January 29, 2011

The S&P500 slipped almost 0.6%, losing ground for the second consecutive week.  This is has not happened since August 2010, not coincidentally when Ben Bernanke announced to the world that the Fed would embark on another round of quantitative easing.  QE2 is almost 50% completed, with most of the remaining money printing to be conducted over the next two to three months.  The S&P’s volume jumped up, which makes the price drop more important:  real selling was behind the price movement.  The VIX spiked up for the second week in a row, also confirming the price drop.

Economically, the news was poor to mixed.  The Case-Shiller home price index is now all but confirming the double dip in housing.  While new home sales were better than expected, the unadjusted figure set a record low for the month of December, and sales were still almost 8% lower than they were in December 2009.  Durable goods orders missed badly; instead of rising 1.5%, they fell 2.5%.  Initial jobless claims shocked everyone, coming in at 454,000 when the experts had predicted only 405,000.  Q4 2010 GDP (first estimate) came in below expectations.  Consumer sentiment was slightly stronger than expected.

Technically, the daily charts have not yet confirmed a break in the Fed-induced uptrend that began several months ago.  If the S&P falls below 1250, then the uptrend should be broken.  The geo-political unrest in Egypt, as bad as it is, may not be able to overcome the similarly powerful forces being unleashed by the Federal Reserve, namely quantitative easing.  Until this money printing program ends in a few months, any forces that push the market down will need to overcome the Fed’s massive forces that are fighting to push it up.

Over a year ago, gold was recommended here as a long-term investment opportunity.  At that time, gold had run up to well over $1,200 per troy ounce, and the investment idea was to buy it, but only after it fell back down in price.  Soon after, gold fell down to about $1,050 and after that, it began its year long march up beyond $1,400.

Over the last couple of months, something interesting has happened.  Gold has formed a major topping pattern, and has fallen about 8% from its recent peak.  If this drop continues to say $1,275 and certainly to $1,150, then we would have another major opportunity to buy gold at an attractive price.

Why gold?

GATA, or the Gold Anti-Trust Action Committee, summarizes the reasons why every serious investor should consider owning some gold. 

First, per GATA “true value relative to currencies is vastly greater than its nominal price today, since much of the gold that investors think they own doesn’t exist. The actual disposition of Western central bank gold reserves is a secret more closely guarded than the blueprints for the manufacture of nuclear weapons. For gold is a deadly weapon against unlimited government.”

Second, “the intervention against gold is failing because of overuse, exposure, exhaustion of Western central bank gold reserves from gold sales and leasing, and the resentment of the developing world, which is starting to figure out how it has been expropriated by the dollar system.”

 To sum up, gold’s price has been severely suppressed, in dollar terms, for many years.  And as the US Federal Reserve keeps on printing (electronically) trillions of dollars, then owning gold is not only a good investment, it’s also an important hedge against the possibility that the Fed’s printing-gone-wild scheme will fail miserably.

Also, unlike a traditional hedge, such as buying term life insurance or put options, the advantage of owning gold is that your “premium” paid never expires worthless.  In other words, if the Fed’s policies do not end in failure, then you can still sell your gold (although at possibly a reduced price) and recover some, if not all, of your initial outlay.

But judging by the way the Fed is trapped (if it continues printing, the US dollar could collapse; if it stops printing, the US fiscal hole could lead to an immediate funding crisis), the odds of losing on a gold investment are low.

Borrowing from the words of the financial economist and money manager, be your own central bank.  Buy and hold gold.

Room to Fall: 110 Year Perspective for the Dow Jones Industrial Average

January 22, 2011

The S&P500 slipped almost 0.8% last week, on lower volume.  But since the week was holiday shortened, the decline in volume does not take diminish the importance of the price drop.  The VIX (or fear) index, interestingly, spiked up almost 20%, supporting the argument that more downside price risk may lie ahead.

 The week’s economic data were mixed.  The Empire State Manufacturing survey was weaker than expected.  Housing starts missed to the downside.  Existing home sales were slightly better than expected, but they were still down vs. last year and the median home price continued to decline.  Initial jobless claims were better than expected, but once again, the unadjusted figures were far worse than the headline claims number.  Leading economic indicators were stronger than the consensus forecast, while the Philly Fed survey came in below expectations.

Technically, the stock market is near the top of a long-term rising wedge pattern that began to form in the summer of 2010.  And it’s showing signs of pushing away from the top of the wedge.  The momentum and oscillator divergences are growing stronger and therefore point to a stronger correction when it finally arrives.  As far as the possible timeframes for this correction, the analysis is fairly straightforward.  Before QE2 winds down in a few months (and almost half of the $600 billion has already been pumped into the markets), any correction would have to overcome the strong forces created by the Fed.  It’s possible, but they would have to overwhelm the Fed’s powerful money printing machine.  But by the end of spring, markets will anticipate the wind down of QE2, and should start to sell off meaningfully.

Longer term, however, it’s useful to think about where the US stock markets could be headed by looking back in history.  And the longer one looks back, the better one can assess the range of possible outcomes.

