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04172014 April 17, 2014

Posted by easterntiger in economic history, economy, financial, markets, stocks.
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Weather Report 04172014

Current Positions  (No 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 4/11/14

-2.72, -19.48, +12.67, -5.41, (S&P100 compared to exactly 3 weeks before***)

(Today from 3 Fridays ago/2 Fri’s fm 4 Friday’s ago/3 Fri’s fm 5 Friday’s ago/4 Fri’s fm 6 Friday’s ago)

 

In the U.S. the yield on the ten-year closed at 2.62% and right at support. The rapid decline from 2.81% to 2.62% in only a week suggests a lot of money is rotating out of equities towards the safety of treasuries given the global uncertainties.  This desire for safety has kept the F fund as the place to be since the start of the year, as it has outperformed all of the other funds.  It should continue to do so until such time as when the rewards for stock ownership outweigh the risks of loss to stock portfolios.

Regarding this Weekly Momentum Indicator, which was designed to measure recent momentum, or the lack of momentum, it’s value is a reference to the range of the S&P100.  

For the past 26 weeks, it has been range bound between 785 and 826 on a closing basis. There have been some slight penetrations higher, intra-day, but on those days, it closed lower than these highs.  The S&P100, which closed at 824 today, has crossed back and forth across 824 20 times in the past 6 weeks.  One broad market mutual fund, the Vantagepoint Broad Market Fund, with top 10 components of Apple, Exxon, S&P500 Emini contracts, Microsoft, Johnson & Johnson, Chevron, GE, Proctor & Gamble, IBM and AT&T, is also expressing a similar pattern

.

This next chart below shows the number of stocks in the S&P500 that have confirmed ‘buy’ signals. Keep in mind that as you look at the peaks and valleys in the chart, the ‘sell’ signals appear every 2-6 months.  These are not long-term buy signals.  They represent the short-term trading signals that correspond to the fundamental financial picture, such as, earnings announcements, Fed policy changes, currency fluctuations, global news that impacts multi-nationals, government actions (or inactions).  The relationship between the flattening of the S&P100, above, the VantagePoint Fund and the lower peaks in the index below are very clear.

Analysis –  This is no longer an uptrend.  This has every appearance of a multi-year top, with the highest risk to reward ratio in at least 7 years, and one of the four highest risk profiles of the past 85 years, with 1929, 2000, and 2007 being the other three. (see next chart)

Based upon patterns in the past, I will not rule out one more attempt to establish another short round of ‘record highs’.  This next round would correspond historically as the ‘right shoulder’ in a ‘head and shoulders top’ pattern, and would signal a final opportunity to take refuge from the imminent reversion to mean values.  Stocks are presently 66% overvalued, according to an average of four, well-established methods that have been in use to measure over 100-years of stock averages. (see below-‘right click/view image’ on chart to expand for a better view)

QE Infinity has so distorted the prices of stocks and bonds that nobody can possibly determine what the investing landscape would look like, or, what conditions of the economy and financial system would be, in the absence of Fed bond-buying.

-Paul Singer, Elliott Management, October 2013

This past week saw the biggest spread so far this year in the weekly performance of the top and bottom indexes on this watch list. The Shanghai Composite turned in the best gain for the week, up 3.48% while Japan’s Nikkei suffered a dramatic 7.33% selloff. The general skew was downward. Five of the eight indexes posted losses ranging from the -2.00% of the FTSE 100 to the aforementioned Nikkei plunge.

It takes a wider view in time, and, of several major markets at once in order to correctly filter the relative value of where we stand, particularly in view of this looking very much like the peak for the next 4+ years.  Over the past 14 years, only one market, the BSE Sensex in India, has provided gains in excess of long-term market averages.  All the rest are in the single digit range, per year, including four markets with negative returns for the period.

Within the last week, the Japanese Nikkei plunged -340 points to close under the 14,000 level and the lowest point since October. The Japanese economy is struggling and as a consuming economy it is closely related to the health of China’s economy. With Chinese exports declining it suggests further weakness in Japan.

The decline in the Nikkei suggests global equities may have peaked. The yen carry trade, when currency traders borrow yen at a low interest rate and invest it in a currency with a high interest rate, is on the verge of coming unglued with the yen rising to four-week highs. A rising yen depresses equities. The Nikkei appears to be headed for a “death cross” where the 50-day crosses over the 200-day moving average. That is typically a sell signal. At this point even a sharp rally could not prevent the cross of the averages.

The Fed is playing a very dangerous game and they need to stop. …this is bad, this is heroine addiction…and now they are printing more money than the deficit……all my friends who are money managers..are much closer to the sell button than they ever were before..everyone’s holding cash since if they start to get nervous, volatility will come back instantly…you known when this ends, it’s gonna get ugly.”

