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04222017 April 22, 2017

Posted by easterntiger in economic history, economy, financial, markets, stocks.
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Current Positions  (No Changes)

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

F(bonds) – up to 100%; G (money market) – remainder

======================================================

Weekly Momentum Indicator (WMI) last 4 weeks, thru 04/21/17

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

-11.3, -3.43, -6.54, -1.94

Partial recap of my interim report of 4/19 – Stocks have given up much of their gains built on the ‘hopes’ of health care reform, tax reform, relief in regulations, or, any of the political promises that fueled one more fluff-filled rally.  Optimism was enough to create this last opportunity.  It is not enough to sustain, or, incur any reasonable risk.

Four days later, from CNBC – Stocks surged as talk out of Washington pointed to the potential for some action on health care, which is viewed as a precursor to any move forward on tax reform. Treasury Secretary Steve Mnuchin also said Thursday that progress is being made on tax reform. President Donald Trump said he was hopeful there would be a vote on health care next week and also to fund the government.

With virtually no gains for over 2 months, rhetoric such as the above keeps markets stuck in a perpetual, dream-filled loop to nowhere.

The chart below shows the wasted motion currently underway.

That MSCI World Index is a broad global equity benchmark that represents large and mid-cap equity performance across 23 developed markets countries. It covers approximately 85% of the free float-adjusted market capitalization in each country and MSCI World benchmark does not offer exposure to emerging markets.

Otherwise, and with all due respect to the advances from Election Day into February, it’s worthy to note that pre-Election Day price levels were flat to down for most of the previous 18 months; from March ‘15 to November ‘16, C Fund 44 to 45, F Fund 51 to 49, I Fund 61 to 56. Early in February, several days of the bulk of February gains resulted from comments from administration officials giving hints of a tax cut.

Any news on (1) health care reform, or (2) tax reform, or (3) tax cut, or (4) infrastructure = automatic stock rally; a rally that might or might not remain several weeks later. (‘tax cut’ in the news on 4/21 – index prices moved slightly upward immediately, though, it reversed within minutes. There were two such occasions in early February that created the same ‘sugar high’ for the markets.)

Billionaire investor Paul Tudor Jones has a message for Janet Yellen and investors: Be very afraid.
The legendary macro trader says that years of low interest rates have bloated stock valuations to a level not seen since 2000, right before the Nasdaq tumbled 75 percent over two-plus years. That measure — the value of the stock market relative to the size of the economy — should be “terrifying” to a central banker, Jones said earlier this month at a closed-door Goldman Sachs Asset Management conference, according to people who heard him.

This chart shows the S&P 500 with respect to the size of total economic activity, GDP.

The market is expensive!  A week ago, I mentioned the 28.8 price-to-earnings ratio, which is 73% higher than the 100 year average. This expense projects a future return in the very low single digits over the next ten years.

The 500 companies in the S&P500 can be divided into 11 sectors.

Each sector contains different number of companies.

Within this current 29.1 P/E, as of 4/21, the individual S&P sectors are shown as follows:

Sector                            Number of Stocks        Shiller P/E        Regular P/E

Energy                                35                                 17.40           -41.80**

Consumer Defensive          41                                  23.30            19.20

Financial Services               70                                 23.70            16.00

Industrials                          70                                 23.90             21.50

Utilities                              28                                  25.00            34.20

Healthcare                         59                                  27.40            20.60

Basic Materials                   23                                  27.70            35.60

Consumer Cyclical             85                                   28.20            21.90

Technology                       60                                   30.80            24.10

Communication Services   9                                     31.20            20.80

Real Estate                        24                                   47.80            22.70

S&P 500                           500                                  29.10            26.40

** – negative price-to-earnings in the energy sector are due to significant losses in coal, oil & gas exploration, integrated oil & gas, gas & oil storage, as a result of oil prices remaining below the break-even points for many companies in the sector.  This is also evidence of the flaws in ‘regular’ p/e ratios, versus the Shiller p/e’s.

Meanwhile….a short-term underlying technical picture is absolutely unchanged through this week, and is decidedly negative. For eight days in a row, many major averages have hovered UNDER a line of resistance, a ceiling, at the 50 day moving average.

Friday’s S&P500 level is actually 15 points lower than the February 21st level of 2366!

Last September, the C fund lost 4% within 7 weeks after breaking below the 50 day moving average.

Similar patterns show up in the F and I funds.

S fund’s 50 day moving average is 57.08.

I fund’s 20 day moving average is 62.03, as it nears the 50 day average at 61.36.

The more consecutive closes below these key averages, the more negative the near-term technical picture.

F fund performance relative to C fund

F fund performance relative to S fund

F fund performance relative to I fund

The F fund is poised to outperform C, S and I funds, with (1) the topping of the equity markets in early March, corresponding to (2) the topping in interest rates early in the year, a perfect, normally correlated occurrence.

On the liquidity front, this month the Fed added $23.4 billion in cash to Primary Dealer Trading Accounts in the period April 12-20. This is slightly more than the March addition of $21.9 billion, the smallest add since January 2016. It was a sharp decline from February’s $41.6 billion.  These levels are far below the QE levels of a few years ago.  What’s different this time? That QE support, that ended in 2014, was NOT withdrawn the next month, as is the support from mortgage backed securities!!!!

In the past 18 months, there have been several periods that tied or exceeded 20-30 year records in the number of days where major stock averages did not exceed 1% up or down for a number of days in a row.  This shows a lack of conviction on the part of both buyers, AND sellers.  Potential buyers are waiting on lower prices.  Potential sellers are waiting on higher prices.  In either case, no one wants to be first, to get in OR out. The latest report on borrowing to buy stocks (margin debt) has just hit another high.  Those borrowers might believe that it’s a good idea.  They won’t believe so later, if their gains don’t meet their expectations, forcing them to sell sooner than expected, and, possibly, under pressure to do so.  If this happens, you’ll know!!

So, as you thought that the Fed ended QE in late 2014, and it did, the Fed has continued to add cash to the financial markets every month. It does so via the purchases of mortgage backed securities (MBS). It calls them “replacement purchases.” The Fed is the bank for the banks, i.e. the central bank. It has resolved since 2009 to force trillions in excess cash into the banking system and making sure that that, somehow, some additional money flows through the system. It has also resolved to make sure that the amount of the cash in the system does not shrink. It does that each month via its program of MBS replacement purchases. The Primary Dealers* are selected by the Fed for the privilege of trading directly with the Fed in the execution of monetary policy. This is essentially the only means by which monetary policy is transmitted directly to the securities markets, and then indirectly into the US and world economies. The only means which the Fed uses in the transmission and execution of monetary policy is via securities trades with the Primary Dealers.  Yes! The Fed is still providing some degree of artificial support to the markets.  It’s just not to the same degree as before the expiration of quantitative easing (QE).

  • List of current primary dealersBank of Nova Scotia, New York Agency, BMO Capital Markets Corp., BNP Paribas Securities Corp., Barclays Capital Inc., Cantor Fitzgerald & Co., Citigroup Global Markets Inc.,Credit Suisse Securities (USA) LLC , Daiwa Capital Markets America Inc., Deutsche Bank Securities Inc., Goldman, Sachs & Co., HSBC Securities (USA) Inc., Jefferies LLC, J.P. Morgan Securities LLC, Merrill Lynch, Pierce, Fenner & Smith Incorporated, Mizuho Securities USA LLC, Morgan Stanley & Co. LLC, Nomura Securities International, Inc., RBC Capital Markets, LLC, RBS Securities Inc., Societe Generale, New York Branch, TD Securities (USA) LLC, UBS Securities LLC., Wells Fargo Securities, LLC

When the Fed buys MBS to replace those paid down from its balance sheet, it does so via trades with Primary Dealers. It buys MBS via forward purchase contracts which are typically settled in the next month or the following month. The Fed is only keeping the amount of its assets level. But it pumps billions in cash into the accounts of Primary Dealers each month as part of that process.

The dealers are in the business making markets in a broad spectrum of securities, including MBS. Their biggest customer is the Fed. When the Fed cashes out the dealers by purchasing MBS from them, the dealers can both leverage and redeploy that cash to not only buy more MBS, but to purchase whatever other securities it wants to. Stocks are a favored vehicle. The Fed cashes out the dealers when it settles the MBS purchases around the third week of the month each month. Even though the amount of cash in the system is roughly static, the Fed is still pumping cash into Primary Dealer accounts each month. That has an impact on the stock market. It’s obviously not the only impact, but it’s still part of the central bank game of rigging the market.

This chart of the combination of all of the Fed feeding since 2009, and even beyond the quantitative easing (QE), although it ended in 2014, continues, in reduced effect, through monthly purchasing of mortgage backed securities, providing trading revenues to participating banks.

Notice that from the end of QE, in late 2014, and on to late 2016, market levels were insignificantly higher overall. This ‘juicing’, only within the past 5 months (post-election) was on the ‘hopes’ I mentioned in the interim report, based upon prospects for health care reform, tax reform, etc., that, realistically, won’t have the market impact that is was already anticipated. Almost none of these elements are going to address the ‘greed’ factor that’s already been cranked into markets over the past few years, to get them to current levels.

With mortgage rates coming off the highs, there could be a slight increase in refi activity. That causes an increase in MBS paydowns, which the Fed will replace in the next month. Then it takes another month or two for those purchases to settle. There is a lag of 5-6 months between the drop in mortgage rates and the increase in the settlement of the Fed’s replacement purchases. By then the Fed may have begun to implement its proposed policy of “normalizing” the balance sheet. That’s a nice way of saying “shrinking” the balance sheet. To do that the Fed is proposing to allow its Treasury holdings to mature and not be rolled over. It’s also proposing not replacing MBS as they are paid down. So instead of a small addition to the Fed’s MBS purchases from the Primary Dealers a few months down the road, the Fed will indirectly withdraw money from the banking system and the markets. By doing it slowly over several years, the Fed may be able to avoid crashing the market. I use the word “may” purposely. Any shrinkage of the Fed’s assets will increase the odds of an accident. Slow and steady tightening will act like the drip, drip, of the old Chinese water torture. It will promulgate a bear market in stocks. Accidents do tend to happen in bear markets. The drip, drip, drip eventually turns into a cascade.

Most interesting, the Fed minutes last week also showed that Fed officials were discussing what to do with the central bank’s massive $4.5-trillion balance sheet, which was quadrupled during the financial crisis and its aftermath as the Fed engaged in three rounds of bond purchases as a way to depress long-term interest rates and give the stock market a boost. The minutes said that Fed officials agreed “a change in the committee’s reinvestment policy would likely be appropriate later this year.” Currently, the Fed has been keeping the level of the balance sheet steady at $4.5 trillion, by re-investing 100% of maturing debt.

It has been held for years that we’ll know the Fed is serious about tightening when it starts shrinking the balance sheet. Right now they are in the signaling stage. They’re talking about it. When the Fed talks about an idea, it eventually gets around to doing it. The Street is already telling you it will be no big deal. Don’t believe it. It’s time to ‘sell’ the stock rallies.  Not everyone will get the message in time.

Will the Fed Burst the Bubble in 2017?

