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July 21, 2017

Close to a Market Top?

As the S&P 500 approaches another significant milestone at 2500 we must ask the obvious: Are we near a market top?

The answer is YES from David Know Barker, whom I regard as by far the world’s top expert on the Kondratieff Wave cycle. I have subscribed for almost four years to his service at his Market Cycle Dynamics website and have also read his magnum opus on K-Wave theory titled Jubilee on Wall Street. His quarterly reports are so technical in nature but also provide objective fundamental analysis too. I have studied KWave theory since a course I took in college in 1982 and I never seen anything even close to his superb work and I would strongly suggest that our readers give serious consideration to signing up with him too.

Let me summarize his findings for you now. Like so many he believes we are now at a market top primarily because the scale and scope of the massive global debt cannot endure and will crumble under its own weight. But unlike so many he has resisted for so many years any calls for a market top unlike practitioners of the Elliott Wave theory or even long wave (K-Wave) theory. My respect for him stems primarily from this resistance to call a market top despite so many reasons beyond global debt, i.e. sub 2% growth, multiple expansion, the Eurozone crisis, our own S&P debt downgrade and so much more. It also comes from such a great attention to detail provided from his objective analysis.

Barker has maintained in his quarterly reports for the past several years what he refers to as his Level 1 grid target for the S&P would be 2486. This target is derived from the sacred geometry underlying Fibonacci mathematics. The origin of the Level 1 target was derived from the September 1982 lows in the S&P at 100 and the Dow Jones average at 777 combined with the low of 666 on the S&P on March 9, 2009. Although the US economy bottomed out a few months later, the market bottomed first. Let’s remember that the same idea works in vice versa so the markets going forward should top out long before before the economy does. This reflects the forward looking nature of all capital markets.

I have referenced Barker’s work several times in my monthly and quarterly posts for the past several years but I felt it prudent to devote a special post today on this exclusively given that we are less than one half of one percent away from his level 1 grid. I want our readers to understand however that it is not impossible for the S&P to go a little higher than the 2486 in what is known technically as an overthrow.

But I will say now that historically any technical overthrows are very small and very brief. Thus given all of the above I will do something now in my post that I have refused to do for many years- say that a long term top is very close and it is now safe for my clients and any of our like minded readers to venture out in either shorting any of the three major indices or even a particular stock or perhaps even better buying a short ETF that is very liquid and trades on the New York Stock Exchange. The risk/reward parameters today make these levels an extremely good entry point for taking on such a posture.

As we all know it has been harmful to one’s financial health to short the markets in the past 25 years except for a very brief period from February 2007 to early March 2009. Ultra-loose monetary policy by central banks never seen in the form of low interest rates and QE combined with even larger growth in fiscal deficits from state, local and the federal government since then has accounted for the lion’s share of those massive gains. There has been no public outcry yet because the increased debt levels have not materially impacted the average person too much. They typically don’t until they do, and by then it would happen in a remarkably swift and ferocious way.

It is this dynamic that has allowed the VIX, or the volatility index to plunge from 43 at during the financial crisis to under 10 today. Such a plunge in the VIX should be seen as a contrarian indicator that may embolden someone to consider shorting this market. Ask yourself if it feels right.

So here’s the view from 10,000 feet.

We have a market at all-time highs that has moved up since 1982 in lockstep with the explosion of global debt. It is estimated that in 1982 aggregate global debt was under $10 trillion USD and today it’s calculated accurately at $217 trillion and growing at an unsustainable pace. In a world where few can agree on anything this notion of un-sustainability really stands out and it also enjoys a prohibitive consensus.

We must also remind ourselves of what exactly happened in early March of 2009 to mysteriously reverse nine months of utter doom into the greatest bull market of all time. Was it QE or ZIRP? Nope. Was it a promised bazooka from the Obama administration to spend our way out of that recession?

