On Tuesday the S&P both sliced through 200 day EMA support and violated a trendline that had been in place for nearly a year.
The major indices, including transports, appear to have confirmed large rolling top formations of 4 to 6 months duration — on high volume no less.
This price action does not occur in a vacuum. It fits our longstanding thesis that (1) misguided stimulus efforts did not work, and (2) a significant “deleveraging” is still needed as Western consumers — and governments — work their way out from underneath a mountain of debt.
It was not enough to pump the banks full of cash and reinvigorate corporate profits without addressing the heart of the problem.
In Europe, that problem is the periphery countries choking on unsustainable debt loads; in the United States it is persistent unemployment and overburdened household balance sheets.
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The sting in the tail comes when Keynesian-themed efforts to pump and prime a sick economy lead to unsustainable leverage and debt buildup.
When the ponzi structure of wasted effort and unproductive spending finally topples, you get a nasty surprise — either a full blown credit collapse, a “katastrophenhausse” Austrian style “crack-up boom” in speculative assets, a Japan-like train wreck in deflationary slow motion, or some unholy combination of all three.
Right now, in the U.S. and Europe, there is great anguish over gridlock and government decisions to step back. As the decisions get harder, leadership is nowhere to be found. The Economist argues that politicians have simply botched everything:
In the early days of the economic crisis the West’s leaders did a reasonable job of clearing up a mess that was only partly of their making. Now the politicians have become the problem. In both America and Europe, they are exhibiting the sort of behaviour that could turn a downturn into stagnation. The West’s leaders are not willing to make tough choices; and everybody—the markets, the leaders of the emerging world, the banks, even the voters—knows it.
But those who are sick of excess debt rightly point out that denial ain’t just a river in Egypt, and that the fruitless spending we were already doing had little effect in the first place. It isn’t just a lack of stimulus, it’s a lack of intelligent logistical structure able to deliver helpful stimulus to the place it needs to be.
Time to wake up: After the party you get the hangover, which could mean risk assets getting repriced lower as the belated deleveraging begins. As mentioned in the note on long bonds, QE3 remains the wild card (as does China to some degree).
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