The End of the Bull Market Is In Sight

Stock market action over the past week did not play out as we expected. This would have been a continuation of the corrective pattern that would refresh markets for a longer-term push higher. Instead, the leading index, the Nasdaq, confirmed that the mania for technology stocks is still intact. Without the pause and consolidation that would provide the basis for another leg higher, the markets are likely to reach exhaustion high in the near future. This will end the cyclical bull that began in March 2009.

This market top has been in the making for some time led by markets in Europe and Asia. The significant difference is in the technology sector where the US is dominant with no real competition. Thus, the recovery in markets from the February correction has been minor in Europe and Japan while the Nasdaq reached new highs. This is against a monetary background where the US is tightening and the ECB and BoJ remain in crisis mode.

Our confidence in this outlook is buttressed if not driven by the steady decline in our monetary and liquidity indicators that are our basis for forecasting financial markets. These indicators today are declining in a similar manner to their performance in 2007. The difference is that the financial system is in better shape and the central banks are on alert rather than being asleep at the wheel. There is no obvious area of extreme speculation unless you want to say it is the stock market itself which would be a valid target because of the mass participation in corporate leveraging to boost stock prices. This is what the Japanese called “Zaitech” in the 1980s and it is one reason why the Nikkei has gone through such a long bear market.

The deterioration in monetary conditions comes despite Fed policy that remains seriously behind the curve without much sign that it will hasten to catch up. Expectations are adjusting to a somewhat tighter stance of four rather than three hikes this year and this is not expected to hurt markets overall. While a Fed hike this month might provide an excuse for a market fall, the fall itself should only lead to a successful test of the February lows. This will not be enough to alter the course of Fed policy that will remain on track for four hikes this year and the bulls will justify as “the wall of worry”.

The next week or two will see further strength in most equity markets. The Nasdaq will confirm new highs and may take the S&P with it if it closes above 2800. Europe and Japan will bounce further. We do not expect this strength in equity markets to last very long and will be monitoring our models for a top in the US indices

Against a background of steady or rising stocks the dollar should consolidate for a while longer but we remain confident that a base is built for a multi-week recovery in the dollar with an initial target of 95 to 96 on the DX index. The basing pattern may continue while equities rise as the dollar is a central part of the carry trade and so currencies may peak with the US stock markets.

In the background there is the inevitability of rising long-term interest rates. We remain long-term bears on global bond markets with selling opportunities arising in the event of any deflationary shocks. Only a total recommitment to bond buying by central banks can prevent this and the political back for this is fading rapidly.

With many questions coming in on the issue of trade (one of the most discussed and written about sectors in economics) we do not think a trade war is coming. Once again, the “Trump Derangement Syndrome” infects people’s minds. In the US, the liberal intelligencia can’t see straight when discussing him and Europeans think the US has gone crazy. Meanwhile Trump scores one impossible political victory after another.

The purpose of the tariff threat seems pretty clear—first it appeals to his base that cares more about theatrics than action and second, it is carefully targeted against every country except America’s allies, friends and neighbors. Just to be clear, they target China. We looked at the data and, yes, the actual imports of steel/aluminum are not a big deal. China is pursuing economics as war by other means and the time for pushback is here. We are relieved that America is waking up to the threat.

The danger is that this latent conflict between the US and China comes at a time when both economies are at cyclical peaks and any escalation of friction in trade will accelerate the coming cyclical downturn. We think that the consolidation of power by Xi marks a peak in the economy and that centralized power will be useful in handling the political and economic difficulties of coming structural change in the Chinese economy.

The geo-political danger is that Chinese leaders use international threats to divert criticism for economic mismanagement. The same disingenuous motives will likely to likely drive Trump when he seeks reelection.

Developments with North Korea.

The prospects of face-to-face dealings with North Korea raise the stakes significantly for war on the peninsula. The deal is clear—the North will have to give up nuclear weapons in exchange for peace with the US that may involve US withdrawal from the South. If the North does not agree this time, a US strike is likely before the November elections. No one can say the US did not try diplomacy first.

This crisis comes at a time when both China and Russia are using the decline of American power to destabilize the global order that has been the basis for world peace and prosperity since WW2. A strike on a recalcitrant North Korea sends a powerful message to Russia and China not to take advantage of America benevolence and may thus extend the American Century for a while longer. An American failure invites an already aggressively expansionist Russia and China to push harder. This will generate a major political crisis if not an all out war.

Malcolm Tulloch

The writer is director of the firm Tulloch Research. The company provides bespoke advice to clients on macro-opportunities in financial markets.

“Intuition is a product of accumulated experience”

Tobias Truman