Bull Market Peak?

At what appears to be the completion of an outstanding bull market for equities, it is appropriate to review our checklist for a top. This study will include a review of critical fundamentals, such as the yield curve, credit spreads and industrial commodities. It is an approach we use at potential cyclical peaks.

Checklist

1. Is the market up when it should be? Yes, with the April “Springboard Buy” our target for an important high became “around June”. The previous Springboard signal occurred on November 3rd, ending a period of uncertainty. The Springboard is a technical model designed to identify “dips” in a flat to rising long trend.

2. Have there been signs of speculation? Yes, momentum and sentiment numbers for the general market have been exceptionally high. The number of stocks in sensational rallies has been reducing, typical of the end of a bull market. These, such as Amazon (AMZN) and Microsoft (MSFT), are being monitored for individual opportunity. When the hot leaders climax and fail is important ending action.

3. How sound is the basic story supporting the bull move? It is not so much the soundness of the story, it is that it is in the market. The Trump Rally has reached excesses in bringing the public in. It will take some time to implement a Great Reformation.¹

4. Aside from the Reformation, what about the underlying economic expansion? As weak as it has been, the expansion has been on since June 2009. On the Treasury curve, back to 1860, it need not invert to signal a recession. Just approaching inversion and then reversing has been enough to prompt a credit contraction. The action in the credit markets is not as clear as it was going into the peaks of March 2000 and October 2007.

5. On May 31, a “Hindenburg” registered. This involves the number of 52-Week Highs and 52-Week Lows, plus other stuff. While each signal has not been followed by serious liquidation, each severe liquidity problem has been preceded by a “Hindenburg”. One registered in June 2007 and on October 15, 2007. The last one was in July 2015.

Fundamentals

The bull market that completed in 2007 had the main features of a Classic Bubble and a long post-bubble contraction would follow. The key features include the worst credit convulsion in more than a generation then a weak recovery, accompanied by moderate rises in industrial commodities.

The first business cycle out of a Classic Crash is close to maturing and is vulnerable to a change in the yield curve, credit spreads and weakening industrial commodities. As the latter roll over, so will S&P earnings. Often in a completing boom, credit markets can reverse to adversity at “around June”. It is worth noting that there is no record of the senior central bank preventing the reversal that precedes a contraction.

Recently, there have been comments that the Fed has some room to cut rates, which would keep the good times rolling. The problem with this theory has been that shortdated market rates of interest go up in a boom and down in a contraction (???). The senior central bank, since the 1840s, follows the natural changes in market rates. Our focus now is the 1-Year Treasury yield to stop increasing.

Resumed weakness in industrial commodities would indicate reduced corporate pricing power and the ability to service an unprecedented debt load. This would show up in widening credit spreads, perhaps sufficient to get the attention of rating agencies. As indicated by NYSE margin outstanding, leverage is again popular.

In “normal” times the stock market leads the peak in the economy by some 12 months. One of the fundamentals of an era of inflation in financial assets is that the recession starts with the bear market. Stocks peaked in September 2007 and the recession started in that fateful December. Stocks reached their best in September 1929 and the recession started in August. The 1873 Bubble ended in September and as determined by the NBER, the recession started in October.

Exceptional Event

Commodities completed an outstanding boom in 2008 and for the last six months the duration of the stock boom has been fascinating.

This makes 2017, the ninth year.

There is a history of commodities blowing out and 9 years later, a stock boom concludes. Since the advent of modern finance with publically-traded stocks and central banking the pattern has occurred five times. The first pattern had the key years as 1711 and 1720, the conclusion of the South Sea Bubble. The last example was 1920 and 1929.

It is uncertain within the key year when this would conclude. Of course, it won’t complete without a speculative thrust.

The ChartWorks Presidential model has been calling for an important high in the lateMay to early-June window. This covers the first year following the November election.

Conclusions

The stock market is up when it should be and recording excesses that can’t be erased. So, the question becomes will the condition be eased by many years of flat markets? Or by some key failures that would prompt forced liquidation of suddenly unsupportable positions?

Suggesting a cautious decision, the change in the curve and spreads can be seasonal and completed by July-August. Industrial commodities have been declining since their highs in February. The US dollar is measurably oversold.

Speculation has not been recorded only in the equity markets. The Bond Bubble has been without precedent and the amounts issued can only be the result of a rare mania. The amount issued is likely too much for a flat economy to service, let alone a weakening one.

Most equity markets and lower-grade bonds markets are vulnerable to a serious loss of liquidity.

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​1 Please see American Spring, Bob Hoye, July 4th, 2016.