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03042014 March 4, 2014

Posted by easterntiger in economic history, economy, financial, markets, stocks.
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Weather Report 03042014

Current Positions  (Changes)

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

F(bonds) – up to 80%; G (money market) – remainder

Weekly Momentum Indicator (WMI) last 4 weeks, thru 3/3/14

+16.14, +17.75, +23.21+10.29 (S&P100 compared to exactly 3 weeks before***)

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

Some of the longer term topics not included in the last report, to control report length, are continued here for their long-term impacts.  One additional short-term topic has offered new insight since last month.

*******************SHORTER TERM*******************

Today’s S&P100 is now floating at 1/2 point lower than the ‘highs’ of January 15th, after 30 market days.  Today’s new ‘record high’ on the S&P is 2 points higher than the ‘record high’ from Friday(!) (I find it amazing how these indexes can rise, then stop, as if hitting the white line at a stop light; these are billions and billions of dollars of securities that are manipulated like sports cars.  Hmmm…) Placed in between those two highs was a dramatic, one-day plunge, supposedly reacting to the Russian invasion on Ukraine.  Similarly, the lack of a real threat, as if such a serious threat could resolve in one day, is the alleged impetus for today’s reversal.  This is a good example of one of the many games being played to keep potential sellers on the sidelines, while offering them increasingly marginal gains, and increasingly high risks.

Many indicators point to other, more relevant risks that have nothing to do with events in the Ukraine.

Regardless, since the first of the year, bond prices, like our F fund, have outperformed equity indexes, which have struggled just to break even for the year.  This means that the trend toward an upper limit on interest rates which began last summer has continued, with falling rates this year, and rising F fund prices.  The current stability in interest rates is now several times longer than the temporary panic when rates increased from their record low of 1.63% in April to near 3.0% in June, and September, and January.  Rates have now fallen back in the 2.6% range, and without the accompanying panic and drama from the fear permeated by the media of ‘higher rates’.  Both 2.6% AND 3.0% are lower than the lowest rates of just 4 years ago.  The long-term trend is still down. Therefore, the trend in the F fund is up, at low risk.  The higher upside to equities can be attractive, if it fits your time horizon, but, only if you consider the extreme risks due to events, Fed decisions, volatility, and the potential for fast losses to go along with the slow gains.

Does this mean that the ‘flight to quality’ normally associated with peaking stock markets and shifting into bonds has been established?  It’s likely, and, is also likely to further confirm in the months to come, regardless of the Fed’s position to continue or pause the pace of tapering that is already underway.

Two data points revealed Monday fuel this case.  For the first time in many months, the probability of a recession, as measured by the leading economic indicators, (LEI), is over 20%.  The LEI itself shows a downward trend in the past 6 months growth rate, and showing two consecutive monthly declines.  This does not look like an economy that is stabilizing or one that has shown an ability to stand on it’s own, even with record levels of assistance.

An additional case for going to cash or bonds in the near future is shown in the chart below. Returns are calculated for the annual returns (capital appreciation only) using monthly data for the S&P 500 for the past 115 years. Then, just the first year in which a 30% or greater increase in the S&P 500 is used as a reference toward the subsequent years following that 30% gain.

Each bar above the horizontal dashed line represents a year of 30% or above returns.  Notice how years following the 30% years, such as last year, represented a high point, followed by declining returns, if not, recession. Prior to last year, the most recent years were 1998 & 1996.S&P-500-30Percent-Years-112513

Here are the statistics:

  • Number of years the market gained 30% or more:  10

  • Average return of 10 markets:  36%

  • Average return following a 30% year:  6.12%

Notice here that each 30% return year was also the beginning of a period of both declining rates of annualized returns and typically sideways markets.  It is also important to notice that some of the biggest negative annual returns eventually followed 30% up years.  With the markets rising to just under 1850 at the end of 2013, since managers were chasing performance, it marked the 11th time in history the markets have attained that goal.

