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07262017 July 26, 2017

Posted by easterntiger in economic history, economy, financial, markets, oil, stocks.
Tags: , , , , , , , , , ,
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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 07/26/17

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

-13.07, +2.39, +18.35, +26.39

With the very slow market action of the past few months, I like to begin each report with a memory refresher to the environment that was in place at the previous report.  Let’s look at the TRUE reflection of change since late April, and further.

The S&P500 was UP on it’s open on the 24th, but, only a half-point below Friday’s high.  So, why is there so much talk about UP for the year, yet, so little movement in general, and, often for many days at a time?

Here is a chart of the average change, in points for the S&P on top…. .  Notice that through all of March, April & May, there was a net negative from March 1st.  Total change from March 1st to July 6th was 1%!!

 

 

and, for the Russell 2000/S Fund since March 1st.

 

Even with an S&P500 all-new ‘all-time high’ early Tuesday, the change since March 1represents an average of 1/2 point/day.

 

 

 

 

The small caps are averaging less than 1/4 point per day…since early DECEMBER!!

And, likewise on the Dow Jones Industrials with SEVEN new all -time highs since June 19th.  Yet, averaging the difference between the June 19th all-time high and the July 25th, the latest all-time high, is only 3.25 points per day.  So, be very careful of reading too much into the repetitive ‘all-time high’ hype in the financial news. These half-point per day increases won’t compensate you in an average correction, or, after years of just normal inflation adjustments, and, particularly in view of the RISKS that are presented to your portfolios as you WAIT on the next few points.

Screen Shot 2017-07-25 at 11.42.18 PM

With this reflection on how ‘easy’ it is, supposedly, to make money in the first half of 2017, it appears that the Wall Street Journal recently noticed something is different this time. Three major stock-market benchmarks in Asia, Europe and the US have avoided pullbacks this year, commonly defined as -5% declines from recent highs.

The last time the S&P500 <SPX> slumped at least 5% was in the aftermath of the June 2016 BREXIT vote — marking a 273-day streak that’s the longest since 1996, according to data compiled by Bloomberg. The last time equity markets went this deep into the year without all three of the global benchmark indexes suffering at least -5% pullbacks was nearly a quarter-century ago, in 1993.

Never in at least the past 30 years have all three indexes – the S&P500, MSCI Europe and MSCI Asia-Pacific ex-Japan–gone a calendar year without falling at some point by at least -5%.  In good years and bad, markets tend to fluctuate wildly, with stock indexes often falling by double-digit percentages before bouncing back. That hasn’t been the case this year, another reflection of the historically low volatility that has gripped the world.

 

The CBOE Volatility Index, or VIX, finished Friday at it’s lowest since 1993. The chart above shows that this years average is the LOWEST IN HISTORY.

It has hit ALL-TIME LOWS every day this week, including a level of 8.84 on Wednesday, 7/26. Extremely low volatility conditions tend to produce very high levels of complacency, and unknown risk, into market participants, who aren’t prepared for the ‘what happened’ moments that approach. Fluctuations in trading volumes are nothing new on Wall Street, but the levels of volatility are the lowest in history.  You can view low volatility directly in terms of the 1/4 and 1/2 point average gains on major indexes.  You must view extremely low volatility as the ‘calm before the storm’, rather than to greet it with a feeling of comfort or complacency, particularly when they accompany all-time price highs.

How are the market gurus dealing with this challenging environment?

Legendary investor Carl Icahn is 150% net short of the market. The net short position means Icahn’s firm is betting against 1.3 shares for every one share it’s betting on. In other words, Icahn’s investment portfolio will generally gain value when prices decline, and vice versa.

86-year-old former Quantum Fund manager George Soros, who retired from fund management in 2011, has come out of retirement, sensing a critical opportunity approaching for major stock declines.

Seth Klaman is CEO & Portfolio Manager of one of the largest hedge funds, the $30b Baupost Group in Boston. He believes that “investors are underestimating risk and the insufficient margin of safety.” His book ‘Margin of Safety’ is a favorite of Wall Street investors. http://www.safalniveshak.com/wp-content/uploads/2013/05/30-Ideas-from-Margin-of-Safety.pdf

Quite clearly, there is substantial risk during these long periods of time, regardless of the overall measure from the election, or, from year-to-date.  It is this measure of more risk to reward that keeps me away from equity markets under these conditions.  I’ve seen an image of your being given just enough UP, over long periods of time, with the appearance of little downside risk, to guarantee ‘complacency’ in these risky market conditions.  DO NOT FALL ASLEEP!

How are institutional investors preparing for their futures during these deceptively calm waters?

First, institutional cash levels are at multi-year lows.  There just isn’t much cash left to put back into the markets to drive them higher.

 

Secondly, institutional buying is largely offset by proportional selling to lock in profits from share appreciation over the past 6-7 years.

