Signs of Euphoria Creeping Into Markets?

Amanda Diaz of CNBC reports, Euphoria is creeping into the market, and that’s giving me déjà vu:

Signs of euphoria are creeping into the market, and that's giving one trader déjà vu.

"I'm getting a little worried here," Matt Maley said Thursday on CNBC's "Trading Nation." "We're starting to see some of the traditional signs of getting near a top being explained away for whatever reason."

Specifically, Maley pointed to the flattening yield curve — where short-term and long-term rates compress — as reason for concern.

"If you go back to 1999 and 2007, the yield curve was flattening for a year while the stock market was going straight to the moon, and that's exactly what we're having now," said Maley.

After a disappointing jobs number on Friday, the spread between the U.S. 2-year yield and U.S. 10-year yield fell to around 72.7 basis points, marking a 10-year low. Despite the move, some market participants didn't seem too concerned.

Michael Schumacher of Wells Fargo told CNBC that it was nothing more than a "head fake," explaining that investors shouldn't "leap to any conclusions" based on the report.

"Of course people explained it away that it didn't matter, until it did," added Maley. "I'm not looking for a repeat of any of those two years, but we are seeing some signs that some of the euphoria that people have been worried about is starting to creep into the market."

Furthermore, Larry McDonald of AGC Analytics cautioned that the number of new highs on the New York Stock Exchange has been declining, a sign of a "tired" bull market.

"New highs have been trending down for weeks, the amount of stocks above the 200-day moving average has been trending down," he said Thursday on "Trading Nation."

On the NYSE, 108 stocks hit a new high Friday. That's down from the 166 we saw a week ago, according to McDonald. "Over the last 30 years, rarely have we seen the S&P 500 rate to new highs with so little participation," he added.

"The biggest thing to watch for, however, I think, is the global growth story is picking up, and central banks around the world ... they're all trying to do this ... dovish hike, one and done," McDonald said.

The Bank of England hiked interest rates on Thursday for the first time in 10 years. Meanwhile, the Federal Reserve is expected to hike rates next month for only the fourth time in nearly a decade.

"But at the end of the day they could, because of this global growth surge, the central banks including the Fed could very well be forced to hike ... faster than the market expects," he explained. "And I think that's what's going to happen in the next couple quarters, and the market's not going to like that one bit," he added.

The Dow hit a record intraday high on Friday.

Central banks are in hike mode for now but that can change quickly in these fragile markets where volatility remains at record lows.

Are central banks making a huge mistake? I think so but their rationale is they have a very small window to raise rates and "store up ammunition" before the bubble economy bursts and markets fall off a cliff.

In fact, central banks know it's as good as it gets for stocks, corporate bonds and other risk assets that some of them are openly buying stocks, like the Bank of Japan and the Swiss National Bank which now owns a record $88 billion in US stocks to counteract the appreciation of the Swiss franc (traditionally, a safe haven currency when global investors are jittery).

Does the Fed actively buy and sell stocks and bonds too? You bet, some of it is on the books (QE operations which expand the balance sheet) and some of this activity is off the radar like the so-called Plunge Protection Team which is the worst kept secret in financial markets.

Basically, when markets are getting clobbered, the Fed comes in and buys massive quantities of S&P 500 futures to limit the damage.

Every central bank now has learned how to prop up its market (or foreign markets), including the central bank of China which also intervenes (like other central banks) in foreign exchange and bond markets.

With all these interventions, central banks have effectively managed to kill volatility, perpetuating the myth that they can backstop all markets, all the time. No wonder some think the greatest fear today is the lack of fear.

Every dip in markets is being bought hard by algorithmic traders anticipating central banks' activities so it shouldn't surprise us the buy-the-dip mentality reigns supreme in every market all over the world.

Much of this is explained away as "growing optimism about the world economy fueling an increasing eagerness by investors to step in and buy assets whenever prices dip," but as I keep warning you, the higher risk assets rise to record levels, the bigger the downside risks going forward.

Also, let's not kid each other, as passive investing takes over active investing, every portfolio manager worried about underperforming and losing their high-paying job is chasing indexes higher and higher praying "central banks' put" will save them in case someting goes wrong.

I'm on record telling you there are two major risks in these markets:

1. A melt-up unlike anything we've seen before precisely because these are the most highly manipulated markets ever as every central bank stands ready to bid up prices. 
2. A meltdown unlike anything we have ever seen before precisely because if investors lose faith in central banks' eternal ability to prop up markets, there will be a severe crisis of confidence, ushering in the worst bear market ever. 

Even before that happens, there are real risks deflation will strike America but if you listen to market gurus, you'd think global growth is firing on all cylinders.

It's all nonsense because people confuse cyclical shifts in economic activity for structural shifts which are what ultimately matter most.

And some structural shifts should worry us. For example, while the US nonfarm payrolls gain of 261,000 was well above September's meager 18,000 (but still way below consensus) and the unemployment rate fell to a 17-year low of 4.1 percent, the relatively weak growth in worker paychecks continued to raise concern.

Not surprisingly, the bond market is sending a warning as Powell gets ready to take over at the Fed, and it's one he cannot ignore. As long bond rates continue to decline as global inflation remains in freefall, the risk of an inverted yield curve rises, and that doesn't bode well for stocks (SPY) or high-yield bonds (HYG and JNK).

I was disappointed President Trump chose Jerome Powell over a much younger but wiser Neel Kashkari to be the next Fed Chair. Kashkari understands the "baffling" mystery of inflation-deflation better than anyone on the Fed, but like my buddy told me, "there's no way Trump is going to appoint a brown man to be the next Fed Chair". Huge mistake, or as Bernie who also got shafted by a corrupt DNC would say, "YUGE!".

Anyway, there is still plenty of liquidity in these central-bank-controlled markets to drive risk assets higher, which is great news for quant hedge funds taking over the world, but be very careful investing and trading these markets, something will go wrong when you least expect it.

Below, I embedded the top gainers and losers from my watch list (click on images):

Don't read too much into these screens as they are useless to someone who doesn't know what these companies are all about and how to trade them.

For example, the biotech stock on my watch list which impressed me the most this week is Juno Therapeutics (JUNO) which could be breaking out here on its weekly chart (click on image):

And the biotech/ generic drug company on my watch list which impressed me the least this week was Teva pharmaceuticals (TEVA) as it got clobbered yet again after another bad earnings report, sending the stock to a multi-year low (click on image):

Now, I'm not going to tell you Teva shares will continue sinking lower and Juno shares will continue making new highs but I've traded long enough to know not to touch broken charts and that upward momentum typically begets more upward momentum (with huge volatility along the way, especially in the biotech space).

As I've stated before, all my money is in US long bonds (TLT) but I will trade actively and quickly when I see opportunities arise in stocks I track closely. I just don't think it's worth the stress or risk now.

That is the problem with euphoric markets, they are a lot more stressful by nature and you need to take more risks to make great returns, effectively exposing you to wipeout risk.

Anyone who tells you otherwise has never traded for a living (or was good at it) and they don't have a clue of how risky these markets are as euphoria creeps into them.

Below, euphoria is creeping into the market, and that’s giving some traders pause for concern. Just remember that in these central-bank-controlled markets, things can remain irrational a lot longer than skeptics think.

On that note, please remember to show your appreciation for the work that goes into my blog comments. I appreciate all of you who take the time to financially support this blog via your contributions and donations which you can make via PayPal under my picture on the right-hand side.