Was that the Pinprick?

Daniel Shainberg
October 12, 2018

The art investor and collector community was stunned last week when immediately after Sotheby’s completed the auction of Banksy’s Balloon Girl the piece started self-destructing. Of course the notoriety of the surprise is believed to have actually increased the value of the piece! One might call it “art in motion.” 

Unlike Balloon Girl, the economic bubble will eventually pop, and it won’t increase the equity value of its stakeholders. 

  

The big debate currently roiling the financial news is whether or not the spike in volatility this week was the pinprick that will bust this cycle’s bubble or just standard volatility that re-entered the markets after a dull “low-vol” start to 2018.

• Peter Schiff: “The Recession is Coming”

• Howard Marks: “No Signs of an Imminent Correction or Crises”

• Ray Dalio: “War With China is Coming”

• Jeffrey Gundlach: “Something Bad Must be Happening”

• Larry Kudlow: “Normal Correction in a Bull Market”

• Scott Minderd: “More Inflation in the Pipeline”

• Mnuchin: “Yield Curve is Normalizing”

Everyone wants to predict where the market is going. It makes us sound smart. Of course nobody knows…. At least in the short term. 

The technical crash through the moving averages is not a good indicator for those bullishly exposed. The fact that the global markets have been rocked year-to-date while the U.S. was an outlier until this week likely as a hangover from the Trump tax cuts is not a good sign. The elevated level of volatility as measured by the VIX index is not a good sign. The likelihood that the move down is correlated to rising rates is not a good sign either.

As we noted in yesterday’s podcast, if the market is starting to reflect the anticipation of higher rates, then equities will demand a spread commensurate for its higher risk. And with the 10 year on a straight trajectory to 4% within the next 12-18 months, equities simply cannot trade at 20x earnings unless justified by material economic growth. And that just becomes a harder and harder sell when the economic growth we have been experiencing was largely due to one-time tax cuts, one-time global-trade wins upon the threat of tariffs and an end to the interest rate cycle. Nobody can predict daily moves or accurately predict where the market’s are heading next week. It’s just too tough. But when you consider all of the noted artificial stimulus that buoyed the market up, and the fact that they are all turning now, it just gets harder and harder to believe this bull cycle is just witnessing a bump in the road. And we haven’t even discussed margin debt!

Dallas Fed Chief Robert Kaplan recently addressed NYSE margin debt as it hit another record high. The reason this matters so much is that when markets tank, investors with margin exposure become forced-sellers. The lenders require them to liquidate their equity positions to repay their loans as their assets drop below minimum coverage ratios relative to their liabilities accounts. This has the effect of magnifying market selloffs. It becomes an excellent and ripe ground for value oriented investors, but only once the full brunt of the forced-selling waves is complete.

While we have listed true market indicators in this newsletter previously, NYSE margin debt reversals are excellent warning signs to the next bear market. Even FINRA warned in January that investors may be underestimating the risks. The chart below shows how the current market cycle could see a record forced-selling blowout as NYSE margin debt is ~50% greater than the peak of the 2008 market precipice. 

Dan Shainberg

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#RecessionResister
@DanShainberg