The Deflating Bubble of Everything

The Deflating Bubble of Everything

The deflating bubble of everything could now be playing out…

It is the most overvalued stock market in history by whichever matrix you wish to use. Bonds, particularly European bonds are in a bubble also. For example, European junk yields are now lower than that of US Treasuries.

Is Euro junk debt less risky than US Treasuries?
It underscores the fact that Euro junk bonds are so overbought, they too are in a bubble.

Moreover, when you compare earnings to real estate prices, particularly in the main capital cities you’ll also conclude that real estate is in a bubble too.

Everything is in a bubble

Perhaps what is now on every trader’s mind is whether the main central bank, the Fed is about to deflate the bubble of everything?

Unprecedented central bank liquidity, post-2008 financial crisis, which could have amounted to well over 18 trillion USD has sent asset prices to historic price levels.

The major central banks, particularly the BoJ today have blowout balance sheets, they are now by far the largest owners of assets, including stocks.

But when one major player accounts for the majority of trading volumes then assets price are no longer determined by free market forces, to put it bluntly, price discovery is today irrelevant.

So what then is the current main driver of asset prices?
The invisible hand of free-market capitalism used to be the market, today it has become the central bank. It is the paradox of free-market capitalism of our age. We no longer have a market.

Put another way, asset prices have become a function of the central bank’s balance sheet and Quantitative Easing (QE- which is the amount of liquidity that the central bank pumps into financial markets through its bond purchasing program). In other words, asset prices are centrally planned by the central banks.

So if you are gaming these “markets” that is pretty much what you need to know; the size of the central bank’s balance sheet and amount of QE going forward.

But it is like giving an exam to students, supplying them with the answers, then go outside the room. The results would most likely be that everyone passes, in fact, most students would probably get full marks.

So it is no surprise that if central banks are being assessed on their ability to keep assets prices bullish (because it suits their business model) then they too will cheat, bearing in mind that there is little or no accountability. Think about it. Does anyone audit the central bank’s balance sheet?

The central bank will do whatever it takes, create as much fiat currency as required to keep asset prices high. In fact, they have gone overkill on fiat currency creation and we have ‘the deflating bubble of everything’. It is indeed a stock bull market by default.

The Dow has set 72 new record closing highs (October 2, 2017)

While we are seeing some good news on the fundamental front. For example, the 261,000 US job gains in October it is unclear whether this is a long-term trend or just noise, in other words, hurricane inflated.

Moreover, Trump’s tax cuts could also provide some tailwind for stocks going forward.

But let’s get back to front-loading the central bank’s next move (which is what trading these markets have become).

What do the central bankers want?
They want to maintain price stability without destroying their most lucrative business model on the planet, fiat (debt) money.

It is for the latter reason why monetary easing cannot continue indefinitely. The fed fund rate is unlikely to be left artificial low for an indefinite period because it would create a proliferation of zombie companies which survive not because they have viable business models but because of this life support machine of artificially cheap money.

Furthermore, the proliferation of bad loans would destroy the value of debt which is also (fiat) money and that could also trigger a monetary crisis.

Moreover, the central bank is probably concerned about creating asset bubbles in the wake of this unprecedented monetary easing.

So the best time for the central banks to deflate the bubble of everything is likely to be as soon as the fundamental show signs of improving (or at least appear to be picking up).

Unless you are a fly on the wall of the monetary committee’s meetings then the only heads up is likely to come from the technical analysis (internal link) which can be a useful tool to help traders front load the central bank’s next move.

What is the technical analyst’s view of the deflating bubble of everything?

The mainstream keeps talking about record stock prices. But when you look at the charts you see a very distinct pattern emerging. The rally in stocks appears to be deflating from within.

Only 56% of components are still above the 50MA.

It’s a similar story on the $SPX. Moreover, all recent highs have come on a negative $NYMO.

The take away is that someone is selling this market every day without wanting to disturb the market’s stability.

If that somebody is the central bank (and it seems very likely) then this bull market in stocks could be on its last legs. In short, the deflating bubble of everything could be about to play out.

Could this be finally a market top?
Maybe.

Time will tell…