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American Graffiti

By: Erik Swarts | Thursday, May 15, 2014
Art - Pink Bull

The writing on the wall that began ever so discretely and scribbled in pencil has become full blown graffiti installations - replete with colorful tags and innuendo.

CAPE ratio's? - Permanently high.
Euphoria? - Everyone's looking.
Bid? - Endless.

Don't get us wrong, we've seen these conspicuous expressions stick around in plain view far beyond even the most flagrant artists wildest imaginations. Heck, the M&A cycle hasn't even shifted into 2nd gear and corporations are flush with more cash and credit than the consumer spawned housing mania of 2004/2005 ever had access to. But unlike the more recent cycles, these ancillary capital accoutrements - as broad and deep as they may extend - are disjointed from the markets in ways recent history poorly conveys. This is also why we take a tempered long-term outlook to a prospective twist of fate in our own equity markets and for now view them in a variant but contrasting light to 2000 and 2007. Having said that, we have seen a fair share of American graffiti lately plastered on billboards and smattered around the Street that takes a convenient sample set to push a less than blatant bias.

The most recent -

"Every recession over the past 50 years was preceded by the Fed hiking rates enough to invert the yield curve. That is seven out of seven times - a perfect forecasting track record."

While impressive as that may seem at face value, it reminds us of the great quote from Aaron Levenstein - "Statistics are like bikinis. What they reveal is suggestive, but what they conceal is vital."

Looking for an inversion in the yield curve as a proactive bear market/recession signal during an era of ZIRP is akin to using a smoke detector to alarm occupants of carbon dioxide. I.e. - different environmental conditions yield different hazards and require different analytics. Unfortunately for us residents, the signal is likely less than binary this time around the block and a result of the low interest rate environment we currently find ourselves trudging through - while the last QE IV runs out.

Have recessions/bear markets occurred in the past without an inverted yield curve? Yes, the US had six recessions without an inversion between 1935 and 1965 - and most recently Japan has had five in the last 20 years. The common denominator? They all occurred during low interest rate environments - with Japan's five recessions during their own ZIRP. For the record, we are not looking for a recession in the near future and take more issue with the idea of using an inversion to proactively position oneself for bear market conditions in equities.

Maintaining their perfect record of picking the end of the over 30 year young bull market in bonds, the Street once again pulled a Zoolander this year and couldn't turn lower on yields. We think a similar misperception currently exists with regards to rate hikes - as reflected in the statement above that implies the equity markets have time because rate hikes won't happen for at least another year. Assuming that logic applies (which we don't) - well then we'd guess equities have far longer than another year to run. Alas, we'll try hard to not asphyxiate in our sleep and prefer to just follow the money and what we perceive to be more appropriate comparative reasoning that incorporates a low interest rate environment.

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Author: Erik Swarts

Erik Swarts
Market Anthropology

Although I am an active trader, I have always taken a broad perspective when approaching the markets. I respect the Big Picture and attempt to place each piece of information within its appropriate context and timeframe. I have found that without this approach, there is very little understanding of ones expectations in the market and an endless potential for risk.

I am not a stock picker - but trade the broader market itself in varying timeframes. I want to know which way the prevailing wind is blowing, where the doldrums can be expected and where the shoals will likely rise. I will not claim to know which vessel is the fastest or most comfortable for passage - but I can read the charts and know the risks.

I am not a salesperson for the market and its many wares. I observe it, contextualize its moving parts - both visible and discrete - and interpret.

I practice Market Anthropology - Welcome to my notes.

Erik Swarts is not a registered investment advisor. Under no circumstances should any content be used or interpreted as a recommendation for any investment, trade or approach to the markets. Trading and investing can be hazardous to your wealth. Any investment decisions must in all cases be made by the reader or by his or her registered investment advisor. This is strictly for educational and informational purposes only. All opinions expressed by Mr. Swarts are subject to change without notice, and the reader should always obtain current information and perform their own due diligence before making any investment or trading decision.

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