Barry Sterlicht, CEO Starwood Group

Still another filter to clarify the gains over the past 4 decades is this comparison (above) of the nominal’ S&P500, which is the chart most used in the media, that, unfortunately, does not take into account the effect of inflation.  We all know that, back in the real world,  inflation impacts everything that comes into and out of our purses and wallets.  The ‘real’ S&P500, in black,  is the one that shows us what has really happened, apart from that which is overly/optimistically portrayed in the media, in red.  Keeping us believing in the ‘pie in the sky’ is what the media’s role is all about. It’s up to us to adjust the hype with doses of reality.  If you believe the red line, then, you believe that you can buy an average NEW house for under $85,000, or, an average NEW car for under $5,500, as you could in 1980.

This chart above uses the starting year of the last 11 economic expansions as a basis for the amount of growth that occurs during that expansion.  It’s easy to see two things.  (1) The current expansion is the weakest in the entire post-World War 2 era.  (2) Each expansion since the early 1970’s has been weaker than the one before it. Yet, there are those who would lead you to believe that market all-time highs are totally justified, and, that this current expansion, now the longest on record, in terms of time, (thanks to the equivalent of 25 years worth of Fed stimulus compressed into each of the past 5 years), has a solid foundation for even more growth.  Given the conditions in points (1) and (2), you would have to believe otherwise.

On the issue of market valuation levels/stock price levels, some find it amusing when the stock market “cheerleaders” on mainstream business news grab their pom poms and cry out “all-time highs, record earnings.”  Others prefer time tested ratios over rhetoric, and in the opinions of some, probably the most reliable of them is the Market Capitalization divided by Total Revenue indicator, or simply MC/TR.  A MC/TR ratio greater than 1 indicates total market capitalization has grown at an inflated rate that is not supported by total revenues.  A MC/TR ratio that is less than 1 indicates total market capitalization is lagging behind the total revenues of the market.   Between 1979 and 2008, the capitalization-to-revenue ratio averaged 1.12. The ratio is 1.05 when calculating the index data back to 1968.  

Data supports the assertion that market forces are constantly seeking a natural equilibrium between total market capitalization and total revenue.  Investors that can identify the points where a market has strayed too far below 1 can buy stock index futures before total market capitalization catches up to total revenue, and vice versa.  Past performance validates this assumption. When the cap-to-rev ratio was less than 1, the S&P 500 returned nearly 10% more than in periods when the cap-to-rev ratio was greater than 1.

S&P 500 Futures – Monthly Continuation

Chart from QST

Before the 2008 market crash, the cap-to-rev ratio was 1.39 and indicated an overvalued stock market.  Where are we now?  Based on the current market capitalization, total revenue and the MC/TR ratios on the popular Dow 30 stocks we have come to some very interesting conclusions. The average MC/TR ratio for the Dow 30 is currently 2.34. WOW!!!! When we recognize a fundamentally severely overvalued stock market, we should ACT on any technical sell signal with built in risk parameters, because you never know until after the fact, that this could be the big one!

An article written by Fran Hawthorne for The New York Times on March 2, 2011 sums up the scare potential built into retirement plan options:

“When the markets tumbled in 2008, many investors who had hoped to retire in the next few years were shocked to learn that at a number of funds, far more of their money than expected — typically half of the assets — was in stocks. Rather than being a haven, the average 2010 fund — aimed at people expecting to retire around 2010 — fell 24.6 percent in the downslide.”

So, just where is the fuel for these lofty valuations?  

(Hint -we’ve been here before.)

(‘Right click-view image’ for a larger view)

On the ‘street’ side, we are currently in record territory with the use of credit used in stock purchases, that is, borrowed money, known as ‘margin’.  As soon as this rising black line slows down and falls down below it’s own 12-month average, it means that borrowing for stocks has slowed and the power behind rising prices is weakening dramatically. On the ‘stimulus’ side, there’s the never before seen (at least before March ’09) $85b/$75b/$65b per month from the Fed(QE), used in purchases of bonds and other assets from banks. So, it’s not so much that the Federal reserve is buying stocks.  The banks are using the money received from these bond purchases to purchase other assets, including stocks.  Without this fresh daily supply of new money, the banks would certainly not be purchasing stocks, mostly for a quick sale.  The banks are not ‘buying and holding’ stocks.  They are ‘buying and selling’, or, trading stocks to raise their own revenues.  So, it’s no wonder that the banks appear to be so healthy under the current conditions, being so heavily supported by trading revenues.

Unfortunately, for all that quantitative easing has done for the financial sector, the impact on the ‘man on the street’, or, so-called, ‘Main Street’, can be typified by the chart below.

As you can see in the chart, there are now 63% of eligible workers who are actually on the employment rolls.  This is a level not seen since a time when many households included only one working parent.

The Fed has now removed their QE targeting as it was originally pegged, with the original goal of lowering the unemployment rate.  Since it wasn’t working, there’s no point in having it as a point of measurement.  The original plan was to ‘stimulate the economy’ with the new lending that the banks were expected to provide to the business sector, which was to then stimulate hiring, employment, etc. Instead of lending to businesses, the banks have used the money for their own health, using methods that they were better able to control, stock trading.

We’ve entered the calendar period, that window from May to October of  each year, that for the past 60 years, has resulted in some of the weakest market returns.  With the highest returns, in 2013, than we’ve seen since 1997, this year, and this weak part of the year ahead, it statistically represents a period of extraordinary risk as compared to the potential for reward.

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