The Iranian nuclear deal may catch Oil and Gold investors in a Bear Trap. Initially it will be very negative for both - Oil and Gold should drop - as war fears had built a risk premium into these assets. When Oil gets and stays below $90 it should spook a lot of other markets by raising Liquidity issues. It is after that we may see a bear trap as bears pile on the dropping assets. This will, however, unfold slowly.
Yves Lamoureux sent a message to that effect, and will follow up with more specific recommendations. His chart on Gold shows the coming drop as a fifth wave down, indicating end of trend. He also expects it to show capitulation, necessary prior to a trend change.
For fun I post the pattern comparisons to past crashes. Recently bears tried to compare this relentless up market to 1987 (fail) and 2007 (fail). The latest is to 1937, which at least has an historic logic to it: we are in a new Great Depression, which is following a different path but may end up even worse for cumulative loss of GDP.
More to 1937, the sequester led to the Budget Control Act, which has remarkably lowered actual Federal spending for two straight years (that hasn't happened in a long time) and reduced the deficit both in nominal Dollars and as a percent of GDP. This reduction of Federal stimulus has made Keynesians nervous, since they worry that it is similar to what happened in 1937 to throw us back into a Depression after the New Deal seemingly had brought us out.
At a broader level, comparisons are often made to 1929=2000 but it seems 1929=2008 is more apt. Looking to the period before 1929, we find a curiously comparable story:
- a tech boom in 1914-1919, the auto bubble (vs. the dot-com bubble 1994-99)
- a sharp recession (1921, 2001) followed by a classic credit bubble (Roaring '20s, Housing Bubble)
- a banking crisis followed by GDP drop and persistent high unemployment (1930s, 2009-now)
Now today the Fed is back to talking of Taper, which could spook equities.
Enjoy the stock chart eye-candy.
Albert Edwards prediction: sees the Emrging Market economies collapsing,driving down US stocks and reversing the recent rise in interest rates to a sub-1% 10-yr Treasury. In his diatribe, he references Zerohedge and its wont to show analogies to 1987, like this:
I have run a number of these sorts of charts over the years, including recent 2007 comparison, and none has come to fruition. So treat this as stock market eye candy.
Edwards does not say a crash is imminent either; he thinks hte next shoe to drop will be China in Q4, and will come with a rather shocking devaluation of the RMB. That could spook markets worldwide.
I have seen an increasing number of chart comparisons to 2007, right before we entered the Global Financial Crisis and suffered the 2008 crash. PragCap has a good discussion of this, here, with this chart:
Jeff Saut gets credit for first popularizing this meme. John Housmann has also picked up the thread. One upcoming event that may spook the market is the GDP report. Predictions have been sinking, now below 1%, essentially stall speed. The first shot across the bow may be around August 7.
Yves has an update to his recent posts:
Sitting on an Inflation Powder Keg
Voices of hyperinflation have been quieted down. We have agreed with participants on the matter but not on their timing.The economy has shown more resiliency than economists expected. We have been and remain bullish.
As fear dissipates, we are sitting on an inflation powder keg! Massive amounts of liquidity will move back to real assets in due time. It has been a slower process because there is a lot of fear out there.
We think that we are now nearing this inflection point and it is quite exciting. Our advisory services already look to score nicely for the first half as we have been mostly long stock indices only.
It has been brutal for many markets. Money managers have unwinded bets on the conviction of a slowing global economy.
We think the second half provides hope of picking up great plays to finish up the year strongly.
Already amongst the back drop of a slower macro economic picture bonds should have rallied. They have not and the drop took players by surprise.
It is further proof that we are turning the page. As our forecasts are right on, we have growing confidence in our outlook of a better coming future.
A massive liquidity wave is coming. We feel that it is going to be exciting. Participants are unprepared !
Yves Lamoureux http://lamoureuxandco.com/
The market seems to be in its final run to an epic Triple Top back to 2000. Chris Martenson supplies a nice piece of analysis, expecting a 40% drop after we top. His chart shows this in the S&P:
Zoran Gayer, whose analysis updated Wave Theory with Chaos Theory, demonstrated how triple tops are good indicators pf trend changes. The Chaos Theory view, which is based on Thermodynamics, is that markets move in Thrusts and Plateaus, where a Plateau is the market on the edge of chaos, seeking order. A Thrust is order. All non-linear chaotic systems show this behavior, including weather and market economics. The formation in the S&P is a classic Plateau after a really strong thrust up in the '90s. The Plateau does not pre-determine the next Thrust, but Zoran found that after a triple touch of a trendline, the Plateau usually was showing exhaustion and the Thurst coming out of it would be the other way. In 2002-3, for example, we had a strong Thrust down, then a triple bottom in what he called the Iraqi War Triangle, followed by a Thrust up into 2007 that marked one of the largest asset bubbles of all time.
The timing of the triple top looks to be within the next few months. Seasonal patterns usually top around April or May, followed by a correction into September. Some pundits (like Neely) expect a sharp rise towards SP1600 in March, with a top in early April. Whichever it is, expect a bit of a throw-over at the end and then a really sharp "bifurcation" move down to mark the top.
The Plateau since 2000 marks a huge experiment with economic history, where all of us are the guinea pigs: central banks are trying to apply the lessons learned in the Great Depression to reflate the global economy. Problem is, they first created a terrible asset bubble in real estate, and after that corrected, they are now putting the global economy on central bank life support. As more fiscal borrowing is pumped out into the system, nominal GDP levels atrophy as the ever-increasing debt puts pressure on continuing this flow of monetary oxygen into an increasingly-moribund economy. As the system approaches the Rogoff Level of 90% debt-to-GDP, economies began to sag. Europe is already entering recession, as has Japan; and the US is skipping across the 0% GDP level, skating on very thin ice. Worries abound about China as well.
The Triple-Top Plateau therefore reflects markets at the edge of chaos on whether this huge central bank experiment will work.
Looking forward, history says this long secular bear market should last 16-20 years. The last one from 1966-1982 was 16 years; the prior one from 1929-49 was 20 years, and we saw a similar long plateau around Dow 100 from 1901-1921. The Depression of 1874-1896 was even longer, as was the one from 1837-1859. This puts the bottom out to between 2016 and 2020.
Sharp drop today has the bears on the prowl. Technical analyst Glen Neely cautions that in the formation we are in - an expanding triangle (actually nested at three levels), a sharp drop often happens before the top - and is a bear trap. He still expects a final runup into late March or April.
I have been expecting a triple top with the S&P highs of 2000 and 2007 - and we are close but not quite there yet (ie 1565-1600 would be a better finish).
Yet with all this hemming and hawing and cautionary notes, there is one analyst who has stepped up to a clear and brave call. Yves Lamoureux has called the end of the Bond Bull Market, and also a top in Gold, and now calls a top in US equities, before a Great Bull Market in equities. Enjoy!
Is The British Pound Giving A Market Top Warning?
We have been absolute bulls on stocks. Interest rates are too low and have been for too long. The crowd has caught on. We believe in an important market top now. Some observers are calling for the end of the equity bull market. We have a separate view of this.
A solid pullback should be part of a larger degree wave two. We maintain that stocks will double from the 2013 bottom. The market appears, so far, on the path we have been describing to our subscribers since last year.
A correction now would increase our confidence in the next stock melt-up. It is a large phenomenon and best ascribed to risk preference and behaviour. How would you explain the recent stock jump? Most participants are at loss and are mostly invested in bonds. They are playing catch up.
We, on the other hand, are exiting our long stock plays. We have increased considerably risk off positions as described recently in "How to Catch This One Impressive Rally". We are very excited about introducing investors to the coming wave 3 of 3 in agriculture. We suggest direct long exposure. Our timing relies on a proprietary weather model.
We show you today this one clear warning. It is associated with the British Pound. We have seen a similar behaviour back in 2009. The Pound as a precursor is a great tool. You have to combine this with patience as well. In 2009 the Pound started to move down. It did so for many months. The stock market finally caught on. It resulted in the May flash crash. We think similar conditions are in place. The "all in" crowds have a stop loss strategy. Momentum will turn down and we think it could begin a negative feedback loop of selling. Remember that in absolute terms cash is low.
The market has risen with low volume. Illiquidity events are going to be more common in our opinion. They should be seen more frequently as the Fed starts to pull back on quantitative easing.
The Pound in effect acts as an early warning system. The recent drop has to do with a huge UK money expansion. Measured on a year over year changed rate, it is up 100%. We think something more is going on.
You will see above a long term chart of the Pound. We have labelled the drop in five waves. We think the bounce is a clear correction. It is indicated as an A-B-C pattern. This suggest new lows ahead. Is the market now set up to catch on? We think so.
Now is the time for a defensive stance!
Yves Lamoureux http://lamoureuxandco.com/
Why Our Model Values Gold At $1450
We have watched the big wave one and two unfold in the bond market of Europe. We think we have seen the turn. It is therefore likely that a huge wave three in rates has begun in earnest.
It has been our contention that the interest rate cycle would turn in 2010. It did in Europe. We stuck to our 2.5% US long bond call has the recipient of scared money. Massive spikes are always deemed turning point. We explain this phenomenon in “The End Game is Here”.
We attach a lot more importance to what takes place in Europe. Our gold model is geared that way.
The recent behaviour of gold is the best proof. How can you account for a weak gold price when the US dollar is weak? We do cover the grounds on this topic in a recent gold article. Some of the intricacies of movements are popular trades being undone.
The start of a wave three in rates sets up a deflation trap once again. Primary waves all sport typical 5 waves form. The corrective nature is mostly of a zigzag type. This is why we are short 10 years Italian Treasuries from 4.20%.A quick look at wave two is beautiful textbook Elliot. We are now at 4.62%.
The market thinks it has everything to do with politics. As you are a good student of waves, you know better. Keep the cycle in mind as we cover the gold valuation model.
We thought that gold would top in September 2010. We think of this time spent as a large degree consolidation. We have not been at all worried to miss the bull market. We have fully participated in it the last 10 years. The recent bounce is more likely viewed as a B wave. I suspect, we are at the start of a C wave. I factor the coming rates increase. Our model values gold at $1450.
We look to make a big entry once again. We are extremely disciplined and wait for things to be aligned perfectly.
Yves Lamoureux, http://lamoureuxandco.com/
Whne a trendline gets breahced, the market typicaly comes back to test it from below. Will it kiss it goodbye, or show the break to be a False Break? Chart courtesy SlopeofHope:
Bespoke notes how the recent drop is symmetrical with the prior summer drop - 42 days top to bottom. This suggests a bottom with a final leg up still. Tony Caldaro further notes that the recent drop "retraced 61.8% of the previous uptrend [which] fits within the parameters for the typical wave 2 corrections during this bull market."
On the other hand, Zerohedge points out that today's action betrays the signature of a serious short squeeze. When we broke below the lower trendline of the big rising wedge, short interest increased; and often when the market comes back up to kiss the trendline goodbye, it denotes a short squeeze.
