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posted on 03 July 2016

Central Banks To The Rescue

by Lance Roberts, Clarity Financial

Ronald Reagan once wrote:

"There is a legend about the day of our nation's birth in the little hall in Philadelphia, a day on which debate had raged for hours. The men gathered there were honorable men hard-pressed by a king who had flouted the very laws they were willing to obey. Even so, to sign the Declaration of Independence was such an irretrievable act that the walls resounded with the words 'treason, the gallows, the headsman's axe,' and the issue remained in doubt.

The legend says that at that point a man rose and spoke.

'They may turn every tree into a gallows, every hole into a grave, and yet the words of that parchment can never die. To the mechanic in the workshop, they will speak hope; to the slave in the mines, freedom. Sign that parchment. Sign if the next moment the noose is around your neck, for that parchment will be the textbook of freedom, the Bible of the rights of man forever.'

The 56 delegates, swept up by his eloquence, rushed forward and signed that document destined to be as immortal as a work of man can be. When they turned to thank him for his timely oratory, he was not to be found, nor could any be found who knew who he was or how he had come in or gone out through the locked and guarded doors.

Well, that is the legend. But we do know for certain that 56 men, a little band so unique we have never seen their like since, had pledged their lives, their fortunes and their sacred honor. Some gave their lives in the war that followed, most gave their fortunes, and all preserved their sacred honor."

All people want is to be in a place where they can improve their lives. Where their children can have a brighter future than they did. The system in England did not provide that. The revolution was born from economic frustration, oppression, and depression.

240 years later America has descended into much of the same extractive system as Europe. There's a tiny elite showering itself with free money and political favors at the expense of everyone else. Meanwhile, America continues down its path of more debt, more money printing, more regulations, and less freedom. How long can this go on without consequence?

As you celebrate your "4th of July" holiday, it is worth remembering the sacrifices made by those 56 men who signed the declaration of America's birth.

"We hold these truths to be self-evident, that all men are created equal, that they are endowed by their Creator with certain unalienable Rights, that among these are Life, Liberty, and the pursuit of Happiness."

Giving up freedoms in the name of national security, political correctness, and social equality were not the intentions of our founding fathers. Nor should they be yours.

Happy "Independence Day!"


A copy of last week's Webinar: Summer Market & Investing Outlook


In this past weekend's commentary, I discussed the likelihood of Central Banker's leaping into action to stabilize the financial markets following the British referendum to leave the E.U. To wit:

"Of course, the reality is that we will likely see a globally coordinated Central Bank response to the financial markets over the next few days if the selling pressure picks up steam. This will come in the form of:

  • Further interest rate reductions

  • Deeper moves into negative rate territories

  • Increased/accelerate bond purchases by the ECB

  • A potential short-term QE program by the Federal Reserve

  • A pick up of direct equity/bond buying by the BOJ.

  • Liquidity supports through FX swaps or direct intervention

  • Lot's and Lot's of "Verbal Easing"

Not to be disappointed, Mario Draghi sprung into action on Tuesday suggesting a greater alignment of policies globally to mitigate the spillover risks from ultra-loose monetary measures.

"We can benefit from the alignment of policies. What I mean by alignment is a shared diagnosis of the root causes of the challenges that affect us all; and a shared commitment to found our domestic policies on that diagnosis." - Mario Draghi at the ECB Forum in Sintra, Portugal.

Furthermore, as noted by John Plassard, a senior equity-sales trader in Geneva at Mirabaud Securities via Bloomberg:

"Stocks are rebounding on the expectation that there will be a coordinated intervention by central banks. What central banks can do is put confidence back in the market by telling everyone that they are here and ready to act. If we don't get that sort of support, we'll see further declines."

Then on Thursday more announcements came from both the Bank of England and ECB:






While many had predicted a market crisis of magnitude stemming from the "Brexit" vote, the reality was a 100-point swing in the markets in just one week. No matter how you bet, you were probably wrong.


So, yes, from "Brexit Fears" to "Brexit MEH" in just one week. Talk about volatility.


However, this is why over the last few weeks I have continued to recommend "Doing Nothing" in portfolios.

"There are times in portfolio management where 'doing nothing' is better than 'doing something.' This is one of those times.

With portfolios already running at just 50% of total recommended equity exposure, portfolio risk is already substantially mitigated. This leaves us is the best place to be for the moment as we await the outcome of the 'Brexit' vote on Thursday and the culmination of Yellen's testimony on the 'Hill.'

