The Mystery Spot Top

By Kevin Muir of the Macro Tourist

Over the past couple of years, stock market bulls were often portrayed as knobs who “didn’t get it.” Many portfolio managers wrote eloquent pieces about the un-sustainability of the stock market rise. Former corporate raiders created elaborate websites warning of the DANGER AHEAD! Hedge fund wise guys made compelling presentations that made you want to run out the door, sell all your stocks, put it all into 30 year stripped treasury coupons, and wait for the repeat of the 2008 credit crash (only worse according to them). If you dared suggest maybe their theories might be flawed, you were labeled a luddite who did not understand the massive imbalances in the global financial system.

Well, I contend too many pundits were using previous cycle playbooks for an environment that looks nothing like the past few decades. When the Great Financial Crisis hit, we entered a new period. Investors would be better off reading Richard Koo’s works about Balance Sheet Recessions that most of the research produced on Wall Street.

All along the way, there has been no shortage of forecasters calling for a top of the stock market. Yet each and every time, the Market Gods have made fools of anyone who doesn’t simply accept the inevitability of BFTD.

I say that sarcastically because contrary to popular belief, we will have a bear market (or at the very minimum, a dip that scares people). And I guess this is the point I would to make. Whereas six months ago I found that writing bearish pieces was too easy, it’s almost the opposite situation today. Bearish posts are now much more rare, and most importantly, they are scoffed at. A feeling of an inescapable stock market rise has emerged from even the most ardent bears. Practically no one is calling for a top. Everyone is too scared of looking stupid.

I am not scared about looking stupid – I manage it all the time.

For me, one precondition for a stock market top has been the abandonment of the excessive pessimism. I didn’t need the opposite extreme with a 1999 style exuberance, but the bears needed to throw in the towel. I have no proof that this has happened, but this weekend, I was listening to a famous hedge fund manager who is quite bearish. He explained all the reason for his bearishness, and then went on to say everyone was calling for a 1987 October crash, so that made him predict a melt-up before the inevitable crash.

Maybe that’s as good as we get. Maybe that’s rampant bullish for this crowd.

I don’t know why this hedge fund manager thinks everyone is calling for a 1987 October crash because in my books, sentiment feels about as bullish as any time over the past few years. Even the bears seem to be pulling a Chuck Prince and staying for one more dance. Yeah sure there are those purebred perma-bears who will never change, but ignore them. Looking at investors who actually alter their investment forecasts, I think we are at full-on bullish. Everyone thinks they are outsmarting everyone else by trading from the long side.

Trading these days is tough. There aren’t nearly enough dentists anymore. It’s difficult, but today often the best crowd to fade is the hedge funds. And I think they are long stocks. Maybe I am wrong. Maybe we are about to spike higher. Maybe this is the start of the final 50% of the price move that occurs in the last 10% of the time. Yet, every time I have felt like I am all alone in a trade with the hedge fund guys on the other side, it has proven to be the right trade.


Why now?

I know I am going to get all sorts of questions about why now? How can I be sure that this is the top?

Well, I am not sure. Not even close. But I know that implied volatility is extremely low, and I can buy a put position for dirt cheap. And given sentiment, I think we are due for a rolling over.

Yet, the main reason I am bearish is that inflation is coming back.

Look at this morning’s ISM Prices Paid release. Consensus was for a reading of 63, but it came in at a blistering 71.5!

Remember, over past few years, what has been the end result of economic weakness? Why, more monetary easing (or at least a slowing down in the pace of tightening.)

That is why I have always said this bull market will not end with economic weakness, but instead with economic strength.

The true end game occurs when the economy rips higher, along with inflation, and the Central Banks lose control of the bond market (™ Fleckenstein Capital).

If we get a Trump tax cut, along with the Japanese & ECB quantitative easing kicking in, there is a decent chance the global economy could uptick. Growth, and even more importantly, inflation might outperform expectations in the coming months. And if that is the case, it is a terrible development for the stock market.

We have gone up for the past nine years on moribund growth and low inflation. Why wouldn’t the exact opposite not cause a decline?

Everyone complains Central Banks are busy propping up the value of equities through their quantitative easing, but why aren’t they worried about the conditions that will bring about the end of those programs? As far as I can see, if you are an equity investor, the last thing you should be hoping for is economic strength. The moment that happens, the world’s biggest buyers will put away their blue tickets.

Anyways, these are kind of pie-in-the-sky theories, but I am willing to bet I finally found the spot. Many of us have valiantly searched for it, but the fumbling in the dark has always proved elusive. I know all too well that it is a low probability event. What are the chances that I nail the top? Pretty dismal, but with the confidence of a naive teenager, I am going to put it out there – this is the mystery spot top. And if I am wrong, you won’t be my first disappointed partner.

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