Buying/Holding/Selling on S&P500

SPXGuruTrades

 

 

 

 

 

 

 

 

Buying/Holding/Selling on NASDAQ 100QQQGuruTrades

 

 

 

 

 

Note the prevalence of more selling in the major stocks, last year, with scant buying.  They are anticipating lower prices. Most of the buying, driving positive earnings, is as a result of financial engineering accomplished through  the result of stock buybacks, since earnings are derived based upon a smaller base of remaining shares outstanding, after the buybacks.


And in what few areas where this momentum is taking place, the appearance of true buying is also deceptive.  INSIDERS include corporate officers, executives, board members, etc.

Why are they selling so many more shares than they’re buying????

Apple

Net Insider Selling;  P/E Ratio of 17.92 (P/E ratio is share price divided by earnings per share, or by market cap divided by net income; market cap is value of all of the shares totaled together)

Apple has 3 BIG concerns (1) declining gross margins, (2) declining operating margins, and, (3) asset growth is faster than revenue growth.

AAPLInsiderSellsBuys

Warren Buffett/Berkshire Hathaway appears to be supporting the market all by themselves. They’re holding 186,716,758 AAPL shares. The next 10 holders only have another 65,617,772 shares, total. Everyone else is reducing, making small buys, or, already sold out. Apple is the #1 company in market cap, over 3 times Visa, or, WalMart, or GE, or, Bank of America.

Amazon.com

Net Insider Selling; Shiller P/E Ratio of 197.65!!!

Amazon is also getting less efficient, with asset growth moving faster than revenue growth.

AMZNInsiderSellsBuys

Google

Net Insider Selling; Shiller P/E Ratio of 34.23

GOOGInsiderSellsBuys

The tech sector has been virtually tilted upward by the flooding of a handful of big-name stocks, which are also represented in the S&P500 to a lesser degree.

According to a FactSet analysis, while there have been massive inflows into ETFs in 2017, the bulk of that money has gone into a vanishingly small part of the industry. The vast majority of funds have been left to essentially fight over the scraps.

The most popular ETF this year, in terms of flows, has been the iShares Core S&P 500 ETF IVV, +0.23% which has taken in $18.51 billion. Two other iShares equity products—the iShares Core MSCI EAFE ETF IEFA, +0.13%  and the iShares Core MSCI Emerging Markets ETF IEMG, -0.25% —rounded out the top three, amassing $13.1 billion and $11.3 billion in inflows, respectively.

This trend also held on the fixed-income side, as the iShares iBoxx $ Investment Grade Corporate Bond ETF LQD, -0.59%  and the iShares Core U.S. Aggregate Bond ETF AGG, -0.36% topped the list for inflows, taking in a combined $15.1 billion.

It has been widely documented that exchange-traded funds (ETFs) set a torrid asset-gathering pace in the first six months of 2017, with U.S.-listed ETFs hauling in $245 billion in new assets. Fixed income and international equity ETFs were primary drivers of the avalanche of new assets flowing to ETFs.

Year to date, three bond ETFs are among the top 10 asset-gathering ETFs. Those funds are the iShares iBoxx $ Investment Grade Corporate Bond ETF (LQD), the iShares Core U.S. Aggregate Bond ETF (AGG) (a valid proxy for the F fund) and the Vanguard Intermediate-Term Corporate Bond ETF (VCIT). As highlighted by the massive inflows to LQD and VCIT, investors have been searching for higher-yielding though still conservative options for U.S. government debt.

Another prominent theme has been investors’ thirst for ex-U.S. equity funds, which has been stoked in large part by the notion that, with the bull market in U.S. stocks aging by the day, domestic equities are richly valued. “Investors deposited over $20 billion into international ETFs in June and over $80 billion through the first six months of the year – marking the best start to a year ever for international funds,” said SSgA.  The roughly 10% surge in the I fund between February and June is reflective of this short-term event.  This parallels  the +3.29%/+5.25%/+6.6%/8.2% increases in the French CAC, British FTSE, German DAX, and Swiss market indexes, respectively, year-to-date.

How else do we reconcile so much of the bullish news on ‘strong earnings’ on the S&P500?

First, almost half of the earnings for the S&P500 come from just one sector, energy!!

While the S&P 500 earnings outlook looks impressive mainly due to a bounced-back energy sector, technology and financial services look impressive as well. But they depend on energy, too.

If oil prices fall enough to hurt the energy sector, some producers will miss loan payments. That would be bad news for the lenders in the financial-services sector.

Likewise, energy companies won’t buy as much hardware and software if they have to cut back on drilling activity. Not good for some technology companies.

Bottom line: the bull market in US stocks will be on even shakier ground if oil prices dip below $40 again. In any case, earnings growth probably won’t continue at current rates unless oil prices climb higher.

The FED

Fed Chair Janet Yellen said just this month that the Fed will be kicking the dollar ($USD) off a cliff.

 

 

 

 

 

 

 

She didn’t use those words, but the words she did use weren’t all that different.

