Correction or Bear Market? Find Out Soon

Earlier this year, I posted 2018: The Pivot Year. Coming into the year, many markets were poised for bullish breakouts if they weren't already breaking out. Massive inverse head-and-shoulders patterns on coal, steel and various emerging markets pointed to a potential inflationary breakout. Long-term bond charts signaled confirmation of higher inflation. On the other side of the argument, macro forces were arguing for a downturn. I favored the macro argument for deflation/disinflation and a downturn, but I had to respect the signal the charts were throwing off. Wrong or right, the year 2018 was going to shut the door on one of these scenarios.

One way or another, I expect action on trade in 2018.

Finally, the overall trend in social mood remains negative. I believe this is a higher order decline as in the 1930s, and thus dollar positive (deflation) rather than a correction and inflationary (1970s).

As I said above, I could be wrong. And the best case for my being wrong is still the commodities markets. Several funds such as steel, copper and coal (and related emerging market countries reliant on natural resource exports) are on the verge of breakouts. I expect China to slow, but FXI recently broke out above its resistance again and opened up 3 percent on Tuesday.

Macro proved correct. Slowing credit growth, slower economic growth, a stronger U.S. dollar and tumbling asset prices turned breakouts into failed breakouts.

Many are convinced this is only a correction and not a bear market. The reason is 2016, 2011, 2010 and 2009. Global central banks stopped a deflationary panic 4 times before and they'll do it again goes the bullish argument. Bears were burned each time, including in 2016 when it looked like a bigger decline was underway. In December 2015, I posted 1937 Redux: Deflationary Wave Has Returned. I was wrong then because I was focused more on the Fed and not global central bankers.

For the same reason I was mistaken about a large move in 2016, I believe this time is either a monster correction that will be aborted by central bank panic, or a bear market. Here's the global credit impulse from Saxo Bank.

Aggregate credit growth slumped in 2014 and into 2015 before turning up. Asset prices started wobbling in 2014. Oil plunged in November 2014. The yuan was allowed to devalue in August 2015. Global asset prices bottomed in January and February 2016.

Credit growth is a slow-moving leading indicator and bear market (correction) phases are short and brutal. It's always possible markets respond to other factors, but if credit growth is a key driver of global asset prices, it has yet to bottom, indicating global markets may not bottom until Q3 2019 at the earliest. That's assuming a central bank reverses policy. The Federal Reserve could signal a slower pace of rate hikes this week, but that doesn't do much for the market over the long-term. The ECB ended QE in December, as the Fed did at the end of 2013. Chinese credit growth is still slowing.

Back in August 2015, the month China allowed the yuan to depreciate, I posted: Shenzhen Home Prices Rise 20% in Three Months, Some Beijing Developers Hiked 10-20%, Each New Project Opens 5% Higher. I thought home prices were rising nominally ahead of a breakdown in the yuan, but it turned out it was a major burst of credit growth. In early 2016, China would layer on more stimulus to drive the market higher. A few months after global markets bottomed, I was posting articles such as Reform Can Wait: 4 Trillion Stimulus All Over Again as SOEs Pour into Land Market and Flour More Expensive Than Bread: Second Tier Land Prices Soar 180 pc and Ministry of Finance Owned Cinda Real Estate Becomes Land King. The seeds of a credit bubble were sown in mid-2015 and they were in full bloom by mid-2016. Starting in October 2017, China kicked off another major deleveraging effort. The last one started in 2013.

As that prior deleveraging wave was kicking off, I posted China Real Estate Rage Is Back; Ghost Cities Everywhere; Offshore Yuan Plunges; Talk of Falling Real Estate Prices Across China. In October of this year I posted: Real Estate Rage Spreading As Developers Grab Golden Week Opportunity, Will 2019 Be the Year of Defending Rights?

How do things look today in China?

iFeng: 专家：明年经济增速目标或下调 预计增速为6.2%至6.3%

Xu Hongcai, deputy chief economist of China International Economic Exchange Center, said that from the accumulated data, the economic operation is still stable. Judging from the figures in November, the current downward pressure on the economy is high. The economic growth slowed down in the fourth quarter, and this trend may continue into the first and second quarters of next year. The economic growth rate for the whole year is expected to be 6.2-6.3%.

