One can never underestimate the impact that liquidity has on pushing stock prices higher
Frequently I receive emails from clients who ask variations on the theme of the QE-driven stock market in light of the long-term Kress cycles. For instance, one client recently wrote: “I really like your work but lately am struggling to piece together the longer-term direction. You seem perpetually bullish, which has proven to be right, but am struggling to see what will change your mind to be bearish at any point. Is it mainly liquidity that you see driving the market higher from here to the end. Or the New Economy Index?”
My answer to this first question is that one can never underestimate the impact that liquidity has on pushing stock prices higher. The Fed has committed itself to a policy of stock market recovery. As the noted economist Ed Yardeni has opined the Fed’s “shadow mandate” is to support stock prices by means of its QE policy. As another observer stated, “Never sell short a liquidity-driven bull market.”
It should also be mentioned that Bud Kress, the late cycle expert, emphasized that as long as there are no major long-term yearly cycles down for the year in question, there’s no reason to assume the Fed can’t engineer a bull market even in the face of the major structural problems facing the U.S. economy. The next time a major series of yearly cycles will bottom is 2014. Therefore there’s a very real possibility the U.S. stock market will be able to dodge another bullet in 2013 before the next set of long-term cycle bottoms arrive.
He continues, “If earnings continue to grow and liquidity is maintained, will this override your 2014 bear thesis?” To this I can only answer that earnings growth will eventually reach its limitation and will be hard pressed to continue expanding into 2014 with the long-term deflationary cycles in the “hard down” phase next year. Already we’ve seen evidence that the all-important rate of change (momentum) of earnings is slowing down.
Another question: “When the departed Kress thought that if you artificially extend the cycles via direct intervention (i.e. the Fed), it may produce deeper ramifications down the line. Is that possible here?” I would argue that not only is it possible, but indeed likely due to the distortions the Fed’ endless QE programs are creating.
Another question: “If you don’t see any problems amounting until end of this year or early next year, it all seems a bit too quick to bring about a deflationary cycle, does it not?” Under normal circumstances I’d agree with this observation. These aren’t normal times, however, and we’ve seen just how quickly markets can turn with the slightest provocation in recent years (e.g. the “Flash Crash,” Greece, Crete, et al). If you go back to the last time the 120-year cycle bottomed in the mid-1890s, you’ll find that the stock market was in a roaring bull market right up until the start of 1893 – less than two years before the scheduled 120-year bottom in late 1894. The panic of 1893 was swift, sudden and virtually without warning. If it can happen once it can happen again.
A final question: “Will a possible pick-up of inflation in 2015 be good or bad for stocks, margins etc.?” After the 120-year cycle bottoms in late 2014, a new inflationary cycle will commence. Historically it takes several years after the start of a new long-term cycle – usually around 10-12 – before inflation starts to take off. There is a question as to whether this time around, starting in 2015, inflation will accelerate due to the enormous amount of corporate cash and bank reserves on the sidelines. If this money is quickly introduced into the financial system after 2014 it could kick-start the inflation cycle at a faster than normal pace.
The Fed has defended its aggressively loose monetary policy since 2008 in the name of fighting deflation. It has also admitted that its object is to artificially create inflation in an effort to increase economic activity. Would it not be the ultimate irony if its efforts end up creating a massive inflation problem – much more than it bargained for – in the years following 2014?
Probably the most important indicator of the market’s short-term overbought or oversold condition that I track is the 20-day price oscillator for the S&P 500. The following graph shows the 20-day oscillator to be at an “overbought” extreme and has reached virtually the same level that turned back the market’s rally the previous two times this level was reached.
I would emphasize, however, that an overbought market condition is much less reliable as a timing tool compared to an oversold condition. Moreover, the market can remain overbought for an extended period – sometimes weeks at a time – before pulling back.
I’d also point out that while the 20-day oscillator is at an extreme, there was at least one instance in the last two years when the oscillator was even more overbought – back in the summer of 2011 (see above chart). It’s possible, then, that the market could become even more overbought before the next market-wide correction. The oscillator’s reading, however, suggests traders should hold off on making new purchases until the indicator improves.
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