Popping the Bubble

by northmantrader

Now that we have an open admission from the Fed that their balance sheet expansion is exacerbating asset prices and creating excess and imbalances (see Ghosts of 2000) the term bubble can no longer be dismissed as some fringe rantings by cranks like me, but rather a recognition for what any bubble is: An overpricing of asset prices far above where they should be based on earnings, fundamentals or the growth basis of the economy.

The question on everybody’s mind of course: When does the rally end, when will the bubble get popped? You know it’s bad when even bulls call for corrections but can’t get any. In December what seemed an aggressive call for 3,333 $SPX by March 3rd by BAML already looks overly conservative as $SPX got within a stone’s throw of 3,300 on January 10.

Current sentiment:

And that’s the sentiment in every bubble. Until it pops.

But for now there’s little doubt that the Fed’s liquidity machine maintains full control over the asset price inflation equation seeing again multiple daily repo operations this week in the $70B to $100B range.

Yet this week also offered an example of how quickly the bid can disappear.

You couldn’t tell by the $VIX closing at 12.56 at the end of the week, nor by the cash charts, but this week was actually pretty wild:

An 800 point drop in the $DJIA followed by a 1,000 point rally.

While all focus was on the again swift recovery lost in the shuffle was how quickly markets can drop out of the blue for any reason. Unprotected investors (as evidenced by extreme low put/call ratios and the lowest $SPY short position since January 2018) could take comfort in that the aggressive drop in overnight was erased in overnight and markets gapped up and raced higher in what can only be described as indiscriminate panic buying. Classic bubble behavior. The desperation to buy.

None of this is new. We’ve seen bubbles before that brought about major pain when the excess and imbalances were wrought out following a period of extreme greed and complacency.

And it’s fair to say that this the environment we’re in now as CNN’s fear and greed modelappears to now have settled into what seems an unprecedented permanent full greed mode:

What can we learn from the bubbles of the past? What do the technicals suggest how this might unfold? What are the risks to the upside and downside?