Articles, Blog

Theater of the Absurd (w/ Sven Henrich) | Expert View


That’s what the market said to the Federal
Reserve. This attempt to finally normalize was stopped
dead in its tracks. We always intervene. We will never stop. We can’t stop. The moment we try to be non-accommodative,
everything blows up in our faces. For example, right now I don’t like the long
side here. I’ve made no secret about it. At the same time, I recognize the factors
that play that say, yes, we can get this crazy blow off move. Most people know me on Twitter under NorthmanTrader,
the website I operate, looking specifically at market direction. We analyze market from a technical perspective
as well as the macroeconomic perspective that includes politics, central banks, what’s happening
with the economy, and all that good stuff. Prior to trading, many years ago for 20 years,
I actually was in the corporate world. And this is probably where I picked up all
my analytical skills, if you will, sharpened the skills. Mostly corporate finance, but also operations
management, did a lot of international corporate development in Europe, Asia, South America,
and we looked at valuation of companies, obviously the build out of companies. So I had always had a good knack for analyzing
business plans. What’s driving this hated equity rally? Well, it’s very simple. We’ve had basically three drivers. The first and most obvious driver was central
bank capitulation. Obviously, we came from a period where the
Federal Reserve claimed they were on autopilot and the balance sheet roll off. They were projecting rate hikes for 2019 and
obviously caved on every single aspect of that. And it brings back the same spiel, basically,
that we’ve seen in equity markets for the past 10 years. You see a little bit of trouble in the equity
markets. In this case, maybe a bit more serious trouble
because we had a 20% correction. And then immediately, central banks back off
or intervene. In this case, they backed off completely reverse
policy. And that had a dramatic effect on expectations,
on rates, and of course, getting back into the regular mode of, OK, the central banks
have our backs and therefore we rally back into equity markets. It’s been really well documented script that
we’ve had in markets now since the financial crisis. And hence, every corrective activity doesn’t
last very long. The second aspect, of course, is also the
amazing amount of jawboning that we’ve seen on the side of the administration with regards
to dangling a China deal, right. Because a lot of the growth slowdown globally
is now blamed on trade wars, if you will. And so there was hope that a China trade deal
will miraculously return the growth curve around. And we’ve seen it. I mean, many of you may have seen me on Twitter
documenting it and others do as well, you know. You see constant headline coming out. We had a phone call tonight, or there’s going
to be a phone call tomorrow. And the algos react to that, or they have
been reacting for a long time in this first quarter. And then, of course, the third aspect is buybacks. Record buybacks. We have $270 billion in buybacks in the first
quarter. Mind you, we had a record buybacks last year
as well, and that did not stop selling at the end of the day. But when you see, again, an environment where
you have low volume being predominant marking the landscape, buybacks obviously make a difference
because they maintain a steady bit in the market. How long can the rally keep going? First of all, there’s technical factors that
I’m watching, and what I see in the rally specifically now is it’s kind of repeating
the pattern that we’ve seen last summer, actually. And what you see is a lot of gap ups, you
know, tight intraday price ranges. These gaps not getting filled, volume declining,
and one of the patterns I am watching is a rising wedge. Now these wedge patterns can last for months. Last year it lasted for months. It actually was an aggressive wedge pattern
into January 2018 highs. So what happens is price compresses ever more. Volatility compresses, and at some point,
you get a trigger and the pattern breaks, and then you have that volatility explosion. Specifically, we see it on the NASDAQ, and
it keeps rising. And what I said last summer too is that as
long as these things keep rising, they can stretch the imagination, if you will. I think this is probably the biggest challenge
for traders to, frankly, also for me, you know. You see something, and you have to have the
patience to wait for it to happen. But then of course, it can happen so fast
then you’re either in the move or you’re not. That’s one of the big challenges. So from that perspective, as long as the pattern
structure holds, it can keep going, you know. When it breaks, I think that’s when we ultimately
have the first challenge for this market in 2019. Because so far, this rally– and this is probably
to your point, the most hated rally– it does not correct in any shape or form. This has been completely uncorrected from
day one. We had this initial blip in early January
when Apple announced earnings warning, and then Jay Powell came in with his flexibility
on the balance sheet. And since then it’s been nothing but up, right. NASDAQ had one down week in all of 2019. And that’s concerning. You’re on a trajectory that’s not sustainable