The blog Risk Averse Alert focuses on almost exclusively on technical analysis, and has put together an interesting chart of the Dow Jones Industrial Average from 1900 to the present. 

There are two very important takeaways from the enclosed chart (using a log scale for price) and the trendline analysis provided by Risk Averse Alert.

First, note that the Dow Jones has shot way to the top of its 110 year old channel and well above its 75 year old (from 1935 through today) channel.  Applying the principal of mean reversion, one can easily argue that the price could drop down to about 3,600 before touching the bottom of the 75 year old channel.  Even more scary is the fact that the Dow could drop well below 2,000 before touching the bottom of its 110 year old channel.

Second,  in both cases, the UP trend line would NOT be broken.  Think about that.  The Dow could fall over 70% and STILL be in an uptrend that’s 75 years old.  It could fall about 85% and STILL be in an uptrend that’s 110 years old.  

This is what’s really scary about today’s valuations.  The stock markets are SO overvalued, that it would take a drop of over 90% to break a 110 year old UP trend line!

And most of the experts, today, don’t foresee a drop of even 10%. 

I’ll take the over.

Finally, an Attractive Asset Class Emerging?

January 15, 2011

The S&P500 crawled up another 1.7%  last week on declining volume.  The VIX (or fear) index fell to near one year lows, as many wise analysts are warning of complacency taking over the stock markets.  These crowd followers claim: “Why worry?  Just keep buying because the Federal Reserve wants stock prices to go up?  It’s can’t lose bet.” 

We’ll see about that.  Similar claims were common in late 1999 and early 2007.  Things didn’t–clearly–turn out as the cheerleaders had promised.

Economically, the week were mostly weaker than expected.  Wholesale trade disappointed.  Year-over-year changes in import and export prices show signs of growing inflation pressures.  Jumps in CPI and PPI both pointed to the same conclusion.  Initial jobless claims soared right back to the mid-400,000 level associated with recessions; the non-seasonally adjusted claims figure went through the roof, spiking to 770,000, calling into question how the headline number could be “adjusted” so dramatically.  Retail sales came in below expectations.  Industrial production was better than forecast; consumer sentiment and business inventories were lower.

Technically, the S&P is behaving just as a heavily Fed-manipulated market would be expected to behave.  The S&P has not closed below its 50 day moving average for a longer time than it has in decades.  It’s closed above its 10 day moving average longer than ever in its history.  This is not normal market behavior.  It is easily explained when one considers the billions of dollars that the Fed pumps into the capital markets on a monthly basis. 

So as almost all asset classes are being artificially inflated to higher and higher values, making the attractiveness of buying them grow dimmer and dimmer, it’s refreshing to see one asset class that’s heading in the opposite direction.

As boring as it may seem, the muni market has been full of fireworks lately.  After prices (for short and long maturities) peaked in late October 2010, they’re started a steady decline.  By last weak prices for many medium-term muni ETF’s have dropped over 10%. 

How bad is this in the muni world?  It’s catastrophic.  The drop in one of the largest ETF’s, MUB, has wiped out all the gains from the last year and a half. 

What’s causing the plunge?  A combination of factors: the retirement of the Build America Bond program, the sell-off in US Treasuries, and perhaps most importantly, the growing fears that state and municipal fiscal health is bad and will get much worse in the upcoming year.

But setting aside the exact reasons, what’s making muni’s stand out is that their prices are FALLING when pretty much every other investment asset class is RISING, courtesy of the Fed’s money printing.

Why is this important?

First, the lower muni prices fall, the more attractive they will become to a long-term investors, you know the kind that own their securities for months and years, not milliseconds.  Is it time to jump in and buy now?  No, not yet.  The safest time to buy–technically–will be when prices stop falling, and that hasn’t happened yet.  So let them keep dropping; the more they fall, the greater the margin of safety when purchases are finally made.

Second, the muni market is collapsing DESPITE the massive money printing of the Fed.  So if the muni market can still crash, then why is it that other investment asset classes can’t crash?  

That’s right, there is no strong reason.  So while the muni market may soon become a terrific buying opportunity for value-oriented investors, it should also serve as a reminder that NO asset class can–or will–rise forever without a severe correction.

Here’s looking at you Mr. (Stock) Market.

Another Flash Crash?

January 8, 2011

The S&P500 crawled up another one percent last week , with virtual all of the week’s gain coming in on Monday.  Volume picked up, but mostly in relation to the anemic holiday weeks in late December.  The VIX index fell only slightly. 

A large batch of economic news was released, starting with the ISM manufacturing survey, which was slightly lower than expected.  While ISM services was slightly better, its prices paid component shot up; its employment dropped, and inventories rose.  All are leading indicators of future weakness.  Initial jobless claims were a bit worse than expected, and back in the recessionary 400,000 range.  Even worse, the unadjusted claims soared to almost 600,000, rising over 50,000.  Nonfarm payrolls disappointed…..again.  They rose far less than expected, and far less than needed to absorb the natural rise in the working age population.  While the U-3 (headline) unemployment rate fell, it did so only because 260,000 unemployed folks were so discouraged, they dropped out of the workforce, and thus were no longer counted as being unemployed.  Also grim were the average workweek hours which did not rise, and the average hourly earnings which inched up an anemic 0.1%.  The labor force participation rate fell to 64.3%, a 25 year low, and a sign of how bad the employment situation is for Americans.