While it is entirely possible that the markets could “melt up” another 30% from current levels due to the ongoing monetary interventions; history suggests that forward returns not only tend toward decline, but bad things have eventually happened.

It’s important to add that among all 30% years, last year is the FIRST that was supported by record stimulus from the Federal Reserve bank, loans that must not only be reduced, through tapering, but, eventually withdrawn, as they draw a threat of a heavy interest burden with any increase in rates, until they are dissolved sometime around 2025.  This is a huge risk.  This is as if you use all your credit capacity to get you through a crisis.  You can’t have another similar crisis before you pay off your debt, without creating a brand new crisis; a new crisis on top of the debt from your old one.  Only now, you have to find another way out, since you’ve ‘charged up’.

TODAY’S MARKET LEVELS ARE SUPPORTED BY CREATING A BUILT-IN RISK FOR THE NEXT 10 YEARS!

This is what the past 20 weeks of the S&P 100 look like visually, between yesterday and today.

<-Yesterday

OEXWkly2

<-Today

Clearly, there is much more risk in the market at this point than reward.

(Now, mentally place this chart above into the red box below for an overall perspective.)

*******************LONGER TERM*******************

AREN’T STOCKS CHEAP?

You’re likely to hear this from those who are using a relatively short time frame (a decade or so), to try to convince you that things are fine, your money is safe, and that you’ll lose if you don’t hang around.

How useful is a 10-12 year time frame in a market that typically takes about 80 years to make three major peaks (1929/1966/2000)? It’s not.

The following chart covers over 130 years of market results. The red box covers the current period.  It shows the 10-year adjusted price/earnings ratio, the best 10-year measure of whether or not stocks are cheap.  Only when measured against the most expensive stocks ever, our last two peaks in 2001 and 2007, do current stocks appear cheap.  More correctly, this is the 4th most expensive stock picture in the past 100 years. The facts that indicate more interest and more participants in history does not make any ‘stocks are cheap’ announcement more accurate.

The median price-to-earnings ratio on the S&P 500 has reached an all-time record high, and margin debt at the New York Stock Exchange has reached a level that we have never seen before.  In other words, stocks are massively overpriced and people have been borrowing huge amounts of money to buy stocks.  These are behaviors that we also saw just before the last two stock market bubbles burst.

Currently, the GAAP (generally accepted accounting principle) P/E for the S&P 500 is 19.11 (as of 12/31/13). But the problem is we can’t really tell whether this is high, low or indifferent, short-term, due to the wild swings seen over the past 20 years.

From 1925 through 1995, the average GAAP P/E was somewhere around 14. The average for the full period is about 17. The average for the last 50 years is 19.2. And the average over the last 25-years is nearly 25 – a level that was never once hit only once prior to 1990!  The averages have skewed higher due to the overvaluations of the past quarter century.  Any measure within the past quarter century is bound to be inaccurate.

Technically, a p/e ratio of 25 implies that you are paying $25 dollars for every dollar of earnings.  Obviously, lower, not higher, is better.

BUT WHAT ABOUT THE RECOVERY?

Housing

Just as stocks are valued according to earnings, housing has to be valued according to income.  Housing values, rising or not, must be tied to incomes.  (What’s the first requirement to qualify you on your mortgage application?)

Real median household income peaked right near the last two equity price peaks.  It’s quite interesting that there is no corresponding increase in incomes along with the current peak in equity market prices.

Income

As with housing and income, a direct relationship must also be established to the number of people actually working, without which no positive income influence can take place.

Current levels of people actually working, officially called the labor force participation rate, are at levels not seen since the mid 1980’s. Unfortunately, this already includes people working multiple part-time jobs to make ends meet, people who are in no financial condition to provide momentum to power a stronger market of any kind, particularly housing.

What’s left?