But first a little context…

The fact is that the $USD has been falling steadily throughout 2017. At this time of this writing, it was down nearly 8.5% year to date. (The dollar should be ‘strengthening’ during rate increases, not falling. There is no confidence in the Fed’s moves to tighten monetary policy.)

The International Monetary Fund (IMF) just issued a warning, reflecting the weakness of the dollar to other currencies.  The IMF also noted that “the U.S. Dollar has depreciated by around 3½ percent in real effective terms since March,” while the Euro was strengthened. Countries such as Germany, France, Italy and Spain all saw growth projections increase. China’s growth was expected to stay at 6.7%. They also placed uncertainty in U. S. political leadership as one of their criteria for their warning.

“The major factor behind the growth revision, especially for 2018, is the assumption that fiscal policy will be less expansionary than previously assumed, given the uncertainty about the timing and nature of U.S. fiscal policy changes.”

The four largest central banks now have a total of THIRTEEN TRILLION dollars on their balance sheets, nearly TRIPLE their balances from the bottoms of the last financial crisis in 2009.  Anyone who has believed during the past 8 years that our markets are on strong financial footing, worthy of full confidence and bullish appetites, is sadly out of touch with the reality of the TEMPORARY magic of electronically created money.

THERE IS NO FREE LUNCH!

THE PARTY IS NEARLY OVER!!

IT CARRIES INTEREST PENALTIES!!!

IT RESTRAINS GROWTH!!!!

THIS MONEY MUST BE WITHDRAWN!!!!!

In a Fed statement in early July, the following stunning statement  was issued.

In the assessment of a few participants, equity prices were high when judged against standard valuation measures.

That is an incredible statement.

It tells us:

1)   The Fed is openly discussing stocks prices.

2)   The Fed is openly discussing whether stocks are in a bubble (when prices are high against standard valuations).

3)   MORE THAN ONE Fed member believes that stocks ARE in a bubble.

On June 27th, ECB President Mario Draghi raised the possibility of reducing their 2-year quantitative easing support, totaling €60 billion/month, before the end of the year. An Q2 annualized 3% growth rate in the Eurozone gives Draghi the room to take his foot off the pedal.  This was the fastest pace in a decade. Of the €4.25 billion on the ECB balance sheet, €2.25 billion have been added since March ’15.  Most of this liquidity was channeled into the high-flying NASDAQ, led by Facebook, Apple(!), Amazon, Netflix, Google, and Microsoft, as well as Alibaba and Tencent pushing the Hang Seng index to a recent 2-year high, and pushing Samsung in Korea. With this combination from the ECB, the Japan Central Bank, as well as the Swiss National Bank, the NASDAQ has doubled in value from the post-Brexit lows in June ’15, in the face of 3 Fed rate hikes, and threats to reduce the access to liquidity by reducing the $4.5 trillion balance sheet.  A clearer signal on the ECB’s plans will emerge when Draghi addresses the Jackson Hole, Wyoming financial summit in late August.

Central Bankers are absolutely terrified.

In the last month, both Fed President Janet Yellen and ECB President Mario Draghi have issued somewhat hawkish statements, only to turn around within 48 hours and walk back their comments.

Where has this nearly decade-long Fed support to the market left Main Street?

image1(1)

Study shows 1/3 of Americans not recovered from Great Recession. ? Still ok. After all, equity averages up > 3 times since March 2009.

However, even Main Street is exhausted.

Notice how this chart shows market peaks, shown by the S&P 500 index on the right, at nearly the same times that household percentage of ownership reaches historical peaks, shown on the left.  We are now at 30%, slightly higher than the previous market top in 2007, and just about 6% under the tech bubble peak in 1999/2000.

Stocks look expensive by multiple measures, and they have for a while now. But that hasn’t stopped major indices from achieving new highs as market fundamentals have looked more than capable of withstanding higher prices.

That all could change as the stock market swells to a size rarely seen outside of 2000 and 2008, just before the two most recent stock market crashes, says Deutsche Bank.

Rather than assessing the stock market using more traditional methods such as price-to-earnings ratio, Deutsche is instead looking at equity market cap as a percentage of gross domestic product (GDP). And it attributes the recent rise in historical highs to a shift in monetary policy.

While global markets benefited from a “long period of post-global financial crisis accommodation,” that’s changing as central banks like the Federal Reserve move to tighten.

It’s also important to note that Deutsche’s measure of market cap as a percentage of GDP also spiked to current levels in 2015, yet the market didn’t become embroiled in a crisis. This is because the Fed didn’t tighten to the degree that was expected, waiting until December of that year to increase rates, and then waiting another full year to hike again.

The situation showed that swift central bank tightening is a key component to unwinding an equity bull market. And this time around, stock bulls may not be so fortunate, with the Fed signaling a clear path of rate increase after already hiking multiple times.

THE CURRENT US TOTAL MARKET/GBP RATIO is 135.3%.  This is closer to the historical maximum than in any other industrialized nation right now.