The Fed has engineered the second longest Bull market in Wall Street’s history. It’s been dubbed the “Least Loved” Bull, because the US-economy’s recovery from the Great Recession has been the weakest since the 1930’s averaging only +2% growth per year. Still, the rising market for US-stocks, turned eight years old on March 9th, and might have finally silenced the critics in the “Doom and Gloom” business, who doubted its staying power. From a statistical perspective, this market’s no slouch. It has posted big enough returns to rank #4 all-time in terms of performance, with the mega-Bull run from the 1990’s taking top honors with a gain of +417%, according to S&P Dow Jones Indices. The current market can’t be faulted for a lack of endurance, either, as only one Bull has lasted longer. It has also generated more than $21-trillion in new stock market wealth.  ALWAYS keep in mind that these ‘returns’, always measured from the March ‘09 bottom, are measured from a point of a 12-year low, where all of the gains from 1997 to 2009 were wiped out.  Any triple-digit gains for the past 8 years also apply from 1997 to today.  That places averages for this 20-year period right back in the range of long-term norms.  There are no free lunches.  You only get returns with time, or, with higher than average risk, in the absence of sufficient time.

The best-performing group for the past eight years was the consumer discretionary sector, which includes home improvement retailer Home Depot, coffee shop Starbucks and athletic apparel and sneaker giant Nike, has benefited from an improving economy and people’s willingness to buy things not deemed necessities. The S&P-500 index has rallied +250% since hitting a closing low of 676.53 on March 9th, 2009. The gains since, uninterrupted by a decline of -20% or more, rank this bull market as the second longest ever. The S&P continued to rally through a five quarter long recession in corporate earnings through most of 2016, supported in part by historically low interest rates which made stocks comparatively cheaper and more rewarding than high grade bond yields. The “Least Loved” Bull market is nearly three years older than the average Bull, and is more than a year shorter than the longest one: the rally from October 11th, 1990 to March 24th, 2000.

However, this Bull market isn’t only the second oldest, it’s also the second-most expensive. On a trailing 12-month basis, using Q’4 2016 GAAP earnings per share, the S&P 500’s price-to-earnings ratio stands at 25x, -second only to the 30-times earnings multiple recorded at the end of the tech bubble in 2000. (The range was also into the high 20’s surrounding the Great Crash of 1929.  We’ve left that out, since it predates everyone reading this.) Investors, however, are encouraged by a projected +11% rise in 2017 operating-earnings per share and think the growth could be even stronger if the Trump administration successfully delivers on promised tax cuts and increased infrastructure spending. Others see the potential for a final “melt-up” that could mark the top. Share prices could shoot up sharply if retail investors get jazzed about stocks again and start “pouring” money into the market. The melt-up may have already started, or finished on March 1st (the current high), on expectations that Trump’s tax reform will significantly cut taxes for both corporations and individuals. The stock index hasn’t suffered a drop of -20% since the Great Recession Bear, which ended on March 9, 2009. But the broad market gauge is up more than +250% since. There is no doubt that when the SPX is up +250%, with mid-single-digit sales growth, that it is a liquidity driven market. Then again, liquidity is one of the five cornerstones of the investing process, along with valuations, fundamentals, technicals and fund flows. This is clearly not going to last indefinitely, but the conditions for a Bear market – a decline of -20%, are only in place WHEN the Fed drains liquidity to the extent that it causes an economic recession (more on that below). Whether we like the interventions or not, for markets, the Fed matters. It has always mattered.

Indeed, if one left it at that, the answer would not be exactly wrong. However, there is one more factor which is rarely discussed, and which – according to Deutsche Bank – virtually the entire equity rally of the past four years is the result of plunging bond yields, which as a reminder, is the direct pathway by which central banks operate. As Deutsche Bank’s analysts warn, “various Fed officials have raised the issue of financial stability in the context of the reach for yield and riskier products to make up for low rates. This is part of financial repression. The logic might be that once the Fed has normalized, elements of that reach for yield and risk would be unwound and this could lead to disruptive financial market volatility.” Put in the simplest possible word, this means the Fed is worried that once rates go up as a result of renormalization and the lack of a central bank to front-run, stocks will crash. As it turns out the Fed has ample reason to be worried. Because QE and the Fed’s Zero Interest Rate Policy or financial repression is responsible for 92% of the S&P-500 rally since it launched QE-2 in Nov 2012, or just over +800-points, that would suggest that the Fed super-easy money policies are directly responsible for approximately 25% of the “value” in the market, and any moves to undo this support could result in crash. In retrospect, it becomes obvious why the Fed is petrified about even the smallest, +25-bps rate hike. The problem is an irredeemably flawed monetary doctrine that tracks every tick in the S&P-500 index, and uses financial repression, or artificially low interest rates and bond yields were the principal mechanism whereby wealth is transferred from savers to the US-government and shareholders in the US-stock markets.

Stock traders have been under the spell of monetary easing” to the point where negative news such as downbeat US jobs data in March did not stop stock prices from going up. Traders shrugged off uncertainty because they expect any bad news to be followed by continued low interest rates or bond purchases that increase the supply of money in the economy. Yet again, massive credit-fueled capital misallocation simply papers over short-term cracks and extends the life of the economy’s expansion cycle, but leaves a bigger more damaging hangover of credit defaults in its wake, unless just a little more credit fueled zombification will help. Many traders don’t expect the Fed to normalize its interest rates or reduce the size of its bond portfolio in any meaningful way, and the feeling is that we’re OK for a while, and everyone thinks they’re smart enough to know when the music is going to stop.

Many investors are bullish on stocks in the ninth year of a rally. Earnings will improve with future tax cuts and the liquidity spigot is still wide open, so it’s like a giant game of musical chairs. The attitude on the part of most investors is that they have to play while the Fed got the music going.

The Fed’s bombshell announcement; “a change in reinvestment policy would likely be appropriate later this year,” from the minutes of the Fed’s discussion at their March Meeting released Wednesday, showed near-unanimous support for the +25-bps rate hike to 0.875%, the second rate hike in three months. The group decided to keep signaling that future rate hikes would be gradual, and futures traders are giving 60% odds of a +25-bps rate hike to 1.125% at the June meeting. Traders are split on the likelihood of a rate hike to 1.375% by year’s end, with the Dec ’17 contract priced at an implied yield of 1.25%, or a 50% chance. The Fed has a major credibility flaw and traders are skeptical of their hawkish rhetoric.

Not so coincidentally, as the Fed Fund rate has been increasing, mortgage rates are falling. Why is that?  While increasing the Fed Funds rate makes it more expensive for the banks to borrow from the Fed, mortgage rates are based on the 10-year Treasury Note, which has been weakening since it’s peak in December and March. The 10-year Treasury Note is more responsive to changes in the dollar, and to global rate concerns.

Final Note

There’s always a possibility of unexpected, but, related, outside negative influence that can always act to disrupt even the most carefully positioned scenarios.

The Shanghai index has been locked in a tight range, also pretending to project a stable financial environment.  This has been accomplished with some degree of force, using involuntary means to prevent selling. It has even been illegal to sell stocks under some conditions.

In the event that the support range currently in play doesn’t hold, it could result in a wave of forced selling that could destabilize our markets as well.  I’ll be watching for any echoes that come in our direction.

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11132015 November 13, 2015

Posted by easterntiger in economic history, economy, financial, markets, stocks.
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Current Positions  (No Changes)

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

F(bonds) – up to 75%; G (money market) – remainder

=================================================================

Weekly Momentum Indicator (WMI) last 4 weeks, thru 11/13/15

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

-18.07, 36.28, 36.12, 62.48

=================================================================

(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 2001, the trend turned bearish, by falling through the 9 quarter moving average, stocks rallied 20% in 32 days, then fell 29% in the next 90 days. Stocks fell 44% within 7 quarters.

In 2007, the trend turned bearish, by falling through the 9 quarter moving average, stocks rallied 12% in 40 days, then fell 23% in 3 months. Stocks fell a total of 53% within 4 quarters.

Now, in 2015, the trend turned bearish in August, by breaking the 9 quarter moving average, then rallied 11.44% in 51 days into November 3rd.  We have now fallen 4% in 8 days. The pieces are falling into place for a decline of 20% or more within 90 days, and up to 50% within the next 6 or so quarters.

“History never repeats itself,  but it often rhymes”

A lot of attention was given in the past two months to the ‘bounce’ from one-year lows, following a 4-day, 11%, waterfall decline in August.  After taking two tries, over seven weeks, to rebound just over 5%, beyond 2020 on the S&P500, it was only through a sequence of Fed (rate softness) , European Central Bank (extending Quantitative Easing), and Bank of China (surprise rate cut) announcements in mid-to-late October to create a ‘bullish’ impression.  The truth was told at the end, when the November 3rd high failed, by 1%, to match the previous high, established in May.

Even after the recent 8% rebound from the August collapse and the one-year low, S&P price levels were only 1% higher than they were a year ago, even as S&P earnings are DOWN 6% from a year ago. That current S&P price level was still 2% BELOW the highest levels of almost 6 months ago. (This is called a ‘trading range’, no matter what the level of dramatics that occur in between.) The justifications for these zig-zagging price levels are simply to confuse, return only what has already been taken away, and, to continue to offer little reward for great risk. Earnings on the Dow Industrials peaked last May, along with the ‘all-time highs’, and have declined, by 10%(!), ever since.  This is another factor that weighs heavily on anyone’s suggestion for continuation of the bounce.  Earnings drive price levels.

Short-Range

Here is a day-by-day trend of how the major S&P sectors are performing this week.  To get to the main point, or, the bottom line, notice the fading trend on the bottom two rows.

S&PSectors

How has holding F Fund positions compared to positions in the C, I, and S funds this year, given the higher levels of risk?

These three charts tell the story.

Use the ‘0’ line, in the middle, from left to right, as a guide for the plus or minus, advantage/disadvantage from holding in F funds this year, as compared to the other funds.

(click each chart to zoom in, then, back button to return to the page)

PEOPX-AGG

The C fund, most like the S&P500, has carried an average upside of about +1-2%, an average downside risk of -1-2%, a high of +4.53%, at one very, short point, and a downside risk of -6.1%.  It now only has a 0.65% advantage, which even now appears to be eroding today.

EFA-AGG

The I fund, most like the EFA International fund, has carried an average upside of about +2-4%, an average downside risk of -1%, a high of +7.22%, at one very, short point, and a downside risk of -8.24%.  It now only has a -4.84% disadvantage, which even now also appears to be eroding today.

RUT-AGG

The S fund, most like the small cap funds, has carried an average upside of about +3-5%, an average downside risk of -1%, a high of +8.98%, at one very, short point, and a downside risk of -7.23%.  It now only has a -2.86% disadvantage, which even now also appears to be eroding today.

This should make it clear that we are unable to declare any advantage for this year in equity funds, even if the returns in the F fund, and bond funds in general, have been both low-risk, and, of low appreciation.

Medium-Range

Longer term indicators are on the cusp and could go either way from here, either confirming an early stage bear market down phase (most likely) or signaling that longer term cycles have turned back up (most unlikely). Given the underlying adverse liquidity (tightening credit and falling demand worldwide) conditions, that seems a less likely alternative; but, if the indications did turn to the upside, it is suspected that the up phase would manifest itself as little more than a broad trading range that has wide swings in both directions with little upside progress overall. This week has offered a window into this next probability, and, is now unfavorable. As I said in September, fund managers love a ‘Santa Claus’ rally, to fatten up their New Year’s bonuses.  Therefore, one more rally back to recent highs is not out of the question.  It would be very quick and very limited on return.  Don’t try to chase it if you’re already standing aside.  You’re likely to either be in, with risk, or, miss it, IF it comes, and not miss much.

