Is There Reason to the Market's Rhyme?
Was last Thursday's large range reversal a sign of a turning point at the anniversary of historic highs and lows?
Can make a Heaven of Hell, a Hell of Heaven.
--Paradise Lost (John Milton)
Better to reign in Hell, than serve in Heaven.
--Paradise Lost (John Milton)
At the heart of all beauty lies something inhuman, and these hills, the softness of the sky,
the outline of these trees at this very minute lose the illusory meaning with which we had clothed them, henceforth more remote than a lost paradise... that denseness and that strangeness of the world is absurd.
Take me down to the paradise city
Where the grass is green
And the girls are pretty.
--Paradise City (Guns N' Roses)
People love a reason. Unfortunately cause and effect are almost always rooted in people's emotions. But that never arrested the appetite or impeded the quest for men to anchor their actions in a sea of belief – no matter how imponderably imponderable those beliefs may be.
Man values a ruling reason. To underscore how deeply man abhors a paradox and prays for a paradigm, all one has to do is look at the history of war: most wars have been waged over a set of beliefs and in the name of religion.
But the forces that shape the world defy logic. The forces that shape the future rely more on art than science. If a computer model could solve the mystery of the market and forecast its course, it would have been developed long ago.
Going into the top in 2000, the paradigm then was the brave new world of the Internet and technology, much like the hundred-plus stocks in the auto industry were the one-decision names to own in the 1920's. Ditto stocks in the airline industry that have never been the stuff of a profitable portfolio for long. The industries certainly changed the future, but most of the stocks in the auto industry of that era long ago fell by the way-side. Another shattered investment paradigm was the Nifty-Fifty theme of the early 1970's with one-decision names to own such as Eastman Kodak (EK) and Avon Products (AVP).
Where is today's brave new paradigm to justify the current love affair with equities? First and foremost it's the belief that the baton of growth has been handed from the West to the East and that Asian growth will fuel globalization. Is that much like the West was leading a wave of permanent prosperity in the 1920's? Moreover, the new Asian growth story is an echo of the Japanese equity bubble in the 1980's. Been there, done that.
As for the bullish backstop in the U.S. equity argument, the argument is that U.S. stocks will find the buyer of last resort on the premise of Sovereign Wealth Funds. These are funds structured by nations to presumably diversify partly out of U.S. Bonds and Treasuries and into U.S. equities. But the falling dollar suggests that these Sovereign Wealth Funds may look elsewhere for much of the investment of their excess cash.
Backstopping the argument behind the argument to own U.S. equities is the idea that if all currencies are becoming debauched, the logical course of action is to invest in tangible assets. So the conundrum is whether a corporation is actually a tangible asset. Perhaps. Perhaps the means to produce owned by some key corporations are tangibles. But, if that's the case then two questions must be addressed: is no price too expensive to pay if paper currency is going to Hell in a hand basket? And secondly, at what point does ownership by Sovereign Wealth Funds in a corporation with the means to produce by an international investor interfere with strategic and national interest?
What is tangible and what is intangible value?
When I got into this game in the early 1980's, I was taught by my mentor at Drexel Burnham that disinflation favors intangible, paper assets such as equities while inflation favors hard assets. Today the world is upside down. Today we live in a smorgasbord of asset inflation. Money flows where money goes. We're living in a world awash with money pumping up the value of everything – a world exploding at the seams with liquidity. Be that as it may, then, it's ironic how one of the great tangible assets that they're not making any more of, real estate, managed to meet up with the day of reckoning.
One has to take a parallactic view and wonder why the powers that be continue to pump up the money supply. Is it because they know the U.S. situation is so fragile so as not to be able to withstand a normal recession?
Who knows how long the current Bullish Paradigm Piñata can float or what will puncture it, but it won't feel like pennies from heaven or Willie Wonka's bid factory when it occurs.
Some say the stock market was more overvalued than it ever was prior to the crash of 1987 and that stocks have a much more stable foundation now then in 1987. Perhaps, but it seems to me that a bull market in complacency against a backdrop of extremes in oil, gold, real estate, currency dis-intermediation, dislocation in the credit markets, derivatives, quant funds, more complex computerization and interconnectivity in the financial fabric makes for more, not less, potential dangers and the possibility of rain over Paradise City.
That being said, this week, the anniversary of the October 1987 crash sees that the S&P has doubled from the advance that began in March 2003. Last week, as one Minyan pinged me, saw the S&P up 212 points in 212 days from this year's March low: another sign of a potential square out and turning point? Was last Thursday's large range reversal a sign of a turning point at the anniversary of historic highs and lows?
Did Thursday morning's spike to a new high signify a misdirection day on the Thursday the week before options expiration Friday? Was Friday simply a pause day before continuation to the downside? If so it is notable that there is a Head & Shoulders Pattern on the hourly chart of the S&P with a neckline at 1550ish, which if broken projects to around 1525ish.
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