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01222014 January 22, 2014

Posted by easterntiger in economic history, economy, financial, markets, stocks.
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Weather Report 01222014

Current Positions  (No Changes)

I(Intl) – exit; S(Small Cap) – exit; C(S&P) –exit

F(bonds) – up to 70%; G (money market) – remainder

Weekly Momentum Indicator (WMI) last 4 weeks, thru 1/21/14

(S&P100 compared to exactly 3 weeks before***)

+22.33, +6.01, -3.61, -4.8

(3 Friday’s ago/2 Friday’s ago/last Friday/today from 3 weeks ago)

Investopedia explains ‘Unrealized Gain’

A position with an unrealized gain may eventually turn into a position with an unrealized loss, as the market fluctuates and vice versa. An unrealized gain occurs when the current price of a security is higher than the price that the investor paid for the security. Many investors calculate the current value of their investment portfolios based on unrealized values. In general, capital gains are taxed only when they become realized.

How does an investor honestly reconcile the comfort and enthusiasm of results on a paper statement with the reality of the fact that, until sold, the gain will remain‘unrealized’? With full disclosure from regular Fed notes, it’s no secret that the Fed is ‘supporting the markets’ with daily cash injections.  The source of these injections are, simply put, electronically created LOANS that, for accounting purposes, are listed on the Fed’s balance sheet as items to be restored at some future point in time.  Therefore, the ‘gains’ in the current markets aren’t to be confused with cash to be distributed.  This is a loan that must be paid back.  The question is, who will get to cash in their ‘unrealized gains’, and who will pay the price for the current appearance, or deception, that everyone will be paid? Ask yourself – will I sell before the Fed withdraws from the market?

Since 2009, the correlation between S&P500 trends and Fed injections has increased from 53% to 100%.  This means that 100% of positive market movement is related to Fed injections.

Put another way, there is no other significant body participating in the markets presently outside of the Fed.  Selling by insiders remains a hundred or more shares times the number of buyers.  http://online.wsj.com/mdc/public/page/2_3024-insider1.html?mod=mdc_uss_pglnk  So -called ‘smart money’ has refused to commit money for other than short periods of time, or, has ‘hedged’ their buying heavily with derivatives which pay off in a decline.  We don’t have that luxury of that kind of risk control.

Ask yourself – is the Fed factoring in our withdrawal plans into their actions?

Here are the 2013 returns from some key major markets around the world.

The S&P 500 finished the year at 1848.36, for a return of 32.4%, an incredible return for one year by any standard.  The impact of a gain of that magnitude can easily be demonstrated by the absolute miss that I made for last year’s projection, even knowing in the fall of 2012 that Fed injections would begin.  So, from my own proprietary studies and tables, my day-to-day tracking for the year showed these patterns, now, of course, with perfect hindsight.  (Remember – these ‘returns’ must always be adjusted for (1) comparison to the ‘risk-free’ rate of treasury bonds, similar to our F fund, roughly 3-5%, and (2) inflation, at 2-3%, which NEVER show up in price charts, or, in quoted prices compared to other prices. So, these stated returns are never as high as they seem, regardless of the hype and emotion that’s associated with them.)

Positive/Neutral/Negative signals for the year, number of days

Positive     Neutral    Negative

  91

    59

    97

36.8%

23.8%

 39.2%

By all appearances, during the year, the markets never appeared particularly ‘healthy’.  Further, I found that for most of the year, the number of positive weeks in a row never matched the number of neutral or negative weeks in a row until the final 10-12 weeks of the year, which coincided with the Fed’s final, contradictory, ‘no taper’ announcement.   My suggestions for ‘entry’ or ‘exit’ signals during the year would have had to take nearly full advantage of our two moves per month allowed in our funds.

Therefore, I did not feel fully confident with the ‘risk’ side of the picture ahead of the potential reward.

So, how did my ‘miss’ compare with  early ’13 projections of the financial professionals?