Interest Rates

The shell game with the Federal Reserve continues, now with the December meeting supposedly holding the next key to whether or not rates will rise from the floor.  We’ve heard this before – next meeting….next meeting….next meeting.  So, how does this impact us?

Every threat to raise rates puts downward pressure on our F fund, and upward pressure on interest rates. Each realization of a weakening economy puts upward pressure on our F fund and downward pressure on interest rates.  This tug-of-war seems never ending.  The likelihood of a truly, major positive event signaling economic health is simply a pipe dream.  The further denial, and never-ending, but unfounded hope that the worst is behind us, only serves to stall the inevitable – that the Fed is bluffing on raising rates, since they are hinting at strong economic growth that simply cannot be sustained.  Recently, a ‘strong’ jobs report raised talk last week and this week of raising rates in December.  That report is only an estimate.  Averaging that report into the last 2 previous reports only creates an average jobs trend and outlook.  I mentioned earnings earlier.  We are in an earnings recession; declining earnings, year-over-year.  The Federal Reserve has NEVER raised rates during an earnings recession.  That rate decision requires a broader view than one employment report can contain, no matter what, or who, can tell us how certain they are that rates will rise.  Even if they do so in December, it is only by a small amount, and, that has more psychological impact than anything else.  Raising rates will also give them room to lower them again, once the true nature of the unsustainable levels of the current economic condition is revealed in the next few quarters.  We are talking about raising rates, while Europe, Japan and China are in rate cut cycles!! This F Fund strength, relative to the other funds, is already telling you that worldwide rate pressure is low, and, that F Fund prices are performing relatively well. That’s your cue.  Don’t worry about rising rates!!!

03162015 March 16, 2015

Posted by easterntiger in economic history, economy, financial, gold, markets, oil, silver, stocks.
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Current Positions  (Slight Changes)

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

F(bonds) – up to 50%; G (money market) – remainder

Weekly Momentum Indicator (WMI) last 4 weeks, thru 03/13/15

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

-26.06, -13.71, +20.39, +49

(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)

Another better-than-expected jobs report came out last week. This time, the stock market reacted negatively. The reasoning behind the drop is that this continued string of above-expectations jobs reports (this is currently the best sustained jobs trend in 15 years) is quickly raising the odds that the Fed will begin hiking rates at the June FOMC meeting.

Therefore, investors appear to be going through with withdrawal pains ahead of the FOMC announcement next Wednesday. This is premature and unwarranted since there is very little chance the Fed is going to make a material change before June and probably September. The Fed can’t withdraw stimulus by raising rates with the dollar surging nearly 1% per day. That would send the dollar into hyper drive and S&P earnings into the cellar.

Market Statistics

YTD03132015


Margin Debt

MarginDebt01 (click chart to expand in separate window)

Repeated/updated from the four previous reports, an accurate count of margin debt, or, levels of borrowed money at all brokerage firms for each month is carefully watched by the financial media.  It’s this combination of a) margin debt, b) Fed money loaned to investment banks (finished), and c) stock buybacks by corporations (no significant increases over last year) that have provided a vast majority of the power to the markets for much of the past 6 years. The result of margin debt figure through January is shown in the chart above, for comparison to all months of the past 4 years.  (The last two dots have been recorded since the last report)

Update – Notice that the peak in debt for the year, once again, has STILL not exceeded the February ‘14 high, after which the primary indexes channeled sideways, with no price appreciation, for 12 weeks. And, for the first time since 2011, the figure is below the average of the past 12 months.  At that previous decline below the 12-month average, the markets weakened significantly, and quickly, losing nearly 20% of it’s value within 6 weeks. For the past eleven months, the debt level has stalled under $466 million.  This STILL indicates that a primary source of fuel for the market (loans and borrowed money) has stalled and is not likely to resume.  When combined with the now missing portion of Fed stimulation through Quantitative Easing (QE), which ended on October 29th, this removed the bulk of what has sustained the markets back up to the peaks above and below the peaks of 2000 and 2007, depending on the index.

Not so coincident with the weakening trend in margin debt, the S&P celebrated its six-year anniversary of a ‘bull’ market this month. It is up over 200% during that period. Remember that this increase is measured from a 2009 level that had wiped out 12 years of gains.  This 200%, repeated quite frequently in the media, represents much of the same level gained from 1997 to the previous high in 2007, with a loss of over 50% from 2007 to 2009.   And, unfortunately this is the third strongest six-year gain since 1907. The other two times were in 1929 and 1999 and neither ended well. Both resulted in major market crashes.  The biggest difference between this increase and the first two is that only this one required trillions in ‘float’ from the Federal Reserve balance sheet that still has to be repaid, at some point stretching into the next decade.

(click chart to expand in separate window)

SP500-HistoricalRallies-Nominal-030815

The current rally of 154.08% is also the 6th longest in history and very close to becoming the 5th if it surpasses the rally from 1982 through the 1987 crash of 156.62%.

This data alone doesn’t mean much in isolation. It would be relatively easy to argue, according to the charts above, that the markets could go significantly higher from current levels. However, price data must be aligned to valuations.

At 27.85x current earning the markets are currently at valuation levels where previous bull markets have ended rather than continued. Furthermore, the markets have exceeded the pre-financial crisis peak of 27.65x earnings. If earnings continue to deteriorate, market valuations could rise rapidly even if prices remain stagnant.

While stock prices can certainly be driven much higher through global Central Bank’s ongoing interventions, the inability for the economic variables to “replay the tape” of the 80’s and 90’s is not likely. This dramatically increases the potential of a rather nasty mean reversion at some point in the future. It is precisely that reversion that will likely create the “set up” necessary to start the next great secular bull market.

Funds

 (click chart to expand in separate window)

FundsJantoMar15

Fund positioning in the past two months has been difficult, at best.  Notice from the combined charts above of our primary funds, a miniscule loss on the F, to tiny gains on the C and S, to a more measurable gain on the riskiest fund at the moment, the I fund, a gain that is only attributable to the start of a quantitative easing program (QE), the same as which we have just finished last October.  Remember that the I fund and S funds were the weakest performers in the past 12-15 months. While there might be a presumption of gains or strength in the I fund, based upon this QE program initiation, the actual risk can be seen with the anticipation for the first few weeks, now followed by a corrective phase now underway that coincides with weakening in a broader cross-section of world financial markets, including ours.  The jury is still out on whether or not the QE will have a similar effect on European markets, due to their lack of singularity, as opposed to our more unified and somewhat redundant markets, where QE worked, for a while, and, diminished in impact over time.

It was a volatile week in the markets but the damage was muted. Short-term, last week’s price action was bearish. The cash S&P 500 both broke a prior week’s low and closed below the rising 20-day Moving Average for the first time in a month. This altered the bullish price structure. In addition, the market also closed well below the late December high of 2093.55 (WD Gann rule: Old price resistance, once it has been broken, becomes new price support). Despite two days out of the last six with -300 point Dow declines the Dow only gave up -197 for the week or -0.6%. That was the best performance of any large cap index. The Russell 2000 actually gained +1.2% for the week and that is the bright spot this weekend. Obviously the large cap indexes are suffering from dollar pressures where the impact of the dollar on the small caps is minimal.

For instance Hewlett Packard said they could lose $1.5 billion in 2015 because of the dollar and it has only strengthened since that warning. They could be up to a $2 billion loss before the quarter is over. Most small caps don’t even generate $2 billion in annual revenue. The difference in scale is the key. The earnings capacity of the small caps is not being harmed while the big caps are losing billions.

For instance, IBM gets 55% of its revenue overseas. Pfizer 66%, Wynn Resorts 72%, Applied Materials 78% and Phillip-Morris 99%. Even with active hedging programs a 26% increase in the dollar over the last 9 months is a dramatic difference. Companies earning money in euros, yuan or yen have seen their purchasing power drop considerably when products have to be purchased in dollars. In the case of companies like Hewlett Packard they can sell their products in foreign currencies after marking them up but then they have to convert those currencies back to dollars to bring the money home.

In theory we could just ignore the large cap stocks and concentrate only on small caps. Unfortunately the large caps control the major indexes and that is what represents the market. If someone asks you at dinner what the market did today you more than likely would not say the Russell 2000 gained 4 points. They would look at you like you said aliens visited the NYSE today. The market is represented to the public by the changes in the Dow, S&P and Nasdaq.

The S&P gave back -18 points for the week or -.86%. Given the big intra-day swings I feel fortunate it was only -18 points. The index bounced off the 100-day average at 2044 for the last four days without a breakdown. So far that support is holding and the 150-day at 2019 is untested. If you only look at the chart of the S&P it would appear that test of 2019 could come this week. However, if you look at the rebound in the Russell it suggests the S&P could rally into the FOMC meeting on expectations for no change in the post meeting statement.

When the S&P rallied on Thursday it came to a dead stop at 2065 which was resistance in January. With the three-day dip to 2040 and solid stop at 2065 that gives us our breakout targets for next week. A move outside either of those levels should give us market direction. I would not be surprised to see the 150-day average at 2019 to be tested.

Support 2019, 2040, resistance 2065, 2080.

SPX

At the low on Friday the Dow was down -265 points at 11:30. That makes the -145 at the close appear relatively tame. The Dow inexplicably rebounded off the 100-day average at 17,655 for the last three days. The Dow rarely honors any moving average but apparently somebody was watching last week and decided that was a decent place to put buy orders. Since very few people actually buy a Dow ETF that means somebody was buying Dow stocks. If we delve into this a little closer the answer appears. It was the three financial stocks, GS, AXP and JPM, that held up the Dow and kept it from falling under the 100-day. It was not that they powered the index higher but they did react positively to the banking stress test capital expenditure news and that kept the Dow from declining. United Health, Du Pont, Disney, Travelers and Verizon also contributed. They offset the obvious losers of Exxon, Chevron, GE, Visa and IBM.

When the Dow rebounded on Thursday’s short squeeze it came to an abrupt halt at 17,900 and resistance from January. This gives us our trading range for next week from 17,640 to 17,900. A move outside that range gives us market direction.

Dow

The Nasdaq lost -55 points or -1.1%. A funny thing happened on the Nasdaq. The decline came to a dead stop at old uptrend resistance at 4850. The index held up remarkably well and I think it could follow the Russell 2000 higher if the small caps continue their rebound next week. The Nasdaq chart is still in much better shape than the Dow and S&P and could be poised to return to the highs if the Fed makes no changes.

Apple quit going down and that was a major factor in the Nasdaq minimizing its losses. The other big caps were still bleeding points as you can see in the table below but Apple is the 800 pound gorilla and the post Apple Watch “sell the news” event knocked off $5 early in the week but remained flat the last three days.

Resistance 4900, 5000. Support 4850, 4730.