This projects future returns that among the lowest in the world.

And it’s not just US stocks seeing their market cap swell as a percentage of GDP — Japan and the UK are getting in on the action, showing its a worldwide phenomenon.

 

This is a very uncomfortable global picture.  It’s similar to that of a number of pressure cookers all running at once, all inter-connected.  They must all function properly, or, they’ll all ripple their problems from one to the other.

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04222017 April 22, 2017

Posted by easterntiger in economic history, economy, financial, markets, stocks.
Tags: , , , , , , , , , , , ,
add a comment

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.

05232016 May 23, 2016

Posted by easterntiger in economy, financial, gold, markets, oil, silver, 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 5/20/16

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

-6.62, -20.76, -11.11, +6.71

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

(Friday 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)

TSP

As the calendar flips to May, the U.S. stock market enters what is historically its worst six months of the year, in which it typically under-performs the November-April time frame.

This is a well-documented seasonal trend with solid historical numbers behind it. It begs the question: Should investors follow the old Wall Street adage to “sell in May and go away?”

The numbers back it up. Looking at stock market history back to 1950, most of the market’s gains have been made from November to April and the market has generally gone sideways from May to October, says Jeffrey A. Hirsch, editor in chief at Stock Trader’s Almanac.

The November-April period produced an average gain in the Dow Jones industrial average of 7.5 percent since 1950 compared to an average gain of just 0.4 percent from May to October, Hirsch says.

This is just one more reason why I will maintain high allocations to our F Fund, as I have for much of the past 3 years, due to increasing risk and subsequent under-performance of C, I and F funds as compared to the F Fund.  The attractiveness of the F fund has mirrored the lack of increases in interest rates, relatively speaking, from multi-decade, near zero lows.  This lull in rate pressure is in spite of continuous Fed rhetoric projecting rate increases, since the end of Quantitative Easing (QE) in the 4th quarter of 2014.  A continued threat to raise rates is simply a ‘bluff’ tactic, meant to broadcast confidence to the rest of the world of our economic condition.  This is meant to continue to competitively attract capital from other world markets into our U. S. markets.  It is a very risky proposition, given the threat that higher interest rates, even from these generational low levels, can impact on our equally fragile and debt-ridden consumer, government and business purses.

For the following charts, imagine that you had half in F and half in the other fund.  When it rises, the other fund beat the F; when it fell, the F fund beat the other half.

Screen Shot 2016-05-22 at 7.30.31 PM

S&P 500/C Fund Performance compared to AGG/F Fund Over the Past Two Years

Screen Shot 2016-05-22 at 7.34.06 PM

S&P 500/C Fund Performance compared to AGG/F Fund Over the past 5 Years

Screen Shot 2016-05-22 at 7.31.26 PM

Small Cap/S Fund Performance compared to AGG/F Fund Over the past 2 Years

Screen Shot 2016-05-22 at 7.33.25 PM

Small Cap/S Fund Performance compared to AGG/F Fund Over the past 5 Years

Screen Shot 2016-05-22 at 7.31.58 PM

International/I Fund Performance compared to AGG/F Fund Over the past 2 Years

Screen Shot 2016-05-22 at 7.32.53 PM

International/I Fund Performance compared to AGG/F Fund Over the past 5 Years

Stocks

Fed officials have been preparing the groundwork for a rate hike for more than a month, having issued about a dozen warnings through the media.  Problem is, the Fed’s credibility is so badly shattered, that few traders actually believe what Fed officials are saying these days.

On April 28th, more than 80 economists polled by Reuters said that they were expecting two rate increases this year, with the first hike coming as early as June. “The Fed’s next interest rate hike will surely cause market pain, but the Fed should just get it over with as soon as possible,” former Dallas Fed chief Fisher warned on April 28th. “I would be prepared when they move, and I hope they move in June — there’ll be a settling in of the market place. There will be a correction. Suck it up. Deal with it. That’s reality,” he told listeners of the television station, -CNBC.

The weekly chart of the S&P 500 Index (SPX) is labeled as a bearish Elliot Wave 5. This fifth wave typically takes the chart subject down to a new low, after it has completed 4 waves with lower highs and lower lows.

How many bull markets have spent an entire year without making new highs? The answer is just thirteen since the 1940’s.

How many eventually did achieve new highs? Just two.

That is out of thirteen times bull markets did not reach new highs in the last sixty years.

What happened to the other eleven times stocks did not reach new highs for a year in a bull market?

You guessed it. Those eleven times ended in bear markets. So history tells us there is an 11/13 chance we are headed for a bear market. That is 85% for those with calculators.

Sounds simple, but the current market conditions are difficult. One day we are up and the next down. Rallies feel solid but never break out. Declines look like the end has arrived, but then they bounce back.

Smart investors have noted that the S&P 500 just staged a very dangerous looking move.

