There Are No Perpetual Trends

The U.S. equity markets are in their ninth year of gains after the bottom of the financial crisis in March 2009. On a quarterly basis, the S&P 500 has been up 80% of the time with only seven losing quarters in a total of 34. But he second law of thermodynamics excludes the possibility of perpetual motion. Prices will adjust when conditions are right for that.

The strong performance of the stock market in the last eight and a half years, which was mostly financed by central banks, has injected a generous dose of moral hazard in the fund management community and has facilitated the emergence of a new class of “do nothing” managers that have enjoyed high returns.

If fact, anyone with a large enough public relations department but with no investment skills could have accumulated a significant track record during the last uptrend. This violation of finance but also common sense principles will change when central banks abandon their policy of acting as the losing player in a zero-sum game of poker. But no one knows when this will occur and if that will be in a few months, a year or even in a decade.

Technical and fundamental analysts have been fooled several times in the past in trying to forecast tops using indicators that applied in past market regimes. Unfortunately, this tragic error has been committed by some high profile individuals. The current regime has defied uncertainty because of moral hazard. Neither the Ukraine conflict, nor the Syrian war, events that brought a WWIII very close, were sufficient to crush markets. There is now a third event related to North Korea that will probably have no effect also. This type of uncertainty is not enough to defeat the moral hazard from central banks.

However, there is no perpetual motion, especially under highly non-linear zero-sum games where the profits come mostly from major participants that for some reason are willing to lose. Stock markets will correct hard but the trigger may not be what most expect. A lot of people, mostly mom and pop investors, will lose a lot of money. A lot of “do nothing” managers will be looking for a job. A lot of skilled managers will probably refuse to clean up the mess the “do nothing” crowd will leave behind.

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