for the rest of the year. So at some point that pattern will get tested. The question is what happens then, right? I mean, as long as markets can retest some
moving averages and stay above them in some key levels, then we can gather more energy,
right. You currently a classic v pattern. You can see maybe some sort of cup and handle,
if you will. And then off you go to two massive new highs. That’s a possibility unless you break particulate
levels. Then of course, you can make the case we’re
still in the bear market rally, which sounds absurd at this point, because we’re so close
to new all time highs. But that’s a really important consideration
as well. That’s why I like to tell myself and my clients,
we all need to keep an open mind here, because what’s happening here is in many ways unprecedented. So we’ll have to gauge this here during this
earnings season, obviously in the next few weeks. On the S&P, I would say we’re kind of at a
key point here and the pattern has to prove itself one way or the other. On the NASDAQ, I can still see it going higher. But the issue is because these patterns are
so steep, there’s really no room for error. This is one of the reasons we have continued
levitation, because if you break the pattern then a technical overreaction will take place. I mean, if you look at just the last couple
of weeks, you know, prices have been extremely tight, and you got to observe what’s actually
happening in the marketplace, and what’s the actual action. The action has been gap ups and then very
tight intraday price range. You see two, three, four handle price ranges,
and then nothing happens. I don’t like staring at dead screens for hours
on end. We like volatility, right. And so obviously, this is probably one of
the reasons I’m critical of what’s happening with central bank intervention, and buybacks,
and everything else, because it always compresses volatility. It did in 2017, did it during portions of
2018, and then– at least in 2018, we had some nice snaps, and we had some explosions
in volatility. And that’s where traders love that. That’s where we can certainly make good directional
moves in either direction. What could be a catalyst for reversal? You always can assess maybe potential triggers
that are out there, and then there are the ones that no one sees coming that surprise
you. My general view on these things is if the
technicals line up, market will find an excuse to validate the technicals, right. So I mean, if you’re talking about known triggers
or potential known triggers in the immediate front, it would be earnings. So far markets have basically ignored everything
on the earnings front in terms of reduced growth expectation. It’s basically this replay that we’ve seen
in 2015, 2016. We had this earnings recession. Markets dropped hard into early 2016, and
then central banks intervene. This is where we saw this massive intervention
of $5.5 trillion. We saw Janet Yellen pausing the rate hikes. And basically, I think the market’s hope here
is that we’re seeing a repeat, right, because Jay Powell is following the same script. He immediately backed off of everything, and
earnings recession is going to temporary. After all, China is again intervening, right. So we do still have this whole liquidity game
in place. And I think this is the big challenge now
to see whether that program shifts, because at the end of the day, what we saw here in
2018 is a big wall put in front of central banks. Your experiment has failed. I mean, that’s what the market said to the
Federal Reserve. This attempt to finally normalize was stopped
dead in its track. And I think that’s the larger concern here
if you look at credit. One of the big drivers of this rally has been
this move into high yield credit. I mean, it’s absolutely incredible when you
look at that chart. And so the entire market, basically, is trying
to replay the game of cheap money, the Tina effect, there is no alternative, buybacks. And then of course, you have this whole concern
of people being left behind, the FOMO effect. That’s why I wrote about this week about this
potential combustion effect, because everybody may feel the need for speed forced to chase
the ever rising equity market that does not correct. That to me is always a very dangerous environment,
because it’s very unpredictable in nature. I mean, we’ve seen this in 2000, right. These things can go absolutely wild even though
they’re not inrooted in any fundamental reality. And so we’re finding ourselves here in a really
interesting point, right, because equity markets are near all time highs, and the economy has
slowed down. So we have we have a gap, right. So either you’re going to see some growth
re-emerging, maybe through a China deal. And then there’s hope that all this growth
will come in the fourth quarter and, basically, bail everyone out. Because the reality is here, this rally is
not based on fundamentals at all. So it’s basically the hope that central banks
reversing will again provide the same script as they have done for the last 10 years. And you have to ask yourself, how long can
this repetitive game that disconnects equity markets from the underlying growth bases of
the economy further, and further, and further? Can central bank liquidity override future
