Aug. 13, 2016, Weekly Summary: Sitting on a Hedge is More Comfortable Than it Sounds

All summer we have been pointing out how disconnected from the real economy the market is.  This position arises from a number of metrics:  the near-historic high PE ratio, the two-decade high price to sales ratio, low capacity utilization, decreasing sales, and decreasing profits.  The market certainly looks unreasonable from an economic perspective, which is why we need to be both wary, and aware.  Wary of the market’s irrational behavior, and aware of the fact that we cannot impose reason on an unreasonable market.

The market morphs into a casino on a fairly regular basis; that much we know.  What we do not know, is when the music will stop and end the game of economic musical-chairs that is taking place inside the casino.  We don’t know, therefore we hedge.

Today, we will present a similarity between the correction in 1998, and the market action in 2015-2016 which points to the possibility of a continuing bubble expansion.  But first, some more information that keeps us wary.

It has been said that “it is all about money flows; if all the money is over-there, then it can’t be over-here”.  Childishly simple, but simply true.  The money is in the banks, and they are the gate-keepers into the economy.  Since 2008, the banks have not been putting enough money into the economy (loans for share buy-backs don’t count), and now they seem to be tightening-up on the money that they do lend. The next three graphs illustrate this:

Percent of Banks Tightening on Commercial and Industrial Loans

Notice how this tightening is a characteristic of late-stage business cycles.  We are wary when banks start to lose confidence in their commercial clients.

Percent of Banks Tightening Standards for Car Loans

Tightening on car loans means banks are starting to lose confidence in consumers.  This is not a good sign either.

Delinquency Rates on Loans

This increase in delinquencies is what normally occurs late in the business cycle ahead of a recession.  The operative word, however, is ‘normal’, and since zero interest rates are not ‘normal’, it is very possible that the Central Bankers (CB) will continue playing the music that sustains the game; they can always start buying equities and ETFs themselves.  Market participants (money managers) HAVE to put their money somewhere, so what better place is there than the stock market, or bond market where the FED and other CBs have eliminated the risk, for the time-being?  If you have the CBs as guaranteed buyers, then where’s the risk?  As long as the music plays, it doesn’t matter that all the chairs are gone.  

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The sentiment patterns that we follow continue to show a local top forming (chart below), but we emphasize the word ‘local’ as opposed to ultimate.

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Gold

Gold continues to struggle as it remains below the $1400 mark and it looks like it is setting up for another correction (chart below) .

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The commitments of traders remain at historical highs.

The commitment of traders in dis-aggregated  form (chart below) shows how the swap dealers and the producers, who are the experts in the gold market, continue to sell gold, while the money managers, who are trend-followers, continue to buy gold.  Historically, this dichotomy has occurred at gold-price maxima, so we still see the balance of probabilities as favoring a correction in the gold price.

The chart below continues to show the possibility of a price correction in gold.

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In conclusion, it is obvious to us that the equity market is disconnected from the real economy, but it is also apparent that the market has a tendency to do this on a regular basis, and that the expansion of the bubble can last longer than what seems reasonable.  We have evidence supporting both the bear side and the bull side, so we will maintain a cautious stance; we will hedge any new position.

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We wish our subscribers a profitable week ahead and ask that you monitor your email for Trade Alerts.

Regards,
ANG Traders