The Bigger the Stock Bubble, the Bigger the Crash

November 25, 2013

The S&P500 did it again, this time inching up by 0.4% on low volume. Volatility remains stuck at multi-year lows. Complacency reigns as most everyone believes, incredibly, that the stock market simply cannot go down because the Federal Reserve will not allow it to go down. Incredible.

On Main Street, things are not so rosy. After spiking substantially over the last six months, interest rates are finally starting to hurt the US housing market. The housing market index disappointed last week, as did existing home sales, both of which missed expectations. While retail sales, ex-autos, came in slightly stronger than expected, the Philly Fed survey and the PMI manufacturing index both missed. Inflation, both consumer and producer, remains tame; this is not consistent with a strong economy, which continues to merely limp along, having never returned to pre-financial crisis growth rates.

To say that the S&P500 is over-stretched is an understatement. Over the last several months, the index as a whole is starting to look like it’s going parabolic, and doing so when almost all of the long-term fundamentals of the US economy are not doing so well.

Yes, unemployment looks like it’s gone down, but that’s only because millions of unemployed people have dropped out of the workforce, many of them permanently. Real median wages have been falling, and they’re still falling. Food stamp enrollment has almost doubled over the last five years; almost 50 million people in this nation of 307 million are on food stamps. Home prices, after being pumped up by cheap money from the Fed over the last couple of years, are stalling; soon they could start to fall again. Corporate profits are stalling, at best. At worst, they’re starting to fall across many sectors.

But stock prices are rising, seemingly without an end in sight, as the multiple of stagnant earnings creeps higher and higher.

Interestingly, it’s been over two years since the S&P has fallen, if even briefly, by over 10%. The cyclically adjusted PE for the S&P, at 25, is now above levels where all (except the tech bubble) bear markets have started since 1929. And the ratio of the value of all US equities to the US GDP is near record highs.

In no way does this mean that stock prices can’t rise further. Something similar happened in the late 1990’s and stocks kept climbing for another two years.

But in the end, the same thing ALWAYS happens. The more stock prices deviate from their historic long-term averages, the more they correct—eventually—to these averages.

So if stock prices continue to melt up from here, then the pain that follows will be all the more severe. All these gains, and then some, may be lost in a matter of weeks or months. It took the S&P about five years to reach a record high in 2007 after losing about 55% in the early 2000’s. But it took only 15 months f or the S&P to lose 58% in early 2009.

Today, studies show that less than 15% of investors are bearish. So even assuming that you’re one of the smarter and faster ones, meaning you’ll know when to sell and will sell ahead of the crowd, to whom exactly will you sell…..when everyone who could  be a potential buyer of your stocks is already in the market and looking to sell as well?

This will end badly, There is no question about it. The only unknown is the timing.

The Mysterious Gold Market

November 18, 2013

The S&P500 edged up another 1.5% last week. The bubble continues to grow, on nothing more—apparently—than the hope that the Fed can keep the stock market (and many other markets) rising to all-time highs, week in and week out. Volume, an indication of whether or not the average investor is participating in the rally, fell last week. So while the retail investors, as usual, are buying into this rally as it grows older and more vulnerable, by no means are retail investors pouring money into stocks, like they did during the dot-com bubble in the late 1990’s. Volatility fell back down to close to the lows of the year. To say that this stock market bubble is ripe for a correction is an understatement.

Technically, the S&P is extremely over-bought. It continues to hug or exceed the upper Bollinger bands on both the daily, weekly, and monthly resolutions. Several mathematically-oriented analysts have pointed out that the US stock markets are now following a parabolic pattern that always—when something similar happened in the past 100 years—resulted in a severe correction, if not an outright crash.

But isn’t the US economy finally getting better, providing a fundamental foundation for the stock market which tends to anticipate such developments by six months or so?

Nope. Not even close. GDP has never reached escape velocity since 2009, and more recently, its growth rate has actually slowed down to such low levels that whenever they’ve been so low in the last 100 years, recession has almost always followed. Last week, the small business optimism index suffered its biggest miss in almost two years. International trade results came in worse than expected. Initial jobless claims were also worse than expected. Productivity growth missed. The Empire State Manufacturing Survey massively disappointed, by falling instead of rising as expected. And industrial production fell, when it was supposed to rise slightly.

But stock markets liked the news, so the rallied to all-time highs.

But in other markets, there’s a developing story in gold that keeps on confusing many market observers who continue to disparage the asset, one that virtually EVERY central bank in the world finds indispensable. Gold prices, after hitting their most recent peaks two years ago, continue to struggle in bear market territory.

But the real story has to do with actual physical stocks of gold, which have been collapsing for the last year.

This is not supposed to happen. If the price of gold is truly market-driven, then the stocks of gold would remain relatively stable. It’s only when market prices are suppressed, that shortages tend to appear (think back to the days of the USSR and all the consumer goods shortages, shortages that developed because authorities artificially pushed the prices of these goods below market levels….so suppliers simply refused to supply them).

And that’s exactly what appears to be happening in the physical gold market, where the ratio of paper (or derivative-based) gold ownership relative to actual physical gold available is soaring to multi-decade highs.

Today, at the COMEX, there are almost 69 paper claims per each ounce of actual physical gold in inventory.

This is an astounding development, especially when one sees that this ratio was closer to 20 for most of the past decade.

This means that for every 1 ounce of actual gold in this major exchange, there are 69 paper owners who claim to be owners of that same single ounce of gold!

