We’re Rolling Off the Top of the Cycle

Written by Dennis Slothower
Posted May 18, 2018 at 8:00PM

The stock market mostly paused Thursday through Friday, with a slight uptick, as options expired on Friday. I suspect the Fed held off draining reserves until options expired and big investment banks reduced their exposure to options. Options are a liability to investment banks, especially in big market movements.

Meanwhile, oil prices continue to dominate the market.

OPEC has to love this situation, with Brent crude oil prices at $80 a barrel and WTI crude oil prices at $71, being driven higher by geopolitical speculation rather than any supply shortages.

Goldman Sachs and Citigroup are poised to take lead roles in Saudi Aramco’s initial public offering. Saudi Arabia has desired at least $80 a barrel when it comes out with Saudi Aramco’s IPO, which will be the world’s largest IPO ever when the stock is in the second half of 2018.

Meanwhile, U.S. crude oil production keeps climbing to 10.723 million barrels per day, a new record high.

While geopolitical tensions are certainly fuel for driving up oil prices, they are also fuel for driving up interest rates. Talk has shifted back to the Fed planning on raising interest rates four times in 2018. Traders are now assigning a 51% probability of another rate hike, not only in June, but also in December.

Certainly, the U.S. government is being forced to borrow more, which could drive up rates far more than the stock market is anticipating. The 10-year Treasury yield in six to eight months could be closer to 4%!

What we are seeing is the cost of energy, the cost of borrowing, the cost of doing business, the cost of soaring debt, costs of soaring rents, costs of mortgages, etc. All are weighing on the economically-sensitive sectors.

It should not be surprising that, with rising costs, the real estate sector has broken down into a bearish trend. It's trending below both its 50- and 200-day moving averages. With the exception of energy and technology, most sectors are fading. For example, look at consumer staples:

When more and more sectors are breaking down into bearish trends, late cycle, with growth peaking and inflation accelerating like this, it is time to protect capital.

Small-cap stocks have been very strong of late given their large exposure to energy stocks. However, with U.S. macro-economic data worsening and given the Fed’s progressive tightening, this bubble is about to burst.

The truth is the Fed tightening has been a reliable catalyst for the bursting of asset bubbles globally — this is coming and historically, when the bubble bursts, small companies will lead on the way down because the demand for oil plunges in a developing recession!

Higher oil prices means a higher consumer price index (CPI) or rising inflation. Look for an inflation spike here in the second quarter, given oil’s price rise from $60 to near $71. That’s an 18.3% spike over the last couple of months!

Rising inflation robs bond investors of their income, so this is driving bonds down and yields sharply higher.

Higher oil prices at these levels undercut government bonds. The Fed is all set to raise interest rates again on June 13th at its next FOMC meeting, so bonds continue to crash in this environment, warning of big problems ahead.

We recently learned Japan’s GDP contracted negatively in Q1 2018 as it begins to slip back into recessionary mode. Growth in the Eurozone has been cut in half in 2018 (QE tapering) and the emerging markets are really starting to show stress. China’s markets have turned decidedly bearish.

Notice the “death cross” of the Shanghai stock exchange index, a sign of developing stress as a result of rising rates around the globe.

We still have the Fed looking to reduce its balance sheet dead ahead and further advances in the U.S. dollar shouldn’t be ignored. But as long as the indexes can hold above their 50-day moving averages without a crossover through the 200-day moving averages, the bulls maintain control.

However, my analysis shows we are at the peak of the U.S. economic cycle. Sharply higher inflationary pressures from rising oil prices and a persistent advance in the U.S. dollar suggest we’re “rolling off the top of the cycle.”

That may not seem so obvious to you with the major indexes still trending above their 200-day moving averages, but risk clearly outweighs upside rewards for general market exposure!

To your wealth,

Dennis Slothower Signature

Dennis Slothower
Editor, Stealth Stocks Daily Alert and Wall Street's Underground Profits

Dennis Slothower has been leading a small but profitable group of investors to some extraordinary profits in both good markets and bad over the course of a 38+ year investment career, starting as a stock broker in 1979. In 2011 Dennis was named the top performer by Hulbert Financial Digest for avoiding the Crash of 2008. Now, he is bringing his extensive experience to the public through Outsider Club, Stealth Stocks Daily Alert, and Wall Street's Underground Profits. For more about Dennis, check out his editor page.

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