That move was when S&P 500’s 50-week moving average broke below its 100-week moving average. You can see this in the green circle below. We cannot rule out the high probability of a ‘waterfall decline, similar to the 4-day 12% plunge of last August.

Screen Shot 2016-05-22 at 7.45.01 PM

This move is called a “Death Cross” and for good reason. The last time it happened was in 2008, right before the entire market CRASHED. This is another case of a ‘waterfall’ decline.

The time before that was right before the Tech Bubble burst, crashing stocks.

Screen Shot 2016-05-22 at 7.45.30 PM

In short, going back over 16 years, this Death Cross formation has only hit TWICE before. Both times were when major bubbles burst and stocks Crashed.

Margin Debt

A primary fuel for market progress, margin debt, continues to show a peak over a year ago, a month before market prices also peaked.  The last SEVEN consecutive months have been below the 12-month moving average.  This is the first time since 2011 that this has happened.  That period coincides with a 20% decline in market prices around that point.

Screen Shot 2016-05-22 at 10.09.08 PM

Bonds

Notice the actual declining trend in interest rates over the past 20 years, and even in view of the so-called ‘economic recovery’ of the past decade. There is something more involved at work than these short-term ‘bullish’ economic aspects, much of it under the increasing Fed-funded burden of higher debt levels on Fed balance sheets (over $4 trillion in the past 7 years alone).  Long-term economic strength is fuel for higher rates, not lower rates.

Screen Shot 2016-05-22 at 8.19.21 PM

I’ve placed my bets on lower interest rates for the past 13 years, and, I’ve only been proven wrong for very, very short periods of time.

Precious Metals

The demand for Gold surged +21% in Q’1 of 2016, – the fastest pace on record, according to a May 12th-World Gold Council <WGC> report. WGC officials attributed the rise to 4 principal factors: 1- negative interest rates in Japan and Europe; 2- the chance of a devaluation of China’s Yuan; 3- the likelihood of a slower trajectory of Fed rate hikes – than suggested by the Fed’s “Dots Plot,” and 4- expectations of a weaker US$.

A quote from legendary trader and investor W. D. Gann sets the stage for the current state of the gold/silver/platinum/palladium markets.

“Anytime a market exceeds the largest percentage decline or the largest time period of the corrections on the way down in a bear market, it is showing that the momentum is shifting and that buying pressure is finally overcoming selling pressure.”

Screen Shot 2016-05-22 at 10.46.42 PM

Marshaling the evidence, in the gold there has never been a bear market rally which has exceeded the preceding bear market rally highs on the way down. Our advance has exceeded the previous two.

Only the 48% bear market rally in 1980 in the aftermath of the greatest bull market in history and the 27% advance in 2008 in the midst of the financial crisis have been greater in percentage terms than our 25% advance. Our DNA doesn’t match these two at all. The only conclusion we can draw is that we have a 1st leg up in a new bull market and not a bear market rally.

Screen Shot 2016-05-22 at 10.48.11 PM

Silver hit record demand in 2015, but had its third successive annual deficit, which was 60% larger than 2014. These were just a few of the findings of this year’s report. However, the report is backward looking and the silver market is much different today than it was towards the end of last year.  Erica Rannestad, precious metals demand senior analyst for Thomson Reuters GFMS, agreed in that interest for silver has shifted, which is helping to support prices this year. “First off, in the past 2-3 years, you’ve seen bargain buying. This year, you’ve seen a lot more safe-haven buying, which has been pushing prices higher,” she explained.

Oil

Screen Shot 2016-05-22 at 8.49.13 PM.png

There are a lot of tankers sitting off the coast of Singapore waiting for a price increase and refinery availability to dump their cargo (http://www.zerohedge.com/news/2016-05-20/something-stunning-taking-place-coast-singapore ). South American suppliers are trying to sell every drop to have available funds to ensure the population is fed, staving off utter collapse and revolution. India is even trading drugs for oil now. Middle Eastern suppliers are holding supply steady in an attempt to make enough money to support their lifestyles and basic requirements. International refineries are working as fast as they can to turn over supply in hopes of being able to pay their bills. All of this will have a short term cap on prices.

Longer term, as players go bankrupt and governments are overthrown, then supply will be limited into a market of relatively stable world demand. This will drive prices higher, but it is a couple of years away, at least.

In the short term, expect that every approach of WTI Crude Oil near the 50 level will be sold off.

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.

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.

10082014 October 9, 2014

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 10/07/14

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

-31.30, -2.82, -5.09, +7.63

(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)

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’ 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?

Margin debt reversal

 Margin

Repeating from the previous two 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 (declining), 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 years. The result of margin debt figure through August is shown in the following chart, for comparison to all months of the past 3.5 years.


Update – Notice that the peak in debt for the year has STILL not exceeded the February high, after which the primary indexes channeled sideways, with no price appreciation, for 12 weeks. For the past nine 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 diminishing portion of Fed stimulation through Quantitative Easing (QE), which ends on October 29th, this will remove 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.