Usually the stub week of Thanksgiving is positive, and the following Cybermonday is down, so look to several days action next week to get a read on this market. We came up near the tops in 2000 and 2007, close enough to argue for a triple top, but typically the triple top would be closer (ie. around SP1550-1600). It wouldn't surprise me to see a final thrust up. Given the false break below the trendline, this thrust would likely have a false break above - another short squeeze of players betting on the upper trendline - before the end. So SP1565 is still on the radar.
The primary elliott wave counterview is that this rally is a counter-trend rally in a larger move down, and using the math of Caldaro the other way round, should go back 62% before reversing down. So far the Friday thrust got us 38% back, which is usually the minmum retrace; and now we might see a down move (wave B of the countertrend rally) followed by a final move up towards SP1430 (Dow15K). At that point one of the two scenarios will meet their end; this Shroedinger Cat bounce will either be found dead or alive.
I have posted a number of articles of Yves Lamoureux, President at Lamoureux & Co.. In Oct 2009, he predicted the 30 yr would fall to 2.5% when most pundits - including the then-inestimable Bill Gross -expected a rise to 5%. Yves was right, and I christened him the New Bond Guru. On Friday he published his new prediction, that the Great Bond Bull Market from 1982 is now over. Summary:
Bonds have tended to act as expected as risk preference shifted. However, bonds now have neither a credit risk premium and nor an inflation risk premium. Our proprietary model is clear: treasury paper of 30 years has the correct valuation of 3.50% and above. That is the level we would feel confident as buyers.
He makes an intriguing additonal observation, of a type of hyperinflation, but not the type that is commonly bantered about, a Wiemar-Republic style inflationary collapse. Instead, as we risk more of a deflationary environment from too much debt (deflation arising as that debt gets written off or washed out faster than central banks can print), this time it will emerge from increased credit risk in what heretofeore have been the most risk free instruments - US Treasuries.
The harbinger of this may be Japan, which (as John Mauldin has put it) is a "bug seeking a windshield." The expected new Prime Minister wants to go to extremes of monetization to reinflate their moribund economy. As money has bailed out of Europe, it has found Japan, and the Yen has risen. Now it is being purposely weakened, and has hit a seven month low with the USD.
Investors have been selling the yen since Japan's prime minister announced last week that an election will be held Dec. 16. Polls show Shinzo Abe, leader of the opposition Liberal Democratic Party, as the leading candidate to emerge as prime minister. Mr. Abe has been calling on the Bank of Japan to enforce bolder policies, including unlimited printing of money and setting reserve interest rates at zero, or even in negative territory to stimulate lending.
The MMT view has circulated in financial circles, with the core belief that a currency issuer never need to default. This of course flouts history, where fiat currency after fiat currency has gone down in the sort of credit collapse envisioned by Yves. While it seems almost unimaginable that the USD might suffer such a fate - and it is years away from such a crisis - the Yen may become the first major currency to test the MMT approach of extreme monetization.
Financial observers spend undue attention on stock markets. Bond markets are an order of magnitude bigger. It is now time to watch the bond market.
We have been following the AUD as an indicator of coming divergences in US markets, specifically that the correlation between the S&P and the AUD breaks.
Last night the Chinese GDP report caused a spike in the AUD. The report was in line with expectations, which suggests the AUD was a bit oversold.
Technically the AUD is in a triangle, and so is the S&P. We are expecting a downtick shortly, perhaps into the election, to be followed by a sharp rally.
In the S&P it could touch the 1550 area, a triple top back to 2000 and 2007. In the AUD it could breach $1.10.
The Euro is also at an appaent cusp point. Right now the Forex side of EWI is running a free week in case you wish to click through and learn more. Here is a taste of their perspective in this video about the AUD's triangle.
A few soft days and the bears clamor for P3 down or the end of a large Ending Diagonal. Instead I am watching the AUD. An interesting correlation since the Global Financial Crisis has been AUD and the S&P.
The rationale for the correlation is the Global Scramble for Yield that I first mentioned almost a decade ago - in a low return enviroment money mangers scramble anywhere they can for smidgeons of yield. The Greenspan Put exacerbated this, and so too the Bernank's QE.
The more specific correlation is that QE drives up commodities, something also predicted here, and therefore commodity currencies like the AUD. Australia, however, is now in a bind, as its currency is over-valued for its value-added industries, and its mining exports are suffering due to the Chinese slowdown that may yet turn into a hard landing. Indeed, the AUD correlation broke over the past nine months as China began to slow:
Some traders also watch the AUDJPY corelation, which also broke down.
The bind puts pressure on the RBA to lower rates, to weaken the AUD and support the slowing failing housing sector.
I have been following the election year pattern and it remains on track, with a 2 - 3 day lag (see chart, courtesy PragCap). There is an interesting twist this election, but first a discussion of the general situation. The prognosis, per PragCap:
Looking ahead, this version of the Presidential Cycle Pattern says that we should expect to see a choppy uptrend continuing toward election day, perhaps with some significant “texture” along the way. The strong correlation up until now suggests that this pattern is working reliably. Once we see how the election turns out, we can then figure out which pattern to follow starting in November.
What is interesting is that this version of the chart has taken out the 2d terms and only focused on first term Presidents, a more true comparison to this election. The generic chart that we showed in the prior post combines first and second terms and the behavior is different in each term. Per PragCap:
As a rule, [new Presidents] all typically spend the first year in office “discovering” that conditions are even worse than we were told during the campaign, and that the “only solution” is some urgent package of tax changes, spending, regulations, etc. ...
When a first term president wins reelection to a second term, then he typically does not spend much time in the first year telling us all about what a lousy job his predecessor did. That lack of a persistent negative message seems to work out to bring slightly better market performance right after a reelection.
But with a new president from a different party, investors tend to get discouraged hearing that things are worse than expected, and so the market’s performance during the first few months with a new party president is on average slightly worse than if an incumbent wins reelection. Over time, though, it tends to average out to be just about the same.
This chart shows the comparison of first term vs second term Presidents:
What is different this time is the pattern has not worked well in the last three elections, perhaps because we hit a secular bull market peak in 1999 and have been in a secular bear through the past three elections. The pattern broke in 2000 and 2008 when we had market crashes; it also didn't hold in 2004.
This time there is a lot of can-kicking going on to push the problems to after the US election. A lot of commentary over the past week out of Eruope thinks the latest ECB moves can buy 3 months, and of course the fiscal cliff doesnt rear until after the lection. The one stinker is that we may hit the debt ceiling limit faster than expected, before the election.
This chart from Bespoke made the rounds a few weeks ago, and it is interesting to note that it continues to work as a predictor of this year's election rally. We have continued higher, and now may be in the final blow-off stage into early September.
It is mildly interesting to note that late August/early Sept tops happen in big turns years (1929, 1987 etc.); and also happen in relatively normal years. It is just that in an election year, the summer rally seems to last longer. The correction in Sept usually denotes uncertainty over the election. When it becomes clear who will win, the market rallies again. In 2008, the post-correction rally waited until the end; of course a lot was going on in Sept 2008.
The normal seasonal pattern is a rally commences in mid Oct to early November, and continues into late April or early May, with a mild correctiion in late Jan/early Feb. The market then has a June Swoon and Summer Rally, but essentially meanders sideways into Oct, until the seasonal rally takes off again.
The Election Year pattern shifts the swoon to later, usually after the Conventions, and starts the seasonal rally earlier, unless the election is a cliff-hanger (1980, 2000, 2008).
Of course, this is an average of many different years and circumstances, so don't take it to the bank. Just note that almost every election is said to be critical, that the country is in crisis, that This Time It's Different, and then it isn't.
We didn't see a rally from the 2d week of December on, when it often arrives and shows strength. Instead, we have started the Classic Santa Rally, which comes in the last five trading sessions of the year and reflects the common rise on light trading during holiday periods. What to look for:
Last year the January Barometer signaled a strong year, and right now the S&P is barely up - and only because of the Santa clause rally starting yesterday! So don't take this indicators too seriously.
A lot of economic indicators are pointing up. Some should be taken with a grain of salt, like housing (which just got the last four years revised downwards, making recent trends look more positive), but some are interesting. The shale oil surge has changed the dynamic of indicators ike rail traffic, since we are bordering on a net exporting of energy, especially due to LNG. Rail cars shows an increase which has been used to show continued purchasing interest, but in this case may instead be indicating exports.
It also has meant a drop in gas prices, which acts like a tax cut. Even though Q3 GDP was downgraded in its third revision, Q4 is expected to report out higher than expected, giving a spur to stocks in January. When I scan the wave world, it is generally bearish (no surprise), so a warning that we might see a stronger than expected January, have the traditional correction into February, then fly into April or May before the bad economic news catches up with a short-term spur of lower gas prices.
I have been quiet on this site for the past half year, focusing on venture capital not the stock market, but have received a number of requests for a quick market update. We should be entering the seasonal strong period (Nov to May), but instead have suffered the worst Thanksgiving week since the bottom of the Great Depression in 1932. We should be expecting a Santa Rally, which typically begins in earnest around the second week of December, but instead the doom & gloom crowd has suggested that money managers will stay home this holiday season, Grinches all.
The comparisons to 1932 seem particularly telling. The market since 2008 has seemed to replicate other great crashes pretty closely - the best fit being 1907 - and has some parallels to the 1930s, especially if this time it is seen as unfolding at about 1/3 the speed. Specifically, what started as a pretty bad recession seemed to have turned around in 1930, but a sovereign debt crisis out of Europe in 1931 spread like a contagion to the rest of the world, and pulled the US down. In our case, the equivalent to the bounce of 1930 unfolded over three years, 2009-11, and now seems to have run head-on into another sovereign debt crisis out of Europe. If history repeats at 1/3 the speed, we head down, this time in a sickening slide over the next 4 - 5 years, not a dramatic fall in just the 18 months of 1931 to summer 1932.
The pattern that unfolded in 1931 was the sovereign contagion led to capital flight from country to country. Hoover in his memoirs likened it to cannons moving back & forth across a ship on a tossing sea in a tempest (a quote you all have probably seen). Right now a run on the European banks is in process, the commodity currencies like the AUD have fallen hard, and Chinese currency outside of China seems to have dried up as stories emerge of Chinese oligarchs cashing out and disappearing. Back in the 1930s, capital flight led the wealthy to go into tangible assets like gold - transportable across borders as it were to escape currency controls. We may be seeing that in China, although the data is sparse, anecdotal and likely exaggerated. As capital sloshed like loose cannons in the 1930s, safe harbors skyrocketed then fell; recently we saw the Swiss Franc skyrocket until the government curbed its enthusiasm. Eventually money went into cash or mattresses.
This was all very dramatic, and given a slow-motion rotation this time, should unfold more as a surreal process of "this cannot be happening." The slowness gives time for the powers-that-be to find solutions, such as Eurobonds done right, but so far they have failed to rise to the historic challenge.
The markers of the capital-flight stage will be clear:
Looking at the near term, the big issue is whether this will simply spiral out of control or will we muddle through and kick the can farther down the road.
From a Fractal Finance point of view, this chart should give us pause.
Wave practitioners have been trying to count the waves since the big drop last summer. In Fractal Finance, the process is simpler. The Fractal view is that markets normally are in trading ranges - corrective patterns with overlapping waves - as they try to seek order, meaning a direction. When the direction is found, markets thrust rapidly to a new plateau, where they pause to find direction again. Like all non-linear chaotic systems, markets tend to be on the edge of chaos most times and in rapid thrusts occasionally.