inflection points? Here’s the fascinating aspect to me. I mean, look just historically where we’ve
come from. 2009, obviously, we have the great financial
crisis, and central banks had to do what they had to do to save the financial system. Fine. I totally get that. But keep in mind, originally, this was supposed
to be a temporary move. It was supposed to temporarily intervene,
and then we will normalize at some point. And I think all of us now have to– and I
don’t know if central bankers are willing to admit this or not, but this is basically
the reality that this has morphed into. We always intervene now. We will never stop. We can’t stop, because the moment we try to
be non-accommodative, everything blows up in our faces. That’s exactly what we saw in 2018. Keep in mind, the Federal Reserve policy was
accommodative from 2009 all the way into the fall of 2018. Jay Powell still had an accommodative language
in the Fed’s statement, and it was only in the fall that they removed that for the first
time in 10 years. And markets dropped 20%, and the economy started
slowing. And you can argue out markets dropped because
the economy slowed down. Really? Then why are they rising now? Because the economy is slowing down. It’s not that. It’s the fact that yields rose in 2018. They reached a historic trend line, technical
trend line. Got to a little over 3.2%, and that was it. This debt laden construct that’s been created
over the last 30 years and exacerbated vastly in the last 10 years cannot handle higher
rates. It just simply can’t. And that’s why they reacted. And so to me the question is– a lot of people
are now asking, well, maybe there will no longer be a cycle, because central banks will
always intervene. I’m sorry, then we’re creating a spiral to
Neverland, right. Because it takes ever more debt to sustain
the system. In fact, this year now– I mean, just look
at the US government side of it. We’re exploding deficits ahead of a recession. $1.1 trillion dollars already in 2019. We’re basically double deficits in the last
two years. 68% deficit increase in the last 12 months. Obviously, we’re seeing interest rates being
a major decisive factor on how you manage budgets. The US government’s interest payments on debt
are skyrocketing as well. And so lower rates are basically needed to
sustain this system. And by the way, that’s why you can justify
this rally right now, because rates dropped again. The cheap money game is back in town. Central banks flipping. Dovish staying dovish has worked to sustain
the system. But we also have now learned an important
lesson. We know where the red line in the sand is
it. Again, cannot sustain higher rates. And so for the last 30 years, we’re on a process–
look at the Fed funds. Lower highs, lower highs, lower highs, lower
highs. And hence, it’s no surprise that we now see
from the political side pressure for the Fed to cut rates and to start QE again. Can central banks prolong the rally for another
two to three years? It’s certainly the way markets are reacting
at the moment, right. Because a rate cut, actually, was high probability
priced in the last few weeks for the end of the year. And the market, again, is reacting to that. However, historically, and this is interesting,
at the end of a rate hike cycle when the Fed starts cutting rates, it’s actually a bearish
sign. We saw it in 2007. They were able to raise rates to a certain
amount, then they stopped a rate hike cycle. Markets kept rallying for a while longer. They did the same thing in 2000, right. Markets kept rallying for a while longer. But then they had, they were forced to cut
rates as the economy was entering a recession. And none of this was was bullish. So I think a lot of what’s going on right
now is Pavlovian reflex behavior. This is what we’ve been trained to do. Fed’s go dovish. We buy stocks, right. This is the game. The question is, basically, do we have sustainability
on that front? And I, somehow, doubt that. Because remember 2016, the case we just mentioned
earlier, it came with $5.5 trillion of central bank and intervention. There is no such intervention at the moment. There’s a wait and see approach on the side
of the ECB, on the side of the Fed. Chinese are certainly intervening. What are the key signals you’re looking for? Well, first of all– again, I’m coming to
patterns and structures, you know. One thing you see in markets reacting– you
can see it virtually every day– is how price reacts to gaps. So far this year, we’ve had seven open gaps
on the S&P that have now completely unfilled, and we keep building them, you know. We get now to the point where if you have
an eighth or ninth unfilled gap, markets come back, and they fill that, and then the algos
react to that. It’s a fascinating game. I mean, I’m watching it from a technical perspective,
obviously, and looking at the larger structural trend lines, for example. But you can see it on the shorter term time
frames as well. And you see where the algo are a printing
their past. It’s quite fascinating. On the short term time, you can intraday,
basically. I hate to say it, but if markets are as compressed
as they are right now, you can even look at 10, 15 minutes. In fact, a 15 minute chart has ruled so far
this year. You’ve got an RSI oversold reading on the