Compq

The Russell 2000 rebounded to close within 6 points of a new high on Thursday. Friday’s early decline was almost erased with only a -4 point loss to end -10 points from a new high. This is very bullish given the Dow and S&P losses on Friday. Per my comments above the lack of dollar impact on the small caps could make them the favorite of the investing class over the coming weeks. That does not mean they will soar while the rest of the indexes collapse but all things being equal if the big cap indexes are at least neutral the Russell could break out again. That could trigger buying in the bigger indexes.

Watch the Russell 200 closely next week. If the Fed does nothing the Russell could be the leading index. However, they would be hurt significantly by a change in Fed policy because they have a lot of debt and higher rates will hurt. Obviously nothing will change in the near future but a change in Fed policy will make investors more cautious well ahead of any rate hike.

Resistance 1242, support 1220, 1205.

RUT

Bonds/Interest Rates

Declining oil prices will likely continue to lower the consumer price index as well. Also known as the CPI, the inflation metric for the last two figures released on February 15th and March 13th showed a rate that is still falling under expectations. Inflation targets have been hard for the Federal Reserve to maintain and the drop in oil prices isn’t helping matters.

If inflation metrics can’t maintain high enough levels, that may force the Fed to refrain from raising interest rates later this year.

Morgan Stanley economist, Ellen Zentner, said the Fed will not raise rates until March 2016. She pointed out that for every 1% gain in the dollar it is the equivalent of a 14 basis point hike in rates because of the negative impact on the U.S. economy. The dollar is up +26.6% since May. That is the equivalent of a 3.72% hike in interest rates. While the Fed wants to raise rates the rapidly falling inflation and potential deflation risks simply point to the “data dependent” Fed being forced to wait on the sidelines. Zentner said even if the Fed does remove the word patient from the statement they are still not going to raise rates in 2015. They may remove the word just to create some volatility in the bond market and that will force real rates slightly higher without the Fed actually making a move. If they remove the word the equity market could have a tightening tantrum and the Fed has to consider that as well.

The building angst over the soaring dollar is finally translating into the equity market. With 45% of the S&P getting 50% of their earnings from overseas the dollar strength is going to be a major drag on Q1/Q2 earnings. Investors ignored this for the last several months but the daily decline in earnings estimates and the daily rise in the dollar has finally hit critical mass.

Dollar

In the ‘Art of War’, Sun Tzu said that ‘..the threat of an attack is almost as effective as the attack itself..’  The prospect of an interest rate hike in the US while the rest of the world is still easing catapulted the US cash US dollar index to a new eleven and a half year high.

At today’s high of 100.06, the 10 month and 4 day duration of the move from the 2014 low is the second-longest leg up since 1971. To match the record 11 month and 18 day run into the February 25, 1985 high, the greenback would have to post new highs on April 26.

On the monthly time-frame, the cash US dollar index has posted gains for eight-consecutive months. This is a record monthly winning streak.

Furthermore, the 27% rally from the May 8, 2014 low ties for second place as the largest leg up in history. It was bested only by the 30% advance off the March 1984 low.

The rising dollar continues to pressure oil and other commodities. The dollar index closed at 100.18 on Friday. That represents a 26.6% gain since May. This is almost unprecedented.

DollarDaily

DollarMonthly

The idiot light on investor dashboards is blinking red and warning of an impending crisis.

Market volatility has returned with back to back days of alternating three digit moves on the Dow and the 100-day average on the S&P acting like last ditch support. With 2.5 days left before the FOMC statement there was very little short covering ahead of the weekend.

Oil prices collapsed under the pressure of the dollar, rising inventories and a new U.S. production record. Falling oil prices helped drag equities lower and the $40 level for Crude could be hit next week.

Economic news did not help. The Producer Price Index (PPI) fell -0.5% for February after a -0.8% drop in the prior month. This is the fourth consecutive monthly decline. Expectations were for a +0.5% increase. For once it was not energy prices dragging down the index. Energy prices were unchanged thanks to that rebound in oil prices in February. It was a -1.6% decline in food prices that pushed the index lower. This comes after a -1.1% decline in January. How did this happen? Food prices almost never decline. You can thank the rising dollar pushing the prices of all commodities lower and slowing exports.

Core PPI, excluding food and energy, fell -0.5%. The headline PPI is now -0.7% lower than year ago levels and when compared to the +1.0% YoY in December it shows how fast prices are falling.

Not only is inflation nonexistent the risks of deflation have increased in recent months. There is almost zero chance the Fed is going to hike rates in the near future given the strong dollar and deflation risks.

Oil

LightCrude

Oil prices declined to $44.75 intraday and closing in on the January low of $43.58. Inventories rose 4.5 million barrels to another 8- year high at 448.9 million. Cushing storage rose to 51.5 million and just under the record of 51.9 million barrels. Active rigs declined another -67 to 1,125 and -806 below the September high of 1,931. Oil rigs declined -56 to 866 and -46% below the 1,609 high on October 10th. Baker Hughes is targeting a 50% decline as normal in a bear market so another -60 rigs if they are right. At the pace they are dropping I expect to be well below 800 active oil rigs. Active gas rigs declined another -11 to 257 and a new 18 year low.

Offshore rigs declined -3 to 48 and a multi-month low.

The conversation level over shrinking storage is reaching a crescendo. However, numerous energy analysts have come out over the last week saying there is 25-35% storage still available. The additional capacity is in the Houston area and in some tanks around the U.S. shale fields. That is like a driver looking for a 5 gallon gas can in Denver and having the service station attendant saying, “On the computer we have a dozen in Dallas.” If the storage is not where you need it then you still have a problem. With the futures delivery point at Cushing Oklahoma rapidly filling up the pipelines into Cushing will have to be turned off if/when capacity is reached. That means wells will have to shut down if the oil in the pipelines is not moving.

We could be 3-4 weeks away from a critical point for crude pricing. Refineries will come out of their maintenance cycle in early April and begin to produce summer blend gasoline ahead of the Memorial Day weekend that kicks off the summer driving season. Until then we should continue to see inventories build. However, imports did decline about 600,000 bpd last week to 6.79 mbpd. Refiners may also be feeling the storage crunch and will have to cut back on imports in the weeks ahead.

Analysts are expecting the January low of $43.58 to be tested and most believe we will see $40 before March is over. If Cushing does halt or curtail the inflow of oil we could see the prices decline in a hurry.

Precious Metals

Also due to pressure from the rising dollar, gold and silver prices are also being slammed. Gold declined to $1,150 and a 3-month low. Silver has fallen back to January 2010 levels at $15.50 and the 2011 spike to $50 has been completely erased. The drop in silver has been due to the dollar but in silver’s case it also represents a decline in the global economy. Like copper, silver is used in electronics manufacturing and demand has declined as fewer large devices are sold and more phones and tablets with less silver and copper. About 25% of the silver mined today is non-economic. That means they are losing money on every ounce they sell but they have to keep the mines running at a minimum level to maintain operational capability.

Gold

Silver stockpiles are shrinking as the current mine production is less than demand. Eventually prices will rise in spite of the soaring dollar but until the global economy recovers I expect copper and silver to remain weak.

Silver

Copper

Forecasts

The Bloomberg ECO Surprise Index measures the number of economic data beats and misses in the USA economic forecasts. The index has fallen to its lowest level since 2009 when we were in the middle of the Great Recession. Forecasts have been missed by the largest majority in the last six years. The only major report to beat has been the payrolls. Everything else has been routinely missing the estimates and the market has been ignoring it. Citigroup has their own chart of economic misses by country. The U.S. is at the bottom of the list on that index as well. Both charts from Bloomberg.

(click charts to expand in separate window)

Missing

Dissapointed

The Atlanta Fed’s real time GDPNow forecast fell from +1.2% growth for Q1 to only +0.6% growth after the retail sales report on March 12th. How could the FOMC raise rates in these conditions?

AtlFedWe are less than 2 months away from the 3rd longest streak of gains without a 10% correction. The last correction was in 2011. If the S&P did crater again next week all the way down to 2,000 that would still be only a garden variety -5% dip like we have seen many times before in this bull market. It is not the end of the world. The S&P could easily retest that 2,000 level soon.

SPX-W

The rebound by the Russell might give some hope for next week but the market will remain headline driven ahead of the FOMC announcement on Wednesday. What happens after that event is entirely up to the Fed.

I expected a market decline after option expiration and the last two weeks may have been just a testing phase ahead of that event. With earnings declining, GDP revisions sinking, China weakening, oil prices potentially testing $40, retail sales and consumer confidence falling and Greece threatening to exit the EU again, it would not take much of a push by the Fed to crash the market. Hopefully they understand the box they are in.

Greece

The Greek government announced it was going to use cash belonging to pension funds and other public entities for its own use. The amendment submitted in parliament said “Cash reserves of pension funds and other public entities kept in the Bank of Greece deposit accounts can be fully invested in Greek sovereign notes. Pension funds and public entities will be able to claim damages from Greek state in case of overdue repayment or partial repayment. The finance minister said pension funds are not required to transfer their reserves to the Bank of Greece. At least not yet.

The Greek Finance Minister Yanis Varoufakis said last week, “Greece is the most bankrupt country in the world and European leaders knew all along that Athens would never repay its debts.” Greek Prime Minister Tsipras said, “Greece can’t pretend its debt burden is sustainable.” Apparently the house of cards is about to crumble.

Very Important

The Debt Ceiling debate returns next week. The temporary reprieve on the $18 trillion debt ceiling expires and congress will have to deal with it in some form. Whenever this has happened in the recent past there has been numerous headlines and market volatility. With a new crop of republicans in office there is bound to be some grandstanding even if it is just temporary. President Obama is not likely to compromise since it is in his favor to have the republicans self destruct over the debt fight. There is not likely to be a Obama-GOP compromise and that means there will be some ugly headlines before the GOP caves in and extends the ceiling. This is just one more reason why other nations want to be freed from using the dollar for their trading. The uncertainty is a headache for them because they really don’t understand American politics.

This is a quadruple witching option expiration week. This happens four times a year and historically these produce bullish weeks for the Dow and S&P about 2 out of 3 times. Since 1983 the Nasdaq has posted 19 advances and 13 declines in the March week. However, the week after quadruple witching, especially in March, is typically negative.

Random Thoughts

On March 16th, 2004 the post Fed statement had the following sentences.

(Hat tip to Art Cashin)

The Committee perceives the upside and downside risks to the attainment of sustainable growth for the next few quarters to be roughly equal. The probability of an unwelcome fall in inflation has diminished in recent months and now appears almost equal to that of a rise in inflation. With inflation quite low and resource use slack, the Committee believes that it can be patient in removing its policy accommodation.

In the May 4th, 2004 statement the Fed said:

The FOMC decided today to keep its target for the federal funds rate at 1%.

The Committee perceives the upside and downside risks to the attainment of sustainable growth for the next few quarters are roughly equal. Similarly, the risks to the goal of price stability have moved into balance. At this juncture, with inflation low and resource use slack, the Committee believes that policy accommodation can be removed at a pace that is likely to be measured.

In the June 30th, 2004 statement the fed said:

The FOMC decided today to raise its target for the federal funds rate by 25 basis points to 1.25%.

Apparently the Fed reuses its prior language a lot and conditions could be shaping up for a repeat of that 2004 scenario. However, economic conditions are significantly worse than in 2004 and that should keep these statements from being repeated.

