The Eminis are (hopefully) about to bag their own Butterfly Pattern. It’s been an obviously “managed” march higher, with very few wiggles in either direction — not exactly the sort of market one encounters “in the wild.”
I could go on. But, the bottom line is that just about every index and instrument I follow is at a turning point. As we’ve discussed many times before, this is not a guarantee that markets will tank overnight. There are huge, moneyed interests that will obviously throw everything they’ve got at this market in order to preserve their gains/prevent any losses — if it suits them.
With a big fat gain in the books for 2013, their bonuses are secure. They can afford to let a little air out (after positioning themselves, of course) and reset sentiment, breadth, etc — again, if it suits them.
Those who aren’t members of TPTB (including yours truly, quite obviously) might take the opportunity to book gains and raise cash in the event we get any volatility at all in the next few sessions. But, I’m certainly not expecting a steep plunge overnight (wouldn’t mind it, though.)
After that, though, things might get very interesting.
A good friend recently asked me if I was feeling better about the economy, given all the positive news. Hardly. Much of the good news is more fabricated than ever. Most of the rest is the by-product of the enormous amount of cash still being pumped into the markets.
Insurance companies, pensions, banks (especially banks) and 1%’ers around the world have to put all that cash somewhere. As long as the markets don’t fall apart, they’ll stick to their asset allocation models. If the markets burp, enough will step to the sidelines that we’ll get a nice little correction. If the markets do more than burp, the downside potential is huge.
We have plenty of potential catalysts. My favorite is the derivatives market. Last I looked, it was up to around $800 trillion dollars, though I’ve been told it’s now closer to a quadrillion. How often do you get to use a word like “quadrillion?” These are mostly contracts between banks and others to limit exposure to interest rate and currency swings.
The first problem is the size of the market. The second problem is the size of the market relative to the capital of the banks whose guarantees are on the line. The third problem is that banks aren’t required to detail their holdings in their financial statements; a simple “don’t worry, it’s all hedged” is about all you’ll see.
The final and most serious problem is that these obligations have been sliced and diced so many times that no one really knows what might happen if a sizable player goes belly up. We’ve been conditioned to think the Fed and/or ECB will come to the rescue, but what if circumstances prevent it. What if a battle breaks out over who’ll eat the losses?
I believe that a replay on the scale of mortgage derivatives and Lehman is not only possible, it’s somewhat probable. What if the London Whale’s $8 billion loss in derivatives was not an outlier? What if it was the tip of the iceberg? What if it’s most of the banks in Southern Europe this time? Or, China? Woudn’t that be fun?
I realize that such a negative economic viewpoint makes me sound paranoid. Maybe TPTB will stick the landing just right. Maybe when the music stops, there will be extra chairs available. Maybe this time will be different. I sincerely hope so. But, until I start sleeping better at night, I’ll continue to look for reasons to short this market — and, hope that it proves me wrong.