50 minutes chart, bang. The buying comes in, gets overbought, negative
divergence. There’s some pulling back. It’s a very, very tight game. For what we need to see to see some sort of
evidence of a larger pullback evolving, it starts with the basic, easier, daily 5 exponential
moving average dropping and closing below. Need to drop below the 10 ma, and it’ll below
the 20 MA. And then the big one to me is actually not
only the 200 MA but the 50 MA. As long as you can stay now above these larger
MAs, I think bulls are fine. Ultimately, you get a pattern break that forces
price below key supporting levels and averages, and fills some of these open gaps. You get this volatility explosion again. Keep in mind, it can happen fast. We saw that in February of 2018. Boom, we had within four or five days 10%
down. That is the danger in compressing volatility,
and you see a lot of people being net short the VIX again, right. It’s this unfalsifiable belief that volatility
is compressed, that central bankers control now the price liquidity equation again. My wife, by the way, she’s like the swing
chartists excellence. She has an eye for these larger structural
patterns, and she has seen some things right now, for example, on volatility, and knows
a lot of people saying, you cannot chart volatility. Yes, you can. It’s quite fascinating. And we’re seeing some structural patterns
that lead us to believe that there is going to be a larger VIX explosion coming in 2019. The problem with these patterns is, especially
when the VIX is very low, it tends to consolidate. It can consolidate for weeks. And it can be extremely frustrating if you
want to fade it. And of course, we see the monthly OPECS program
as well, you know. VIX gets crushed every time doing futures
expiration each month. But watching larger structural patterns and
being patient to see them evolve, and seeing all of the elements come together, this is
obviously where we risk saying, OK, now we want to be very cautious about any longs. So, for example, right now I don’t like the
long side here. I’ve made no secret about it. At the same time, I recognize the factors
that are at play that say, yes, we can get this crazy blow off move into the 3,100 area
even. Which assets or regions look most at risk? Well, first of all, I’m just looking just
from a pure fundamental structural basis, I find fascinating what’s happening with the
small caps right now. Small caps are massively in debt. Some of the highest EBITDA vis-a-vis valuation
ratios are completely out of sync with what we’ve seen before. We’re also seeing you have a large portion
of small caps being non-earners. This is your classic red flag sign. Here’s a market that keeps diving into an
asset class that has a lot of weakness in it structurally and fundamentally. And on that note, ironically, last year in
2018, small caps were leading. But this year, they’ve been kind of lagging. It’s been struggling with a 200 day moving
average. Maybe that’ll change now with earnings, but
to the extent that earnings growth is actually structurally slowing, I think they’ll be highly
vulnerable. To me, they’re still kind of a warning sign. Of course, you know, if you see earnings all
of a sudden surprise– and this is, by the way, another discussion maybe worth having
is simply because earnings estimates have been taken down so hard. Most likely they’re going to be easy to beat. The question is what what’s happening with
the larger outlooks for these companies. So small caps is area that I’m closely watching
in terms of performance. The other one is Europe. I am absolutely fascinated. You know, we talked a little bit about central
banks and their influence. Here we are in 2019 and Europe is borderline
recession. I mean, I know the central banks of the world
are in the confidence game. They will never go out and say, the recession
is coming The recession is coming. You would have panic, right. That’s when people would sell assets. You can never ever admit that, and keep that
in mind when you watch a central bank declaration minutes or press conference. We see no risk of recession. That was Ben Bernanke’s famous line, you know. Subprime is contained. They will not advertise that. So we’re finding ourselves in a situation
where the ECB had to ruthlessly take down their growth estimates for Europe for 2019,
didn’t see it coming. And here we are 10 years after the financial
crisis with the ECB at negative rates. What are they going to do? The entire financial system appears to be
now completely utterly dependent of ever more stimulus and intervention. We’ve not seen a capital market running without
intervention of some sort in the last 10 years. No new highs without dovish central bankers. No new highs with some sort of accommodative
policy. To me that’s a massive risk factor because
we’ve never been here. We’ve never been in an environment where an
entire larger economic region is on the verge of recession after three years of negative
rates. Where do you go from here? I mean, to me, that’s probably the biggest
question here. We have now for 10 years relied on permanent
intervention, and where did we end up? We end up in a situation where growth is slowing,
yet we have like in the United States, we have 49 year lows in jobless claims, a 3.8%