01292015 Image January 30, 2015

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Click on the image to expand for greater clarity.

01122015 January 12, 2015

Posted by easterntiger in economic history, economy, financial, gold, markets, oil, silver, stocks.
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Current Positions  (Slight Changes)

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

F(bonds) – up to 50%; G (money market) – remainder

Weekly Momentum Indicator (WMI) last 4 weeks, thru 01/08/15

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

-9.74, +22, +2.88,1.26 (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)

The seemingly-invincible US stock markets powered higher again last year, still directly fueled by the Fed’s epic quantitative-easing money creation.  But 2015 is shaping up to be radically different from the past couple years.  The Fed effectively abandoned the stock markets when it terminated its bond buying late last year.

So this year we will finally see if these lofty stock markets can remain afloat without the Fed.  But, let’s not ignore the fact that the $4 trillion added to the market over the past 5/6 years are still on the Fed balance sheet and are still providing artificial buoyancy that was NOT intended to end up in your pockets.  It’s called the ‘wealth effect’, not ‘wealth’.

Mainstream stock investors and speculators are certainly loving life these days.  The flagship S&P 500 stock index enjoyed an excellent 2014, climbing 11.4%.  And that followed 2013’s massive and amazing 29.6% blast higher!  The last couple years were truly extraordinary and record-breaking on many fronts, with the US stock markets essentially doing nothing but rally to an endless streak of new nominal (not inflation adjusted) ‘record’ highs. But, the Fed’s wildly-unprecedented balance-sheet growth of recent years is over.  2015 will actually be the first year since 2007 without any quantitative easing!    

                                   Funds End of Year Results

Here are the relative positions of the respective funds for last year.

************Equity Funds**********                ******Bond Fund*******

S Fund             I Fund          C Fund                       F Fund

+7.80%           -5.27%          +13.78%                  +6.73%

+/- F fund    +/- F fund      +/- F fund

+1.13%            -12.0%         +7.05%

What these end of year results never reflect are the degree of risk involved in generating these returns.  For example, an end of year return on the S fund of 7.8% ignores the -4.9% YTD returns that occurred in the S in February and, even the -4.05%  YTD returns as of late October.  The C fund had only yielded a 2.46% return YTD in early October.  The F fund yielded no negative returns all year, and, ironically, had yielded approximately half of the final return for the year exactly 6 months into the year.  In a bear market, even a bear market pretending to be a bull market, it’s ‘stairs up/elevator down’.  Knowing your risk is just as much a part of the game as knowing your reward. Only one of three equity funds measurably beat our bond fund for the year.

Here are the total 1 mo, 1 yr, 3 yr and 5 yr returns for a range of investments in world financial markets, including bond, commodity, precious metals markets as of 12/31/14.

ret.dec2014 Selected Market Stats for recent weeks, plus December, 2014 and 2013 MarketStats

So, what’s next?

(The following is repeated from a previous post – only this time, the party takes place in Europe) Imagine that it’s 4AM after a huge party. Many have gradually left (a) . All lights are still  on.  There are a couple of large groups still left, talking loudly and sipping on their final drinks. The bar is closed.  The crowds are so busy drinking and talking that they don’t notice that the band has played it’s last tune and has started packing up, all except the drummer, tapping a simple beat.  The room is being charged by the hour, so, there won’t be an announcer to tell anyone that it’s time to clear out; the meter is running.  Every 15 minutes, some guy named ‘Fed’(US), or, Mario Draghi (Europe) walks across the stage and tells everyone to hang around while he looks for another band. (It’s not coming.)  The groups cheer each time.  Outside, there are storms moving in.  Most attendees have anticipated the storm by leaving early (b). Those still there will either take their risks, driving through the storm (c), or, stay around to ‘ride it out’ (d).  In which group are you?  a, b, c or d?

In the US as well as in Europe, stocks skyrocketed on Thursday, as investors got excited about the letter.  In a January 6 letter to European Parliament member, Luke Ming Flanagan, European Central Bank (ECB) President Mario Draghi offered another one of his trademark teasers about the possibility of an ECB-implemented, quantitative easing program.  In this case, the magic word was could: Should it become necessary to further address risks of too prolonged a period of low inflation, the Governing Council is unanimous in its commitment to using additional unconventional instruments within its mandate. This may imply adjusting the size, pace and composition of the ECB’s measures. Such measures may entail the purchase of a variety of assets (?) one of which could be sovereign bonds, as mentioned in your letter.

This tactic never fails to work.  Whenever the European stock market slumps, all Mr. Draghi, or our Fed members, have to do is say that the ECB/the Fed might, or could, or may, or should implement a quantitative easing program – and stock prices skyrocket.  Nevertheless, in the real world, it is highly unlikely that the ECB would ever conduct a quantitative easing program because there are no Eurobonds for it to purchase.  Further, this week the European Court of Justice is scheduled to rule on the legality of quantitative easing on Wednesday, January 14th, which could throw a wrench into the ECB plans.

The president of the ECB and the chief of the Federal Reserve are both reading from the same, flawed playbook.  When the financial markets appear ready to swoon, they just walk across the stage and tell everyone that they’re ‘looking for another band’; so, investors, please leave your money in the market and wait, until you stop believing that the band is coming, or, until you start to suffer losses that you cannot endure.

But, if markets are such great value, why would Warren Buffett now be sitting on a record amount of cash?

At the end of 2007, his firm, Berkshire Hathaway (NYSE: BRK-A), was sitting on $44 billion in cash.  Berkshire’s cash balance was down to a more reasonable $25 billion by the end of 2008 after acquiring partial stakes in several blue chips firms such as General Electric and Goldman Sachs. As Bloomberg News noted in October 2013 , Buffett “likes to keep $20 billion on hand should the reinsurance operations need to pay large claims.” If Buffett thought he was sitting on too much cash seven years ago, before his GE and Goldman Sachs purchases, his troubles have grown larger now.  At the end of Q2 2014, Berkshire Hathaway held $55 billion in cash and investments — a company record. If Warren Buffett is not fully invested and holding cash, why should you be fully invested? Could it be that Warren Buffett knows something, among other things, that this chart I’ve kept up all year is telling him? MarginDebtNov

Repeated/updated from the three previous reports, an accurate count of margin debt, or, levels of borrowed money at all brokerage firms for each month is carefully watched by the financial media.  It’s this combination of a) margin debt, b) Fed money loaned to investment banks (finished), and c) stock buybacks by corporations (slight decline over last year) that have provided a vast majority of the power to the markets for much of the past 5/6 years. The result of margin debt figure through November is shown in the chart above, for comparison to all months of the past 3.5 years.  (I’ll have the December figure in 2 weeks.)

Update – Notice that the peak in debt for the year, once again, has STILL not exceeded the February high, after which the primary indexes channeled sideways, with no price appreciation, for 12 weeks. For the past eleven months, the debt level has stalled under $466 million.  This STILL indicates that a primary source of fuel for the market (loans and borrowed money) has stalled and is not likely to resume.  When combined with the now missing portion of Fed stimulation through Quantitative Easing (QE), which ended on October 29th, this removed the bulk of what has sustained the markets back up to the peaks above and below the peaks of 2000 and 2007, depending on the index.

Where do the experts think the market is headed this year?

Here are the current forecasts by major bank analysts for end-of-year S&P 500 levels.

(the S&P 500 closed at 2058.9 on 12/31/14, and is already slightly negative for the year)

-10.75% – 1850 – David Bianco, Deutsche Bank: S&P: EPS: $119.00

-7.72% – 1900 – Brian Belski, BMO: S&P: EPS: $116.00

-7.72%1900 – Barry Knapp, Barclays: S&P: EPS: $119.00

-7.72% – 1900 – David Kostin, Goldman Sachs: S&P: EPS: $116.00

-6.5% – 1925 – Michael Kurtz, Nomura: S&P: EPS: $112.50

-5.29%  – 1950 – Sean Darby, Jefferies: S&P: EPS: $121.00

-5.29% – 1950 – Jonathan Golub, RBC: S&P: EPS: $119.00

-5.29% – 1950 – Julian Emanuel, UBS: S&P: EPS: $116.00

-4.8% – 1960 – Andrew Garthwaite, Credit Suisse: S&P: EPS: $115.90

-4.07% – 1975 – Tobias Levkovich, Citigroup: S&P: EPS: $117.50

-2.86% – 2000 – Savita Subramanian, Bank of America: S&P: EPS: $118.00

-2.18% – 2014 – Adam Parker, Morgan Stanley: S&P: EPS: $116.00

-2.18% – 2014 – John Stoltzfus, Oppenheimer: S&P: EPS: $115.00

+0.78% – 2014 – Tom Lee, JP Morgan: S&P: EPS: $120.00

The average expected return from these major investment banks for 2015 is -5.11%.

And, keep in mind this is measured on what was the strongest of several markets covering US stocks.  Other US exchanges did not perform nearly as well in 2014 as the S&P 500 (refer to ‘Selected Market Stats’ above.)

With all due respect to these recent returns, such anomalously-one-sided stock markets naturally bred the extreme euphoria universally evident today.  Greedy traders have totally forgotten the endlessly-cyclical nature of stock-market history, where bear markets always follow bulls.  They’ve convinced themselves that these stock markets can keep on magically levitating indefinitely, that major sell-offs of any magnitude are no longer a threat worth considering. But extrapolating that incredible upside action of 2013 and 2014 into the future is supremely irrational, because its drivers have vanished. The past couple years’ mammoth stock-market rally was completely artificial, the product of central-bank market manipulation.  The Federal Reserve not only created vast sums of new money out of thin air to monetize bonds, but it aggressively jawboned the stock markets higher.

Virtually every time the Fed made a decision, or its high officials opened their mouths, the implication was being made that it wouldn’t tolerate any material stock-market sell-off.  The Fed kept saying that it was ready to ramp up quantitative easing if necessary.  Stock traders understood this exactly the way the Fed intended, assuming the American central bank was effectively backstopping the US stock markets! But, the bottom line is the Fed has abandoned the stock markets.  The powerful rallies of  2013 and 2014 were driven by extreme Fed money printing to buy up bonds.

But with QE3’s new buying terminated and any QE4 a political impossibility with the new Republican Congress, 2015 is going to look vastly different.  A shrinking Fed balance sheet sparked major corrections even from far lower and cheaper stock levels.

The domestic stock market cannot deliver a sustainable double-digit return without entering a speculative bubble, based on historical data reflecting correlations between the level of the Shiller P/E and subsequent outcomes in the stock market over the past 134 years.  Conditions are ripe for a speculative bubble in the domestic stock market in 2015, and investors should reduce risk in their portfolios in stages during the coming year. Investors should expect below-average returns from the domestic stock market over the next five to 10 years.  Indeed, to expect anything more than mid-single digits requires an assumption that stocks will enter a speculative bubble.  The reason is excessive valuation.

