Markets (and Brexit) on a knife edge

With the historic Brexit vote tomorrow, I thought I would offer a rare personal take. Incidentally, just for the hoi-polloi  to be allowed a referendum here in the UK of national importance by the elite is so rare as to be highly noteworthy – and to me is a clear sign that political conditions are on a knife-edge not just here but around the globe – and likewise stock markets.

I have long held the view that more government equals bad government for the majority – and especially its obverse, that small government equals better government.  That is a rule I am applying to the Brexit question.

So my decision is based on one very simple principle – do we need the  complex layers of expensive government we currently have, or is there an appetite to get rid of a few?  In the UK, we have parish councils, city councils, county councils, regional government, national government, and the EU.  Not to mention the massed ranks of quangos (that Cameron falsely pledged to have a bonfire of!)

All with their armies of nanny-state employees with generous taxpayer-funded salaries and gold-plated pensions.  Meanwhile, the average Joe barely gets by on measly globalisation-limiting wage rises and the ‘middle class’ must wrestle with a Byzantine tax system that nobody on earth understands.

And what do these bodies actually do?  They pass laws that are prohibitive in essence, not permissive. They lay down what you cannot do. Over the years, this has resulted in a steady erosion of liberty – and it has taken it toll.  The public’s view of politicians run murderers a very close second in esteem.

But is this sense of powerlessness in the people running its course and are they ready to rise up and rebel?

For example, schools have become indoctrination centres where freedom of thought is punished. This helps ensure a compliant populace.  The mis-fits who believe in freedom usually emigrate anyway.

Many times during the Brexit ‘debate’ I have been struck by the Remain side proponents who exhibit a classic Stockholm Syndrome where the captor/hostage express empathy and sympathy towards their captors.  They view the EU as the source of their well-being and source of funds, not realising UK taxpayer cash is the true origin.

That great nation the United States of America started life with very small government thanks to the wisdom of its founding fathers and how did they do with all that freedom?  Did they fail because they did not have enough rules and regulations and high taxes? I think not. It became the most powerful nation on earth over the subsequent two hundred years.

But today, that power and influence has been corrupted as government has got too big since the 1930s, and the original impulse behind the Bill of Rights has been ditched.  Sadly, it has joined with Europe with its love of rules, regulations and sanctions and control and is mired in wealth-destroying government.

I say wealth-destroying because unless you are a crony capitalist who benefits from your friends in high office, the thick layers of taxes imposed on a citizen are taken from the wealth creators and distributed to the unproductive.  That’s the essence of socialism of course and as Thatcher once said, socialism fails when you run out of other people’s money.

The great innovative corporations of today – the Microsofts and Googles all started life in the USA (without government hand-outs, by the way).  Has any great modern tech company ever started life in Europe?  Of course not and that is because the conditions are unfavourable there.

As you know, I adhere to the belief that it is social mood that drives great social changes (as well as the stock market).  And social mood is changing very fast.

One of the concepts that help me judge social mood is inclusivity.  In a positive mood (bull market) phase, everyone wants to come together from nations joining forces (see EU) to smaller groups merging.  Today,  gays and lesbians are welcomed in society.  When I was young, they were very much hiding away in the underworld.

And now transgender people are being welcomed into the fold.  One piece of evidence recently is the advice to school teachers not to call girls ‘girls’ for fear of offending anyone in the classroom who may be uncertain about her gender. They should be addressed as ‘pupils’ or ‘students’.  That is inclusionism taken to an extreme because there is nothing more basic in life than knowing one’s own gender.

So the big question I have is this: Is this theme of inclusivity and diversity reaching a peak – and poised for a turn down in a new phase of disunity and division?  And if so, is the stock market poised for a collapse in a new bear market?

All across the EU, rejection of the status quo is growing with both right-wing and left-wing factions combining to oust the establishment business-as-usual elites.  Rome has just elected its first female mayor who promises to clean the city up of its rampant corruption among the ruling elite.

And in the USA, a certain Donald is causing sleepless nights among the Republican party establishment with his populist messages.  He is certainly no advocate of inclusivity with his calls to build a wall along the Mexico border and to ban Muslims from entering the country.

All of these conflicting forces are being played out in the stock markets today.  The credibility of the Federal Reserve is fading fast as they run out of magic bullets and are deeply divided over what to do in the face of weak recovery from the last Crash.  Equity valuations are extreme and company earnings are falling.

It seems to be only faith that the balls can be kept in the air a bit longer that avoids the start of a collapse.

Here is my long-term S&P weekly chart with tramlines that shows my dilemma

This month, the market came within a whisker of making a new all-time high in wave 5 above last May’s 2136 all-time high and has backed off a little.  If my EW labels are correct, a new all-time high in the final wave 5 awaits – and that has been my default position for a while.  It would then look textbook since wave 3 is long and strong and wave 4 is a classic A-B-C down.

The gyrations in wave 4 were massive with swings of 16% up and down as the tug-of-war played out.

But there are plenty of negatives that could prevent that outcome from over-valuation (P/E is over 24x) to near-record low cash-to-assets ratio of mutual funds.

Perhaps a positive Brexit result tomorrow would allow the flush of excitement to produce a jump over 2136 in the next few days and if so, my next job will be to find the wave 5 top.

In a recent blogpost I showed a chart where all major stock indexes have already made major tops with the USA the only hold-out, so stocks are living on borrowed time.

But now with bond yields also on a knife-edge, a further rise in yields would scare equity investors as the source of cheap money would start drying up and both bonds and stocks would decline together.  When they do, you will know that the bears will be in control – finally.