Is This The Final Blow Off Top Before the Bubble Bursts? Probably yes!

I realize that recent call for a "blow off top" might sound odd, particularly since I've been warning that stocks are in a bubble for some time. So let me provide some BIG Picture analysis for what I see happening here. Calling the precise top of a bubble is all but impossible. This is particularly true for this current bubble because it is an Everything Bubble: a situation in which sovereign bonds (the bedrock of the financial system) are in a bubble, which in turn has resulted in EVERY asset class getting bubbly.

With that in mind, I DO believe that some bubbles are currently bursting while others are entering the "blow off top" phase.

Indeed, my current blueprint for what's to come this year is as follows:

1)   The Tertiary Bubbles burst (has already happened).

2)   The Secondary Bubbles burst (coming later this year likely during the summer).

3)   The Primary Bubbles burst (late 2018/ early 2019).

The Tertiary Bubbles were bubbles based on particular investing strategies in stocks. I'm talking about "shorting volatility" and "risk parity" fund strategies.

That bubble has blew up in February, erasing years' worth of gains in a matter of days.

While this DID represent a significant "risk off" development, this did not mark the end of the Everything Bubble. All told, Short Volatility strategies/ Risk Parity Funds manage $2 trillion.

The Bond Bubble, by way of contrast, is over $200 trillion in size. And the irony of the recent stock sell-off is that it has forced capital INTO bonds, which has resulted in bond yields falling, which has kept the Bond Bubble intact(see the blue square in the chart below).

Put simply, when the Secondary Bubble (stocks) began to get into danger, it saved the Primary Bubble (bonds). By doing this, it allowed the financial system to rebalance itself for a final push in all risk assets.

In the case of stocks, this will feature a Blow Off Top that will take the S&P 500 to 3,000 sometime this summer.

Nobody Is Prepared For The Long-Term Pain That's Coming

The stock market continues its yo-yo ways.

Peter Schiff has been saying for weeks this is a bear market. Well, now even Pres. Trump has said investors may see some short-term pain in the stock market. But the president says it will all be worth it because we will get long-term gain, referring to the benefits we'll reap when we win the trade war. In his most recent podcast, Peter said that's not how it's going to play out.

We're going to have short-term pain and then the pain is going to get worse in the long-run."

The big problem is, nobody is really ready for any pain at all.

Peter said this is pain for no reason because these policies are a mistake. Not that some short-term pain wouldn't be beneficial. But policymakers aren't willing to take the real steps necessary to reap long-term benefits – cut government spending, cut entitlements, cut defense spending, and shut down government agencies and government departments.

There would be some short-term pain that would deliver some long-term gain. How about if the Fed normalizes interest rates and lets the bubbles collapse, lets people lose money, lets the markets restructure? That is short-term pain for long-term gain. That is what a real free-market recession is like. Let the government get out of the way. Let the central bankers get out of the way, and let the free market correct the imbalances and create a good foundation where we can build a lasting, sustainable, viable recovery."

But Peter says that's not what Pres. Trump is all about. He's about avoiding the short-term pain by kicking the can down the road.

Peter also noted that even while stocks are falling, there is no flight to the dollar. When stocks fell in 2008, people ran to the dollar, but this time, the greenback is not a safe haven. He said the dollar is consolidating for its next big leg down. It's the opposite for gold.

Gold is getting ready to blow through the roof."

But right now, people are still complacent. They still believe the fundamentals are good. Peter repeated something he said in a previous podcast – in a sense they are right. The fundamentals haven't changed. They were lousy when the market was going up and they are lousy as the market is coming down. But the key thing to understand is that the fundamentals are actually getting worse.

This is a time bomb. The debt keeps going up. Every day we're closer to the crisis. Every day there is more and more debt, right? And so, every day that goes by, we're one day closer to the debt imploding."

Peter went on to break down the most recent jobs report and highlighted some other bad economic news that didn't get much play in the mainstream media.

He also talked about what will happen if the Fed doesn't follow through with interest rate normalization. The market certainly isn't prepared for that.

