Warning Shot Across the Bow

Posted on Sunday, February 4th, 2018

Bitcoin’s rise and fall has been fascinating to watch and its technology may, in time, be of great significance but for now but the most important takeaway for us may be the signal that the rise and fall of bitcoin has now seemingly produced. The rise of bitcoin leads us to the inescapable conclusion that its very existence and subsequent popularity is due to excess liquidity in the financial system. After real estate, stocks, bonds, art, rare automobiles have all reached excessive valuations it was time for a new asset to arise for money to flow. We may look back in time to see that the rise of bitcoin was the last gasp of the “Everything Bubble”, a time when every asset on the planet was at extreme valuations due to central bank policy. We believe the fall of bitcoin coincides with the threat to withdraw liquidity from the system by central banks led by the United States. Like air, bubbles require excess liquidity to form. The market is a discounting mechanism and is, at the dawn of 2018, discounting 6 months forward the withdrawal of liquidity. The warning shot has been sent across the bow for investors. Of course, central bankers can always just stop draining liquidity and even add more but the tide seems to be going out for now. Watch for who has been swimming naked.

I think there are two bubbles. We have a stock market bubble and we have a bond market bubble…I think [at] the end of the day the bond market bubble will eventually be the critical issue…In fact I was very much surprised that in the State of the Union message yesterday all those new initiatives were not funded and I think we’re getting to the point now where the breakout is going to be on the inflation upside. The only question is when…We are working our way towards stagflation. – Alan Greenspan former FOMC Chair Bloomberg TV

Jim Paulsen from Leuthold Group joined Jeff Gundlach and Alan Greenspan calling for commodities to outperform in 2018. That’s a pretty elite group. Commodities tend to outperform at the late stage of the cycle. Here is what Paulsen told CNBC’s Squawk Box.

“Challenges are mounting here for stocks,” Paulsen told “Squawk Box.”“And for bonds, I think.”

“The values have been high. They still are. You’re losing the element of surprise. You know, these economic and earnings reports are fabulous, but we know they’re fabulous,” he added. “It just has never felt this bullish.”

At some point, the economic and earnings numbers won’t have the same impact on the market they had previously, Paulsen argued. He sees commodities outperforming stocks and bonds this year.

A 15% selloff from the highs would only bring us back to market levels of August 2017! A 20% selloff brings us back to January 2017! Not the end of civilization. In fact, a healthy retrenchment of recent gains. We felt that the market would struggle for 18-24 months when it hit 2666 on the S&P 500. The market has spent time at each multiple of the 666 low in the S&P. 2664 is 4x the 666 level. You must remember we are dealing with algorithms written by humans. Levels like 666 and 2x, 3x and 4x are just levels in a computer program. Be careful of computers. They only do what they are told. As computer use has created a wondrous cycle of upward movement so we can have the vicious spiral downwards.

We have talked of a 1987 style market for over a year now complete with melt up. Now it seems all the rage to compare our current market to 1987.  In fact the two years are eerily similar. We build scenarios and invest accordingly. Now that everyone is on board with the 1987 style melt down we are getting off the train. Our new scenario calls for a more drawn out selloff. First, we may see a drawdown in the magnitude of 5-15% followed by a retracement back to the old highs. From there we should see a selloff of a larger magnitude leading to a bear market over the next 18-24 months. It’s not voodoo. Valuations show that historically we will see limited upside from these levels. Markets are high. Rates are rising. The yield curve is flattening. Markets tend to struggle in the second year of a Presidency as midterm elections approach. It’s not rocket science. It’s the study of psychology and history. We have seen the warning shot across the bow.  Buckle up. It’s going to be a bumpy ride. Watch the central bank balance sheets. If they stop tightening all bets are off.

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I  think we aspire less to foresee the future and more to be a great contingency planner… you can respond very fast to what’s happening because you thought through all the possibilities, – Lloyd  Blankfein

To learn more about us and Blackthorn Asset Management LLC visit our website at www.BlackthornAsset.com  or check out our LinkedIn page at https://www.linkedin.com/in/terencereilly/ .

Disclosure: This blog is informational and is not a recommendation to buy or sell anything. If you are thinking about investing consider the risk. Everyone’s financial situation is different. Consult your financial advisor.