From today’s valuation level the only way to sustain significant upside is to assume a future valuation multiple that would put the stock market into bubble territory. The S&P 500 Index was recently trading at a cyclically adjusted price-to-earnings (p/e) ratio, or “CAPE” of 27.3, meaning the stock market is priced at more than 27 times the 10-year average earnings of the underlying companies in the index.  This is highly unusual.  Out of 1,608 monthly observations between January 1881 and December 2014, the CAPE for the U.S. stock market has measured 27 or higher just 88 times. That is a frequency of only 5.5% throughout this 134-year period. CAPERatioBlending several forecasts together we get a 0.89% annual return forecast for the stock market over the coming decade. A straight comparison to 10-year treasuries at 2.2% shows them to be the more attractive of the two asset classes right now. Even 5-year treasuries are paying 1.6%, nearly double our model’s forecast.* All in all, this looks to be the second worst time to own equities in history.

Still, the stock market’s uptrend remains intact as all of the major indexes currently trade above their 200-day moving averages. But as I’ve noted recently, there are plenty of signs that the trend is not as healthy as bulls would hope. The advance/decline line, new highs-new lows and the percentage of stocks trading above their 200-day moving averages are all diverging fairly dramatically from the new highs recently set in the indexes. This is a serious red flag.

And now that our market cap-to-GDP and household equities indicators have possibly peaked, along with high-yield spreads (inverted), margin debt (shown on my chart above) and corporate profit margins, there seems to be a very good possibility that the uptrend could be tested in short order.  In fact, when I go back and look at the times when all of these indicators peaked around the same time over the past 15 years or so, they coincide pretty neatly with the major stock market peaks: StockMarketPeak   MarginDebtPeak So the uptrend may still be intact but I think we have a plethora (yes, a plethora) of evidence that suggests its days may be numbered. Foreign equities have mostly given up their uptrends over the past few months, demonstrated in the negative return of our I fund, and commodities, led by the oil crash, look even uglier.  Precious metals, a refuge, have held up surprisingly on a rising channel going back 10-15 years.  How much longer can the US stock market swim against the tide?

Bonds

My exit from the F fund in early October was timely, since the price level fell immediately afterward, by about 1%, and only barely exceeded above that exit point by year-end. The weakness in equities after the fake ‘Santa rally’ showed a corresponding strength in bonds, and, another increase in F fund prices.  Current levels are about ¾% higher than that October exit. This trend is expected to continue with the failure of additional strength in equities.  More importantly, any significant breakdown in equities would translate into an immediate transfer from stocks to bonds, and further strengthening in the F fund.

FFund

Oil

The reason oil prices started sliding in June can be explained by record growth in US production, sputtering demand from Europe and China, and an unwind of the Middle East geopolitical risk premium.

The world oil market, which consumes 92 million barrels a day, currently has one million barrels more than it needs. The US pumped 8.97 million barrels a day by the end of October (the highest since 1985) thanks partly to increases in shale-oil output which accounts for 5 million barrels a day.  Libya’s production has recovered from 200,000 barrels a day in April to 900,000 barrels a day, while war hasn’t stopped production in Iraq and output there has risen to an all-time high level of 3.3 million barrels per day. The IMF, meanwhile, has cut its projection for global growth in 2014 for the third time this year to 3.3%. This year, it still expects growth to pick up again, but only slightly.

Everyone believes that the oil-price decline is temporary. It is assumed that once oil prices plummet, the process is much more likely to be self-stabilizing than destabilizing. As the theory goes, once demand drops, price follows, and leveraged high-cost producers shut production. Eventually, supply falls to match demand and price stabilizes. When demand recovers, so does price, and marginal production returns to meet rising demand. Prices then stabilize at a higher level as supply and demand become more balanced. It has been well-said that: “In theory, there is no difference between theory and practice.

But, in practice, there is.” For the classic model to hold true in oil’s case, the market must correctly anticipate the equalizing role of price in the presence of supply/demand imbalances. By 2020, we see oil demand realistically rising to no more than 95 million barrels a day. North American oil consumption has been in a structural decline, whereas the European economy is expected to remain lackluster. Risks to the Chinese economy are tilted to the downside and we find no reason to anticipate a positive growth surprise. This limits the potential for growth in oil demand and leads us to believe global oil prices will struggle to rebound to their previous levels.

The International Energy Agency says we could soon hit “peak oil demand”, due to cheaper fuel alternatives, environmental concerns, and improving oil efficiency. The oil market will remain well supplied, even at lower prices. We believe incremental oil demand through 2020 can be met with rising output in Libya, Iraq and Iran. We expect production in Libya to return to the level prior to the civil war, adding at least 600,000 barrels a day to world supply. Big investments in Iraq’s oil industry should pay off too with production rising an extra 1.5-2 million barrels a day over the next five years. We also believe the American-Iranian détente is serious, and that sooner or later both parties will agree to terms and reach a definitive agreement. This will eventually lead to more oil supply coming to the market from Iran, further depressing prices in the “new oil normal”. Iranian oil production has fallen from 4 million barrels a day in 2008 to 2.8 million today, which we would expect to fully recover once international relations normalize. In sum, we see the potential for supply to increase by nearly 4 million barrels a day at the lowest marginal cost, which should be enough to offset output cuts from marginal players in a sluggish world economy. OilSome analysis leads us to conclude that the price of oil is unlikely to average $100 again for the remaining decade.

Normally, falling oil prices would be expected to boost global growth. Ed Morse of Citigroup estimates lower oil prices provide a stimulus of as much as $1.1 trillion to global economies by lowering the cost of fuels and other commodities.  And, unfortunately, another downside to falling prices are related to high levels of junk-bond financing to increase the drilling infrastructure.  Therefore, due to falling prices and the resulting closing of drilling rigs with higher operating costs, many of these bonds will fail, putting pressure on other related assets that are dependent on them.  This could very well provide the catalyst to a stock sell-off, without warning.

Per-capita oil consumption in the US is among the highest in the world so the fall in energy prices raises purchasing power compared to most other major economies. The US consumer stands to benefit from cheaper heating oil and materially lower gasoline prices. It is estimated that the average household consumes 1,200 gallons of gasoline a year, which translates to annual savings of $120 for every 10-cent drop in the price of gasoline.

According to Ethan Harris of Bank of America Merrill Lynch: “Consumers will likely respond quickly to the saving in energy costs. Many families live “hand to mouth”, spending whatever income is available. The Survey of Consumer Finances found that 47% of families had no savings in 2013, up from 44% in the more healthy 2004 economy. Over time, energy costs have become a much bigger part of budgets for low income families. In 2012, families with income below $50,000 spent an average of 21.4% of their income on energy. This is almost double the share in 2001, and it is almost triple the share for families with income above $50,000.” The “new oil normal” will see a wealth transfer from Middle East sovereigns (savers) to leveraged US consumers (spenders).

The consumer windfall from lower oil prices is almost matched by the loss to oil producers. Even though the price of oil has plummeted, the cost of finding it has not.  The oil industry has moved into a higher-cost paradigm and continues to spend significantly more money every year without any meaningful growth in total production. Global crude-only output seems to have plateaued in the mid-70 million barrels a day range. The production capacity of 75% of the world’s oilfields is declining by around 6% per year, so the industry requires up to 4 million barrels per day of new capacity just to hold production steady. This has proven to be very difficult.

Analysts at consulting firm EY estimate that out of the 163 upstream mega-projects currently being bankrolled (worth a combined $1.1 trillion), a majority over budget and behind schedule. Large energy companies are sitting on a great deal of cash which cushions the blow from a weak pricing environment in the short-term. It is still important to keep in mind, however, that most big oil projects have been planned around the notion that oil would stay above $100, which no longer seems likely.

The Economist reports that: “The industry is cutting back on some mega-projects, particularly those in the Arctic region, deepwater prospects and others that present technical challenges. Shell recently said it would again delay its Alaska exploration project, thanks to a combination of regulatory hurdles and technological challenges. The $10 billion Rosebank project in Britain’s North Sea, a joint venture between Chevron of the United States and OMV of Austria, is on hold and set to stay that way unless prices recover. And BP says it is “reviewing” its plans for Mad Dog Phase 2, a deepwater exploration project in the Gulf of Mexico. Statoil’s vast Johan Castberg project in the Barents Sea is in limbo as the Norwegian firm and its partners try to rein in spiralling costs; Statoil is expected to cut up to 1,500 jobs this year.

And then there is Kazakhstan’s giant Kashagan project, which thanks to huge cost overruns, lengthy delays and weak oil prices may not be viable for years. Even before the latest fall in oil prices, Shell said its capital spending would be about 20% lower this year than last; Hess will spend about 15% less; and Exxon Mobil and Chevron are making cuts of 5-6%.” Based on analysis by Steven Kopits of Douglas-Westwood: “The vast majority of public oil and gas companies require oil prices of over $100 to achieve positive free cash flow under current capex and dividend programs. Nearly half of the industry needs more than $120. The 4th quartile, where most US E&Ps cluster, needs $130 or more.” As energy companies have gotten used to Brent averaging $110 for the last three years, we believe management teams will be very slow to adjust to the “new oil normal”. They will start by cutting capital spending (the quickest and easiest decision to take), then divesting non-core assets (as access to cheap financing becomes more difficult), and eventually, be forced to take write-downs on assets and projects that are no longer feasible.

The whole adjustment process could take two years or longer, and will accelerate only once CEOs stop thinking the price of oil is going to go back up. A similar phenomenon happened in North America’s natural gas market a couple of years ago. This has vast implications for America’s shale industry. The past five years have seen the budding energy renaissance attract billions of dollars in fixed investment and generate tens of thousands of high-paying jobs. The success of shale has been a major tailwind for the US economy, and its output has been a significant contributor to the improvement in the trade deficit. We believe a sustained drop in the price of oil will slow US shale investment and production growth rates. As much as 50% of shale oil is uneconomic at current prices, and the big unknown factor is the amount of debt that has been incurred by cashflow negative companies to develop resources which will soon become unprofitable at much lower prices.

Robert McNally, a White House adviser to former President George W. Bush and president of the Rapidan Group energy consultancy, told Reuters that Saudi Arabia “will accept a price decline necessary to sweat whatever supply cuts are needed to balance the market out of the US shale oil sector.”

Even legendary oil man T. Boone Pickens believes Saudi Arabia is in a stand-off with US drillers and frackers to “see how the shale boys are going to stand up to a cheaper price.” Prices will have to fall much further though to curb new investment and discourage US production of shale oil. The breakeven point for most shale oil plays has been falling as productivity per well is improving and companies have refined their fracking techniques. The median North American shale development needs an oil price of $57-64 to break even today, compared to $70 last year according to research firm IHS.

Type Average Cost Per Barrel
OnShore Middle East $29
OffShore Shelf $43
Deepwater $53
OnShore Russia $54
Onshore Row $55
North American Shale $62
Oil Sands $74

While it’s not universally believed that Saudi Arabia engineered the latest swoon in oil prices, it would be foolish not to expect them to take advantage of the new market reality. If we are entering a “new oil normal” where the oil price range may move structurally lower in the coming years, wouldn’t you want to maximise your profits today, when prices are still elevated? If, at the same time, you can drive out fringe production sources from the market, and tip the balance in MENA geopolitics (by hurting Russia and Iran), wouldn’t it be worth it? The Kingdom has a long history of using oil to meet political and economic ends.

