This is one of the most important things you will read this week.
By Bill Fleckenstein President Of Fleckenstein Capital
October 16 (King World News) – Once again while I was away we saw a fair amount of volatility pretty much everywhere. I believe what happened last week confirms my view that the new highs we saw over the summer, given the various signs of their weak technical nature, were the final highs and a bear market is now underway…
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As the Paint Closes In
Once the market falls far enough, the Fed will respond with a move back towards QE, at which point we will have to gauge whether markets are going to rejoice over that outcome or if there will be some concern (i.e., you can do QE, but you can never undo it all via QT). That is a couple of steps ahead of us for now, however.
I continue to expect that the downside will see serious dislocations (i.e., gaps and large declines in short spaces of time). We may have a better handle on that after we see how the market digests the upcoming earnings season, where there could be a fair amount of warnings about the fourth quarter.
Turning to the action today, the market was weaker early on, led by the Nasdaq, which lost about 1% while the Dow and S&P behaved noticeably better. From there the indices spent the rest of the day grinding higher, led by the Dow, until the last hour when the rally fizzled out. In the end, the market closed lower, as you can see in the box scores. (For what it is worth, afternoon selling is one thing I like to see if I am looking for downside action to continue.)
Away from stocks, green paper was weaker, as was fixed income. I think the weakness in fixed income will continue, in general, until stocks fall far enough to move the needle on Fed expectations.
Luster for Life
As for the precious metals, I expect most readers noticed that they came to life last week. Interestingly enough, the Commitment of Traders report on Friday showed that the most recent break below $1,200 was almost totally a function of shorts pushing their futures positions while in the physical market, demand was so strong that commercials increased their exposure significantly.
I think it’s safe to now say that the gold market does not want to spend much time under $1,200. We even saw a pickup in the holdings of the gold ETF last week, finally. Today, both silver and gold popped about 1% early on before closing with gains of 0.5% and 0.75%, respectively.
The New Abnormal
At the Grant’s Conference I attended last week, Stan Druckenmiller made the point that the combination of the massive artificial suppression of interest rates by the central banks via QE, combined with algorithms that have “grown up” in the QE era, has produced an environment that is particularly difficult to deal with. Firstly, because no one has ever seen this before. Secondly, the next-to-zero rates picked by the central banks misprice virtually everything, as regardless of what the rates would have been, had they been set by the market, they certainly wouldn’t have been 0%, let alone negative.
With more or less everything mispriced and the noise factor created by the algos, it is particularly difficult to understand what the market actually thinks about individual companies when they report news, so “reading the tape” has become extra complicated. Nonetheless, Stan is bearish on both bonds and stocks, and thinks the stock market would have to decline 15% to 20% to get the Fed to say uncle.
He suggested one way to participate in the generational bond bear market is to be short various types of “credit” rather than being short government bonds. If you’re short credit you could possibly get paid two different ways: rates could rise and/or credit spreads could widen. The latter will almost certainly occur, even if the former bounces around some, and I am going to try to find ways to capture that theme.
Ledgers of the Fall
Another interesting speaker at the conference was accounting super-sleuth Francine McKenna, who was very negative on Berkshire Hathaway’s use of non-GAAP accounting. I know it’s sacrilegious to disparage anything Warren Buffett does, but she thought there could be real trouble regarding the acquisition of the Marmon Group. I don’t know anything about that myself or how likely it is to occur, I’m just passing it along. But if Uncle Warren was ever in trouble from an accounting standpoint, I think that would really rattle folks.
There was also on expert on China from the Rhodium Group who made a pretty forceful argument that the deleveraging campaign undertaken by the Chinese government to shrink the so-called “shadow banking” system was going to weaken their ability to respond to the financial stress that the crackdown is causing. He also felt that the weakness in China is worse than it appears and the most likely outcome over time is a yuan that is much lower.
I have tried not to have a big opinion about China over the last couple of decades because I have always felt the data was so questionable that it was so difficult to really know what was going on. I still think that is the best strategy, but at the margin I think one would be wise to expect more weakness, although I’m not making any investments predicated on that.
There were many great speakers and interesting points made, but I thought those were the most important highlights to pass along.
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