Submitted by Taps Coogan on the 4th of April 2019 to The Sounding Line.

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Sven Henrich, founder of NorthmanTrader, recently spoke with Peak Prosperity in a long and wide ranging interview about the market and whether or not we are headed for a recession or new highs.

Sven Henrich:

“Passive investing obviously is becoming a larger portion of the investing mix to the point where we have more ETFs investing than we actually have stock traders. And so there’s this element of automatic allocations. A lot of these are driven by market cap weightings, for example.  

So to the extent that you have a lot of influence coming in from passive funds or ETFs, they will buy a certain set of stocks more actively than others, because it’s just the way it’s allocated. We saw that last summer — and this is one of the things want to pay attention to, when you see divergences and deviations.

In September of last year, I wrote a piece called “Lying Highs” in which I pointed out that we were seeing ever-narrowing slope of the rally, driven by fewer and fewer stocks. It’s kind of one of those classic ‘popping’ signs, but the problem with it is it doesn’t give you precise timing. This stuff can drag on, and on, and on. We saw that throughout all last summer.

So these passive investing vehicles come in and keep buying high cap tech stocks —remember, this drove Apple to $1 trillion dollars market cap, Amazon to $1 trillion dollars, and analysts kept raising their price targets. And so money keeps flowing in and stock prices go higher. It attracts more money, and  that attracts more money, and that attracts more money. It becomes this pyramid scheme — until something breaks. And that’s what we saw in the fall. The rally was just too thin leading up to that, and then required the technical downside reaction. That’s the danger of it... It’s not fundamentals, necessarily. It’s basically just the flow of money at the end of the day. And the algorithms buy it. So be aware of the structure of the market…”

“One of the lessons I drew out of 2018 was this simple message: Extremes will become more extreme. And that’s the biggest danger for traders, because you can easily get chopped up. And when things get so extreme, you’ve got to be very careful in not losing sight of the big picture and be patient and wait for the right setup…”

“The fact that we’re here now 10 years after the GFC and the Fed tried for only three brief months in 2018 to be non-accommodative. Jay Powell dropped the “accommodative” just in the September/October time frame, and it blew up in their faces. And the ECB is still sitting with negative rates — they ended QE at the end of December and European growth is maybe 1%, and Germany looks around 0.6%. We’ve never been in an environment where we are risking entering a recession with negative rates. We have no idea what that means.

And so the concern is that this past decade’s wave of cheap money will be our undoing. Since 2007 global debt has increased by $70 trillion. We’ve now got corporate debt at $6 trillion. And at the same time, when you look at real GDP growth, it just never kicked into high gear.

If you go back to the last 30 years, and you can look at the Fed funds rate, you can look at the TNX 10-year, and you can look at real GDP growth. It’s the story of lower highs all around. And it’s all sustained by massive, massive debt. And so now that we’ve tried it for 10 years, and the Fed recently admitted that they’re done and that they can’t do anymore. It’s highly concerning. Because how do you sustain an economy that can’t even handle a 2.5% Fed funds rate?

“…The Fed over the years has obviously become increasingly susceptible to market fluctuations. It used to be that the Fed would do what the Fed would do, even if it was uncomfortable to markets, but those days are long gone. And I think the bigger problem here is simply that there’s a big reality here. Markets and economies are totally intertwined now. And if you have a mass selloff that lasts longer than a few days, you’re going to see economic impact that’s negative. And maybe that’s the big unspoken truth…”

“And maybe we can explain some of this (slowdown) with global trade, but the reality is we are really long on the tooth here on the business cycle. And so I think there is a lot of hope right now, if there is a trade deal with China and maybe there’s a miraculous Brexit recovery, that all this turns around and recession fears go away. It’s possible. But there’s, obviously, the other possibility that the macro wheels have already turned so deep that it’s going to take—maybe it’s not even possible. The machine is already on it’s way.”

There is much more to the interview, so enjoy it above.

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