The blue lines in the chart aptly convey the trading range, and the momentary breakout above. Often a trading range of a chaotic plateau shows a false break below (as we see at the end of September) followed by a false break above - which is what the whole month of October now appears to be. When a thrust fails to sustain above the prior plateau, a reversal is in order. We saw in 2009 a thrust out of a multi-month trading range, and the market never looked back. This time we have fallen back.
It is now crucial to head north again in that proverbial Santa Rally. If we do, the break above is still on. We should then run up into January, and we might confirm a prediction of several years ago by Bob Prechter, that the top would be in January 2012. But we really only have a week or so for this to occur.
One of my readers predicted I would blog again when the perma bears like Prechter went bullish. Alas, they remain super-bearish. Let me finish below the fold with a recent Interim Report from EWI so you can see for yourself their latest view. It may be that even their January 2012 prediction for a top was too bullish for the currenct circumstances.
At the start of February, on Groundhog Day, the Dollar came down and tested a trendline that has provided resistance since Bear Stearns Day in 2008 (the day Bear went under). Apparently the Dollar saw its shadow when it bounced last Groundhog Day, and has remained in the winter of its discontent - it is now back to that level, a double-test in less than a month.
This trendline has provided resistance since March 2008, at lows in August 2008 as we began the great slide down, in Nov 2009 as the Hope Rally appeared to stall, and more recently in Nov 2010 at the kick-off of QE2. It is now Groundhog Day all over again for the Dollar, as it once again has come down to the critical support level (chart courtesy EWTrends):
If it does not hold these levels, it is poised for a fall based on technical, fundamental and cyclical considerations. PIMCO even put out a comment today that the Dollar was about to lose its status as the reserve currency. SImon Black added that "the Dollar is finished."
The primary basis for these assertions is the oil trade, which has been primarily in Dollars since a deal was cut in 1973, after Nixon went off gold. Given the Brent Crude market, an increasing quantity of oil is being bought directly with Euros, which suggest that the world's reserve currency is moving to a basket of at least the Dollar and the Euro.
Still, these pronouncements seem grossly overblown. Sentiment is very bearish against the Buck, at similar levels to the Nov 2009 and Nov 2010 bounces, and according to the STU, the total net positions against the Dollar are at the extremes of the Bear Stearns low and the Nov 2009 low. This suggests another bounce is imminent.
A lot of folk are watching for a first-day stock bounce as we march forth to a new month. I suggest watching the Dollar instead for an indication of what is to come.
On and off I show market analogies to famous corrections & rallies in the past. These are more like one-off events than predictive patterns, but are interesting to show that this time it is NOT different no matter how much investors would like to think so. Here is the prior 1937 analogy, which for a time looked spot on:
Updated and re-based by the Chart Store, here is how it now looks:
Not so good. First thing to note is how the basing of these analogies can make them fit or throw them off. In the first case, the basing was to the 1932/2002 lows; in the second, to the 1938/2009 lows. Caveat Investor.
Doug Short does this all the time, and he has a recent 1937 analogy chart where he based it on the peaks in 2007 and 1937. It shows we have gone a bit higher in 2011 than the market did in 1940, but then again, back then Germany invaded France with tanks, whereas now the Fed invaded Treasury with QE2.
Back to the issue of basing these charts, the initial 1937 chart above based on the 1932 low & the Oct 2002 low, and the match since remains uncanny. We peaked in 2007 ahead of the 1937 peak (in trading days), and fell farther. Rather than shooting beyond the red line in the prior chart, using the 1932/2002 low basing, we would be coming up to the break point where the 1940 market took a sharp fall and ran down to the 1942 low.
Today The Big Picture shows two analogies: 1974 and 1907. The Hope Rally looks ominously like the rally after the Crash of 1907:
Pondering this, both were banking panics. Both also came after a long runup in stocks and a plateau; we had a great rally from the late 1870s to around 1900, when we entered a long trading range around Dow 100. At the next bottom, we created the Federal Reserve. At the next bottom this time, will Ron Paul get rid of it?
The biggest drop since last August got the bears out of their hibernation, as well as the triumphant buy-the-dip crowd. This drop so far is but a blip in a relentless rise, and buying dips has been the right approach. Zerohedge made fun of it in a series of BTFD pictures (parent alert - risque language), my favorite being:
Neely jumped on this today with his second top call. His first was in June 2009 after the initial runup off the March 2009 low. It tainted his reputation when the market turned inexorably back up, so this call is all all-or-nothing move by him:
Applying NEoWave’s advanced market confirmation techniques, Mr. Neely explains that today’s collapse confirms the end of an old pattern and the start of a new one. This new pattern suggests a 1- to 2-year bear market has begun and will likely result in a 30+% drop in market valuation. ...
Instead of financial institutions and real estate markets being devastated, Mr. Neely suspects the most likely justification for this future market decline will be severe financial problems for federal, state and local governments. The result could be local and national transportation disruptions, public service problems and government employee layoffs around the country. Other circumstances that might justify a 30+% decline in the stock market could be a substantial increase in the cost of energy or a drastic increase in the value of the U.S. dollar (i.e. deflation).
So Neely is calling for the bursting of the final bubble, the Government Bubble. Could be. "Austerity" is the new black. States are all cutting back. The irony of the protests in Wisconsin is that the protesters are trying to hold onto the status quo, whereas the Libyans (and Egyptian, Tunisians et al.) are trying to upend it. Which side is history on? We shall find out.
Neely's logic on the USD is that once the Government Bubble bursts, the stimulus and subsidies end, leading to improving the prospects for the currency. Why? A falling currency is really a bet against unsound government policies; and at the same time rising gold becomes a hedge against bad government. At some point excessive stimulus/subsidy/easy-credit has to end, and we may have reached that point. Deleveraging will follow, with a vengeance, and the Dollar will soar.
No surprise then that commodities took a huge fall today, other than oil of course.
Tony Caldaro also went bearish: he says a "significant pullback" has begun. He was the first major wave analyst to turn bullish, and gets credit for being on the right side of market history for the past year. He remains mid-term and long-term bullish. His prognostication is crisp:
Technically, the market has just experienced its largest pullback, (32 points), since the Intermediate wave four low at SPX 1173 in November. The short term OEW charts suggest that the SPX 1344 high ended Minor wave 3 of Intermediate wave five. Should the high of Minor wave one at SPX 1303 be penetrated by this pullback, then this count would be questionable and Major wave 1 may have completed. Should the SPX 1303 level hold during this pullback a Minor wave 5 rally should follow to new uptrend highs. With support at the 1313 and 1303 pivots it appears to be “make or break” time for this Major wave 1 seven month uptrend.
Normally we would expect a bounce tomorrow, and then the real test. Sp1303 is not that far from the low today at 1313. Robin Landry put out a bulletin a little more cautious than Neely or Caldaro that explains what to look for:
If events in the middle east worsen overnight we could see the market accelerate to the downside. The decline today broke the trend channel on the hourly chart so a rally back to the underside of the trend channel at 12,300 area would not surprise me before turning back down
Even more cautious is EvilSpeculator, with an admonition of "Don't Be Stupid!" They had expected this drop, but warn that it is not yet time to go fully short. Their advice is to fade the buy-the-dip crowd - a delicious twist on the dippers' fade-the-bears strategy (which has been working!) - meaning go short once we see a double-top:
We have dip buyers at every step of the way through this rally. What we want to see is that the dip buyers, even POMO powered, cannot push it to new highs. At that point the fix is in.
A general theme across the punditry is to wait for a little more downside before calling a bifurcation down. You can see how in this chart from Contrarian Advisor we have just come down to a recent low without breaking it, as a bifurcation needs to do:
MarketThoughts also charts how all we have done is come down to the lower trendline. A break is needed, and usually after the break a bounce to retest the trendline from below. If it then fails (the "kiss goodbye"), we have a bifurcation & with it confirmation of a trend change:
Finally, number of pundits noticed that we broke down off a bearish wedge, and came down in a five-wave pattern, which denotes a trend change. The question is always what degree of trend? WavePrinciple sees this as a minor degree, but notes that a five-wave start suggests a bounce tomorrow and another five-waver down in a classic sharp correction:
Playing with the wedge concept, if we fell 32 pts peak to trough, a normal wave B bounce would be back 50-62%, or 16-20 pts, meaning back to Sp1330-1334. A final wave C of a sharp correction would normally go 32 points again, targeting the Sp1303 area that Tony Caldaro thinks is critical. To make it simple, watch for a break of 1300 before getting unbearably excited.
It's Groundhog Day and the USD is once again giving a wake-up call. AUD popped above parity and the USD is heading into a key support level. Phoenix Capital Research raises the Alert Level with this chart, which shows the mighty Buck once again hitting a key support level:
If it breaks below, and does not quickly come back above (a false break), it raises the awful spectre of a Dollar collapse. The report also sees a possible head & shoulders pattern which suggests a 50% further drop:
Now, H&S patterns are oft seen and seldom realized, because the underlying requirements that need to be met are more than appear in the pattern:
The EWT recently laid out the theory behind the head & shoulders pattern (EWI makes it available for free, in case you would like to peruse an EWT on point to today). Edwards & Magee's book says that the first shoulder should rise on heavy volume, but the second shoulder should have "decidedly less volume" than either the head or the first shoulder. ... The EWT notes as well that the whole formation should come after an "extensive trend". ... Many purported head & shoulders patterns fail these two tests. The weak volume indicates exhaustion of trend and a coming rotation to the other direction.
The current weakness is driven by oil dynamics, specifically the risk of spreading turmoil in the Arab world. Oil and the USD are pretty well locked into an inverse relationship (Oil up. Dollar down), although it often is not clear which is the driver. It could be said that after the US went off gold in 1971, it backed the Dollar with an Oil Standard by making a deal with the Saudis in 1973: you trade your oil in Dollars, and we will defend your oil fields. The US gets a great seiniorage benefit from this, as the rest of the word has to maintain high Dollar reserves just to pay for oil.
Tonight's STU notes that at the intraday low today (DX76.88) the Dollar Index has retraced 78.6% of its prior rise from Nov4 (75.63 on election day!) to Nov30 (81.44), a level that almost always is the extreme for a wave 2 counter-trend move. The percent of Dollar Bulls also fell to 7%, in the range seen at previous bottom (3%-7%) since the April top at 88.71. They expect a rally "now".
The trendline in the first chart stands at 76.08, below this 78% level, suggesting that we may break the 78% level and fall to test the trendline. Wave theory at that point no longer supports a reversal. Watch this development closely.
Uncertainty creeps into the tech world on soft cat's paws. Last week was full of surprises: Eric, Steve, some guy at AMD, half the HP board, gone. Apple has tremendous momentum and had blow-out earnings, but maybe it is all priced in? Google still beat, but a close look suggests it barely made it, and largely on currency hedging, not core business. AMD beat and the stock gets hammered the next day on chip pricing weakness. And maybe it is over for the PC-centic Intel Architecture? The sharp reaction suggests the stock was priced to perfection.
