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Market Price Discovery Has Become "A Toxic Mess"

Authored by Sven Henrich via NorthmanTrader.com,

Market price discovery has become a toxic mess and traders have to adapt to changing conditions. Fast. Blending an understanding of technicals with a keen awareness of the outside influencing factors on price discovery is becoming an ever more vital combination critical to success in navigating these complex markets.

The tape action, long subject to the powerful influences by central banks, computerized trading, buybacks, etc. has in 2019 increasingly become subject to the political sphere taking an overt active role in not only influencing price action, but also directly trying to drive it.

A vicious battle between reality and make belief is unfolding before our very eyes.

Over the past 10 years markets were subject to $20 trillion in global central bank intervention with many central banks still sitting on negative rates today. Just this year one can only imagine where equity prices would be without the Fed cave in January. On the buyback front one recent study suggests equity prices would be 19% lower than they are now without them:

This year alone we’re seeing a record near $100B per month buyback program keeping a bid under markets.

In the first quarter political headlines of “trade optimism”, along with the price pivot known as the “Fed cave” helped drive the action relentlessly higher with overnight gap ups producing price action often times in direct contrast to underlying fundamentals.

Case in point: Semiconductors in Q1 were pushed relentlessly higher to new highs despite a clearly deteriorating fundamental picture:

Nothing in the chart was suggesting fundamentals were improving, yet investors kept piling into the space on “trade optimism” and an easy Fed in the ill-guided belief that trade woes would only be temporary. Yet earnings reports by the likes of $INTC at the end of April woke the space up to reality:

And now the entire space has dropped hard below its 2018 highs rendering, for now, the breakout to new highs an ill-conceived fantasy:

Now that trade optimism has turned into trade dread price action has become much more 2 way oriented and can produce massive sudden moves in either direction often taking traders and participants by surprise. Algos react to any news flash or tweet with vigor and can turn the intra-day price action on its head and option traders in particular can see their positions turn to dust on a single tweet.

The good news for long investors is that, as much as the 2 way action has dominated the news in recent weeks, the political sphere is eager to act as an additional “put” in the market. In addition to the now standard Fed put without which markets can’t seem to survive these days we now also have the Trump put. Here from May 10:

The ‘Trump put’ saves stocks as investors bet the president won’t let the market collapse:

  • Stocks staged a massive turnaround Friday on word from the Treasury secretary that talks between the U.S. and China were constructive, encouraging investors to believe a trade deal is still possible.

  • President Donald Trump later tweeted that the talks were constructive, and he sent stocks even higher.

And yes, the reaction is self evident on prices, here on Friday May 10:

These political efforts to goose markets higher and “save” the week are a real thing. They are not only a political obsession, they may well turn into a critical weapon of war, managing a trade war that is:

According to sources, Kudlow, a famous supply-side free-trader, is burned out by the job. (In June 2018 he suffered a heart attack). Kudlow’s relationship with Trump has never been particularly close. “Any time the markets go down, Trump bothers Larry,” a person close to Kudlow told me. While Kudlow is telling friends he’s “having the time of his life,” he’s also eyeing an exit. According to sources, Kudlow wanted to leave the White House this summer, but Kudlow agreed to stay after Trump said he didn’t want Kudlow leaving until the China trade war was resolved. “I need you here for the markets. We need a united front,” Trump said, according to a source.”

Weakness in markets shakes confidence and projecting strength is critical to win a trade war (and an upcoming presidential election I might add). And this is what both sides are doing. China is intervening in its markets and making the trade war an issue of national pride and in its own way the Trump administration is doing the same thing.

Part of these efforts have contributed to the magic risk free Friday effect that has pushed markets higher 80% of the time in 2019.

Even this past Friday saw the same script unfold turning a negative market to positive on a political headline making Friday magic risk free once again, at least for most of the day:

…only to see these gains again disappear on another political headline in afternoon. “Trade talks have stalled“. Well duh. Tell us something we don’t know, but nevertheless algos immediately reacted to this. So be clear: Friday’s price action was once again entirely driven and dominated by the political.

Bottomline of all of this: With the sudden 2 way price action we have ended up with these massive price structures:

Context matters and I had a chance to speak with Brian Sullivan on Friday about the bigger market picture, magic risk free Friday and a concerning underlying macro issue:

Perhaps lost in the noise of trade wars is the underlying issue of hidden inflation on consumers and I want to highlight this chart from the segment above:

There is a lot of talk on the price impact on US consumers coming from tariffs placed on China. And these impacts are real as companies such as Walmart have indicated that these tariffs will be passed onto consumers in form of price increases and, not counting for the new tariffs, the impact of the previous ones have already acted as a tax increase for consumers:

“The combined $72 billion in revenue from all the president’s tariffs ranks as one of the biggest tax increases since 1993, according to CNBC analysis of data from the Treasury Department. The tariff revenue ranks as the largest increase as a percent of GDP since 1993 when compared with the first year of all the revenue measures enacted since then, according to the data.”

Yet while tariffs are on the forefront consumers have actually already been forced to contend with inflation of a different form that is not reflected in the Fed’s inflation statistics and that is a massive increase in credit card interest rates. This week the news broke that interest rates on credit cards have reached 20 year highs, nearly 17%.

And that’s a big problem for household budgets as it slices into American’s disposable income. For years money was cheap and interest rates were low and Americans accumulated credit card debt as wages lagged. Just in the last 5 years total revolving credit card debt has increased from $857B to just over $1 trillion dollars. That increase may be manageable if interest rates stay constant and real wages keep growing, but not only has debt outstanding increased significantly credit card interest rates have increased by 30% since the Fed started raising rates from the lower bound in late 2015.

As a result total interest payments have steadily ballooned higher from $265B in 2015 to already $365B in March of 2019 a 38% increase in less than 4 years:

With an average credit balance of $7,600 for Americans in the 35-65 year age group this implies annual payments of $1,300 just in interest on these balances suggesting a drag on consumers ability to expand spending, perhaps explaining why retail sales have been somewhat lackluster in recent months.

But there’s more to it then just the Fed raising rates. What’s fascinating here is that credit card companies have been raising their rates at a much faster clip than the Fed. Indeed during that past 2 cycles the Fed funds rate was much higher while credit card interest rates were actually lower.

Example: In 2006/7 the Fed funds rate was twice as high as it is now, but credit card rates remained in the 12-13% range:

This increase here is outsized compared to the previous cycle.

So while the Fed uses inflation measures that suggest very low core inflation, significant real inflationary pressures exist for consumers in the real world and perhaps this little known fact explains why retail sales have been very lackluster in recent months.

After all we are presented with this cumulative picture:

Highest credit card interest rates since 1994.
Housing affordability worse in 10 years.
Auto loan delinquencies highest in 9 years.
If you love all that you're really gonna love tariffs.
In other news the Fed can't find any inflation.

— Sven Henrich (@NorthmanTrader)

There is a battle going on between reality and make belief and equity prices are a play thing of the 3 pillars of make belief: 1. Central banks. 2. Political jawboning and 3. Buybacks the combination making for a toxic mess in price discovery.

Technicals tell a different story, a story of reality trying to break through.

To help make sense of this toxic mess please see the technical discussion below:

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