Firm / S&P 500 Target / Missed it by this much (%, as of 12.10.2013)

  • Wells Fargo / 1,390 / 29.7%

  • UBS / 1,425 / 26.5%

  • Morgan Stanley / 1,434 / 25.7%

  • Deutsche Bank / 1,500 / 20.2%

  • Barclays / 1,525 / 18.2%

  • Credit Suisse / 1,550 / 16.3%

  • HSBC / 1,560 / 15.6%

  • Jefferies / 1,565 / 15.2%

  • Goldman Sachs / 1,575 / 14.5%

  • BMO Capital / 1,575 / 14.5%

  • JP Morgan / 1,580 / 14.1%

  • Oppenheimer / 1,585 / 13.8%

  • BofA Merrill Lynch / 1,600 / 12.7%

  • Citi / 1,615 / 11.6%

  • AVERAGE / 1,534 / 17.5%

  • MEDIAN / 1,560 / 15.6%

Like me, NONE of this long list of professional financial firms pictured anywhere near the advances that we saw last year.   I rest my case.  If they were all this far off, I could only be guilty of following the same signals of those with millions of dollars of staff and resources at their disposal.

As usual, the enthusiasm for continued market participation goes on non-stop. The normal focus in the mainstream media is to emphasize ‘number of weeks positive’, ‘percent gain YTD, ‘all-time high’, and so on.  What the media fails to do is to measure the ‘risk’ of the existing price levels.

The red line in the chart below is an inflation-adjusted measure of the S&P 500.  Your dollars do not buy what they bought in 2000 or 2007, so, why does the media compare today’s prices with the prices of 2000 or 2007?  The blue line measures the amount of margin debt, which is essentially the borrowed money used to buy stocks.  Notice how the peaks in margin debt correspond directly with the eventual peaks in the market.  The only difference this time are the $4 trillion dollars that have been ‘loaned’ to the mortgage and equity markets, from Fed keyboards, just since the last dip in 2009. Does this appear to be a low-risk period for stocks?

How long can this irrational state of affairs continue?  Stocks seem to go up no matter what happens.  If there is good news, stocks go up.  If there is bad news, stocks go up.  If there is no news, stocks go up.  That is, until they go sideways, for weeks at a time. On the Thursday after Christmas, the Dow was up another 122 points to another new all-time record high.  In fact, the Dow has had an astonishing 50 record high closes this year.  This reminds me of the kind of euphoria that we witnessed during the peak of the housing bubble.  At the time, housing prices just kept going higher and higher and everyone rushed to buy before they were “priced out of the market”.

But we all know how that ended, and this stock market bubble is headed for a similar ending.

The most significant factors in the change of market character for the year revolved around the Fed’s policy announcements in May, first to promise to taper after September, followed by the reversals in October, to postpone until after the change in leadership from Ben Bernanke to Janet Yellen. Also, there was virtually no gain from May to October, followed by the surge into the holiday season. This is the risky, news-driven aspect of market action that amounts to a virtual Vegas-style, dice roll; if the Fed is in, stay in.  If the Fed is out, get out.  I do my best to avoid situations such as these altogether, since, the Fed doesn’t exactly ‘have my back’.

Throughout, the safety position I took in the F fund early in the year, as a guard against mid-year stock sluggishness, narrowed much of the loss by the end of the year, the loss that was incurred by the May interest rate rise.  Bonds have held on to their ‘safety’ status and have strengthened since the first of the year as the ‘Santa rally’ in stocks has been erased. Characteristically, interest rates peak, and bond prices bottom (F fund) just as stock prices reach their peaks. This current action also appears to fit that historical pattern.

Two big events are occurring in the next ten days that could impact current trends in several world markets. One, the next Fed meeting occurs on the 29-30th, where a new and currently unknown tapering level is expected. Whether this means less support for the markets, or, no change/reversal with even greater support, is anyone’s guess.  Second, on January 31st, the first ever default of a Chinese ‘wealth management product’ will occur, in the range of half a billion US dollars.  This could ripple into other debt and loan offerings, given it’s rather unprecedented nature.  Asian markets will have to respond with strength or weakness to this event. There will be an obvious impact on many of the traditional lending policies in the Chinese financial industry. In the fall, I sought to avoid making allocation decisions that appeared to be based upon short-term events, or news, including Fed news, or Fed ‘noise’ as it’s also been called.  And, because of the abnormal time length between this report and the last report in October, there is simply too much material to update in one report.  So, I will end this as ‘Part 1’, and continue with parts 2 & 3 over the next few weeks.

Be careful.  Be safe.

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