Nope. Instead it was an archaic, technical provision from FASB, the ruling body in accounting that won the day. Rule FSP FAS 157-4 was proposed on March 12, 2009 and soon passed. As is often the case on Wall Street investors, expecting a possible panacea just days away and knowing that the markets to date had declined 58%, they chose to bid up the market a few days earlier in anticipation the regulators would not dare deny the proposed fix needed at that moment, never mind that such a move would run counter to every principle of general accounting principles.

What we are left with to day is the proverbial mark to fantasy approach (versus the proper mark to market approach) taken by the top six money commercial banks in how they value their non performing loans. Why is this so crucial?

Under federal regulations such bad loans would have to be written down to their fair value. In doing so banks would then be forced to raise several trillions of dollars to meet their Tier 1 capital requirements and given that many of these banks were under $10/share and some under $5/share any needed capital to be raised would have diluted their shares ad thus would have destroyed their capital base and eventually lead to bankruptcy.

This is so because under the reserve lending system employed by the Federal Reserve banks are only required to maintain a deposit base that is a tiny fraction of their potential liabilities. That is why they must maintain at least the minimum requirements set forth i those Tier 1 capital requirements at levels deemed by the Federal Reserve to be sufficient in maintaining order within the commercial banking system.

Many, included myself, believe those emergency measures were needed at the time because without them there is no doubt our entire banking system would have collapsed. This FSP FAS 157 rule change was actually far more powerful than QE or ZIRP because neither of those would have saved the banking system, they only enhanced the stock market. Only an unambiguous abandonment of the ethical principles that underpin accounting could have done that.

The problem however is that when the economy and capital markets improved in 2010 these rules did not revert back to their longstanding tradition. Here greed took over and these rules remained in place even today, severely misrepresenting the health of our banking system for the sake of the stock market. Let’s remember that many of the mortgage loans taken out from 2005 to 2007 are still underwater but you would never know that from their financial statements.

Very few people, even most stockbrokers, truly understand what really happened in March 2009. I would urge our readers to research this for themselves and determine if I am overstating the significance of FSP FAS 157-4 or if I am delusional.

Also worthy of note is the pace of market gains since the 2016 election. Initially the Trump victory induced much fear in the market averages as Europe cratered and the Dow Jones futures plunged some 400 points in the overnight session that night.

But against the prevailing sentiment at the time the market staged a remarkable rally on November 9th, holding in disdain their typical fear about the decidedly uncertain outcomes a Trump presidency would bring in favor of the benefits that massive tax cuts and deregulation would bring to the economy. After six months in office one thing is clear- the negatives of uncertainty inherent with Trump have proven all too real while the perceived gains from tax reform appear to be dead on revival.

Perhaps investors are still hopeful of a miracle there but next week’s promised vote on a repeal of Obamacare by Senate Majority leader McConnell could put a fork in that pipe dream. And that could serve as the pivotal catalyst for a reversal that would jibe very nicely with Barker’s financial forecast.

Amazingly, the rate of debt explosion closely mirrors the pace of gains in the broadest measure of stocks, the S&P 500. (Wilshire 5000 is not a good measure for this piece now because it includes so many foreign stocks).Debt has exploded around 22 times and the S&P has exploded 24 times. Can’t get much closer than that, especially over such a long period. We have the US and global capital markets, both stock AND bonds, going up in straight line for 24 of the past 25 years since 1982. And despite global debt now at such stratospheric levels, levels at $217 trillion that human minds just simply cannot quantify, we have a Price earnings multiple expansion that has exploded to historical highs through purely artificial means in monetary and fiscal policy.

It is widely perceived today that one can only make money in stocks alone given that returns on fixed income are net negative on a real inflation adjusted basis.

Doesn’t it just sound to you that the elements above provide the ideal backdrop for a market top?

Feel out your intuition on this and decide what’s best for you.

One Response to “July 21, 2017”

  • Stan

    I do plan on doing that once the markets begin to fall. The overall theme has been steady for a few years now with QE being the dominant force in the global markets. I did do a report on July 21at and another one yesterday


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