We’re back in the phase of markets where bears look like idiots and bulls look like geniuses. In 2018, following the US tax cuts, a growing economy and expanding earnings had bears look the fools as markets moved on to record high after record high. By September and October bears had thrown in the towel so relentless was the constant drift higher amid shrinking volumes, dying volatility and uniform bullish consensus. It was a very deceptive environment as divergences and negative signals were ignored and markets ended up dropping 20% into December.
Now, ironically, it’s a slowing economy and slowing earnings, the very thing bears had predicted last year, that has bears on the ropes again. Why? Because it’s not the economy stupid. It’s liquidity. The oversold rally emerging from the depths of the December carnage has morphed into a liquidity bonanza as record buybacks are flushing relentlessly through the system and central banks have flip flopped on their previous policy stances. With algos latching onto any tweet or newsflash promising a coming recovery from the current slowing growth environment (think China deal) the liquidity machine has once again set markets on a relentless path of magic levitation accentuated by overnight gaps and market open ramps, tight intra-day ranges and magic risk free Fridays:
All the while volatility being relentlessly crushed. Bad economic data? No problem. No China deal? Not a bother, it’ll come someday. Brexit chaos? It’s just fun and giggles. All that matters is liquidity.
Indeed on Friday we saw the lowest volatility print of not only of 2019, but as I had outlined on twitter the lowest print since the $DJIA highs in early October of 2018:
$VIX 12.50
Lowest $VIX read since the beginning of October when markets were near all time highs and complacency ran rampant. pic.twitter.com/RxEvec1ovZ— Sven Henrich (@NorthmanTrader) March 15, 2019
And let’s be clear: This program is in full control and will remain so until something breaks.
$SPX may only be 4% off of its all time highs, but don’t think for a minute that the dovish parade will end any time soon. Next week central banks around the world will gather and keep touting their market supportive dovish tones, led by the US Fed which is now, according to Pimco, rumored to perhaps announce the end of their QT program for this year.
Why cling to dovishness now that markets have recovered most of their losses? Maybe, just maybe, central banks are looking at the bigger picture which suggests any renewed selling could prove disastrous:
Yet, amid all this bullishness and dovishness, the market action has also become overtly reminiscent of last year. Divergences that were ignored in September when I penned Lying Highs are once again making their presence felt, rendering this rally perhaps an exercise in deception as well. I said it last summer, and I say it again: Divergences don’t matter until they do, but when they do they matter greatly, hence bulls may be only one proper sell-off away from major trouble for a proper pullback would awaken the slumbering beasts of negative divergences.
In this week’s Weekly Market Brief I’m taking a closer look at these divergences and the structural weaknesses beneath this rally:
For now bulls remain in full control of the action and bears need to prove their case. Keep in mind that so far this year markets remain inside the trading range of 2018, making 2019 currently an inside year. It can’t be stated with integrity that $SPX would be currently trading anywhere near 2800 if the Fed had not turned dovish. For 10 years central banks have successfully levitated asset prices by being dovish. For 3 months in 2018 they weren’t dovish and it blew up in their faces. The big debate for 2019 will be if being dovish will once again succeed keeping the boogeyman at bay. So far the answer is a resounding yes. We’ll see what happens when the $VIX acts up for real. But don’t worry, Wall Street can’t even think of any catalyst for $VIX to rise. And so complacency was made great again and that, in itself, may be an act of deception.