Markets Disconnected from Reality?

The S&P500 inched up another 1.2% last week, on even lower volume than the prior week. Volatility, meanwhile, dropped back down only slightly, but back near to the lows of the year. Complacency, it seems, has fully returned to the risk markets. Everyone, apparently, has bought into the belief that you should “buy stocks and other risk assets because the Fed has pretty much guaranteed that prices will go up, and at the very least, not go down.”

This is not the first time this type of conventional wisdom has dominated the markets. It goes without saying that in NONE of the prior occasions did this belief hold true in the long term.

There were only a handful of US macro news releases last week. Consumer credit, even though it’s being pumped out liberally by the US government via student loans and auto loans, disappointed. Initial jobless claims beat expectations, and wholesale trade figures met expectations.

But the trend line in the US economy is clear. Without a doubt, the economic growth is slowing to crawl speed. The leading indicators in particular, when averaged over the last three months, are pointing to a substantial slow down in growth. Meanwhile, most of Europe is—without a doubt—already in serious recession. Japanese growth is very weak. And Chinese growth is collapsing, especially if you follow the difficult-to-fudge figures in shipping and utility usage. Pay very little attention to official results—leading experts around the world are finding evidence that Chinese growth has been massively inflated not just recently, but for the past 20 years.

Technically, while the US stock markets are still in an uptrend on the daily and weekly charts, they are extremely overvalued and extremely overbought. According to John Hussman and his research which spans the last 100 years, when both these conditions are met, losses—-not just low returns—-are virtually guaranteed to follow in the future.

So why are stock prices in the US soaring when the economy in the US has been slowing, not just lately, but for the last 12 months or so?

Well, anyone who claims to have the definitive answer is most likely wrong. While there are many plausible theories, nobody can know the exact answer with 100% certainty.

An internationally recognized authority on markets, Marc Faber, also doesn’t know for sure when he states:

“In the 40 years I’ve been working as an economist and investor, I have never seen such a disconnect between the asset market and the economic reality… Asset markets are in the sky and the economy of the ordinary people is in the dumps, where their real incomes adjusted for inflation are going down and asset markets are going up…”

But his opinion, guided by history, on what can go wrong must be respected:

“What was the trigger of the ‘87 crash when markets fell 21 per cent in one day? What was the trigger of the Nasdaq crash in 2000? What was the trigger of Japanese crash of 1989? What was trigger of 2007 crash that brought global stocks down 50 per cent?

We don’t know these things ahead of time, but something will always move markets up and something will always move them down.

…. Something could come along, geo-politically or otherwise. I would be very careful being overweight equities.”

And most importantly, we should pay attention to his conclusion:

“Something will break very bad.” 

 If history is any guide, yes it will……break very bad.




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