unemployment rate, and a Fed completely capitulated. We’re too scared to raise rates. There’s a gap. There’s a gap in the narrative. There’s a gap between the fundamentals of
the economy. There’s a gap between capital markets and
structures and how everything is placed, and it’s completely disconnected. And to me, the question is how will this ultimately
balance out and reconcile. Will we first get this massive blow off move
to the highs, to two new highs, or will we see something on next month or two that basically
test this Q1 rally? I’ve posted some charts on Twitter, and it’s
been a massive move that is also completely uncorrected. And so to me, again, this is the test that
needs to take place. You can either assume that these charts will
go vertically for the rest of the year, or you may not. I choose to believe at some point there will
be some sort of corrective test. Otherwise, you end up S&P 4,500 by the end
of the year. You can’t maintain a pace like that. So then the question is, OK, will we have
some smaller corrective moves, and they will get bought? It’s possible. It would get to 3%, 5% move, and in the control
of the system maintains itself. And maybe you get the China deal, and you
get this blow off move. But the fact that you have so much liquidity
jumping into the same, chasing the same vehicle, to me is a concerning sign. How do you play this environment? From our perspective, we are trying to be
swing traders. By saying we are trying to be, we pick our
spots. We’re not day traders. That’s not our game. And right now, the environment– if you’re
in the long side– it’s fine. You just keep riding the wave, and you adjust
your stops. Once your stops are taken, OK, then you can
relook at this picture. If you’re trying to fade it, you got to be
very disciplined. There is no place for stubborn bears just
like there is no place for stubborn bulls, you know. We saw that in October, right. Everybody was stubbornly projecting 3,000
is coming, and then all of a sudden we’re at 2,300. These moves can keep going. I’m interested in at least testing this simply
because of what I see on the technical side on the extensions, on the divergences, and
in the fact that this thing has not even had a basic technical correction. So yeah, you got to be disciplined in dealing
with it. VIX futures is an interesting one, because
you can work with stops but got to be very aware of the pivot points. What’s been working, obviously, for the last
10 years is selling volatility, specifically on spikes, when they come. But we’ve also need the flip side of that. A lot record people shorter with this product
last year was called XIV, and then blew it up in everybody’s face. And that’s obviously danger with those things,
because volatility can happen overnight. And then you’re trapped. This low vol game that’s been permeated the
landscape so, so long, I think, is going to continue to be challenged. Keep in mind, as much as we have low volatility
now, what we’ve seen in the last year and a half is not low volatility. In January 2018, we had a massive global blow
off top in China, Europe. Everybody peaked during that time frame. It was the US that managed to squeak out a
new high after that initial correction. Remember, it took months and months and months
in that tide channel. And then obviously, we had that massive sell
off into December. So this rally here– and I think maybe all
of us are forgetting this because we’ve been so accustomed to this new regime of really
short term corrections and vertical Vs going back up. This rally here, 23% off the lows, that’s
a classic bear market behavior, right. It keeps stretching it, but there’s obviously
a trend line I’ve been following from 2009. Basically, on the logarithmic basic it says,
we broke the bull market trend. And this rally here, as aggressive as it’s
been, keeps tagging that trend line. Now you can argue, OK, well that trend line
keeps rising so you can just keep tagging it and get to new highs. That’s possible. But one of the things that was working again
last year– and it worked in 2007, and it worked in 2000– it’s when you make these
new highs on specific technical signals, negative divergences, weaken participation. These kind of signals, and I just mentioned
these two here, worked in 2018. I wrote that piece called lying highs where
I said none of this looks technically well, but no one cares, right, because you have
all this wave of optimism. You’ve got trillion dollar valuation. Everything is fantastic. Stocks keep going up and keep going up. But then it happened, right. I mean it frustrated the heck out of me too. And this is kind of where we’re in the phase
right now. You either blindly buy and you ignore the
signals, or you try to carefully position yourself for what the signals are actually
telling you. Because the signals are there, you know, they’re
here again. But unlike bottoms, which are events, tops
are processes. So in the overall structure we have these
massive moves, you know. 15% up. 10% down. 10% up. 20% down. Now 23% up. That’s not a sign of a stable bull market. That’s a sign of a lot of things going on
underneath. And again, this rally here not fundamental
base, but central banks, buybacks, and political jawboning. So we still have that gap of price discovery
that has to realign itself somehow, and it hasn’t done so yet.