Perhaps next week will be a general tech stock smackdown, as the whole market is priced to perfection.
Small caps have taken a dive (see chart).
Tech is where the action is. First AAPL. Casey Research had done a bearish number on them last June, but reconsidered this weekend as the iPad has blown past all expectations. AAPL is poised to be the WinTel of the tablet era; it might garner the combo value of Intel+Microsoft as of the 2000 peak. They find the current stock price in line with expected earnings. And add this:
Now that Jobs might be gone for good, would we recommend shorting the company?
Apple had its Q1 2011 earnings call yesterday, and results were again better than anybody could have expected. Revenue for the quarter of $26.7 billion reflected an increase of 31% from the previous quarter and 70% from the same quarter a year ago. Earnings per share came in at $6.43, a full $1.79, or 38%, increase from last quarter. What’s more, iPad unit sales came in at 7.3 million, indicating an average of 2.43 million per month – more than 20% higher than the 2 million units we assumed for the conservative earnings forecast above.So, for now, Apple is running like a well-oiled growth machine. An amazing feat given its size (with a market cap over $320 billion). And we expect this to continue for at least the next several quarters whether Jobs is at the helm or not.
The test for AAPL will come when it hits the 50 DMA, which has provided support during prior Whither-Steve-Jobs episodes:
Over to GOOG. Larry Page was the initial Google CEO, and he stepped aside for Eric Schmidt for a decade. Now he has gone back into the drivers seat.
Is the second coming of Larry Page the return of a Steve Jobs, or of a Jerry Yang (YHOO)?
Other founders have returned to run their company and done middling, such as Michael Dell right now. At moments of market transition a successful tech CEO needs to bet the company on a new vision. Google is at such a moment, losing momentum to Facebook and the whole social mobile web phenom.
Most tech companies fail to come up with a second act: IBM, DEC, Lotus, Yahoo, to name a few. Consider the fate of Microsoft since the departure of Bill Gates:
Ballmer completely fumbled the transition for PC to mobile. Compare MSFT to AAPL during the Ballmer era:
Will there be a general tech selloff next week, bring the broader market down? It seems much more likely afer this past week. Uncertainty begats profit taking.
Oil has three cracking points: when it gets refined, when it stops rising, and when it breaks the economy. Econbrowser analyzed oil prices and the economy and concludes:
Every recession (with one exception) was preceded by an increase in oil prices, and every oil market disruption (with one exception) was followed by an economic recession.
Merrill Lynch’s Sabine Schels, a commodity analyst, calculates that $120/bbl will break this recoveryless recovery. This price makes the energy sector 9% of the economy, and she says we saw that in the 1980s and in 2008. Since oil tends to rise into the summer, this puts the cracking point out in Q2.
Might oil peak before $120? Oil's price is approaching a key level at $105/bbl (see chart, courtesy Market Oracle), the 61.8% retracement (this is the Brent Crude level; in the US WTI, oil fell a bit more on a cash basis, to $32, so the US level is just above $101/bbl.) You can see how it oscillated around the 38% level for a while before testing the 50% level at $90/bbl and falling back. It has now crushed through $90 and fallen off a bit, but stayed above $90. Watch to see if it falls back below in short order, indicating a false break. Otherwise we seem headed above $100 in short order.
It is difficult to imagine a world without Steve - he has been the prime driver for three generations of computing: Apple // begat PC and MSDOS; Mac begat Windows; and iPod begat a whole new mobile experience, with iPhones and iPads. This is an unparalleled achievement. Whither technology if Steve really retires, or his illness worsens?
His leave was announced a day before earnings, which suggests Steve's situation is too serious to wait even a day.
Apple is expected to announce blow-out earnings tomorrow, but AAPL is down 7% in German markets, and the Nasdaq 100 futures are down hard (see next chart from SlopeofHope). Apple has had such a run that stories are beginning to emerge that the stock has no place more to go. The next frontier would be to conquer TV, but Steve has insisted the Apple TV offering is but a hobby - which means his vaunted Steveness has not yet figured out how to conquer the world of Mad Men. Most likely it is his failure to negotiate deals that would enable Apple to offer a $30 cable TV bundle over the Internet within iTunes. It could be this is the time to sell AAPL, not buy the coming dip.
Of course, last time this happened, the stock dipped 10% and then tripled. This time Steve's condition may be worse.
This drop started before the Steve announcement, which suggests the expected January correction has begun. This event could trigger a series of falls. Investors are best described as jittery.
That time of year again. I did surprisingly well in 2009, with 7 of 9, including predicting the Dow would exceed 10500 at a time when it was in free fall below 8000 heading to 6400. Not as well in 2010. Where 2009 was Hope, 2010 was to be Change, and it was, with an historic election and the emergence of the Tea Party. Got that right, and a few others, such as 2010 being the Summer of Disillusionment, which it was, and no double-dip until 2011; but while I was directionally right I was too bearish in the predicted levels. Thought stocks would top in Q1 and bounce, and they did, but did not go as low as I predicted. Thought bond rates would rise then fall, which they did, but not as much a rise as I thought. Expected the Dollar Index to break 90, and it got to 89. Close but no cigar. Let's see about this year:
1. 2011 is the year of Chickens (coming home to roost) - kicking the can down the road is ending. The Tea Party really has an impact to stop Keynesian stimulus and cut the growth of government. But you never know - the GOP may screw it up.
2. Housing will drop 20%, if not all in 2011, over the next three years
3. Margins get squeezed as inputs (commodities) rise but pricing power is not there, causing a flattening of domestic profit growth. PEs go up! Stocks go down! Timing dependent on how long oil stays up.
4. Commodity Bubble Echo peaks and then drops hard - it is already at the 50% retrace and could drop from here, but more likely goes a bit longer to the 62% retrace (another 10% higher in the CRB)
5. China slows enough that the Chinese bubble is said to burst. Already growth is slowing and the Shanghai index is showing weakness. China raised rates again to stem an inflation that is at least at 5% and rising. NIxon imposed wage/price controls in 1971 and junked the entire world financial system (Bretton Woods) when US inflation got to those levels.
6. Dollar surprises by rising. This year it really does break DX90.
7. Stocks move sideways all year. We may see a peak in January but will rebound and head to new highs, above Sp1300. The Hope Rally may end in 2011 but more likely limps into 2012. If we get a double-dip in Q2, October could be a cruel month.
8. Muni bonds do not face the sort of disaster predicted by Whitney among others
9. GDP starts strongly but heads south by end of year. We might get a negative quarter if oil stays high for the first half of the year. If not, 2012 will have the dreaded double-dip.
10. The Social Mobile Web boom continues, with high-profile IPOs. The Nasdaq100 should therefore outpace the broader indexes.
11. The world gets colder. Climate Change becomes a joke. Every weather event that is blamed on "global warming" is now done with tongue in cheek. Political support chills for subsidies for green technologies, whether carbon taxes, cap & trade schemes, cheap loans or outright subsidies. CleanTech VCs switch focus to real breakthroughs which can compete without subsidy.
Margin debt - borrowing to buy stocks - has shot ahead of the S&P. It normally follows the index up and down. When margined stock gets ahead of the market, any significant drop is in danger of snowballing as stock is sold to cover the margin. Call it the old fashioned type of Flash Crash, of the sort we saw in 1929 when stock was bought with subprime margin (90% margin on 10% cash), or right after the Lehman debacle when TARP was pronounced (see chart, courtesy PragCap). How the 'bots might handle that we may find out - technicians are all over themselves with expectations of a 5-7% drop as early as tomorrow.
Don't fight the Santa. Markets are at sentiment extremes, at the highest levels since October 2007 just before the all-time top, and this has led the punditry to expect a reversal; but it rarely comes this time of year.
The Santa Rally comes on the soft whispers of machines turned off, as professionals close the books for the year and head home for the holidays. Markets tend to rise on light volume. More stats here. The rise often persists into the first few days of January, making January 10 the day to watch, but be cautious (chart courtesy Doug Short):
A more bearish view comes from Citigroup. They look at three similar prior markets (1906-10, 1937-40, 1973-77) and conclude that the market is likely to turn on January 3 and fall at least 20%. Their chart:
This outlook will be quickly dismissed by almost all market traders, given the optimism that reigns. I will provide a technical analysis in my next post, but let's first explore the fundamental viewpoint. The sentiment extremes are driven by four core beliefs:
QE and Bonds. I explored the first two in a recent post on Japan's QE experience, which supports the view that stocks will tend to rise as the Fed continues some form of QE. One should take such analogies with a grain of salt, as many other conditions are different, especially the fact that the two US bubbles (dot-com and real estate) pulled Japan up; which large economy will pull the US up? This makes the final two beliefs of larger importance.
Tax Deal. I explored the tax deal in my prior post, concluding it is much less stimulative than it has been sold. It can be estimated at adding around 0.9% to GDP based on around $270B of stimulative effect over the next two years, with much of that in 2011. This is not very compelling, but sure beats the alternative of austerity and a real double-dip next year. Of course, this all happened in the lame duck Congress, and the Tea Party influence is not yet being felt.
In general, the Tax Deal bolsters the Four Year Cycle, which is driven by Presidential politics. The Four Year Cycle makes the two years leading into elections bullish. The third year tends to be the best for stocks as the President has taken the hits from his predecessor's mistakes and is pumping the economy towards re-election. If the Prez waits too long to pump, as Bush Senior did in 1991, he risks not getting credit for the pump. (In that case, the economy had bottomed and was in a rebound through the 1992 election, but Bush got too little credit for it.) If he starts too soon, as Jimmy Carter did in 1977, he risks a flagging economy in the fourth year. Obama shot his arrows early, and we are now in the backside of the Stimulus where it will act more as a drag on growth than a spur. Best that can be said is we may avoid the 1937 analogy of a double-dip but are still waiting for a real recovery to start.
Signs of Recovery? So far Santa has left jobs behind. This recoveryless recovery is not showing the type of turn we have seen in prior rebounds. Q3 GDP just got revised up by a small amount (to 2.6% from 2.5%), which was below consensus (2.8%). Goldman has done a great job of parsing through the GDP revisions and concludes that they have to pull back from the prior optimistic view of 2011. Key changes:
There have been signs of improvement in Q4, and I expect a higher Q4 GDP than Q3, but this report puts a damper on 2011. In particular, the consumer is not back, despite some promising holiday sales. Keeping the consumer on life support, such as the two most stimulative parts of the Tax Deal (the FICA tax reductions and the extension of unemployment benefits), is just kicking the can down the road. The Consumer Metrics Institute shows the consumer still in a funk, and starting to trend down again (the blue curve):
Tesla is by far the most shorted stock in the Russell 1000 at 64% of its public float sold short. This is incredibly high. The next highest are half this level. The chart below from Bespoke speaks loudly. What gives?
Tesla appears to have run up in the wake of the GM IPO and its hyped car, the Chevy Volt. Tesla even popped above $30, getting back to where it peaked after its IPO. The shorts are betting this is short-lived.
GM offering priced today at the top of its range, which had been revised upwards. Much of the excitement surrounds the Volt, which is winning car of the year awards. I find the Volt to be the most interesting car in the world right now.
