The Disconnect Between Markets and Economics (DIA)

There’s a concept we’ve spoken of several times over the last few years that bears a little more discussion, and that’s exactly what we’re damn well gonna give it.

Listen up.

Markets and Economies

There exists the possibility for markets to rise while an economy is contracting. Or they can fall while an economy is expanding.

It’s a notion that’s counter-intuitive, though it’s really nothing new – Both scenarios have happened in the past, and will certainly repeat sometime in the future.

How does it happen? Very simply, there’s a natural lag-time between a market’s apprehension of an economic turn. That is, at major turning points between bull and bear markets, equities start to lose their collective ability to discount the future price of stocks.

The numbers simply become muddy. Corporate profits are in some cases expanding, in other cases contracting. Meanwhile, the economic markers are equally foggy, with some series climbing and others dropping.

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Often months, or years, will pass with a bull or bear market inertially gliding along its path before the forces of truth finally subjugate it.

New Realities

Today, we face a brand new reality in this regard.

How so?

We believe that we’re shortly going to face a flat, or even contracting, economy for an extended period of time… alongside a stock market that continues to rise disproportionately.

And when we say ‘disproportionately’, we call upon your imaginative faculties.

Because at this stage, there are only two possibilities – call them ‘inevitabilities’.

1) The system shuts down because of war or some other technical failure resulting from an exogenous event, such as a terrorist attack, a meteorite striking the NYSE, or a coronal mass ejection knocking out the electricity grid, etc.  Or…

2) We will continue to see the market rise on the back of an unprecedented wave of global liquidity that continues to swell every month. Not just the U.S. Fed, but EVERY major central bank around the globe continues to print more and more money.

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In this case, it’s inevitable – all this new money will artificially pump up asset prices, including equities, to levels that are outright absurd… even compared with traditional bubble-study numbers.

Individuals and businesses will also increase their debt levels as it becomes counter-productive not to finance and refinance operations on increasingly cheaper debt.

And then, of course, the bottom will fall out.

What to do?

The task for us as investors is to successfully navigate this rocky reef. We’ve got to continue to make money while corporate earnings flatten and go south, when economic numbers contract and the stock market continues to climb. Or, to be more precise, as the major indexes continue to climb.

Because the scenario we see unfolding is predicated on a diminishing number of corporate entities gaining the attention and flow of funds… while smaller, less popular, less media savvy outfits follow their profits off the edge of a cliff.

No. It won’t be pretty.

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And it will come to pass that this ever-thinning group of rising stocks will give the impression of increased wealth for all, when in fact it represents but a thin veneer covering one of the greatest lies of our times.

It will not be easy to swallow that the whole thing was just sleight of hand. That we permitted those minding the mint to get away with the most irresponsible behavior – with theft, really – while we watched and trusted and sometimes protested, but not with any heart.

And so the system was eventually sequestered from us. It’s been corrupted and turned into a monster that we never knew it could become – one that will, in the end, thieve from a great many of us all too much, all too quickly.

And the blame of course will be ours.

Where’s the Evidence?

We’re beginning to see signs of the slowdown now. One of the best indicators of overall global trade is the Baltic Dry Index (BDI), a measure of the cost in U.S. Dollars of moving commodities by sea. And a chart of the BDI shows nothing too encouraging.

Have a look –

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In short, we’ve returned to fifteen year lows.

This, of course, could mean that we’re simply returning to a longer term, average cost of shipping by sea (and there’s some truth in this). But it could also spell something more alarming – that there’s a slowdown in the aggregate amount, and therefore cost of seagoing freight is now underway.

If it’s the latter… If global trade is contracting, then shippers should be feeling the pinch.

And indeed they are.

For example, Danish shipping giant Maersk Line (who control roughly 15% of the seaborne freight market) says they will see markedly diminished returns this year. As of late, the industry relied heavily upon Brazil, Russia, and China for its growth. But there’s nary a trickle of new demand from those countries now.

Søren Skou, Maersk’s CEO, says –

There is nothing in container volume numbers that suggest that the global economy is on the verge of starting a new growth trend.

Not so encouraging. But also not unexpected.

The BDI is but a single indicator in the stock analysis salad, and though it’s an important one, it can’t be relied upon alone.

We see fit to look, therefore, at the Dow Transports to get a supplementary indication of the state of the overall economy, and there, too, we see potential trouble in the making.

Why? They look fine…

The Transports generally discount higher prices ahead for the Dow Industrials, as shipping orders are often placed months in advance of industrial production. In other words, we can discern new or rising demand first with signed freight contracts.

And yet we see that as the Dow Industrials have risen to set numerous new highs over the last six months (including four in just the last two weeks), the Transports have been stuck cold since late November when they topped out and failed to rise above their all-time 9310 marker.

See here –

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Until we see a new high that confirms the Dow Industrials’ break to higher territory, we’ll have what’s known as a ‘Dow Theory Non-Confirmation’, a sort of limbo-like existence for those who trade according to that system.

That being said, the ever-growing tide of liquidity may render Dow Theory – and every other traditional measure of market analysis – entirely superfluous.

And leave us no choice but to simply buy the indexes with two fists. We recommend the following NYSE:DIA Options spread for investors to prepare themselves with:

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Options Trader Elite recommends you consider buying deep-in-the-money CALLs on the SPDR Dow Jones Industrial Average ETF (NYSE:DIA). We like the January 150 CALLs, now trading for $34.00 – just 4% over intrinsic.

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Options Trader Elite recommends you consider buying deep-in-the-money CALLs on the SPDR Dow Jones Industrial Average ETF (NYSE:DIA). We like the January 150 CALLs, now trading for $34.00 – just 4% over intrinsic.

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With love of the hunt,

Hugh L. O’Haynew

See what people are saying...

  1. Jim Rodgers

    Hello Hugh, Well, I never thought about receiving such a thorough response, but I want you to know I sincerely appreciate you taking the time to answer my questions in ” The one percent rule.” Keep those educational tidbits coming!
    Thank you again Hugh,
    Jim

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