An interesting thing has begun to occur in the market which is more a symptom of exuberance than prudence as there seems to be nothing that can derail the market advance to new highs. However, as Doug Kass noted recently in his diary, the ingredients to shock market participants are already in place.

•  Speculative activity is on the rise (materially so in the case of Tilray (TLRY) and others in the space).
•  Investor complacency (not a soul, save permabears, are looking for anything like a large markdown in market).
• Rising interest rates — with the pace of the yield climb now accelerating to the upside.
• Trade and tariff risk is rising.
• An extreme change in the market structure — much like portfolio insurance in 1987, (ETF and Quant strategies and products dominate the market) — in which participants are all on the same side (long) of the boat.
• Social unrest as the benefits of monetary and fiscal policies failed to trickle down.
• Weak market seasonals.
• Technical divergences.

The market is currently ignoring, in my opinion, two of the biggest risks to the fundamental underpinnings of the market which are earnings growth and valuation.

While the market has been rising on stronger rates of earnings growth, due primarily to tax cuts and share buybacks, that effect will begin to roll off in the months ahead. Tariffs and higher interest costs are a direct threat to bottom line profitability, particularly when combined with higher labor costs.

Today, however, I want to focus on the interest rate issue as it is the biggest threat the markets currently face if rates do indeed continue to rise further.

But this is THE chart you should be paying attention to:

(Click on image to enlarge)

There are several important points to note in the chart above:

1. In the past 40-years, there have only been seven (7) other occasions where rates were this overbought. In each case, it was a great time to buy bonds and sell stocks. (When rates got oversold, it was time sell bonds and buy stocks.)
2. There were only two (2) other periods where rates were this extended above their long-term moving averages. The one that occurred between 1980-1982 began the long-term decline in bond prices. 
3. Economic growth has peaked every time rates got this extended. (Which shouldn’t be a surprise.)
4. Whenever rates have previously pushed 2-standard deviations of their 2-year moving average – bad things have tended to occur such as the Crash of 1974, Crash of 1987, Long-Term Capital Management, Russian Debt Default, Asian Contagion, Dot.com crash, and the Financial Crisis.

While the markets are currently ignoring the risk of higher rates, even a cursory glance at the chart above suggests that we are near the point where “rates will matter.”

I suspect the “Magic Number” is likely no higher than 3.25%.

But we will only know for sure when the “rabbit pops out of the hat.”

Just something to think about as you catch up on your weekend reading list.

Economy, 2008 & Fed

• Fed Officials Are Playing With Fire by Caroline Baum via MarketWatch
• Burying Our Heads In The Sand by Hunt Lawrence via American Spectator
• Further Tax Cuts, Further Fiscal Irresponsibility by Committee For A Responsible Federal Budget
• Tax Reform Promised A Deluge, We Got A Drip by Omri Marian via The HIll
• Trade War Escalates – Markets Shrug by Matt Phillips via NYT
• 6-Signs We’re Closer To A Recession Than You Think by Sean Williams via Motley Fool
• Wages Are Low And Workers Are Scarce by Annie Lowrey via The Atlantic
• The Casualties Of The Trump’s Trade War by Steve Chapman via Reason.com
• Economic Bump Due To Stimulus by James Macintosh via The New Yorker
• Can American Be A Successful Low-Tax Society by Grover Norquist via Ozy
• Who Really Creates Value In An Economy by Mariana Mazzucato via Project Syndicate
• A Decade Later, Is The Global System Safer by Knowledge@Wharton

Markets

• Edwards: Next Recession Only 6-Months Away by Tyler Durden via Zerohedge
• This Market Indicator Most Inflated Since 2000 by Mark Hulbert via MarketWatch
• TSLA: Headed To The Graveyard by Shawn Langlois via MarketWatch
• A Warning From Europe by Anne Applebaum via The Atlantic
• It’s A Nightmare Scenario For The Markets by Wolf Richter via Wolf Street
• The “Junkie Market” Is Back Again by Dana Lyons via The Lyons Share
• Central Banks On Gold Buying Spree by Simon Constable via Forbes
• Emerging Pieces From The EM Decline by Seth Levine via The Integrating Investor
• Markets Don’t Care About Trade Wars by Ryan Vlastelica via MarketWatch
• When Is The Next Recession & Bear Market by Jesse Colombo via Forbes
• The End Of The Incessant Bid by Kevin Muir via The Macro Tourist

Most Read On RIA

• The World Diverges From The U.S. by Lance Roberts
• Buffett: A Walking Contradiction by Michael Lebowitz
• The Ingredients Of An “Event” by Lance Roberts
• 80% Of Americans Face A Retirement Crisis by Lance Roberts

Research / Interesting Reads

• The Confidence Game Being Run At Salesforce by Ben Hunt via Epsilon Theory
• 2/3rds Of Americans Believe The Stock Market Hasn’t Risen by Tyler Durden via ZeroHedge
• A Decade Later: How The Recession Changed Everything by Liz Wolfe via Playboy
• How The Next Downturn Will Surprise Us by Ruchir Sharma via NYT
• 5-G Will Change Everything by Gary Shapiro via Real Clear Markets
• Statistics Say The Financial Crisis Is Behind Us, They’re Wrong by David Leonhardt via NYT
• The Biggest Economic Change In A Decade by John Stepek via MoneyWeek
• Is The Stock Market Overvalued? by Knowledge@Wharton
• Retirement Is In Peril For Most Americans by Ted Knutson via Forbes
• Fed Should Go Lower For Longer by Janet Yellen via Brookings
• The Will Be The Mother Of All Minsky Moments by John Mauldin via Mauldin Economics
• What We Should Have Learned From 2008, But Didn’t by Carmen Reinhart via Foreign Affairs

“It’s all fun and games until someone gets their eye put out.” – Every Mom In History