The last time a big IPO like this came out to such accolades, it marked the 2007 top. The cheeky site ZeroHedge ran a poll and found 35% expected the IPO to trade below its offer price within 24 hours. Another 35% thought it would take no longer than a week. The WSJ also ran a poll, and 56% thought it would be below within three months.
I hope the Volt proves them all wrong ... but the offering seems over-hyped. Never forget your are buying a stock, not a company, nor a car!
In the '80s it was Granville, in the '90s it was Henry Blodgett, and now we have ... Bob Prechter!? Bespoke charts how David Tepper spiked the rally last Friday, and suggest that Prechter's call Monday afternoon for Dow 1K drove it back down. Bob says this is the repeat of the last four times that investors over-committed to a market, pegging high-yield bonds as potentially the bubble that is about to burst like dot-com's in 2000, real estate in 2005, commodities in 2008. His bearishness of course carries over into stocks.
Monday's STU picks up on this theme, headlining that the market has now triple topped at 1150 - the top back in January 2010 and the left shoulder of the large head & shoulders pattern - and seems to be unable to punch through. This next chart from ContrarianAdvisor shows the Fractal Finance plateau going back to Nov 2009 with a false break above in April and the almost invisible (at this scale) false break below in July. You can see the smaller degree triple top since the Flash Crash as well as the larger degree triple top coming at the flattening of the Hope Rally in this year-long consolidation:
Is the top in? We have a consensus of sorts across most blog sites that the low last Thurs was the end of a fourth wave and we are in the fifth wave, with the most likely target 1158 (where C = A) by the end of the week. Of course, it might have ended today with a thrust out of a fourth wave tringle, but more likely breaks in:
Take a look at the Naz compared with the S&P in this chart from MarketThoughts:
The PE ratio has dropped rapidly in the past year, from 23 to 15 (see chart, courtesy WSJ). The WSJ analysis is this reflects increasing uncertainty ahead in earnings estimates. As I recently noted, 2011 estimates have dropped considerably in the past month. On top of that, the skew in estimates has widened, with the spread from lowest to highest increasing from $12 (between $85 to $97 next year across the S&P) to $15 (between $80 and $95). The WSJ concludes this measures an increase in uncertainty, and uncertainty begets a backing off of bullishness in stocks, which turns up in the PE ratio.
It is interesting to look at the WSJ chart above for the past decade: it is as if the great credit bubble of Greenspan short-circuited a normal bottoming process, which is still ahead of us. Similarly, the great inflation under Jimmy Carter kept PEs skimming across the bottom until Volcker finally got it under control and the great bull market of the past 25 years was on. Both these examples support the argument that economic uncertainty depresses the appetite for equities.
SeekingAlpha published a counterpoint to this conclusion: that the sharp drop is merely an artifact of PE being backwards looking:
Corporate earnings have improved very dramatically since the depths of the recession. A higher E with a flat-to-lower P means a lower P/E Ratio. Mystery solved.
This argument proves too much, since it also means as earnings rise in a bull market, PE's should be depressed. A quick look at the chart shows the opposite: PE ratios dropped rapidly in periods of uncertainty, such as 2002 and 1974 (and to the right of the chart, in 1938 and 1930-32), but rose during periods of economic (and earnings) growth.
I still believe the better analytical tool is to look at the first derivative - the rate of change - of earnings forecasts. As they drop, the market tends to drop; and with the PE ratio looking back 12 months, the drop in P should show up in a rapid drop in PE, especially as we step forward each quarter. Using this metric, right now we have rolled over from growth in forward earnings forecasts, which had reached elevated levels (to respect the recovery, such as it was):
The author of this chart has the following observation on earnings revisions and the S&P (emphasis added):
[A]nalysts were forecasting a near 20% decline in earnings at the market’s trough. Today, expectations are for 22% growth in the year ahead. The average annual gain on the S&P when earnings growth estimates have been below 4.2% has been a positive 17.2% return, consistent with last year’s monster bear market rally. Regrettably, the average annual performance of the S&P when earnings growth estimates have been above 14.2% has been a decline of 4.6%.
You could argue that at some point the sharp drop will bottom, and maybe we are about to bottom. The PE is still relatively high at 15; no major secular bull market began with PEs as high as they are now. PEs were below 10 in 1933, 1938, 1949, 1974 and 1982, all kickoffs to a bull (although whether 1974 fits is debatable). A further drop below 10 is probably required.
We might see an interesting phenomenon if corporations continue to take advantage of low rates to borrow: they might turn around and repurchase stock, as HP just announced. This would improve the P by reducing the number of shares, spiking the PE ratio. Related to that is the interesting speculation on ZH today that QE2 may not help the economy, but it could spur a wave of M&A: borrow cheap and consolidate your sector. This should also spike P, by putting an acquisition premium into stocks. Would this be enough to skew the past, and find a bottom with PEs as high as 15? It would take (in effect) more than a 50% premium in P across the S&P to create this effect - unlikely to say the least.
Mish reports how 58 of 58 economists were overly optimistic on the Philly Fed manufacturing estimate, expecting +7 when it actually came in -7.7. This comes after 42 of 42 economists were wrong on the unemployment report, expecting an improvement when instead we got a worsening. Bespoke notes how unemployment hit 500K weekly claims, the worse report since November 2009, and 22K worse than expected. McKinsey has weighed in with a report on how earnings are consistently over-estimated by analysts, despite a decade-long effort of stricter regulation:
Right now analysts are expecting a year-end S&P of 1235. Bespoke looks at this and is shocked, shocked to find that all analysts are bullish and across the board their current estimates are almost exactly 10% higher than their price targets at the start of the year:
You can see a lot of ink spilled about how earnings this year were beating expectations, but as it turns out, the earnings reports drove the S&P to about a median performance, up slightly this quarter. The cheerleading about expectations is part and parcel to the overly-optimistic frame of analysts.
Earlier this year the projected growth in earnings from 2010 to 2011 was around 15%, a pretty robust forecast in an economy with little top-line growth. It means in effect that the cost cutting begun during the Great Recession will continue, wringing out efficiencies rather than investing from growth. SeekingAlpha looks inside the numbers, and concludes that earnings increases in 2010 have now lowered the 2011 growth forecast to around a 125% growth into 2011:
If you believe these forecasts, the market is currently fairly valued. It had increased ahead of earnings in 2010, rising to the levels of expected 2011 earnings over a year early. The fall off the April high brought it back to current levels. A modest 12-13% growth would be expected in 2011:
Of course, this 'fair value' assumes the fairness of current PE ratios, which John Houssman finds 40% higher than normal. A simplistic argument compares PE ratios with interest rates; as Treasuries yields drop, PEs rise as a better performing alternative. In a world of QE and artificially low short- and mid-term rates, however, this simplistic view runs afoul of macro economic conditions. If earnings fail to grow, the PE ratio is too high, even compared with low interest rates. The stocks will simply not generate enough earnings growth to pay for the high stock price. This is one of many reasons why PE ratio analysis is misleading. You can read more on this in the flurry of blog posts on whether bonds are in a bubble and are stocks a screaming buy as an alternative.
This brings us back to looking at macroeconomic conditions, not PE ratios or beating analyst expectations. The Philly report is a disaster. It is also consistent with the recent NY report. Both say that the manufacturing-led recovery is weakening. The Philly report includes a prediction as to future activity, which as you can see is trending downward and may follow the current conditions into negative territory - yet another signal of a double dip:
The jobs report is also concerning:
Unemployment had been trending flat since last November, but now is ticking up. Here is the prior regression on weekly claims. There clearly was a break in trend last November. It appears to have been due to the introduction of the Obamacare bill. Others come to a similar conclusion from their own analysis. There may now be a new break, to increasing unemployment, but it is too early to make that call. I will post an updated chart when available:
Wheat and other commodities have risen parabolically recently, an indication of a blow-off top in the making. Blow-offs are followed by severe drops. Is the blow-off top at hand?
David Rosenberg noticed how the Shanghai stock exchange is a four-month leading indicator of commodity prices. The logic would be a variant on the old saw that stocks predict recessions by six months: that China is such a factor in real demand for commodities, a slackening of Chinese purchases will drive prices down, and the Shanghai stock exchange is a leading indicator of a coming slackening of real demand.
SeekingAlpha revisits this correlation since we are now four-months after the latest fall in the Shanghai index. Are commodities about to follow?
Copper is the canary in the commodity coal mine - very sensitive to changes in real demand. Copper came to life in mid-June, in effect signaling that the Flash Crash was more likely a correction not a change of trend. The canary, however, is beginning to show signs of asthma - copper has reversed to down again; and instead of recovering from the Flash Crash we had several sideways months.
During the period of the recent commodities bubblet, the USD fell fairly hard. The USD has now reversed, and very sharply, in sync with the drop in stocks. It may be my Aug4 turn date marks a major turn across all markets, with commodities shortly to fall hard.
The yield curve right now is steep, which normally predicts recoveries, the logic being the long end rises on demand for corporate investment. Since we do not have any strong evidence of corporate borrowing for investment in growth - instead, corporations are sitting on record cash - this creates a conundrum that needs to be explained.The yield curve short end is being held down artificially by the Fed. The last time this happened for a long duration was in the 1930s. The yield curve bent positive after 1929 and was positive for most of the time we were falling hard into the 1933 bottom - the Fed held the short rate down except during the sovereign debt crisis in 1931 when the Fed briefly raised short term rates to prevent gold flowing out of the US. Even as we came out of the bottom, we fell back down in 1938 when the yield curve was positive. Check out this chart from January 2007 when the curve ran negative (good timing!):
The Cleveland Fed put out a report on the yield curve recently concluding that a double dip is unlikely - but they are tracking experience post the Great Depression. Their dataset does not include any deflationary periods, and deflation changes the real rate on short-term instruments (it raises them - see analysis below). Since we are in the fourth credit collapse in US history (1837, 1873, 1929 and 2008), the best precedent would come from those prior eras, not the in-between times. Japan has had a positive yield curve for both of their lost decades of flat to down growth and continued deflation.
Also, the Cleveland Fed's chirpy conclusion is belied by reports that the Fed is getting ever more worried about a double-dip. The Fed lowered GDP forecasts in their FOMC meeting on Wed.
The curve is flattening right now: The Fed holds the short term rates down, but now the mid term rates are dropping to record lows, and the longer term rates are lessening. Not a promising sign.
The WSJ noted two odd phenomena in this market: small investors have largely bailed out, and (perhaps as a consequence) individual stocks in the S&P 500 have been tracking the index itself to a degree not seen since the 1987 crash (see chart, courtesy WSJ). There is a good discussion over at TradersNarrative.
The average correlation is 44% (since 1980), but is now 81%, higher than in the crash of 2008 (79%) and approaching the all-time high in 1987 (83%). The conclusion from the correlation: fear drives investors to treat the market as a homogenous entity. Adding in the exodus of retail traders, this time the implication is the market has been left for the index 'bots.
For traders, two things to watch:
Carl Futia notes how the exodus of retail means rampant bearishness, which is a bullish sign. Perhaps, if they participate and not abandon the market. When they take short positions, it often allows the market to drive higher on squeezes. When they simply leave, the market is vulnerable.