10212014 October 21, 2014

Posted by easterntiger in economy, financial, markets, silver, stocks.
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Weather Report Update 10212014

Current Positions  (CHANGES) I(Intl) – 10%; S(Small Cap) – up to 10%; C(S&P) –up to 25%

F(bonds) – no change; G (money market) – remainder

Weekly Momentum Indicator (WMI) last 4 weeks, thru 10/17/14

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

-31.9, -42.66,  -2.82, -5.09

(Yesterday 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)

The partial exit from the F fund last week was warranted, as interest rates hit an ‘exhaustion’ low before rebounding.  This offered the opportunity to hold on to F fund profits at or near the highest prices of the year.  (top to bottom C fund, S fund, I fund, & F fund, since May, with S&P 500 superimposed in thick gray background; maps to C fund)

C

S

I

F

Now that the indexes are back from just above or below zero for the year, there is every incentive to raise them back to between 3-8% before the end of the year. This will coincide with optimism leading into the Fed meeting at the end of the month, seasonal strength approaching Thanksgiving, the shopping season, etc., also known as the ‘Santa rally’, the usual medicine to raise the consumer mood to encourage spending during the season.  69% of the economy is driven by consumer spending.  The historical record of strength into the end of the year is somewhat reliable, particularly after a weak September and October.  A partial entry into equity funds, near some of the lowest levels of the year, is a safe way to participate in the year end support, while still considering the risks surrounding the October 29th Fed meeting.  A final ‘signal’ won’t occur until after that meeting. This exhausts our two intra-fund moves for the month, unfortunately.  For safety, an emergency exit to G is still allowed.  We’ll know whether or not to reduce or to increase these positions early in November.

The ‘depth readings’ are similar to those after the February decline, about a 6% loss, after which levels retraced over the next two months about 7%, most of which occurred in about 4 weeks.

Last week, the I fund fell to it’s lowest levels of the year, -7.45% year to date. The S fund fell as low as -3.65% year to date, only 1.25% over it’s low established in February.  The C fund stayed on the plus side by just over 2% year to date, setting it’s lows for the year earlier in the year at -5.66% year to date in February and -1.17% year to date in April.  In essence, the S&P 500 was riskier early in the year, while the small caps and international funds have become riskier as the year has progressed. So much for the idea that we can treat all categories of equities as having equal opportunities or equal risks. The opportunities and risks vary and cannot be ‘sensed’ by occasionally checking price levels, or, casually observing your personal account statements, after the fact, several times a year.  Meanwhile, the F fund found it’s highs for the year last week, near 7% year to date, as the ‘flight to quality’ in bonds absorbed the same capital that shifted from equities of all categories.  After a brief pause between now and year end, this is expected to resume in the 1st quarter.

Positive

  • Weekly indicators flattened this week, showing short-term support.
  • Sales/purchase ratio by insiders dropped from over 50:1 down to 16:1, reflecting a slightly stronger, but, still negatively-biased intention to increase near-term buying, or, to decrease levels of near-term selling
  • New Highs over New Lows reached a 2-month high last Thursday and Friday.
  • The ‘fear’ or volatility indexes reached their highs in 3 years last week. These highs frequently represent short-term market bottoms.
  • The S&P100 has not been this far below the 40-week moving average since November 2012, a previous buy point, rising 7% by that year’s end.

Negative

  • As large as recent rebounds appear, we are still down lower than levels of Friday, October 10th, except on the S fund, where upward momentum is also slowing first.
  • Numerous support zones were broken in the past two weeks and must now be treated as resistance over the next few weeks.
  • ‘Smart money’ still has some positioning as if they expect future declines, with heavy hedging toward downside expectations over the next few months.
  • The level of buy signals on individual stocks are among the lowest levels of the year
  • April lows were broken on the Russell 3000; August lows were broken on the S&P  500 and NASDAQ 100
  • A 1300 point drop in the Dow Jones Industrials avearge in less than two months has not occurred since July/August 2011, near the end of the traditional weak season occurring this far from a market bottom, as in March 2009, carries significantly more weight, projecting a greater likelihood of weakness beyond any near-term ‘bounce’. The last time before that was at the 2007 market top.

Short-term, sixteen key industries have an average potential upside of 10%, based upon measuring against the current lower levels against both recent highs and their 50-day averages. These industries include oil services, pharmaceuticals, networking, airlines, semiconductors, disk drive manufacturers, transportation, computer hardware, banks, broker/dealers, retail, biotech, real estate investment trusts and insurance.
The oversold condition of the silver market ranks 5th in history in terms of the time to reach this point (3 years, 5 months, 8 days), and, 4th in history in terms of the percentage decline (66% from the most recent high).  These traits strongly suggest that only a low probability exists for a further concern for lower prices.  Statistically and historically, this should be seen as a prime buying point with regard to the likelihood for appreciation on any current purchases.

07182014 July 18, 2014

Posted by easterntiger in economic history, economy, financial, gold, markets, oil, silver, stocks.
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Weather Report 07182014

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 7/17/14

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

-2.7,-0.5, +14.7, +4.87

(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)

Margin debt reversal

As I mentioned in the previous interim report, an accurate count of margin debt, or,  levels of borrowed money at all brokerage firms for the month of May, was carefully watched by the financial media.  It’s this combination of a) margin debt, b) Fed money loaned to investment banks (declining), and c) stock buybacks by corporations (declining) that have provided a vast majority of the power to the markets for much of the past 5 years. The result of the May margin debt figure is shown in the following chart, for comparison to all months of the past 3.5 years.

MarginDebt052014

Even though the May level was slightly higher, I measured the 12-month moving average (red line) above and subtracted the monthly levels from the average to derive the black line below, for the trend. Historically, there is significance in the level crossing the 12-month moving average, and, not just whether the level is higher or lower than the previous month. In fact, this current level compared to the 12-month moving average is very similar to the same point in 2011 before the market significantly weakened.

Still, this represents 2 out of the past 3 monthly declines in the level of margin debt continues to confirm, for only the third time in 14 years, that the market has met a significant top or ceiling, in preparation for a downturn for the next 18-36 months, and, therefore, has no further ‘fuel’ for anything other than extremely high risk exposure.  The previous two times that margin debt was in this current flattening/declining pattern, in 2000 and 2007, market losses were over 40% from the 2000 top to the 2003 bottom and over 50% from the 2007 top to the 2009 bottom. I annotated a flattening in May that is very similar to the flattening that occurred after a peak in 2011. The 2011 pause (red dots on the left), similar to the May pause (red dots on the right), was followed by an abrupt decline in all of the stock indexes. This is not a guarantee of a similar impact. This is a statement that conditions exist for even more risky conditions for any exposed positions in C, I or S funds. F fund will be used as a refuge for funds leaving stock positions.

With much of the major markets combining between negative, near unchanged, to slightly positive through much of May, the bulk of recently added upside in market levels is primarily due to central bank related events in June, the first from the European Central Bank (ECB), led by Mario Draghi, (June 5th) and the second from the Federal Reserve Bank Open Market Committee, (June 16th) led by Janet Yellen. These meetings are always full of language that can be interpreted either as boosts, drags, or contrary to positions already in place by traders.

REMEMBER – traders exiting/closing downward bets actually make the market move up!!!

Why?

They ‘sell’ (collect premium) to enter the position, then, they ‘buy’ to exit the position. Their hope is to buy back at cheaper levels than where they sold!! Don’t be fooled by rising markets, by assuming that rising prices automatically equal positive momentum.

GDP Shock

The final estimate of 1st quarter GDP came in at -2.9%. This is a fairly shocking number; this is recession territory. In defiance of reality, some experts still maintain that we will grow 3% 2nd quarter. That would give us a flat 1st half. If you continue that growth at 3%, that would be 1.5% for the year; that would be the worst since 2001. This 1st quarter was the worst since the depths of the great recession in 2009. This is not a great economy. This is not a good economy. Consumer spending is not picking up. ⅔ of new jobs created are part-time jobs.

And, in contrast to those ‘experts’, OECD sees growth at 2.5% this year, 3.5% next year. That optimistic level would be the strongest growth since 2004 (what were they saying last year). The World Bank recently cut 2014 global economic growth estimate to 2.8% from 3.2%; they predict US growth at 2.1% versus the prior estimate of 2.8%. It seems to appear, repeatedly, that future estimates are always overshooting the actual performance, year after year.

Funds YTD

Here are the relative positions of the respective funds so far this year.

S Fund                      I Fund                        C Fund                  F Fund

Early March        Early March            Early March        Early March

+4.43%                      +1.66%                       +2.04%               +2.38%

7/16                               7/16                          7/16                     7/16 

+2.74%                        +4.18%                    +7.17%                +4.41%

It has taken every bit of Fed stimulus, hype, optimism and blind faith for holders of equity funds to match the much safer returns/lower risks, in the F Fund, so far this year. Even the gap between the F and the C fund fails to account for the riskier environment, while, clearly, the under-performance of S and I funds shows both higher risk and relative weakness, compared to the safety of less manipulated segments, like the bond market. These so-called ‘record highs’ and ‘all-time highs’ are stretching the very limits of all of these ‘support mechanisms’. Some reward; monumental risk.

ALL-TIME HIGHS/RECORD HIGHS

Speaking of ‘record highs/all-time highs’…the financial media is not bound to present accurate or legally binding statements. By comparison, your labeling on consumer products, such as food items, etc., is bound by legal requirements prescribed by the Federal Trade Commission (FTC), or, the Food & Drug Administration (FDA). While the Securities and Exchange Commission (SEC) monitors and warrants statements presented to investors, through prospectuses, the SEC does NOT offer guarantees in media reporting.

Here are the two presentations, one as presented by the media (1), and one corrected for inflation (not reported by media) (2), of the current price levels of the S&P500, NASDAQ and Dow 30, since 2000. Notice the absence of a true ‘all-time high’ in the S&P500. Also, notice the impact of Fed policy contributing to the last 5 years bounce, from the 12-year low!!!

(1)

(2)

S&P500 is DOWN -6.8%, and the NASDAQ is DOWN -36.3% since 2000. The DOW is up 4.4% since 2000. You can ignore inflation, if you wish. You’ll see it again when you try to use your gains from ‘record highs’ to make purchases of goods and services whose prices have CHANGED since the 2000 and 2007 peaks.

Here is a similar perspective, taken from NPR.ORG seven years ago, near the most recent previous peak.

What Does the Rise of the Dow Really Mean?

http://www.npr.org/templates/story/story.php?storyId=12118801

However, to continue the deception, profits have doubled on the S&P since that 2009 bottom. So, why has the index tripled???

Negative Interest Rates

On June 5th, world markets reacted to the European Central Banks’s announcement that it has now cut the deposit rate from zero to minus 0.1%, the percentage that the banks will sacrifice if they ask the ECB to hold money for them, rather than lending the money. This is, theoretically, an incentive for banks to lend money, rather than holding it in central banks. (It’s an experiment and has never been done by a central bank!) Markets reacted with upward momentum, which is the norm for both the combination of whose seeking an opportunity to add to positions (minor factor), and, the closing of positions that rely on a negative bias for profits (called, ‘short’ positions, as described above under REMEMBER). To reiterate, closing of short positions limits and/or reduces the risk of further holding these positions, in which the buyers were expecting a decline, leading to profits. Like most central bank actions, this is to suggest actions, not force actions, onto the member banks, who can chose whether to enact the policies desired by the central bank, or not. There is considerable debate, but not history, on what impact the final outcome of this policy will have. The ECB is desperately trying to hold off a threat of deflation, similar to what has kept Japan in stimulative mode, over-saving and under-consuming, for the past two decades.

