What Next?

It’s easy to get lost in the weeds when looking at the broad markets. The one unmistakable trend, however, is that SPX has been on a purposeful path to erase any signs of weakness at every turn.

The brief violations of the rising yellow channel’s midline in December 2018 and its bottom in March 2020 yielded enormous liquidity-stoked and virtually uninterrupted rallies which saw ES rise 47% and 72% respectively. Fibonacci levels which posed little overhead resistance on the way up were assiduously defended once they became support.

The same algo-baiting tools were used in each instance: ramp up oil prices, power up the yen carry trade, and crush volatility every time stocks drop to dangerous levels (or just need a little boost.)  It has worked, by and large. Most indices are at all-time highs.

While this has been a stellar year for equities, we have to wonder whether it’s sustainable – particularly since we face the greatest global disaster of the last 70 years. Have global markets gone the way of Japan’s carefully managed and government supported Nikkei?  Have things changed so fundamentally that downside risk has been eliminated?

The Fed, ECB and BoJ expanded their balance sheets by over $8 trillion this past year. Consider that it took them almost 8 years to expand by that same amount following the GFC.  Future growth of their balance sheets is essentially baked in.Their bond buying has driven over $18 trillion in global debt to negative yields.  That’s somewhere between $500 billion and $1.5 trillion in interest that might otherwise have been earned by pension funds, insurance companies and retirees. Instead, it has been lost and, more importantly, has forced a flood of investment funds into equities.

Central banks will swear they yearn for higher inflation. Yet, higher inflation has always led to higher interest rates. Given the explosion of debt on their books, few nations could withstand a return to normalized rates.

Low inflation and low interest rates are no longer optional. The Fed had no choice this past year to follow the BoJ and ECB’s lead in crushing interest rates.

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