Technically, the Fed-fueled melt up in stock prices is continuing to create all sorts of bearish divergences, where momentum, breadth and money flow indicators are breaking down–even as prices keep rising. 

Eerily, the charts are showing signs of echoing the pre-Flash Crash formations.  Back then–in March and April 2010–the Fed’s QE1 was still pumping out billions of dollars of newly printed (electronically) dollars into the capital markets monthly.  The primary dealers sold Treasuries and mortgage-backed securities to the Fed; in return, the dealers took the billion of dollars and bought riskier assets, mainly stocks.  

But valuations were becoming stretched as high frequency trading helped propel prices to higher and higher levels.

The markets were becoming fragile; they became exceptionally vulnerable to a sell-off from even seemingly minor trigger events.

That event, or series of events, was ostensibly the Greek funding crisis and the sell-off of many other PIIGS sovereign debt and the Euro itself.

But it’s important to remember that there was NO one specific trigger that was 100% responsible for the panic sell-off.  Any one, or a combination of several, events could have been the trigger.

Today, very similar conditions have developed again.  Does this mean that we will certainly have another Flash Crash?  Of course not.

But it does mean that the equity markets, and risk asset markets in general, are today much more vulnerable to a panic correction.  And the wise trader will prepare for one–to protect against losses and to take advantage of the price drop.

Be prepared!

Demographics vs. Stocks

January 2, 2011

The final week of the year ended on a flat note; the S&P500 was virtually unchanged from the prior week.  Volume, unsurprisingly in a week bracketed by two holidays, was very light.  But interestingly, as with the prior week, the VIX (or fear) index rose again, this time almost 8% as traders braced themselves for some possible turmoil ahead.

There were only a few economic data releases.  The Case-Shiller home price index fell, but much more than expected.  Consumer sentiment also fell; it was expected to rise.  Initial jobless claims fell under 400,000, but the seasonal adjust–mysteriously–was massive; it added 133,000 jobs, meaning that the actual unadjusted claims figure was 522,000.  This represents an increase of 25,000 over the prior week’s unadjusted claims.  More importantly, it depicts a jobs picture that’s far more downbeat than the “adjusted” figure does.  Finally, the Chicago PMI was better than expected.

Technically, the S&P has turned slightly bearish on the daily charts.  We’ll need to see more confirmation to over the next week to make this a more definitive call.  But at least the end-of-the-year mystery ramp seems to be running out or steam.  On the weekly charts, the uptrend is still intact; but the long-term bearish divergences are building.

The blog Contrary Investor recently published an insightful piece on the impact of demographic forces on the US stock market over the next several years. 

Drawing on the work of demographer Harry Dent, the blog outlined the ways in which the retirement of the baby boomer population will impact stocks.

Warning:  Prepare Yourselves for an Extended Period of Pain.

Dent focuses on the 45-55 year old subset of the baby boomers.  This group is declining in relative size.  And whenever this happen in the past, the S&P 500 also–not coincidentally–declined.  For example, the last time the 45-55 year old group peaked was 1974, and the stock market dropped and/or stagnated for the next eight years.  BUT one of the main reasons the damage was not even worse was because of the explosion of employer retirement programs that kicked in back then; together with savings vehicles like the IRA, these programs pumped a huge flow of capital into the stock market for the ensuing years.   

So as the next wave of boomers began to blossom in the 1980’s, the seeds for the great 20 year secular bull market were in place.  And when the effects of the huge secular credit expansion is factored in, the great burst of economic and stock market growth made even more sense. 

But now, these positive forces are about to go into reverse.  Retiring boomers will not only eliminate their savings contributions, they will now start selling off their investments to provide a source of income.  Insurance companies, mutual funds, private pensions and even public pensions will need to sell–on a net basis–more stocks than they buy.  Also, many of these retirement funds will shift away from stocks and into bonds to better ensure that they’ll be able to make their scheduled payouts, without the higher risk of loss that’s embedded in higher allocations to stocks. 

While foreign holdings and purchases of US stocks should remain strong, these investors represent less than 15% of the total stock ownership distribution.

The bottom line is this:  the US stock allocation of insurance companies, private pension funds and public pension funds is near all-time highs, when one looks back over the last 65 years.  This allocation percentage is about to plummet. 

Perhaps we’ve already begun to see the effects of this shift.  Over the last 34 weeks, equity mutual funds and ETF’s have seen a net outflow of almost $100 billion.  Yes the stock market has risen over this period anyway.  But as Contrary Investor concludes, in the US stock market, demographics and institutional investor asset allocations have been “tailwinds” that “are set to become headwinds”. 

Making money will still be possible, but for the next 10 years or so, this will become much more challenging, especially for those who’ve been conditioned to simply “buy the dips” and let the favorable winds do the work for you.