Normally the markets are forward-looking. They discount things that they think are going to happen. Well, if you don't think something is going to happen, how can it be discounted? So, it's when the markets are blindsided, when they're surprised, that's when you see the biggest moves because they didn't get discounted in advance. You can't buy the rumor and sell the fact if you've never bought the rumor because you don't know there's a rumor or you don't believe it. So when the fact happens, nobody is positioned for it. Nobody is prepared for it. And that's where we are in the gold market. That's where we are in the gold stock market, in the bond market, in the US stock market. Nobody is prepared for any of the things that are going to happen because nobody believes that they are going to happen."

US Futures Spike As Xi Pushes Globalization Agenda, Vows To Open China To The World

It seems the machines never sleep.

Before China's Xi had even uttered a word - in war or peace - Nasdaq futures were ramping up 1% from the cash close and the S&P and Dow following... And once it was clear that Xi was not going to drop another trade war tape bomb, futures extended gains to the highs of the day session.

What futures loved was the series of traditionally hollow promises from Xi including:

• promise to open up China to the world and expand imports
• "work hard" to import more products that are needed by China's people
• implement major opening up steps,
• lower auto and auto product import tariff later this year, open sector to higher foreign ownership
• release a measures to broaden market access
• expand the opening of China's economy
• push forward economic globalization
• relax market threshold, widen access to market; take major measures in opening and sharply widen market access
• implement financial and insurance market opening measures

• strengthen IP protection for foreign firms (to restructure IP bureau

Then there were the ideological vows:

• China reform and opening will definitely succeed, world should push for free trade
• Cold war mentality is out of place, its a zero sum game, isolationism will hit walls
• Urges dialog as only way to resolve disputes
• Says states must refrain from seeking dominance
• Need to uphold multilateral trading system

Incidentally, many if not all of these promises had been made previously, most extensively during last year's Party Congress. In the meantime, the only real change was Xi upgrading himself from mere president and crowning himself emperor for life.

Never one to dig too deep between the lines, algos loved the speech and the result has been a vertical lift in risk-assets:

Now where have we seen that kind of vertical ramp before.. and what happened next?

Xi's speech is being interpreted as somewhat globalist in nature as he plays down tensions and calls for 'free trade'...

• *CHINA'S XI SAYS COLD WAR MENTALITY IS OUT OF PLACE
• *CHINA'S XI SAYS DIALOGUE IS THE WAY TO RESOLVE DISPUTES
• *CHINA'S XI SAYS SHOULD PUSH FOR FREE TRADE
• *CHINA'S XI CALLS FOR UPHOLDING MULTILATERAL TRADING SYSTEM
• *XI SAYS GLOBALIZATION MUST BE MORE OPEN, INCLUSIVE
• *XI SAYS TO EXPLORE SETTING UP FREE TRADE PORTS
• *CHINA TO REDUCE TARIFF ON AUTO-RELATED PRODUCTS: XI
• *XI SAYS HOPES COUNTRIES WILL LOWER CURBS ON HIGH-TECH TRADE

And a direct jab at Washington:

• *CHINA'S XI SAYS STATES MUST REFRAIN FROM SEEKING DOMINANCE
• *XI SAYS CHINA WON'T BE THREAT TO WORLD, EXISTING GLOBAL SYSTEM

Then Xi heads down the comedy road:

• *XI SAYS CHINA WON'T SEEK SPHERES OF INFLUENCE (apart from building islands in the Pacific)

Many on the sellside agreed with the algos and said Xi's speech marked de-escalation of trade war risks:

According to Trinh Nguyen, economist at Natixis, Xi's speech suggests a conciliatory tone with some concession towards market access. Question remains as to how much of the proposals will take place, and whether that's enough to appease U.S. President Donald Trump. Still, markets will see Xi's remarks as positive which will help to lower the risks. "Clearly this is positive for EM Asian FX, especially those closest to the China-U.S. trade spat."

An almost identical take from First Shanghai Securities strategist Linus Yip, who said that "Xi's speech sends a positive signal to the market since he backs globalization and the opening up of China market," although concern over trade disputes remains, as Xi is talking about the long-term picture.