Funds YTD

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

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

S Fund                 I Fund          C Fund                       F Fund

YTD 7/16             7/16               7/16                       7/16

+4.12%                +4.01%        +7.17%                      +3.94%

YTD 10/7           10/7                 10/7                       10/7

-1.04%                -4.18%          +6.39%                     +5.53%

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

-6.57%              -9.71%           +0.86%

In the table, consider the difference between how each fund differs from the F fund results, as what you are gaining, or losing, for the additional amount of risk that are a natural part of holding equity funds.

This weeks’ extreme volatility does nothing to mask the fact that current levels peaked several weeks ago. Most of the indexes are within a few points, high or low, of their 50 day averages.  European markets are all far below this average (they’re at a different party, one that’s already over). Today’s appearance of a reversal, (based upon that guy named ‘Fed’ walking across the stage),  of Monday’s downdraft results in the following net changes for 2 days: Dow Industrials, +3 points; S&P500, +3 points; S&P100, +1 point; Nasdaq Composite, +1 points.

Obviously, the numbers for this year are more favorable for the F fund than other funds.  Last year, the F fund trailed the other funds by a significant margin, and, for the last 3-year period. Surprisingly, the previous 3-year period saw the F fund double, triple, and more the returns of the other funds.  The equity funds promise more upside under some conditions.  The F fund has not produced a negative return in any one-year period over the past decade.  So, why is there so much more interest, each and every year, in chasing equity funds?  It’s due to the focus on the potential upside and ignorance  of the potential risk. It’s also where the majority of financial managers make their money.   Are you really getting paid enough in your returns to justify the additional risk within your personally chosen time frame? Can you afford to be wrong on the third equity peak since 2001?

Three major components of the I fund, the English FTSE, the French CAC and the German DAX, are back to the levels of their May ‘13, November ‘13, and December ‘13 levels, respectively; sideways for a year or more.

I am partially exiting the F fund temporarily.  It is now at one of it’s highest points in several years.  A simple reversal on technical measures would not be much of a surprise.  This is exactly what occurred in May of ‘13.   I will re-enter if equities continue their breakdown, forcing a run to the safety of bond assets, or, if a continuation of the uptrend strengthens.  A seasonal aspect in equities might lead to October weakness and a November/December rebound.

Less than a month from now the QE new-buying era ends, leaving the Fed bereft of the ability to convince traders it is backstopping stock markets. Harsh political realities make launching QE4 risky to the Fed’s very existence.   The imminent end of QE3 is the best catalyst we’ve seen for sparking a major correction or new bear market since QE3 was launched.  The precedent on this is crystal-clear, the ends of both QE1 and QE2.

The first major correction of this cyclical bull in mid-2010 was triggered when QE1’s buying was ending.  And the next major correction in mid-2011 erupted when QE2’s buying was ending. These once again were not trivial sell-offs, with SPY plunging 16.1% and 19.4%.  And the stock markets then were far less risky, overextended, overvalued, and complacent than they are today. QE3’s impending end is truly predictable, and ominous.

The bottom line is that stock markets rise and fall.  And thanks to the Fed’s gross distortions of psychology, today’s markets are overextended, overvalued, and epically complacent.  That means a major sell-off is long overdue to rebalance sentiment.  Best case if the bulls are right, it will be a major correction approaching 20% like at the ends of QE1 and QE2.  But far more likely is a new cyclical bear ultimately cutting stocks in half no later than 2015.

Interest Rates

U.S. 10-Year Treasury Note

15-tnx

World Markets

Major Markets Composite

 MajMktComp

This composite index combines the ten largest world markets with equal weights into one index.

Australia, Brazil, Canada, China, France, Germany, India, Japan, UK and US

Individual markets around the world, including many of those in the Major Markets Composite Index, and several other key indexes, are shown individually on the next few pages. Each bar is a week, to smooth out daily ‘noise’.  Also note ‘rate of change’ on the black, wavy line at the top of each chart, indicating positive or negative momentum, above or below the horizontal line.

Europe

FTSE

9-ftseCAC

8-cac

DAX7-dax

US

 Russell 20005-rut

Dow Industrials1-indu

Nasdaq Composite4-compq  S&P 500 2-spx

Wilshire 50003-wlsh

ASIA

Shanghai Composite11-ssec

Singapore Straits13-stiHang Seng  12-hsi

SOUTH AMERICA

Bovespa

14-bvsp

Insider Selling

With Form 144, required by the Securities and Exchange Commission (SEC), investors get clues to a corporate insider’s pattern of selling securities and pressure to sell. It’s a notice of the intent to sell restricted stock, typically acquired by corporate insiders or affiliates in a transaction not involving a public offering. These filings are shown daily on a Wall Street Journal blog.