The STU commented on this tonight as well: the high correlation is an extreme example of herding behavior. Despite our vaunted individualism, Man is a herd animal. EWI has been on an All-The-Same-Market argument since the Greenspan Bubble got recognized in 2004. From 2004-2008 all markets went up as the USD went down. After the 2008 crash that linkage broke, but since the Hope Rally we have seen an all-one-market return.
My take is the floor can drop out of this market rapidly, as we saw with the Flash Crash, as it is floating on arbitrage and program trading, not real conviction. The STU thinks we have about ended the second countertrend rally:
The second retrace has gone 62% of the fall from Sp1131 to 1010, and could be considered complete, since in their count this is a wave ii, and wave 2s normally go 50-62%.
Mother Market will pick the path that frustrates bull and bear alike. My speculation is that we continue to rise back towards the Sp1150 level into August, with Aug4 a key date; then the floor drops. This rise will embolden the bulls and scatter the bearish herd into a loss of conviction. The wave count would shift to a large irregular flat. Put simple, we would still be in the first retracement after the flash crash:
If we get much past Sp1086, this alt count gains in likelihood; if we break the 78% retrace of STU's nested 1-2 i-ii at 1106, that count should be abandoned. Although the STU has not posited an alt count, this one should be considered.
Neely considers us in a corrective wave since the April high, breaking as a triangle B wave (the Jan drop is an X wave and the rise from Feb5 to Apr26 is wave A). A C wave would follow but it need not break the April high. Hence Neely's count might lead to a similar result, albeit a bit slower in time.
Oil is in the news, and the huge gulf spill is giving credence to even higher oil prices - yet oil has dropped. At the same time, despite the flash crash, other commodities have continued to rise, closing in on levels last seen at the top of the bubble in July 2008. Are we in a huge Bubble Echo in commodities, and is oil signaling a top?
We all remember how oil went to $147/bbl in 2008 and then fell fast to $31 six months later. As it was rising, the cries of Peak Oil! rang out, but as it dropped, we shook our heads and mumbled about a huge commodities bubble.
Peak Oil is passé (see chart, courtesy InfectiousGreed), but Oil is half-way back to those bubblicious heights, and again the conventional wisdom is justifying high prices on faux fundamentals and momentary events. Lost in the noise seems to be it rose before the spill.
What is behind Peak Oil is a serious discontinuity: oil becomes more expensive to extract, and global production finds it hard to keep up with demand. We already appear to be beyond the era of cheap oil. Chris Martensons' Crash Course has more on Peak Oil. The US military is worried. His blog has just put out a great resource on this issue, with specific advice for investors, to wit: if Peak Oil hits, we won't see oil spiking to $500/bbl, but a political and military response.
But we are not there yet. Instead, something else is driving up oil, and it is not increased demand. Miles driven have dropped during the Great Recession, and on a month-to-month basis has dropped since the start of 2010:
Sunday's NYT has a great graphic of oil going in reverse. Even during the oil crises of the '70s, per-capita driving increased. In the Great Recession, in contrast, per-capita driving is decreasing, yet oil prices have bounced back up. What gives? If the demand is down, and we are awash in supply, why are prices back up?
Maybe China is driving demand for oil? Nope. Chinese miles-driven has been flat. Chinese data on this stat may be statistically sketchy, but the NYT reported last Dec how Chinese car sales are booming but gasoline sales are flat.
As recently as May 2, oil was heading to match its 52-week high of Apr6. Pundits were calling for a breakout. Just before the breakout, we saw an increase in the same sorts of cries to buy! buy! we saw in 2008. So it goes at a bubble top - where were they when oil was hovering at $50? Instead it did a triple top and collapsed. It had bounced off the 50 DMA after the second top, but this time it ran through the 50 DMA without pause, jittered a bit around the 200 DMA (around $76/bbl) and kept falling.
The best explanation is that we have been in a bubble echo. The signature of a bubble was recognized before the triple top that "trading activity seemed to mirror the pattern leading up to the oil market's breakdown in the summer of 2008." Commercial interest peaked last December, just like it peaked in late 2007, six months before the bubble burst:
Oil had also gone into contango (indicating too much oil). Yet even this pundit was caught up in the bubble, expecting it to continue up despite the warning signs. Bubbles can do this to pundits.
After the peak of commercial interest, speculation drove oil and other commodities to absurd heights in 2008. You can see the same pattern now; speculative has gotten back to bubble levels:
Besides oil, Copper (the Cunary in the commodities pits) has given off a big warning signal: it began falling in April around the time oil began peaking, and has since dropped below its 200 DMA for the first time since coming off the commodities peak in 2008. This is a warning sign that manufacturing is slowing.
The WSJ's blog noted this warning sign as well, and attributed it to China tightening. This meme is gathering adherents: the FT noted it back in March, and the UK Telegraph's Amborse Evans-Pitchard picked it up in April, that China's credit curbs could cause a Great Unwind of commodities. Chinese base-metal stockpiling reached "epic" levels in early April. Of course the pundit expected it to continue.
But not everyone. David Rosenberg came out with a great predictor of commodities: the Shanghai Index. He shows how it leads the CRB Index by four months (72% correlation). It peaked before 2008 top in commodities, and it peaked again in Nov 2009. Since then it has broken down out of a four-month trading range, right as oil and copper have burst. A week ago CreditWritedowns posted a comprehensive analysis of this indicator and others which supports the Great Unwind thesis.
MPPTrader provides a comparison of oil & copper to gold & silver, showing how the crude oil and copper futures have broken below trendlines. Oil is well below, and copper has recently rallied to test the trendline. If it kisses it goodbye, it is pretty well confirmed that the Bubble Echo is done.
UPDATE: The STU led its latest update with commodities, showing in the chart below that the CRB commodities index has broken decisively below the trendline that guided its rise since the beginning of 2009 as well as the Feb5 low. The STU has been predicting this for months, and will likely continue to highlight this change of trend since it supports one of their core investment theses: deflation. The PPI came in negative in April, a surprise to pundits, and CPI will be reported tomorrow.
While the punditry still searches for a "glitch", ZH got it right: we are seeing the consequence of a market driven primarily by 'bots. Read the WSJ take on this in The Dark Side of Algorithms, followed up by Computer Trading is Eyed, summarized:
When the NYSE went into a circuit-breaker slowdown, called by the human specialists, trades spilled over into other exchanges. The specialists only manage 25% of trades anymore.
The 'bots take advantage of inter-exchange divergences and found them, as the NYSE fell behind.
Two major 'bots had also shut down from trading. The buyers had left the market.
This is how Accenture got to 1c: the 'bots ran down price points in microseconds looking for a bid, and seeing none, went to the bottom. No buyers, no bids.
The mindless machine did what a human market maker would never do. A person would have realized something odd was up and stopped. The human market-makers did react, but their time scale is measured in seconds - an eternity to a 'bot.
When the 'bots hit the bottom, literally, at 1c, they stopped, as any idiot-savant machine would do. When a real (human) bid came in, it was way above the fake HFT attempt to suck all the margin between bid/ask.
You could do a pretty funny treatment on this, when the dust settles: see what happens when you turn the market over to HFT 'bots gaming each other! Maybe this is how we can get to Dow 36,000!
Maybe instead this fall will scare the H (as in HFT) out of us. Read Sy Harding's morning rant: program trading used to arbitrage inter-market divergences, but that is below 1% of their activity. The other 99% is gaming the system for no useful value. Ever wonder why we get magic runs up near the close? Did you know that 'bots are now 50-70% of all trading? And where was their supposed liquidity when we needed it?
How did our rudderless SEC let it come to this? HFT is designed to skim the margin between bid & ask, scamming the real traders who are trying to take or lay off a real position in a real market. The machines trade back and forth, gaming each other, and not taking real positions. Now that we know the purported "liquidity" justification is bogus, why wouldn't the SEC ban HFT Monday morning?
The fault lies not in our machines, but in our saves - our reckless attempts to paper over real problems with gobs of debt and heaps of hope.
Economists talk of "moral hazard" and people's eyes glaze over. Let me try this:
We live in the Era of Entitlement where:
... and on and on across all sectors of responsibility.
There is feverish activity this weekend between the IMF, central banks, European governments and investment banks to come up with a better bailout of Greece: a Wolfpack Fund. The first solution ran into the Creditanstalt Problem that I warned about two weeks ago: instead of calming markets, creditors took it as their last chance to run for the doors before the rest of the PIIGS-in-Poo failed.
The Wolfpack solution is based on the false premise that the problems are coming from the pack of wolves (shorts) trying to drive down the Euro and the bonds of the PIIGS. The wolves are simply calling the bluff of papering over the problem without fixing it (which means getting the PIIGS debt back in alignment with their income). The Wolfpack fund is larger (€500B) than the last fix (€110B), but rather than ameliorate the run is likely to embolden it: it gives liquidity when the problem is insolvency. The PIIGS are still insolvent with no way to cover the debt nor the will to take tough measures other than to rely on the generosity of strangers to push the can down the street a little farther.
The whisper this weekend is Wolfpack will be further backstopped by €1T from the Fed and ECB, financed by quantitative easing (QE). Since no one believes the Greeks are serious about solving their problems, what if this backstop fails? There is no other bullet left in the gun.
The crash last week may have finally begun to change minds: Tom Friedman in the Sunday NYT talks of taking a root canal to the problem rather than painkillers. Andy Kessler in the WSJ suggests that the cornerstone of confidence in the Euro has broken, and the Euroland entitlement problem has to be faced. Papering over the problems and continuing the Era of Entitlement with false promises fueled by debt is not the path of serious people. Maybe it is time to take the problems seriously. I fear, however, the blue pill of the Keynesian dreamworld will require the final $1T backstop to be tried, and fail, before we can finally take the red pill and deal with the reality.
Until then, party on! A Wolfpack Bailout will likely bolster the Euro and spark a 300-400 pt rally in the Dow.
The post mortems on the 1000-pt crash are coming in. AllAboutTrends gives a tour of the fateful 11 minutes of the drop and pop, and gives this advice: "when in doubt, stay out." A number of other sites are trying to pinpoint the glitch. The irony may be that the circuit breakers put in place after 1987 may have exacerbated this crash: specifically, the NYSE may have slowed trades, pushing the 'bots over to other exchanges and overwhelming them. Rather than add to the speculation of what happened, let me review some of the better commentary on "what does this mean" for the market.
ZH's "I told you so" piece is a must read. They had warned of what could happen when market liquidity is replace by high-frequency trading (HFT) 'bots gaming each other:
[T]he market, for all intents and purposes, broke. Liquidity disappeared. What happened today was no fat finger, it was no panic selling by one major account: it was simply the impact of everyone in the HFT community going from port to starboard on the boat, at precisely the same time. And in doing so, these very actors, who in over a year have been complaining they are unfairly targeted because all they do is "provide liquidity", did anything but what they claim is their sworn duty.