Then, on June 18th, the Fed completed it’s 5th round of tapering, reducing by $10 billion per month, the availability of purchases of securities under it’s QE3 program, designed to stimulate financial, mortgage and employment.  So far, the positive results are debatable, but, certainly, less than originally promised or planned.

Market Technical Positions

Back in 2001 Warren Buffett said in an interview with Fortune Magazine that “the single best measure” of stock market valuation is by taking the total market cap (TMC) and dividing it by the total gross domestic product (GDP). Today TMC is equal to 114.5% of total GDP.


At the market top in 2007, just prior to a -54% crash in stocks, TMC was equal to 104.9%. According to Buffett’s “favorite” market timing indicator stocks are more overvalued today than in 2007.

The US market is not alone. London (FTSE 100) and France (CAC 40) broke steep support lines back in 2000-2001 and 2007 and proceeded to fall hard. The FTSE is back at the 2000 & 2007 levels at this time and the CAC 40 is weaker, creating so far, lower highs in 2007 and now, compared with the high in 2000. Both are testing steep support lines.

FTSE

 

 

 

 

 

 

 

 

 

 

 

CAC

Are European banks in trouble? If so, could weakness in the Europeanfinancialsector spill over intostock markets around the world?

European Financial ETF EUFNhas formed a bearish rising wedge over the past few months and a few days ago broke below support in the chart below.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Could this put downward pressure on risk assets and push up metals? So far today, this spread between stocks and metals is skyrocketing!

 

Gold/Gold Stocks

In times of crises, many turn to gold, seeking its safe-haven attributes. However, with a 28% price drop in 2013, followed by a 12% gain in the first ten weeks of 2014, can we really continue to label gold a safe haven?

No investment is “safe.” Gold is no exception, of course, given that our daily expenses are generally not priced in gold, but in a currency that fluctuates relative to the price of gold. However, we believe gold continues to play an important role as part of a diversified portfolio. We would go so far as to say that gold belongs in every portfolio.

Despite its recent slide, gold has an enviable long-term performance record:

GLD

 

 

 

 

 

 

 

 

 

 

 

The results have shown that big declines in the broader stock market do not always see gold drop as well. In fact, gold fell in only five of the S&P’s 16 declines of 10% or more, four of which occurred either during an existing bear market in precious metals or after the blow-off top in 1980. Gold rose in the 11 other episodes.

This outcome makes sense. A big drop in the stock market usually reflects trouble in some part of the economy or the world, which is good for gold, as a “safe haven” asset. This suggests that a decline in the stock market is not necessarily something to fear.

Gold stocks are a different story; they tend to follow steep downtrends in the equity markets. Of the 16 declines in the S&P, gold stocks tagged along in 11 of them. However, in smaller declines or flat markets, gold stocks were more likely to follow gold.

In a surprise move after months of subdued trade, the gold price jumped more than $48, nearly 4%, on Thursday, its best trading performance since September last year. (6/23)

Gold’s positive momentum sparked heavy buying of the Market Vectors Gold Miners ETF (GDX), which holds stocks in the world’s top gold miners, soaring 5.4% to bring its YTD gains to 23.5%.

The bellwether for the industry for decades, the Philadelphia Gold & Silver Index (XAU), gained 5% and is back to levels last seen in March when gold hit a 2014 high of $1,379 an ounce.

It looks like many investors are choosing to ignore the advice of investment bank Citigroup, which last month warned not to buy gold stocks no matter how tempting valuations had become. (Heh, heh…)

Unlike equities, bonds, and currencies, gold is not a liability of any government or corporation. Governments and institutional buyers invest in gold directly, and they’ve been doing so for decades. For centuries, people have turned to gold during times of economic uncertainty.

And what about both gold and silver?  When the investment world finally realizes that the unorthodox accommodative monetary policies of its central banks do not lead to sustainable economic growth, but only boom and bust asset-inflation cycles, gold and silver will be poised to resume their momentum.  After over 5 years of these historic near-zero interest rate policies (devaluing paper currencies), and a host of quantitative easing (QE) attempts, sustained economic growth is still elusive (1st quarter GDP FELL2.9%, recession territory).  The investment community is starting to see this now, as the low in gold on June 28, 2013 continues to hold.

 

Market Complacency/Record Low Volatility

The Chicago Board Options Exchange Market Volatility Index (“VIX”) is a popular measure of S&P 500 index options’ implied volatility. By measuring options rather than equity, the index predicts future volatility over the next 30-day period rather than the current volatility within the index. Many financial professionals refer to the index as the “fear index” or “fear gauge” as a result.

VIX

This index is now at 7-year lows. These lows have led to very narrow movements in many indexes, beyond the S&P500.

The June 23rd intra-day range (high to low) in the S&P was the 3rd lowest in the past 20 yrs.

About 1.8 billion shares traded each day in S&P 500 companies last month, the fewest since 2008,

As of July 15th, it has been 62 days since the S&P500 had a 1% or better gain, or loss. This is the longest stretch since 2006. Only on July 16th did the S&P500 break this streak of weakness, appearing as strength, by falling more than 1%.

Over the past five years through April 30, the S&P 500 returned a sizzling 19.1% annualized. But from December 31, 1999, through April 30, the index returned only 3.7% annualized.

Complacency in the markets always leads to shocks. Calm markets do not go on forever. At some point, shocks will occur to ‘reset’ portfolios.

This is additional confirmation that rewards are declining even while risks remain high.

So, why the restraint, given nominal (not actual) ‘all-time highs’?

Oil

Oil

This 5-year chart of oil clearly shows the uncertainty that connect a stagnating economy, world-wide, against a steadily creeping S&P500. A healthy and rising market, based upon solid fundamentals, should also reflect rising oil prices, to reflect consumption. However, this is just another ‘divergence’ between the perception of a strong financial market and real economic performance. Notice how prior to 2013, dips in the S&P were correlated to dips in oil prices. However, since the last round of QE by the fed, this relationship is weakening. Something is not connecting here.

With Libya returning to exporting oil and Iraq finally making gains against the ISIS insurgents the next topic for energy investors is Iran.

However, with U.S. production growing and Libyan production coming back online they are losing their bargaining chip. Libya could be exporting an extra 560,000 bpd within a couple weeks and Iraqi oil fields are not in danger at the present time. The new Kurdish pipeline into Turkey will double exports to 250,000 bpd and up to 400,000 bpd by year-end.

Oil prices continued to fall recently as Iraq fear exits the market and Libyan oil ports prepare to reopen. The insurgent uprising in Iraq has yet to have an impact on Iraqi oil production or supply which is allowing the fear premium to subside while at the same time the stand off in Libya which has had oil shipping ports shut down for over a year is near an end. Rebels and officials have reached some agreement which could lead to ports reopening in the near future. If so Libyan supply could more than double to nearly 1.5 million barrels per day. This has been on the table before and failed to come to fruit so there is still risk up to and until the ports are actually opened. In the meantime the Oil Index also traded down today, losing about three quarters of a percent. The index remains above long term support along the 1650-1675 level. The indicators are bearish at this time, in line with the current pull back from the recent all time high, but not to troubling at this time so long as support holds. The prolonged run of high oil prices this spring should convert into higher revenue and potential earnings for the big oil companies, the bulk of which will report earnings in the first week of next month. Until then watch support levels and developments in Iraq and Libya.

Let’s connect the rising cost of oil to debt. As we all know, oil matters because it’s the foundation of our economy, and the cost of oil is built into virtually every sector in some way. For example, look at how the the cost of food rises and declines in lockstep with the cost of oil:


Despite the substitution of cheaper natural gas for oil, we use a lot of oil.



While the recent increase of 3+ million barrels a day in domestic production is welcome on many fronts (more jobs, more money kept at home, reduced dependence on foreign suppliers, etc.), the U.S. still needs to import crude oil.

U.S. Imports by Country of Origin (U.S. Energy Information Administration)

The rising cost of oil acts as an economy-wide tax. Everything that uses oil in its production or transport rises in price without offering consumers any more value than it did at much lower prices.

Look at the impact on food prices as oil rose from $20/barrel in 2002 to $140/barrel in 2008. While government statisticians adjust the consumer price index (CPI) based on hedonics (as the quality of things goes up, the price is adjusted accordingly) and substitution (people buy chicken instead of steak, etc.), the reality is, as a once heckler put it, “We don’t eat iPads:” that is, all the stuff that is hedonically adjusted (tech goodies, etc.) is non-essential.

The long-term answer is to avoid the pursuit of ever dwindling supplies of oil, a finite resource, and to avoid the yoke of oil to everything we do. Alternatively, we must seek as many alternatives as possible to reduce the dependence on oil, foreign or domestic. The sun, wind and ocean waves are infinite sources of natural energy production. This would dramatically transform future energy needs, and, employment growth and stability!

Real Estate

RealEstate

A year ago, rising rates took the life out of new construction, existing home purchases and refinancing. In spite of continuing rate weakness, with 3% serving as a ceiling on 10-year treasury note rates for over a year, home buying has continued to lag, due to tighter lending requirements and weak incomes.

Just a minimal rise in rates sent volume tumbling 9.2 percent, according to the Mortgage Bankers Association (MBA).

During one recent week, applications to refinance a loan fell 13 percent versus one year ago, while applications to purchase a home fell 5 percent for that week, and are now 15 percent below the volume seen a year ago.

Even so, in a few markets, the gaps have been filled by institutional buying, actual home purchases by US based funds as investments, and, foreign buyers flush with cash from their better performing economies, relative to the US economy. This is the source of the bulk of upward price pressure. This has even worked to keep some potential US buyers out of the markets, from competitively higher pricing pressures.

Foreign clients made up about 7 percent of transactions in the $1.2 trillion US real estate market.

Chinese buyers, looking for their own piece of the ‘American Dream,’ paid on average $523,148 per property. By comparison, Americans paid an average price of $199,575, according to NAR’s statistics.

Foreign buyers of US residential real estate surged 35 percent last year, with Chinese buyers, searching for moderately priced, safe investments in a sea of economic and political uncertainty, outspending the rest of the world.

Chinese buyers spent $22 billion on US homes in the 12-month period ending in March, or about 24 percent of total foreign sales by dollar value, according to a study released Tuesday by the National Association of Realtors (NAR). That’s up from $12.8 billion, or 19 percent, on the previous year.

Total international purchases of American homes jumped to $92.2 billion, according to the NAR, an increase of $68.2 billion on the year before and $82.5 billion for the year ending in March 2012.

Thanks to a surging economy that has seen China rival the United States as the world’s economic superpower, newly affluent Chinese customers are the silver lining in the US real estate market, which is slowly rebounding following the 2008 financial crisis.

Sixteen percent of sales went to Chinese buyers, and is the fastest growing sector, behind Canada at 19 percent, down from 23 percent the year before. Mexico ranked third with 9 percent of sales and India and the UK both accounted for 5 percent

 

04172014 April 17, 2014

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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.

03042014 March 4, 2014

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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.

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.