24 Comments

  1. Derek Drushel Author

    Once they intervened during the GFC there was no turning back. We knew they'd never stop intervening from the moment they started. These sociopaths refuse to allow the patient to go through withdrawal, therefore the patient must always get more heroine.

    Reply
  2. Rapier P Author

    Sven's analysis is based upon how capitalism and markets have operated for perhaps 100 years. When things like cash flow profits strongly determined capital flows. Where interest rates had cycles and where risk was thought to exist when lending. Those things currently do not apply.

    The influence of China has to be considered. Their ability to direct gigantic flows of credit to grow has been a monetary revolution. The China story is essentially a credit/monetary story. For the US if the Fed and the banking system would tap the brakes, as QT attempted, while China was almost full speed ahead on credit expansion then China was 'winning'. For all practical purposes this has to be considered an existential impossibility for our political and really all leaders. Actually nobody in America want's 'tight' monetary and credit policy. The political forces against the Fed are simply too much on that score. What exactly is the upside for anyone for a bear market or a recession? Nobody can think of any, except we people who perhaps naively believed the story of capitalism and markets that has been told for a very long time were right and the best possible course. China is suggesting a different course. Unlimited credit forever and ever.

    Will markets reassert themselves as they have in the past or are we in a new era?

    Reply
  3. swordoftruth Author

    The FED know EXACTLY what they are doing and have since their beginning. They are clever sinister thieves… criminals of the greedy, void of compassion or empathy, totally psychopathic variety. They are stretching this theft out as long as fools will allow it. There is only one way out of this and it is a fundamental system change, back to honest money. All central banks must be ended in their current form and re-purposed and integrated into their relative countries, and these countries must declare their sovereignty and take FULL CONTROL of their monetary systems.

    Reply
  4. Andre De La Fontaine Author

    There are no markets, there is no democracy, there is no justice, those were back in the good old days, before the 2007/8 crime of the century.

    Reply
  5. Laith B Author

    Negative interest rates next and with more printing central banks can inflate assets forever. Until people lose faith in the fiat system and majority of people refusing to work we are long way away. Far away from today knowing most people havnt got a clue and still saving cash for retirement.

    Reply
  6. Pekka Rousu Author

    The tie Sven wore. It looks like the Swedish flag. The colors are right. As a Swede I can wear it myself. Good of his parents to give him such a nice name. And everything he said was spot on. Great guy.

    Reply
  7. The Krutchinator Author

    Great topic and guest!… The thing is …. Many smart and intelligent people and even many not so smart are talking about the insanity of what is happening in the economy and Negative interest rate and yet the Controllers just blissfully plow ahead with their agenda and all we can do is watch!…. There must be a better way surely?

    Reply

Leave a Comment

Your email address will not be published. Required fields are marked *