Barry Ritzholz thinks more happened than just a mistake, as the market had already fallen 3% due to worries over Europe, but he adds this:
PragCap has a perspective across the Crash, the Election (UK), and the Tragedy (Greece). While Greece can, and probably should, and likely will default, the UK still manages its own currency, and cannot default, yet "they ... are somehow attempting to drive their economy into a near equally disastrous situation." The implication is that the Euro crisis will deepen and spread, even to England. On the Crash he notes:
After work, I did some digging, made some calls, and came to the conclusion that most of the worst of today’s move was a mistake. Does that mean investors should buy with both fists tomorrow? No, though I think stocks could enjoy a nice snapback rally in the coming days.
This is now the second market crash in less than two years and could be shaping up to be the third time small investors have been seriously burned in a decade. You have to wonder how comfortable the small investor is in this market now. The game must appear entirely rigged to an unsophisticated investor and the accusations of a system error during yesterday’s trade has to make some people wonder why they are putting their hard earned cash at risk of a massive computer glitch.
Nic Lenoir of ICAP adds perspective to his target of Sp1041 in the futures, a huge additional drop ahead:
There is the danger of walking out of today's session with a sense of relief for equity traders, because that insane move was "just" a fat finger or at least it is the word in the media and on the street. There are three things to keep in mind:
- the market was down 3% already when the alleged input error happened
- we are still in the middle of a major unresolved currency crisis threatening all of Europe and that led to deadly riots already
- the financial industry does not need any bad press right now and detractors just got some more ammo to push tough regulation
What to expect?
The next few days were sideways, and on Friday we went out and got a price that was twice as high as the low on Tuesday. The week after the Naz began a slide from which it never recovered.
In the weeks preceding the runup to today's crash I saw a number of overlays of the Hope Rally to the 1987 market before the crash, including this comparison and chart:
I expect more on this over the next day or two. We explored it here at some depth on the anniversary last October and later in December. Even before then, Yves made the first comparison. What shoudl be clarified overnight are the three main causes of today:
Here is the result (from Jesse's Café Americaín:
I first went bullish in Nov 2008. A normal bounce from the deep drop goes at least 50%, so in Jan 2009 I predicted the Dow would break 10500, which it did in Nov, nine months after the bottom. Since then we are only a bit higher after five more months. The rally is flagging. Both technicals and fundamentals are signaling the odds have changed from bullish to bearish: the modest possible upside is offset by the higher risk of a deeper downside. You may want to see what the first few days of the new month bring, but be nimble.
Fundamentals in this post. Technicals in the next one.
Fair value on this market given the expected year-end earnings of $80/share in the S&P is 1200 at a normal 15 P/E - where we are right now. Unless the market accepts a higher than normal PE ratio, the market may be flat for the rest of the year. It might run at higher PEs, given unusually low interest rates, but that is the bet the fundamentalists are making. Betting on upside surprise in earnings is no longer worth making, especially given the GDP report:
Bottom line: "Asia good, America bad." As goes the Chinese bubble, so goes US earnings. Here is CAT's profile of retail sales:
Bonds are at the cusp of a breakout to higher yields. This chart from StockTiming shows the 30-yr Treasury hitting the down-sloping resistance line for the 7th time in 17 years. With the end of QE, it seems poised to break above, and if it remains above, signals a major trend change - the end of the Bond Bull Market of the Great Moderation since 1982.
We almost broke the trendline recently (Oct), but the market did a head fake away from it. We have now returned.
The STU's wave count has the 30-yr in a wave 5 up to above 5%. This would break the trendline, but it would also complete the wave structure, leading to a drop back below. As mentioned, a break above a trendline confirms a change, unless it quickly falls back below.
The WSJ has reported on a divergence on rates between Morgan Stanley and Goldman Sachs:
The Sunday NYT chose the MS position, citing Bill Gross of PIMCO, which believes the thirty year bond bull market is over. If so, the impact on the economy could be rough, as mortgage rats could rise 25% to over 6%, and consumer credit costs may seriously erode household discretionary income (see chart).
David Rosenberg summarizes the argument in a recent Breakfast With Dave, and concludes that bond yields do not tend to rise with high deficits after a credit contraction; instead they rise from increased economic activity or inflationary fears. He points out the contradiction in the NYT's position: if they do rise, as the NYT suggests, "there will never be a sustained improvement in the pace of economic activity." His view comes down to his expectations of inflation vs deflation, and he is in the deflationist camp:
Fiscal deficits that are designed to cushion the blow from a credit contraction, especially among households, generate far different results. With credit contracting, rents deflating, the broad money supply measures now declining and unit labour costs dropping at a record rate, it hardly seems plausible that inflation is a risk at any time on the near- or intermediate-term forecasting horizon.
Paul McCulley of PIMCO hangs with their "New Normal" view of prolonged low rates. He sees real GDP settling down to 2-2.5%, and expects 10-yr rates to settle to 4-4.5%, somewhat above where they are now, but not much, and only after unemployment normalizes to 5%. That could take a while, hence his view of prolonged low rates by the Fed. His view can be summarized as "never fade the Fed." Of course, with a huge bond portfolio, the last thing PIMCO wants is a sharp raise in rates, devastating their holdings, hence they have been very vocal promoting their New Normal.
The primary counter to Rosenberg is that the current deficits are unprecedented in size and stretch (ie. indefinitely forward). Even WWII had an end to it, and was financed by forced savings by the public due to deprivation as production was targeted to the war effort. Sure, Japan has extended their deficits for two decades, maintaining low rates, but they have benefited by huge savings domestically plus relatively strong capital markets globally.
ZH did a deep dive into this topic, beginning with analyzing how the problem has been kept in check for the past two years: the Fed's QE plus lots of short-term Treasury borrowing has resulted in modest interest costs, with 40% of the Treasury holdings being let out at essentially no interest. With QE ending, they think it unrealistic that the blended borrowing rates will remain low. They present several scenarios, focusing on what percent interest becomes of Treasury receipts (ie taxes):
The most likely case would be a rise from 6% to 16%. If MS is correct in their 5.5% 10-yr rate, this grows to 25%. If inflation rockets out of control, possibly this climbs to a catastrophic 50%. Worse, if tax receipts continue to fall, this could go towards Japan levels of 100%, the point of no return.
The ZH analysis basically says that the Fed cannot use inflation to get out of the mess we are in. (Paul Krugman would do himself and all of us well by doing the math for himself.) Of course, the Fed believes it has a way to tighten without unleashing the $1T reserves it created for banks into a hyperinflationary lending binge: raise the rates paid on the reserves to keep them in the Fed.
It always amuses me how fundamental analysis can come up with scratch - sound positions both ways. Sure, the fundamentalists can take comfort in the contradictory TA assessments as well, but often they provide stronger warning signs. Here is a classic TA pattern to watch, a head & shoulders in the 30-yr:
If we break the trendline, we could see bonds drop below par (100) as the H&S setup suggests a drop below the neckline the distance of the head above. Rates would shoot above 6%. Confidence in the US would drop, and the Treasury auctions would become more difficult.
A lot if technical indicators are hitting extremes. The STU tonight reports that the USD's recent drop signals trouble: either a much deeper drop ahead, or sideways for a while. A further drop tomorrow pretty well confirms a downtrend. Weakness in the USD is another warning sign of weakness in bonds to come.
I did a recent post on whether stocks are fairly valued, looking at PE ratios and expected earnings going forward. PE ratios are high (above 20), but if they fall into typical ranges (of 15) the year-end S&P would track to Sp1200, where it is now. For reference, future projected earnings across the S&P are:
2010: $75 (BofA) and $76-79 (GS) - so say $75David Rosenberg of Gluskin Sheff, however, throws a huge bucket of cold reality over these numbers. As reported by David Galland's Daily Report of Casey Research, this number is almost entirely made up of financials, not industrials:
2011: $85 (BofA) and $90-95 (GS) - so say $90
2012: $90 (BofA) - too far out to know
THE PROFIT PICTURE - THE REAL STORY
Total U.S. corporate profits (national accounts basis) rose 30.6% YoY in Q4, a huge swing from the -25.1% trend a year ago.
Almost the entire story is in the financial sector where profits have soared 240%, which is unprecedented. With the banks shrinking their asset base, the surge in earnings has been due to the ability to 'extend and pretend' post the FASB 157 changes a year ago and the ability to play a super steep yield curve.
Financial sector profits have accounted for 85% of the overall increase in corporate earnings. Total nonfinancial earnings are up the grand total of 5.2% on a YoY basis, though this is still much better than the -17.9% pace a year ago.
UPDATE: Bloomberg reports that Jim Reid of Deutsche Bank believes that continued low interest rates are "creating the same kind of imbalances that fueled the credit crisis." He finds it "incredible" that financials are "scaling their 2006/2007 heights again." He notes that banks made $1.2T in excessive profit (vs historical levels) then gave almost all of it back in $1.15T of write-downs. The comparison of excessive bank profits once again with anemic industrial profits is well captured in this chart from Infectious Greed:
American business has cut back and accelerated "productivity" tools, replacing people with machines, in order to generate positive cash flow from flat to reduced revenues. ALCOA is generating a lot of gnashing of teeth today as earnings season kicks off, as it eked out a profit (before special charges) yet revenues disappointed. Higher commodity prices squeezed it, a topic I will comment on shortly.
The warning sign is that outside of financials, who are pumping out earnings but no one thinks are in good shape, the rest of American business is NOT in good shape.
This is an update to a post on PE ratios. Last year we had for the first time the earnings of the S&P go negative, which drove the PE ratio to absurd levels, as you can see from this chart by Hans Wagner.
As we got the final results in from Q4, we have an overall $51.15 per share for the trailing twelve months, putting the current PE at 23. Future projected earnings across the S&P are:
2010: $75 (BofA) and $76-79 (GS)
2011: $85 (BofA) and $90-95 (GS)
2012: $90 (BofA)
Hans discusses past behavior after a recession, and finds that PEs tend to drift down towards 15 as an economy normalizes. If the PE drops into a normal range of 15, as is shown in his first chart, the 2010 projections would target a year-end S&P at 1200, essentially flat for the rest of the year. He sees the trailing EPS rising to just under $60 after Q1, putting a fair value at Sp1200 if we drift down to a 20 PE, but at a bullish 1350 if we remain around 22-23 PE. Given the drift downward of PE from 23 to 20 and then to 15, he projects a range of 900-1250 through the end of the year. This is not far off my January predictions for a rolling market in 2010, not a break below the Mar09 lows nor a rise to new highs.
Barron's roundtable on this topic in January focused on the economy. It is well worth the read. The closest analogy discussed is Japan, which bodes poorly for the US. The biggest wildcard is whether we recover in the 4-4.5% GDP range, which should enable the Fed to completely end QE and other stimulative measures. Overall the group was gloomy, pinning their minimal optimism on a liquidity-driven market, and expecting the Fed to continue easy credit. At best their S&P range was 1250-1300 at the end of the year.
The NYT also ran a piece on fair value, and expressed the concern that interest rates are rising, putting a damper on the Fed's easy money policy. More on that topic in this post: Did ObamaCare Spook the Bond Market? The WSJ weighed in on this topic, suggesting first that a massive increase incorporate debt offerings may have pushed the swap rates with 10-yr Treasuries to negative, and second that funds were caught off guard by the negative rates, and dumped Treasuries, making last week's debt offerings unusually weak. In other words, the weakness might be a blip.