From that vantage point, we can then assess the markets and make a reasonable assumption about what to do next. Could we miss a bit of upside? Absolutely. But such a small lag is a much better outcome than trying to recoup a substantial loss if things go wrong."

However, the problem is we remain trapped in limbo. With the markets holding above supports, but still within an overall corrective topping process, there is no reason to become extremely negative on the markets at the moment OR be extremely bullish.

In other words, the only option is to continue to "do nothing" until the market resolves its current state in one direction or another.

The bad news is the longer the market remains in this current state, the risk are rising of a more substantial downside break.

As I have discussed many times previously, the current topping process, stuck below "all-time" highs, is not too dissimilar to what has been seen at previous major bull market peaks.


However, importantly, the long-term bullish trend remains intact. This is why the focus on 1990 as support is so critical. A break of that level would signify the completion of the market topping process and an entry into a full-fledged bear market correction.

Conversely, a breakout above all-time highs would signify a continuation of the current bull-market. While such a breakout is feasible given the reassurance of further Central Bank interventions, it will be increasingly harder to justify higher valuations given the ongoing deterioration in the earnings and economic backdrops.

For now, as has been repeatedly discussed over the past few weeks, the markets remain trapped within the ongoing range of 2040 to 2135.


The vertical dashed lines are "momentum sell signals." Even with the massive surge this past week, there was not enough pickup in price momentum to reverse the current "sell signal." Such suggests, with the markets now back to overbought on a short and intermediate-term basis, there is little buying power available to push stocks substantially higher. The chart below shows the same issue on a weekly basis.


As shown below, while price action has certainly been "exciting" of the last week, which is only getting investors "back to even," volume has been lacking.


All evidence continues to suggest the current rally will likely fail in the short-term. But given the resilience of the markets in the short-term, and the credence given to ongoing Central Bank support, it remains important to not become overly bearish in the short term.

However, given the extremely low risk/reward environment for investors at the moment, it is also not advisable to become overly bullish until the fundamental and economic backdrop improves markedly.


Given the technical backdrop of the market this week, the rally over the last several days has returned the markets back to upper resistance levels and pushing into overbought territory.

If you have not taken any actions over the last few weeks, this is a good opportunity to clean up and reduce excess risk in portfolios.

Continue with the steps laid out in the "Monday Morning Call" Section a few weeks ago:

  1. Tighten up stop-loss levels to current support levels for each position.

  2. Hedge portfolios against major market declines.

  3. Take profits in positions that have been big winners

  4. Sell laggards and losers

  5. Raise cash and rebalance portfolios to target weightings.

Next, as shown in the chart below, tighten up "stop loss" levels and have a strategy to hedge equity risk in portfolios in the event the market breaks down.


Last week, I stated:

"While the 2040 level was "technically" broken on Friday, I recommend waiting until next week before liquidating positions. With the markets now very oversold on a short-term basis, a bounce early next week would not be surprising. Use any bounce to rebalance portfolios."

Waiting for a confirmation of the break of 2040 proved prescient given the conditions present at that time.

Given the depth of the recent decline, the trading range has been expanded from 2100 to 1990. Therefore, I am adjusting the hedging level to the bottom of the trading range to reduce the potential for a "whipsaw" effect of another short-term "sell-off." Therefore, I am moving the level where a "negative market (short) hedge" is added to portfolio down to 1990 from 2020 last week.

T.I.N.A. IS B.S.

I liked this note from Doug Kass this week:

"I also reject the idea that stocks are 'attractive' because they're cheap relative to bonds right now.

This is known as 'T.I.N.A.' - 'There Is No Alternative' to stocks - but I don't buy it. If bonds are overvalued, where does that leave stocks?

Or how about another 'relative' notion - that U.S. stocks are the 'best house in a bad neighborhood' when compared to foreign equities? If non-U.S. economies are problematic and their share prices vulnerable, I think that argument holds little water in our flat and interconnected global economy."

His point is well made. Stocks DO NOT preserve capital, bonds do. Even if interest rates do reverse for some reason, while bond prices may fall, the corpus is still returned to the investor at maturity along with all interest payments along the way. Such is not the case for equities.

Eventually, even the best house in a bad neighborhood is eventually devalued. Global low to negative interest rates are not a function of financial market strength but rather global economic weakness. There is only one way this ends which is badly.

But for now, the party rages on with little regard for the consequences of partying too long or too loudly. There are always a few who leave the party too early, but the consequences are substantially worse for those who stay too long.

"There is nothing riskier than the widespread perception that there is no risk." - Howard Marks

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