This Stock Market Decline: The “Real Deal” Or Just Another “Head-fake” Bear Trap?

Is this stock market decline the “real deal” (that is, the start of a serious correction of 10% or more) or is it just another garden-variety dip in the long-running Bull market?

The above introductory comments are edited excerpts from an article* by Charles Hugh Smith (peakprosperity.com) entitled Is This Decline The Real Deal?Or just another head-fake bear trap? with additional comments related to the price of physical silver from an article** by Gary Christenson (deviantinvestor.com) entitled The Big One – 2014 Version – Maybe. 

The following article is presented courtesy of Lorimer Wilson, editor of www.munKNEE.com (Your Key to Making Money!),  and www.FinancialArticleSummariesToday.com (A site for sore eyes and inquisitive minds) and has been edited, abridged and/or reformatted (some sub-titles and bold/italics emphases) for the sake of clarity and brevity to ensure a fast and easy read. This paragraph must be included in any article re-posting to avoid copyright infringement.

Smith goes on to say in further edited excerpts:

Let’s start by looking for extremes that tend to mark the tops in Bull markets.

Many analysts have posted charts depicting these extremes, and perhaps the one that [best] distills the multiple extremes into one metric is Doug Short’s chart [below] of the S&P 500’s inflation-adjusted Regression to the Trend, another way of saying mean reversion or reverting to the mean, in which I have added two red boxes: one around the peak reached just before the Great Crash of 1929 (81% above the trend line), and one around the current reading (86% above the trend line).

That the current reading exceeds the extreme that preceded the Crash of 1929 should give us pause and little comfort should be taken that the bubble of 2000 reached even higher extremes, as that should likely be viewed as an outlier rather than the harbinger of the New Normal.

What the above chart demonstrates is the market tends to overshoot to the upside or downside before reversing direction and once again reverting to the mean.  Other than a very brief foray below trend line in 2009, the S&P 500 has been at or above the trend line for the past 20 years. While the Gilded Age boom of a century ago stayed above the trend line for over 30 years, more recent history suggests that markets that stay above the trend line for 20 years are getting long in the tooth.

Extremes in Risk Appetite and “Risk-On” Asset Allocation

One measure of risk appetite is junk bond yields, which as Lance Roberts shows in the chart below have reached multi-year lows:

Money managers’ appetite for the “risk-on” asset class of equities is similarly lofty:

Previous readings near the current level preceded major stock market declines—though high readings have been the norm for the past few years without presaging a major drop.

Can Extremes Be Worked Off Without Affecting Price?

From the Bullish point of view, these extremes have been worked off in relatively mild downturns in the seasonally weak periods of February to April and August to October:

Let’s look at a chart of the S&P 500 (SPX), with a focus on the seasonally weak periods:

Rather significant declines in indicators such as the MACD have translated into relatively brief, shallow declines.

From the Bull’s perspective, all the extremes in valuations, sentiment, leverage and complacency have been worked off in modest declines that haven’t reached the 10% threshold of a correction – so why should the present period of seasonal weakness be any different?

One potential difference in August 2014 is the sheer number of current financial/market extremes  which analyst John Hampson has prepared in the following list ofall-time records delivered in 2014:

1. Highest ever Wilshire 5000 market cap to GDP valuation for equities
2. Highest ever margin debt to GDP ratio and lowest ever net investor credit
3. Record extreme INVI bullish sentiment for equities
4. Record extreme bull-bear Rydex equity fund allocation
5. All-time low in junk bond yields
6. All-time low in the VXO volatility index (the original VIX)
7. Highest ever cluster of extreme Skew (tail-risk) readings in July
8. Highest ever Russell 2000 valuation by trailing p/e
9. Lowest ever Spanish bond yields
10. Lowest ever US quarterly GDP print that did not fall within a recession

​And this week:

11.  Lowest HSBC China services PMI since records began

12.  Lowest ISE equity put/call ratio since records began

If we had to summarize the current set of extremes in risk appetite, valuations and sentiment, we might state:

• the Bear case as: These extremes characterize the tops of asset bubbles that inevitably deflate in dramatic fashion, despite the majority of participants denying the asset class is in a bubble.
• the Bull case as: The fundamentals of low interest rates, abundant liquidity, slow but stable growth and rising corporate profits support current measures of value, confidence and risk appetite.

…The prudent observer would also ask: Have stocks been pushed to their current valuations by these extremes, or are these extremes merely temporary spikes of exuberance that have little to do with the fundamentals driving valuations higher?

The abovequestion is critical because:

• if extremes in risk appetite and sentiment have underpinned the market’s rise, then as these tides recede, price will inevitably follow.
• If these extremes are merely temporary spikes that can dissipate without effecting price, then we have to ask: If this is the case, then what are participants afraid of?

We know participants are afraid of something, because the Put/Call Ratio—a measure of participants buying hedges (put options) against a downturn—has skyrocketed to a multi-year high in the past week:

This ratio has traced out a declining channel for the past two years. If nothing fundamental has changed, then what are we afraid of right now?

The Challenge To The Bulls

Those who are confident in the Bull case—that rock-solid fundamentals will drive stocks higher—have a daunting task ahead:

• they need to explain away the obvious spike in fear/caution, and
• they need to explain why all these extremes in valuations, sentiment, leverage and complacency have no real bearing on the rock-solid fundamentals and
• they must also explain why their rationalizations (of why extremes don’t matter) don’t mark this as the top of an asset bubble that is remarkably similar in terms of extremes to recent bubbles in housing and stocks.”

*http://www.peakprosperity.com/blog/86490/decline-real-deal (Copyright © 2014 Whitney Peak Ventures, LLC. All rights reserved. )

Editor’s Note: The author’s views and conclusions in the above article are unaltered and no personal comments have been included to maintain the integrity of the original post. Furthermore, the views, conclusions and any recommendations offered in this article are not to be construed as an endorsement of such by the editor.

Silver & Gold

Now think of the regression to the mean arguments above and apply them to silver and gold. Note the following chart of silver, the red “mean line” as I have drawn it, the extent that silver prices have fallen below that line, and the over-sold conditions on the monthly chart as shown by the StochD and TDI_Trade_Signal indicators.

CONCLUSIONS

Yes, a “big one” could happen. Stocks look over-priced, gold and silver look “beaten down,” the global credit and currencies bubbles could implode, global derivatives are a potential disaster zone, and our politicians seem intent on creating distractions, “false flags,” and new ways to enrich the military-industrial complex and bankers.

Be careful.

Editor’s Note: The author’s views and conclusions in the above article are unaltered and no personal comments have been included to maintain the integrity of the original post. Furthermore, the views, conclusions and any recommendations offered in this article are not to be construed as an endorsement of such by the editor.

**http://deviantinvestor.com/6170/the-big-one/

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