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Bollinger Bands Enantiodromia

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Market Commentary 

 

This year we have dealt with (1) Trade Wars between China and the USA (2) Covid-19 (3) An Oil War (4) BLM (black lives matter) Protesting and Looting (5) Unemployment at near Great Depression levels (6) GDP contractions that would make a midwife panic (7) QE Eternity, to name just a few of the main headline grabbers.

 

Yet despite all of this the NASDAQ is at all time highs. The S&P500 is less than 1% from its all time high. The Dow is 4.5% from its all time high. Gold before Thursday last week was at its all time high and Bitcoin is up 65% for the year.

 

The bulls will have you believe that we are about to have a vaccine in production and that the economy is going to come bouncing back. Excuse me for being a killjoy but do the bulls realize that just because a cure “may” have been found for the virus, the debt that we have incurred through fiscal and monetary stimulus not to mention the personal or corporate debt incurred is still going to be there.

 

There were many (me included) who thought the markets were crazy expensive in January, that was before the virus struck our economies and piled us with a HUGE debt overhang. Just remember a cure for a virus is not a cure for a debt hangover.

 

Lets first look at a couple of charts before delving deeper. I overlay the Fed’s increasing of the money supply to see how dependent we have been since 1971 on an ever increasing money supply, of particular interest is how vertical the money supply pump has become to maintain the price levitation.

 

 

Human nature is always impressed by the headline numbers. My late father always said to me turnover is vanity profit is sanity. So lets look at a little sanity.  What I do in the chart below is divide the price of the S&P500 by Gold which cannot simply increase supply at the rate fiat money can be printed. I go back to 2007 before the QE era became a normal part of our every day financial life. You can see the S&P500 hasn’t done nearly as well in real purchasing price dollars.

 

 

What is important to realize is that knowing all of the above will have done nothing to help you make money over the last few years. In fact over a short period of time it will have cost you money in the form of opportunity cost. Or if you are as much of a believer as I am you would have lost real money shorting the unstoppable bull.

 

With that introduction lets look deeper at a really simple but deep concept.

 

Mike’s Thought Piece

 

When a market becomes immune to negative news the era is often described as a Mania. I think it is fairly obvious that we are currently witnessing such a Mania. I said today on my regular Money FM slot on Singapore radio that if you would have told me that we would not only recover the sharp losses in March and April but go on to surpass them in a few months, I would have said you are mad. It just shows you that when it comes to understanding a one sided market in a manic bull phase there is nothing that can get in its way to stop it.

 

If what I am saying is true then why doesn’t the bull market continue forever. One of my guiding lights, the genius Carl Gustav Jung teaches us a concept in analytical psychology that I think gives us a real insight into what we should expect when a mania finally comes to an end.

 

Before I get to it I need to share one more chart that will provide the visual prompt to hopefully explain this concept in a more illustrative way.

 

 

 

A few years ago at a conference I spoke at in New York, they inducted John Bollinger into the Technical Analyst Hall of Fame. I am sure most of you reading this have heard of the eponymous Bollinger Bands. For those of you unfamiliar with them let me explain how to derive them. You run a moving average with N lookback period and calculate the standard deviation of that moving average in my case I use 2 Std Deviations. In the chart below you can see the shaded area bounded by the these 2 lines running at a distance of 2 Std Deviations from the moving average in the middle. Think of it like a rubber band pulled against an adaptive “equilibrium” mean. We know what happens with an elastic band that we pull too far, it eventually snaps back. Yes the energy build up by the pulled elastic band propels the momentum in the opposite direction with as much and often more force. Kind of like taking the elevator up and the lift down.

 

 

 

Enantiodromia is the compensatory natural force like the Bollinger Band is to runaway price action. Nature provides us with an equilibrium to help keep our system in order otherwise the natural world would simply be all chaos and would destroy itself, which it sometimes does in chaotic fits.

 

We see these one sided behaviours in life all the time. Think of some people who choose a life of celibacy; being so one sided and repressed can often result in unconscious energy (libido) that is not adequately brought into consciousness spilling over into shocking behaviour that leads to rape or molestation.

 

Think of the person who preaches strict morality around business ethics and is so one sided and puritanical, it is not uncommon for such people to be found guilty of theft and or fraud.

 

A healthy psyche is one that brings shadow material, i.e. the side of us we are not happy with our “darker side” to the surface. We all have a shadow and it is important to acknowledge it otherwise it will develop a force of its own.

 

In my humble opinion we have walked away from our responsibilities. We the market have shadow material that we are simply not willing to confront, so instead we ignore it and kick the can a little further down the road. It will be ok we tell ourselves. The Central Bank High Priests have our back. Our governments have our back they will stimulate the economy with the sugar we need to keep the one sided market from retreating and seeing the “other side”.

 

As Jung taught, nature will eventually play its part and the compensatory effects of enantiodromia will take hold and swing things back to the opposite extreme to pave the way for a rebirth to a more normal market.

 

If you haven’t already please be prepared for a wild ride to the “other side”.

 

 

Measuring Backwards Icarus Complex