As of this past Friday, the ratio of intended sales compared to intended purchases is at 51:1.  That’s 51 times as many intended sales as intended purchases.  Just about a month ago, that ratio was 47:1.  This filing also shows an additional ‘planned sales’ category.  When this category is combined with sales and then compared to purchases, the ratio of sales plus planned sales then compared to purchases more than triples to 173:1.  The technology category, for example, shows intended purchases at $81,161, with intended sales at $54,500,780, and planned sales at $139,310,116, which is 2,387:1.  This is a much greater ratio than the mixture of 10 major market sectors. Obviously, those with the connections have no intention of holding on to their large shares of stocks at these price levels.  This is definitely not the kind of ‘bull market’ that some of us are led to believe by the financial media.  Speaking of the financial media, apparently the word is getting around that these talking heads aren’t to be trusted.  The viewership ratings are now at 21-year lows.  This speaks directly to the degree of confidence that the general public has of these programs and their prospects for guiding retail investors toward their investment goals.

All-Time Highs

It’s taken just over a week to erase the significance of so many all-time highs, with market levels now back to where they were in early June.

In hindsight, with these highs now erased and now insignificant, how often does a headline, or, a news story telling you that there was another all-time high make you certain that you’re ‘missing out’?

But wait!  Let’s get one thing straight.

1 – http://www.forbes.com/sites/timworstall/2014/07/23/apologies-but-the-sp-500-is-not-at-an-all-time-high/

2  – Will Hausman, an economics professor at the College of William and Mary, calculates that the S&P 500 hit its true high — its inflation-adjusted high — of 2,120 on January 14, 1999.

To put that another way, the market still needs to rise about 150 more points — nearly 8% — to be on par with where it was in the late 1990s.

But, back to the non-story, there were at least 7 ‘so-called’, all-time closing highs since the last report.

S&P 500 inches to new high … but not 2,000 By Ben Rooney  @ben_rooney July 24, 2014: 4:25 PM ET

S&P 500 MAKES NEW ALL-TIME HIGH By Myles Udland August 21, 2014 4:00 PM

S&P 500 sets all-time high in intraday trading  Associated Press and IBJ Staff August 25, 2014

S&P 500 MAKES A NEW ALL-TIME HIGH Aug. 29, 2014, 4:00 PM

S&P 500 Ends Week at Another Record High with Gains for Fifth Week in a Row By Jeffrey Strain, September 6th, 2014AllTimeHighs

In this chart, the bar on the far right represents the average daily range of the S&P 500, from high to low, for the 3 month time frame of July 3rd to October 3rd.  The 7 bars to the left represent the increment of each new ‘all-time high’ in this same period, over the previous ‘all-time high’. Clearly, the new high was of such insignificance that it takes almost all of the 7 highs together to equal one daily high to low range.  The ‘good news’ about these highs was all ‘fluff’.  Now, they’re all gone.

What is never apparent in the news is just how much each high is above the previous high.  Is it a point?  Two points?  Or, is it twenty?  Waiting 4,5,6 weeks for another couple of points?  Is it wise?  It’s important, because with both the completion of Fed tapering (lower liquidity), and, the flattening of margin debt (lower cash sources) each week of additional equity exposure for the potential gain is also more exposure to the risk of losing it, and, quite often, losing it more quickly than it was gained.

Case in point – a 2% drop on Sept 29th and 30th was the equivalent of losing 25% of the entire gain for the year.

Case in point – Friday’s closing high, even after a relatively strong bounce for that day, was still LOWER than the lows of the 4 of the last 5 weeks, and. lower than the highs of, 9, 10, 11, 12, 13 and 15 weeks ago.

On the equities side, we’re going sideways on the strongest chart (C fund), and, drifting downward on the weakest charts (S and I).  The S fund is lower than the previous peaks in  March, June and early September.  The I fund is back to where it was in early February.

A final point on the ‘all-time high’ myth.  To go along with (1) the Forbes article, and (2) the quote from the William and Mary economics professor above, here is the inflation adjusted chart, using August 2014 ‘constant’ dollars, of the S&P500, from 1877.  Notice the current position, still below the 2000 high.

RealS&P

Source: http://www.multpl.com/s-p-500-price/

Dollar

 DollarThe U.S. Federal Reserve is nearing the end of its most recent period of quantitative easing, or QE (that is, rapid expansion of the money supply). By purchasing U.S. Treasury bonds and mortgage-backed securities, the Federal Reserve has spent the past several years expanding its balance sheet dramatically.

Now, as the current round of QE ends, the Federal Reserve is nearing the end of its unprecedented bond-buying spree. All other things being equal, this would mean decreased demand for Treasuries, and higher interest rates. Clearly, the U.S. government wants to keep its borrowing costs low. So with the Fed withdrawing from QE, how else could the U.S. government encourage demand for its bonds?

Other nations and currency blocs are still on the QE path. Japan’s vigorous QE is ongoing, and may increase. The European Central Bank (ECB) has so far been prevented from implementing outright QE by the resistance of Germany; but it is likely that Germany will eventually relent and the ECB will start QE as well.

