Sell the Rally

Do you have the feeling something just ain’t right?  If so, we suggest trusting your gut on this one.  The financial system’s running head long for a bleak implosion…followed by years of economic hardship.

Certainly, this is only our opinion.  One we’ve advanced over years of self-edification.  But what do we know?  We could be wrong…again.

We thought the DOW had peaked at about 13,000 and that the declining labor participation rate was indicative of a weakening economy…not a strengthening one.  Thus far these notions haven’t played out as we’d anticipated.  Perhaps we’ve been missing something all along.

Somehow, we can’t get past the fact that the economy’s flat yet stocks have gone vertical.  Nor can we comprehend the fiscal and monetary gimmicks that have been issued to make this happen.  TARP, CPFF, MMIFF, TALF, QE, QE2, QE3, ZIRP, and others.

These phony money mechanisms have propped up asset prices and splattered the financial landscape with unrendered pig lard.  Surely there’ll be a great big slippery mess to clean up after it crashes down.  This unwelcomed prospect is becoming more and more likely by the day…

Unrest Lies Ahead

“A ‘sense of an ending’ has been frequently mentioned in recent months when applied to asset markets and the great Bull Run that began in 1981,” wrote Bond King Bill Gross in his latest Investment Outlook.  “Then, long term Treasury rates were at 14.50 percent and the Dow at 900.  A “20 banger” followed for stocks…  Fully invested investors wound up with 20 times as much money as when they began.

“But now, successful, neither perma-bearish nor perma-bullish managers have spoken to a ‘sense of an ending’ as well.  Stanley Druckenmiller, George Soros, Ray Dalio, Jeremy Grantham, among others warn investors that our 35 year investment supercycle may be exhausted.  They don’t necessarily counsel heading for the hills, or liquidating assets for cash, but they do speak to low future returns and the increasingly fat tail possibilities of a “bang” at some future date.

“Savor this Bull market moment, they seem to be saying in unison.  It will not come again for any of us; unrest lies ahead and low asset returns.  Perhaps great unrest, if there is a bubble popping.

“When does our credit based financial system sputter / break down?  When investable assets pose too much risk for too little return.  Not immediately, but at the margin, credit and stocks begin to be exchanged for figurative and sometimes literal money in a mattress.

“We are approaching that point now as bond yields, credit spreads and stock prices have brought financial wealth forward to the point of exhaustion.  A rational investor must indeed have a sense of an ending, not another Lehman crash, but a crush of perpetual bull market enthusiasm.”

Sell the Rally

Markets change like the seasons.  A great spring and summer time bull run has propelled asset prices to levels that would’ve been unimaginable in 1981.  Short episodes of cold weather were quickly overcome by an abundance of sunny days and higher stock prices.

To fine tune the weather, the Fed pushed stock prices higher every chance they got with accommodative policies.  They also succeeded in disappearing risk.  Madmen, who borrowed wildly to speculate on share prices, got rich.

Yet human psychology, though fervent, can be fickle.  Faith in stocks…faith in the Fed…and faith in capital gains can quickly turn cold like an early fall frost.  So, too, perpetual bull market enthusiasm can be crushed.

After hitting 18,288 on March 2, the DOW has meandered back and forth around 18,000.  Could it be coiling up like a spring ready to jump to a new level?  Or could it be rolling over for a long secular decline?  This, of course, is the million dollar question.

Over the last 30 years the correct answer to a stalled market has been that it is coiling up like a spring.  ‘Buy the dip’ has been the mantra for success.  Maybe the next pull back is another great buying opportunity.  But it could also be the last opportunity to lock in gains near an all-time high.

What we mean is sell the rally could be the new order of the day.

Sincerely,

MN Gordon
for Economic Prism

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