday has a good chance to be very ugly again (at least early on).
Away from stocks, green paper was trashed. Why? Two reasons. First, thanks to activist central bankers, we are not in a normal cycle as in the past where the stock market was a reflection of the economy, and a huge run in stocks meant that the economy was quite strong. Instead we are in the era of QE, in which central banks try to drive stock prices higher and drag the economy along with them. Thus, a higher stock market doesn’t mean much of anything, other than they’ve printed enough money to get it there.
Take a Hike
Thus, it was the S&P reaching 2,100 that led folks to believe the Fed was going to be hiking because it had won the battle over the economy, we were out of the mire, and moving on to a normal recovery with higher rates, etc. This is also what drove the dollar to the moon. That thesis is finally being questioned, as the possibility of a rate hike diminishes (the bond market suggests the probability of one in September is now down to 34%, and more importantly, December is down to 60%, and both of those were about 20 points higher a week ago).
The reality is that there will be no rate hike because — as I have said — the market needs more easy money because the fumes it has been running on are insufficient, and momentum has now been established to the downside. So the market will now continue lower until it falls far enough to panic the Fed. There will most likely not be a big rally in the market until we start to hear Fed chatter about QE4. That’s not to say that hints or outright denials of a rate hike won’t cause a kneejerk bounce, but in the absence of more free money, the market is doomed.
Of course, that means that the whole thesis for the dollar has gone up in smoke. I could actually make a case that, despite its warts, the euro is a better currency than the dollar because at least the ECB (and EU) pretends there are rules they have to fight over before it changes them, compared to the academics running the Fed, who just wing it.
“But I Ordered Filet Mignon!”
At any rate, the dollar was clobbered today, the second reason probably being because the positioning was so massive. Vast numbers of people were bullish on the dollar and have expressed it in many ways, e.g., long the S&P or short various currencies and commodities. Now the other side of that trade is causing people to be caught at a moment in time when the thesis is evaporating.
Turning to fixed income, it was higher, but not as strong as one might have expected. Oil lost a couple of percent, and the metals were mixed after being pretty strong overnight, with silver losing 1.5% to gold’s gain of 0.5%. I would expect that, as gold grinds higher, it will find more buyers. It seems to be a fact that these days people want to own gold when it is rallying, not when it is declining, but at some point it will get legs and surprise folks at how fast it can actually go up in price.
King World News
For another take on how this week compares to the week before Black Monday, see my most recent interview with Eric King. Note: this is an article, not the usual recording.
Positions in stocks mentioned: none.