That doesn't sound very pessimistic, but that's because it's translated through a propaganda filter.

More importantly, housing shows no sign of the reversal seen in 2015. Not only that, but prices have only plateaued. A decline in prices is ahead, not behind. China's NBS published November price data and it shows new home prices rose 1 percent nationally, with 63 cities reporting rising prices. Existing home prices fell in 17 cities.

iFeng: 楼市现拐点？连续两月超10城二手房价下跌

In November, the prices of second-hand houses in as many as 17 cities were down month-on-month, with Xiamen, Beijing and Wuxi falling by the top three, down 0.7%, 0.6% and 0.6% respectively.

In addition, the prices of second-hand houses in Hangzhou, Ningbo, Fuzhou, Zhengzhou, Tianjin, Guangzhou, Wenzhou, Jinhua, Shijiazhuang, Shenzhen, Quanzhou, Shanghai, Hefei and Haikou also fell to varying degrees.

Existing home prices rose 0.54 percent nationally, but those first- and second-tier cities are the leading indicator.

I've seen some arguing emerging markets will lead a bullish turn. The U.S. market has underperformed in the past couple of months, but that looks more like the U.S. catching-down to emerging markets.

If I can only have one chart and one asset, then it's all about the U.S. dollar. The broad trade-weighted U.S. dollar is less than 1 percent from its all-time high. The U.S. Dollar Index (DXY) is about 6 percent away. Long before DXY hits a new high for this bull market, the dollar will be at an all-time high versus global fiat currencies thanks to the rising share of EM currencies. Layer on my forecast for USDCNY to blast through 7 and its a recipe for financial market turmoil.

Given my poor timing ability, I would not be surprised to see a rally unfold into the New Year. Longer term, I expect Chinese economic data will worsen in early 2019, around the time of Spring Festival.

Here's one more chart that argues the decline is in the early stages: high-yield credit spreads. Investment grade spreads show a similar pattern. The only time a credit spread breakout failed to terminate at much higher levels was in 2005, when it was driven by an accounting rule change. Stories such as Leveraged Loans Are Looking ‘Scary’ to These Money Managers are reminiscent of the 2014-2016 correction's final stage, but spreads were far higher when funds such as Third Avenue Focused Credit shuttered.

If the "super bulls" are right and this is 2016 all over again, credit spreads and the U.S. Dollar Index (which hit a new 52-week on Friday) will turn down. Chinese credit and economic growth will pick up. Commodity prices will turn higher along with U.S. GDP growth, and interest rates will breakout to new multi-year highs. If the "central-bankers will save us" bulls are right, I'd wager the S&P 500 Index will have to fall another ~10 percent in the first half of 2019. A slow and orderly decline with low VIX and GDP growth above 2 percent won't spur the Fed. If the bears are right, the U.S. Dollar Index is heading above 100, possibly terminating at 120 or higher. The real pain for emerging markets and China hasn't begun yet.

A look at social mood points to either a short-term peak in negative mood or something much greater. The Yellow Vest protests in France continue and have spread as far as Canada.

Express UK : Macron's 'yellow vest protests' set to SPREAD WORLDWIDE - Egypt fear riots and CHAOS
CTV: Yellow vest protests spread to Canada, criticizing illegal immigration, taxes
BI: 70 yellow vest protesters detained after rallies spread to Belgium and the Netherlands

Brexit and Trump came at the tail-end of the prior downturn. Many of these protests (Egypt aside) have begun with major indexes only slightly off multi-year, decade-plus or all-time highs.

Finally, here's the S&P 500 Index and the Federal Reserve balance sheet, percentage change since the end of 2008 on the same axis. The S&P 500 tracked the rise in the Fed's balance sheet. It was in a trading range from the end of QE in December 2013 until the November 2016 U.S. Presidential Election. This time QT is underway. Since it began in October 2017, the S&P 500 Index has again seen virtually no gain (25 points, ~1% since October 31, 2017). In the absence of QE, stimulative fiscal policy and foreign central bank QE, stocks will at best tread water.