All of the money created by the world’s central banks is looking for a home where it will earn a return — without being eroded by inflation. And right now, its best option is to buy assets denominated in U.S. Dollars. To some extent, this will be U.S. stocks, especially large-cap, high-quality companies. However, much of this money will flow into U.S. Treasury bonds.

A U.S. Dollar that is increasing in value may draw global financial flows into the U.S., support the demand for U.S. Treasuries, and help keep the U.S. government’s borrowing costs low.

The recent downside action in stocks may have begun with a German economic report.   The German Industrial Production declined 4 % while their Factory Orders had a 5.7 % decline as well. The International Monetary Fund topped it off with a lower projection of global economic growth from 4.0 % to 3.8 % next year.  The IMF further had concern about the geopolitical tensions translating into the stock market reaching “frothy” levels.  Contagion fears haunt the market with sentiment that the European Central Bank will not be able to add enough stimulus to increase inflation and stir the economic growth.   Their falling Euro FX should prompt better exports and a boost to their economy next to the stronger US Dollar.

Of course, a rising Dollar will also likely have negative effects if the dollar stays too strong for too long. These would take some time to manifest.

A higher Dollar relative to other currencies will make U.S. exports more expensive to customers abroad, and will hurt U.S. corporate profits — the more business a company does abroad, the more it will hurt. Ultimately, over the next few quarters, a Dollar that is appreciating strongly against other currencies such as the Pound, Euro, and Yen would be a modest drag on U.S. growth. Foreign goods would be cheaper, and the U.S. trade balance would deteriorate.

Oil

 Oil

Many globally traded commodities, especially oil, are denominated in Dollars. A stronger Dollar against other currencies therefore has the effect of making those commodities more expensive for non-U.S. customers, and leads to a decline in demand. We are seeing this play out in the price of crude oil.

Also, in the bigger oil picture, true supply and demand does not lie. Strong, vibrant, well-distributed world-wide growth would not produce an oil chart such as the one above.  Oil prices are range-bound since 2011.  Relatively stable oil prices have simply not served as enough of a catalyst for either economic stability or strong growth.  Notice how even the lowest curve, at the bottom of the green area, appears to project even more price weakness/lower prices.

Precious Metals

Precious metals in the form of gold and silver have appreciated by as much as 493% and 607% respectively at their peaks in 2011/12 from their lows in 1998. They are still up over 225% and 300%, respectively, as of today from that time. They are still favored by many who believe that higher intrinsic value will be further realized over the next 10 years. This is due to the combination of continued stress on paper assets, such as stocks and real estate, as well as consequences of escalating central bank expansion of fiat currencies.  This puts higher value on investments that are of limited supply and universal acceptance.  Look for more information on the significance of precious metals under my ‘About’ tab, under the long-wave economic theory.

Gold

 Gold

The soaring US dollar and the prospect of rising interest rates in the US have crushed the metals –both precious and industrial- to the lowest prices they have seen in several months. So far, there is no price action to suggest that this has ended.

A drop to either side of $1,180/oz. fol-lowed by a reversal could create a triple bottom on the weekly and monthly time frames. This could provide a base for a substantial rebound.

Conversely, a clean break below last year’s low and a close below the rising monthly rising 100-bar MA for the first time in a dozen years would be a very bearish event. IF that happens, gold could be doomed to hit the psychological $1,000/oz. mark for the first time in five years. I said several years ago that gold would be a screaming buy at that point.  At it’s peak, it nearly doubled from that point.

Silver

 SilverSilver slumped to a new four-year low of $16.85 this week. Based on a technical wave count, technical support could manifest somewhere around $16/oz. At this price, the decline from the July peak would be 1.618 the size of the decline from the February peak to the May low.

Failure to reverse or even slow down near the sixteen dollar level could indicate that silver is on track for the 2010 low of $14.65.

If the 2010 low is breached, silver may drop another dollar and try for the rising 200-bar Moving Average on the monthly time frame around $13.515.

A sustained close above the 2013 lows could cause a short-covering rally and run the December silver up to the Fibonacci .618 retracement of the decline from the July peak. Currently, this Fibonacci resistance line is located at $19.91.

Four decades of price history indicates that silver has a strong downward bias in the month of October.

As pointed out earlier, dollar strength is responsible for depressing prices of many commodities.  These lower prices are somewhat deceptive for that reason.

According to a report produced for the Silver Institute and created by Thomson Reuters GFMS, in 2013, the silver supply fell to 985.1 million ounces, down from 1,005.3 million ounces a year earlier—a two-percent drop in production. (Source: The Silver Institute web site, last accessed October 1, 2014.) But demand for silver was increasing over the same period. This continuation of falling supplies and steady demand points toward higher prices over the long term. A return by gold to it’s recent high would offer a gain of 60%.  A return by silver to it’s recent high would offer a return of 194%.