History tells us that this massive distortion is always solved by a huge increase in the price of the asset that’s over-owned on a paper basis. Why? Because if some of the paper owners of gold decided to convert their paper claims into the actual metal, then it would take far higher prices for owners of the physical metal to sell it, in order to satisfy the demand of the paper claimants.

The conclusion is simple. It appears that the gold market is being manipulated….a lot. And it appears that when this manipulation ends, that the price of gold must rise….a lot.

The Fed’s QE: Will it Prevent a Stock Market Crash?

November 11, 2013

The S&P500 inched up another 0.5% last week on low volume. Volatility dipped slightly, but only because it started the week already about as low as it typically goes.

Interestingly, there was a sight breakdown in momentum and breadth in the S&P on the daily charts. Stock prices look like they could be topping in the short-term: the MACD indicator has crossed bearishly in a very distinctive way. In terms of breadth, the McClellan Oscillator fell notably during the week. So while the overall S&P rise last week, this occurred because fewer leadership stocks did most of the work.

On the economic front, the news has not improved. Factory orders missed in August, and only met expectations for September. The latest GDP results beat expectations, but only because inventories jumped; personal consumption and corporate capital expenditures were very weak. Initial jobless claims were slightly worse than expected. Personal income beat expectations, but personal spending did not. ISM services came in somewhat better than consensus estimates. Consumer sentiment missed by the widest margin since 2006.  Finally, the big report of the week, payroll for October, was mixed. Yes the headline number beat estimates, but the birth/death adjustment added 126 thousand jobs, much more than it does in a typical October. The headline unemployment rate was unchanged at 7.3%. But the worst part of the report was the labor force participation rate, which plunged to the lowest level since 1978, or 35 years! This means that almost 1 million people LEFT the workforce, and is certainly not a sign that the real economy—the Main Street economy—is actually improving much at all. If it were, the labor force participation rate would  be rising, not falling.

The conventional wisdom behind the apparently unstoppable melt-up in US stock markets is that the Fed’s QE program is working. And since there’s no indication that it’s about to be stopped, then there’s no reason not to put more money into stocks with the clear expectation that prices must continue to rise even more.

But a few days ago, one the biggest hedge funds in the world, Bridgewater Associates, asked a question. They wondered what would happen if QE stopped working?

Here’s what they said:

“The dilemma the Fed faces now is that the tools currently at its disposal are pretty much used up. We think the question around the effectiveness of QE (and not the tapering, which gets all the headlines) is the big deal. In other words, we’re not worried about whether the Fed is going to hit or release the gas pedal, we’re worried about whether there’s much gas left in the tank and what will happen if there isn’t.”

Note what they were NOT asking—they were not asking if or when QE would ever stop. Instead, they’re asking if QE will continue to work its magic on stock prices in the future.

And this is a very important point because as John Hussman reminds investors, the Fed WAS easing immediately before and during both the crashes of 2000-2002 and 2008-2009. So Fed easing did NOT prevent major stock market crashes.

And given that almost nobody can predict exactly when a bubble will burst, the choice investors must make, per John Hussman, is to decide whether they want to look like idiots before the crash (because they missed much of the parabolic run-up) or do they want to look like idiots after the crash (because they rode the market all the way down).

Most successful investors look like idiots because they get out too early. Most unsuccessful investors ride the roller coaster all the way up, and all the way down.

Which type of investor are you?

Are Stocks in a Bubble….Again?

November 4, 2013

The S&P500 ended the week almost unchanged (up just a fraction of one percent). Volume was very light, which as usual means that any buying was not enthusiastic. And volatility was almost unchanged—it’s still firmly stuck at an ultra-complacent level.

Technically, the S&P500 remains extremely overbought on the weekly charts. And while it’s not as extreme, the S&P on the daily charts is also very overbought. On both resolutions, the S&P is hugging the upper Bollinger bands and stretching far away from the respective 200 day moving averages.

Nothing, it seems, is able to shake the steady march higher. Both good news and bad news appear to push the equity markets one way only—higher.

Speaking of bad news, the US economy continues to limp along. Last week, the pending home sales index fell badly. The Dallas Fed survey disappointed. Retail sales missed. Consumer confidence suffered its largest drop in two years. Initial jobless claims were higher than expected. PMI Manufacturing dropped. Consumer and producer prices were subdued….certainly not what one would expect in an economy that’s growing robustly. Only ISM manufacturing beat expectations.

By almost every measure, the US stock market is not only over-priced, but it’s now arguably entering bubble territory.  And what’s shocking is that this is happening only four and a half years after collapsing by almost 60%.

What are some of the signs of this bubble?

The Shiller P/E is now above 25, the second highest level since 1929. The stock market’s valuation vs US GDP is now over 50% above the long-term average. As noted above, the market rises on all news—both good and bad news seem to push prices higher. Yet at the same time, corporate sales are stagnating and earnings growth is faltering. This means that  almost all of the market rise over the last 1-2 years has come from an expanding P/E multiple, not robustly growing earnings.

What’s the biggest argument against any type of bubble?

Simple. Given that corporate earnings have ballooned to record levels relative to US GDP, you must assume that these record high earnings will continue…….permanently.  How stretched are these earnings? They’re about 70% above where they usually are vs. GDP, primarily due to massive deficit spending by the government and by the inability to save among US households.

So if you buy into the “stock market is still cheap” argument, you’re implicitly buying into the premise that the sky-high level of corporate earnings will never revert back to 100 year norms. Ever.

If so, good luck with that.

The prudent investor, who always maintains a long-term investment horizon, would vehemently disagree with this premise. And he’s sufficiently patient to wait for better buying opportunities.

Better buying opportunities will come. They always have in the past. And it will be no different in the future.