Credit

For decades, rising consumer credit was effective in closing the gap between lower savings and the income levels needed to drive consumption, which represents 2/3 of our economic activity.

http://stawealth.com/images/stories/1dailyxchange/Household-Debt-Deleveraging-021914.PNG

Since the peak of the shaded area in 2009, the beneficial effects of deleveraging, or reduction in debts, must transfer into spending capacity.  Much of this decrease of consumer credit was forced upon consumers by lenders during the financial crisis of 2008, through involuntary cancellations or reductions of lines of credit.  Credit deleveraging has been a net withdrawal on spending and consumption rather than a positive influence on spending and consumption.

The brown and blue jagged lines clearly show gradual declines in personal income, savings rates and overall gross domestic product

What about the $4 trillion in Quantitative Easing in the past 5 years?

The Fed’s original intent to increase the amount of credit available to businesses and consumers, as well as target the level of unemployment, at least in theory, has largely failed.

First, the falling levels of unemployment are mostly due to the decline in people giving up looking for work, or, as officials call it, a falling labor force participation rate.

But, two things are obvious from the next chart.  One, the historic growth in the Fed’s balance sheet, used to stimulate the asset markets and to shore up the balance sheets of the financial sector, are also known as that artificial creation of stimulus over this period that must ultimately be withdrawn from the market as certainly as it was added. Two, the amount of wordsmithing that has been necessary in the Fed statements to cover their tracks is also monitored and noted.  

So, who really benefited since the first QE was launched? There is a great deal of debate on the topic, but here are a couple of facts. Financial asset valuations, particularly in the corporate sector have seen sharp increases. For example the S&P500 index total return (including dividends) has delivered 144% over the 5-year period. Those who had the resources to stay with stock investments were rewarded handsomely. (As a reminder, this bottom 5 years ago had the markets at a 1997 level!!!  All gains for 12 years had been wiped out.  This 144%, therefore, should be spread over the period since 1997, or 17 years, to fairly evaluate the 144%.  You won’t hear this on the business channels.)

Therefore, it shouldn’t be a surprise that the three rounds of quantitative easing over the past five years rewarded those who had the wherewithal to hold substantial equity investments. Everyone else on the other hand – which is the majority – was not as fortunate.

Perhaps the best illustration of these distributional effects is in the chart below. It shows the relative performance of luxury goods shares with wealthier clients vs. retail outfits that target the middle class. The benefits of QE are clearly not felt equally by the two groups.

In addition to the luxury goods story shown above, an even bigger story here is that luxury auto sales also rose in 2013, while the lesser under-brands lagged, and this includes a reduction in December YoY sales at GM, Ford, Chrysler, Honda, Toyota, Hyundai, VW, Kia, Subaru, and Mitsu. Light truck sales fell YoY at GM, Ford, Toyota, Honda, Kia, Sabaru, BMW, Hyunda, Mitsu and VW. Nissan was an exception with higher auto and light truck numbers. This is a clear reflection of who benefited from Ben Bernanke’s helicopter barrage of free money, that is, for those who are actually benefiting from the ‘wealth effect’, as opposed to those who are just pretending, as in those waving their 401k statements, which are still filled with ‘unrealized’ paper gains that you can’t actually spend, without penalties, age-restrictions, red-tape. This is a delusion of prosperity, spelled out in who can buy, and who can wish and pretend.

To make matters worse, these declining sales of non-luxury brands were all in the face of increasing incentives/rebates, some incentives increasing by double digits from December ‘12 to December ‘13, by Ford, Honda, Hyundai/Kia, and lesser incentives by Nissan, VW, GM and Toyota.  Only Chrysler had a reduction in incentives in the period.  The results were higher incentives and falling sales, at least among those outside of the luxury bracket.

Based upon measures of housing, income, credit and the impact of QE on the breadth of households, it should be clear that the appearances of a current recovery are an illusion for the bulk of the population, including savers, working people, retirees, people with workforce instability, and, that viewing last years 30% measurement in the growth of the stock sector demonstrates a massive disconnect between how the economy appears and how it actually is.

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