This Financial “Seismograph” Signals A Monetary Earthquake

by Taki, Secular Investor Stock markets in the U.S. are trading approximately 2% from their all-time highs, the German DAX has slightly retraced from its all-time highs, the Nikkei index in Japan has almost surpassed its 2000 highs in recent days, the Shanghai stock index used to be a laggard but is making up at an incredible pace (currently trading at 7-year highs). Indeed, it feels like nothing can go wrong. We are not yet in bubble territory, and the market is not setting up for an implosion as it did in December 1999 or July 2008. However, we are in the midst of a monetary bubble, driven by an explosion of the monetary base and an implosion of interest rates. Paper assets, as opposed to hard assets, have been pumped up by the liquidity that is being funneled into the economic system and the markets. But exactly that perception that nothing can go wrong is so dangerous. The number of divergences in the system is becoming mind-boggling, a red flag for secular investors. Economic activity is not reflecting the performance of the stock market at all, or vice versa. The headline figures all seem to tell a recovery story, like consumer confidence which is back at pre-crisis levels, or the unemployment rate, which is seemingly ok. Nothing new so far. However, deepdiving into the world of economic data proves otherwise. Case in point: close to 50 economic data points which are highlighted in this “chartfest” (from Ed Yardeni) learn how shaky the recovery is. We have chosen three charts to justify our point of view. The global growth barometer has collapsed in 2014. It was undoubtedly driven by the oil market collapse. Low commodity prices are no sign of economic health. SI Global barometer 2015 Potentially more concerning is the economic surprise index by Citigroup reflecting the direction and level of economic surprises. If it rises, it means that economic data are on average better than expected (positive surprise). Currently, it shows a negative reading similar to the depths of the 2009 crisis. SI Bloomberg Economic Surprise Index 2015 One example of a negative surpise is the profit cycle in the U.S. The indicator used for the profit cycle is the forward earnings of S&P 500 companies (red line in below chart). Forward earnings are highly correlated with industrial production, and both are clearly in decline since 2011. That is playing out while the U.S. stock market is reaching one all-time high after another. SI S&P 500 forward earnings 2015 So far, these divergences have not resulted in a meaningful correction of stock and bond markets. Mainstream investors have gotten at the point of “acceptance of the new normal.” And rightfully so, because why worry if markets are climbing higher, indicating that everything has to be ok? The acceptance of the new normal is the most worrisome fact for investors. And that is exactly the time when things mostly take an “unexpected” turn. One of the most reliable indicators of stress in the financial system is the TED-spread. It should be considered as a “seismograph.” It telegraphs that something is brewing under the hood. Its long-term chart below shows that there were plenty of signals in 2007/2008 that telegraphed a significant correction. Although the TED-spread has not generated any extreme readings, a clear rising pattern is unfolding, as evidenced by the five-year chart. Note that the rise started a bit after QE3 ended (in our words: QE infinity). The TED-spread has broken through a first resistance point (lowest red line) and is approaching a second one dating back to the end of 2012. That does not bode well. Continue Reading>>>

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