Barry Ritzholz asks rhetorically, when was the market last under-valued? He is of the camp that since the Greenspan Put after the 1987 crash, stocks have floated at much higher PE levels than in the past. We dipped briefly back into an historical level last year at the Ma09 low, then have popped back up to bubblicious levels again.
Barry may not realize he is making the opposite point of his post: that as long as the Fed's extraordinary easy credit continues, stocks will float at ahistorical PE levels, rather than drift down. Thus the bond market holds the key to stocks: if long rates drift up despite the Fed's best efforts to hold them do this is the warning signal that the excessive easing is losing its grip.
We had negative quarters in the S&P on 2008 which made the PE ratio skyrocket to ridiculous levels. The trailing-twelve-month (TTM) earnings had to deal with negative quarters, until now: the last negative quarter was 4Q08, and it is about to drop out of the TTM calculation. Since almost all S&P companies have reported (99%), we can pretty well estimate the new TTM PE ratio for the S&P: 22. This is still high historically.
The market is looking at estimated forward twelve month (FTM) numbers, which have the S&P at around a 14 FTM PE. Yardeni expects earnings to grow from around $75 to close to $100 per share across the S&P in 2011, which would push the market towards Sp1350 at year end 2010. Still, dividends are lower than normal, down almost 10% YoY. S&P companies are sitting on cash, which in normal times would depress future growth, and earnings. Instead, if we get a recovery, they may increase dividends, sprucing returns to investors.
The Pragmatic Capitalist gives us a handy chart to estimate the S&P at more normal PE ratios:
I do not often comment on gold but as Hank Wernicki posted in a comment, "Gold is Going Nuts!" Even George Soros has jumped in, saying: "When I see a bubble, I buy that bubble, because that’s how I make money." Neely also jumped in today, with a wave structure that says gold is about to rush to a blow off top. Going back to 2005, Neely has gold in an expanding triangle, and says it has entered the final, most vigorous leg E. This indicates we will see gold go to new highs (it still remains below recent highs) and head towards $1300.
Here is a circumstance where technical analysis is way ahead of fundamentals. With inflation fears fading and deflation showing up in the most recent CPI, conventional wisdom is a bit surprised by the new gold rush. The CW fails to see that gold is a hedge not just against inflation, but a hedge against poor government policies. The Greek troubles in the Euro have spilled over into gold. Gold has surged to a six-week high in USD and record highs in the Euro and Sterling:
Pierre du Plessis notes that gold is gong up across all major currencies:
The CW is also surprised as the USD is now rising with gold, whereas they had been in an inverse relationship. With equities floating on speculation and stimulus, it should not surprise how they can float up with gold, but all markets had been in an inverse relationship with the USD. Most likely the change in this Dollar Down/Everything Up relationship is due to Euro and Sterling weakness overcoming Dollar strength.
We have seen the pattern of a Monday Pump begin to fade, yet today was also the first of the month. The S&P was up 1.0%, while the Dow lagged at 0.8% and the Naz led at 1.6%. How does that compare? Here is a chart from Bespoke Investment that shows how first days have done since the Hope Rally started:
While above average, today's 1% is below recent firsts, and notably below Tuesday Dec 1 where the Monday Pump pattern sat aside on the last day of Nov and returned with a vengeance on Tues.
So while today wasn't a surprise, it was a bit less than expected. In the S&P we hover at a gap at 1116 that could be considered closed. I nonetheless agree with the STU's point tonight that we have more upside to go, in part for the Dow to catch up to the S&P to erase a de-confirmation: the S&P got above their Feb16 high today, while the Dow still lags below. They see a five-wave pattern emerging, and think we just ended a wave 4 and are in the final 5.
As the EWP site notes, the pattern is far from perfect, and the more it meanders the less it has the right look. Instead, a three-wave pattern seems to be emerging:
Here is their five wave count for comparison. Note the relatively small wave 2 vs the long wave 4:
A bigger technical problem is we burst above the 50 DMA today. Normally this is bullish, but the volume was anemic. Maybe everyone is exhausted after that amazing USA vs Canada gold medal game? Or recovering from the kitschy Moose Stampede finale? Here is the cross the bears must bear:
My concern is the fan line off the Jan19 top, the Zoran Fall LIne I have mentioned recently. If it is drawn down at the same angle of the upper trendline of the Hope Rally, the slope is relatively shallow and we are still below it. The line is now around Sp1130, so we have a bit to go.
If it is drawn the way Zoran did, which is from one Bifurcation Point to the next, meaning reflecting off the angle from the Mar9 start of the Hope Rally to the beginning of the sharp drop off the Jan top, we have now broken above that fall line. If we don't quickly drop below, this looks like a correction not a trend change.
The guideline is that the drop has to be faster than the rise to confirm a change of trend. The fall line is the line that shows the speed of the rise applied to the drop. Below it, trend change. Above, mere correction. A momentary break is ok, as these tools are never perfect; if we fall below quickly, the break is a False Break and can be ignored. The implication is we cannot meander upwards very long before the odds shift to this being a correction.
We already have gone above the 61.8% retracement, which is Sp1110 if you count the bottom as Sp1045. We remain a little below that level if instead you count the bottom as Sp1072, and the break to 1045 as a B wave in an irregular flat. (This is explained in my weekend post.) A general rule is that waves 2 rarely go beyond 61.8%, and hence when they do, it is a high risk gamble to bet on a short position. Better to stand aside and see how the market develops.
Right now we remain at the moment of maximum entropy, where the market could go either way.
A flood of bad news plus Bernanke saying he will keep rates low sparked a mid-morning pop in equities. If you think equities are tracking recovery, think again - they are floating on easy credit going towards speculation, not investment. Consider these news items:
Calculated Risk has a plethora of charts on this morning's announcement that new home sales (seasonally adjusted) fell to record low levels annualized as well as for a month, even below the prior record low of last January 2009, during the height of fear. You might think this a continued reaction to the end of the first-time homebuyer credit, but that credit was extended. Before the report Bloomberg reported that economists had expected a rise, so this report is unexpectedly bad - as bad as any period back before 1963, when the chart starts. Apparently the tax credit had already pulled forward new home buyers, so the extension has few suckers to pull in anymore. We should see a gap in demand for a while.
Lesson to be learned: gimmicks do create demand, they just pull it forward in time. The implications for recovery are profound, as no real recovery happens without new home sales.
New home sales are far more important for the economy than existing home sales, and new home sales will remain under pressure until the overhang of excess housing inventory declines much further
Housing inventory had been falling as banks worked through the subprime crisis, but are now rising again, indicating the second wave for foreclosure and mortgage defaults is beginning:
David Rosenberg of Gluskin Sheff pointed out this morning that housing prices are falling despite what you may be hearing in the mainstream media (chart courtesy The Pragmatic Capitalist):
The WSJ had a first page prominent article on bank lending falling, the sharpest decline since 1942 at the height of the war economy, which lowered private lending through industrial policy to retool for war. This too is really bad news, as it means banks are not lending but taking all the bailouts and cheap reserves and using it to buy financial assets (Treasuries, stocks).
The rebuttal to those Keynesian cheerleaders is that government stimulus freezes private investment, a phenomenon quite visible in the second half of the the Great Depression. Simple formula:
Banks don't lend, business doesn't borrow, people hide their savings in Treasuries = economy is on government life support
Now we begin to have worries on retail. Retail numbers still seem to be improving, and Wal-Mart announced good earnings, but warned about declining store comps and deflation in prices, and now Nordstrom is warning about 2H10 results. When January numbers were announced, retail seemed to have normalized (see chart from The Capital Spectator), but we may be seeing a snap-back from distressed circumstances, not a return to recovery:
James Picerno had a sound conclusion to this news:
No matter how you slice it, it's all about the labor market for the foreseeable future—and how the ongoing struggle to mint new jobs will impact spending. The next clue comes tomorrow, when the Labor Department updates the latest initial jobless claims.
Market patterns tend to get arbitraged away. The Monday Effect of a bounce on Monday is now widely known, and had occurred in 20 of the past 22 Mondays (and one of them was merely a time shift to Dec 1, which came on Tuesday). Did we pop up last Friday as an arbitrage against the Monday Effect? Or maybe we grant traders with too much prescience - did the shorts panic and cover?
If the pattern has shifted, the fun will happen this Friday, not next Tuesday (next Monday is a holiday). The pattern I suggested last night of a B wave drop at the open and then a rise to 1075-1083 seems on, albeit we only hit 1072 so far. If we drop hard in a minor wave 3 down, we might hit the wave 4 counter-trend around Friday afternoon.
Yves is back. His firm has been bought by Macquarie, the Australian powerhouse, diversifying into wealth management in Canada. After a hiatus to let the transaction settle in, he is back with a continued claim on the title of Bond Guru.
One revealing observation of Treasuries for 2010
A unique look at bond behavior will serve to illustrate how risk is lowered in holding long Treasuries for the coming year. The graph that we produce today is based on data from the St. Louis Fed. The Treasury bond data reflects the constant maturity 10-year bond and includes the coupon plus price appreciation. You are looking at the annual return of the 10 year bonds since 1928.
A startling observation is the large upswing following a negative year. The year 2009 closed with a negative return of -11%.
The readers will notice that over the last 80 years plus rarely has this phenomenon been proven incorrect. The only exception is the period at the chart point 28 and 31 which represents the time frame of 1955 to 1956 and 1958 to 1959 where one negative year was followed by a second negative year. In both instances the following negative year amounts to either -2.26% or -2.65%. These two events are the exception to an 80 year period.
This simple correlation for bonds to turn positive following a negative year is compelling. On a positive note, negative years are often followed by a string of positive years.
To be clear, the consensus is for bonds to drop “again” this year. This market observer will hedge his bets on the simple fact that 80 years of history has demonstrated.Yves Lamoureux, Investment Advisor, Macquarie Private Wealth Inc.
The opinions contained in this report are those of the author and are not necessarily those of Macquarie Private Wealth Inc (MPW) nor Yelnick. Every effort has been made to ensure that the contents of this document have been compiled or derived from sources believed to be reliable and contains information and opinions which are accurate and complete. However, neither the author nor MPW makes any representation or warranty, expressed or implied, in respect thereof, or takes any responsibility for any errors or omissions which may be contained herein or accepts any liability whatsoever for any loss arising from any use of or reliance on this report or its contents. No entity within the Macquarie Group of companies is registered as a bank or an authorized foreign bank in Canada under the Bank Act, S.C. 1991, c. 46 and no entity within the Macquarie Group of companies is regulated in Canada as a financial institution, bank holding company or an insurance holding company. Macquarie Bank Limited ABN 46 008 583 542 (MBL) is a company incorporated in Australia and authorised under the Banking Act 1959 (Australia) to conduct banking business in Australia. MBL is not authorised to conduct business in Canada. No entity within the Macquarie Group of companies other than MBL is an authorised deposit-taking institution for the purposes of the Banking Act 1959 (Australia), and their obligations do not represent deposits or other liabilities of MBL. MBL does not guarantee or otherwise provide assurance in respect of the obligations of any other Macquarie Group company.
Macquarie Private Wealth Inc is a member of CIPF and IIROC.