Alan Richardson, a fund manager at Samsung Asset Management said that Xi's comments are positive for globalization but they don't address Donald Trump's immediate task of reducing the trade deficit with China.

Some were downright skeptical, and echoed our own perspective, noting that Xi was not at all as conciliatory as the markets made him out to be:

With the speech over, I'm not at all convinced it was anywhere near as conciliatory as some are going to spin it. "New" offers mostly old news, no movement on core issues like Made in China 2025. Quite the contrary, doubled down on rhetoric about "innovation driven growth".

— Matt Schrader (@tombschrader) April 10, 2018

For now, and at least until the next Trump tweet, outburst, or Mueller raid, it's risk is on in US markets (but China's tech heavy Chinext is down over 1%) as it seems no news is good news in trade wars.

Offshore Yuan strengthened

It's The Fed, Stupid.

While the mainstream media were quick to blame the recent demise of US equity markets on Trump's trade-war rhetoric, BofAML's Michael Hartnett disagrees, correctly pointing out that risk assets have been struggling because of Fed tightening.

Higher rates and a shrinking balance sheet has shifted investors' appetites from 'buy the dip' to 'sell the rip'...

Via BofAML,

It's the Fed, stupid

We believe the simple reason that risk assets are struggling in 2018 is the Fed. Investors have been forced to acknowledge a tightening cycle is well underway.

Since Oct last year the Fed has been reducing the size of its balance sheet; by the end of this year the Fed will have hiked 8 (maybe 9) times. History shows that once the Fed starts to tighten financial conditions it requires a major "event" to reverse course (Chart 1).

The tightening cycle, which the ECB & BoJ are set to join in coming quarters, follows 9 years of unprecedented global monetary easing & asset price returns. Table 1 below shows the biggest winners & losers as global interest rates have been cut 712 times and $12.2bn of assets have been purchased by central banks since 2009.

The QE winners have been US stocks, tech stocks, US & European high yield bonds, Emerging Markets(themes of scarce growth, high yield & leverage).

The QE losers have been cash, commodities, government bonds and volatility (themes of inflation, low yield & liquidity).

But, as BofAML's Hartnett warns, that is all about to change as the market is forced to admit the regime shift from Quantitative Easing to Quantitative Tightening.

• We believe investors will slowly rotate from QE winners to QE losers, but the pace will be contingent on how quickly profit growth slows; YTD returns indicate that the rotation has begun
• Peak positioning, peak profits, peak policy stimulus imply peak asset returns, and a trading mantra of sell-the-rip not buy-the-dip
• If Q1 was about volatility, Q2 will be about rotation within a big, fat trading range,  rotation specifically from levered cyclical plays to liquid defensive plays
• It's too early to advocate a"Full Bull Detox" and overweight bonds/cash (where yields continue to be meager) and sell equities (the "TINA"argument); but a surge in US dollar/credit spreads could cause fresh lows; key deleveraging levels... GT30 <3%, DXY >93, CNY >6.5, US HY CDS >4%, SPX <2500, SOX <1200, DAX <12,000

Hartnett sees good, and bad, news under each of his Positioning, Policy, and Profits factors driving Q2 investment themes.

Positioning

Good news: BofAML Bull & Bear Indicator has retreated from the dangerous "excess bullish" levels of late-Jan to a neutral levelof 5.4.

Bad news: investors have only partially unwound their crowded Goldilocks positions...short vol/Treasuries/US$, long tech/banks/EAFE/EM.

Policy

Good news: policy tightening has not led to a significant widening of credit spreads, i.e. corporate bonds not signaling a decisive crack in equities(Chart 3).

Bad news: yield curve implies monetary & fiscal stimulus maxed out; only policycards left to play are growth-negative protectionism & populism.

Profits

Good news: global EPS estimates are very strong.

Bad news: global PMIs, the key driver of EPS, are rolling over; EPS rarely this strong for this long when yield curve this flat (Chart 4); longer it takes for 10-year Treasury yield to breach 3% in Q2, the more aggressive the rotation from cyclicals to defensives and bond sensitives in Q2 is likely to be.

So either the bond market is entirely wrong or expectations for forward EPS will have to tumble dramatically.