Standing Clear of Today’s Crowd

I was asked the other day what I thought about the Gulf of Mexico oil spill and whether it would impact the markets in a negative fashion.

We see such questions posed every day. Looking for the edge, today’s market participants of every stripe, from the professional to the casual investor with his discount brokerage account, seek out and chop up news items every which way and trade based on the interpretation that rules the day.

Consequently, strong buying following a news story or government statistic may lead to more buying, since it could motivate sidelined, like-minded investors sitting on the edge of their seats, to click the “buy” button.

That is how multi-week or multi-month rallies get started. The same mechanism works in the other direction as well, with price declines triggered by negative news stories.

But while such strategies may satisfy short-term position traders, they don’t generally mean much in terms of the larger trend in the markets.

In my opinion, the rally from the market low of March 2009 has been a cyclical bull run within a larger trend, that being a secular bear market. Should we have expected anything less from the hundreds of billions of dollars of cheap money sloshing around the world for the past year?

That larger trend turned bearish in 2007-2008, with the onset of a deflationary wave that I expect to last many years. The first leg down of that deflation arrived with devastating force and put in its first bottom in March, 2009. The bounce-back rally since that time appears to be coming to an end.

We entered a deflationary wave because debt levels became so great that debt service exceeded the collective ability of debtors to repay. A necessary deleveraging followed, which was necessary to reduce debt levels and free up capital with which to service the debt that remained. That is the hallmark of deflation.

Deflation and deleveraging therefore go hand in hand. Deleveraging wasn’t a result of some random act, like a one-time irrelevant news story affecting short-term trading.

For deflation and deleveraging to occur, there needed to be many years, decades even, of debt build-up to unsustainable levels. I believe that when all is said and done a few years from now, it will be shown to have been a textbook result.

The European debt crisis is simply a continuation of the deflation and deleveraging. It is still very early in that deflation process, however, one that ultimately takes us much lower in the markets but with intervening periods of bull market rallies.

It is important therefore to understand where we are along the larger trend and stay clear of the daily price action, which in my opinion is sending more false signals than ever before.

The market is a treacherous place made even more so of late by the hundreds of hedge and quant funds looking to outwit each other for fractions. Whether rising prices make any sense is irrelevant so long as a profit is made. Sounds familiar?

These entities now account for a large portion of daily volumes, and for all intents and purposes are the market and the crowd. It seems to me that where we once had quality guards, we now have inmates running the asylum, which underscores the unreliability of the current market’s message.

I suppose much like the debt bubble, today’s market participants and their machinations are taking the market along an unsustainable path. That leads me to conclude that one way or another, when this all comes to end, it will be a sight to behold.

Readers are advised to do so from a safe distance.

Email the writer: