What Could Cause a Correction?

December 30, 2013

To nobody’s surprise, stocks melted up again last week. In the holiday shortened week, the S&P500 inched up almost 1.3%. The Santa Claus rally arrived on time as everyone expected. But since volumes were abysmally low, this increase is not resting on a solid foundation. Volatility dipped somewhat, but only back down to the lower extremes we’ve already seen over the last year. In other words, volatility didn’t fall much more, because there wasn’t much room left for it to fall.

Over bullish doesn’t even begin to describe the extremes at which equities are priced today. According to Investors Intelligence, bearish sentiment has now dropped further (about 14%) to lows last seen decades ago. This suggests that almost everyone who wants to own stocks (and has the capital to actually buy stocks) already owns stocks. Increasingly, it will be more difficult to find new buyers who are willing to put new money to work into stocks at the already record high prices. So it will become increasingly more difficult to continue pushing prices higher.

In macro news, the US economy is still limping along, without reaching escape velocity. Personal income rose a bit, but far lower than expected. But personal spending jumped, as expected. How did this happen? Simple. Consumers either drained their savings (already at very low levels) or took on more debt to fund their purchases. Clearly, neither one of these coping mechanisms is sustainable. Consumer sentiment missed. Durable goods orders beat expectations, as did new home sales. And initial jobless claims beat just slightly. On the unemployment front, next week over 1 million people will lose their extended unemployment benefits; this figure will rise to almost 2 million by the summer of 2014. So not only will all these people lose their ability to buy goods (which will hurt the economy), chances are they will drop out of the workforce (which, perversely, will make the US unemployment figures look better, when in fact it’s getting worse).

Since stock prices are at record highs (with volatility near record lows) while the Main Street economy has yet to properly recover, what exactly can we point to as being a likely ‘trigger’ for a correction in the US stock market? Such a trigger would be important to track because if we wish to stay heavily invested AND be able to escape—at the last minute—any severe correction, when and if it were to take place.

The answer is that there is NO particular trigger we can watch out for. Because the stock market is so ripe for a correction, any number of so-called triggers could spark a significant sell off. So it’s the over-valued state of the market itself that would be the cause of the sell-off. Any trigger, would simply be the excuse that investors and traders would use to run for the exits.

So this brings us to the final point about being on alert to triggers to avoid big losses. If there is no single trigger we can look out for, any investor who believes he can quickly run out the door before the stock market crumbles is deceiving himself. Inevitably, investors will miss the ‘trigger’ and will get caught in the down draft. Some will get hurt more than others, but history shows that everyone who stays in the stock market will get hurt to one degree or another.

Year End Rally?

December 23, 2013

After dropping notably for the first time in many months, last week the S&P500 jumped right back to make up for the prior week’s losses…and then some. The buy-the-dip mentality has completely taken over the US stock market in a way not last seen in 2007, when many market experts asserted that the Fed would simply not let the S&P fall too much so every dip ought to be bought. And it was.

Apparently the same thing is happening today. What remains to be seen if the 58% meltdown (or something similar) that followed the 2007 highs will also follow the surge in 2013.

Volatility, last week, slumped back down close to 2013 lows, which supports the buy-the-dip mentality. Yet volume remained light, which—-in addition to a lack of conviction—might have something to do with the fact that most of the US population does not have enough spare capital to invest in the stock market, despite the massive rebound in we’ve been ‘enjoying’ over the last few years. While most of the population has been suffering from declines in real wages, the top 1% has been the sole beneficiary of this rally. If only top 1% would spend more so that the Fed’s ‘trickle down’ theory would actually kick in to boost real wages, spending and savings that could then be recycled into the stock market to broaden the participation in the market gains. Fully four years after the stock market bottomed, we are still waiting for this effect to begin.

Technically, the S&P500 is back to being extremely over-stretched on daily, weekly and monthly resolutions. There are virtually no bears left in the US stock markets, and the percent of investors who call themselves bulls is near record highs. One can only hope that nobody ever needs to sell his or her shares because there will literally not be any buyers who could possibly buy them….at today’s lofty prices.

In the real world, the US economy continues to limp along. The Empire State Manufacturing survey missed expectations, badly. Consumer prices, as measured by the official government agency charged with reporting these figures, remain relatively tame; just don’t pay attention to soaring food and energy prices. Industrial production beat expectations, as did housing starts. Initial jobless claims missed badly. Existing home sales disappointed, as did the Philly Fed survey. GDP growth was revised higher, but that was mostly due to soaring costs of healthcare and fuel. The big announcement of the week was the Fed taper, which will be reducing the Fed’s monthly QE program from $85 billion to a whopping $75 billion. Put another way, instead of printing $1 trillion of money per year, the Fed will only be printing $0.9 trillion of money per year. Either way, the monetary stimulus remains massive.

Finally, history suggests that in the final week of the year, a yet further jump in equity prices would not be out of the ordinary. In fact, it’s become so common, that traders have nicknamed this effect the “Santa Claus Rally”. Why would Wall Street like to see this happen……pretty much every year without fail? Simple—by boosting prices into the year end, Wall Street ‘professionals’ boost their own year-end bonuses. In other words, this benefits Wall Street much more than it benefits Main Street…….as usual.

Miners on Sale

December 16, 2013

Shockingly, it happened again—the S&P500 did not rise last week. In fact, it slipped almost 1.7% to log in one of its largest weekly losses of the year. Volatility, as one would expect, jumped a bit, but still not to any levels that would signal that complacency has been replaced by fear. Also, volume was light, which means that the selling last week was not one backed by strong conviction. Most investors stayed put, and continued to ride the trend in hopes of even more gains.

It was a light week in terms of economic reports. Wholesale trade was somewhat stronger than expected. Retail sales also beat expectations, but only slightly. Initial jobless claims, on the other hand, surged to one of the highest readings on the year. Producer prices, both headline and core, just met expectations, which proved that upstream prices seem to be under control. And finally, business inventories beat expectations.

Technically, nothing has really changed with the over bought condition of the US equity markets. Sure, the stretched condition has eased slightly on the daily charts, but then again, prices on the daily charts have not even touched the 50 day moving average, perhaps the first sign that the over stretched condition is easing. On the weekly charts, last week’s decline looks like a mere blip on the horizon. Until the 200 day moving average is broken, and even better, until the 200 day moving average turns down in terms of slope (the last time this happened was in 2011), then the bull market move from 2009 is still in tact.

On the other hand, there is one sector within the stock market that’s been in a cyclical bear market since the end of 2011, or two full years. That’s the gold and silver mining industry. Using the same rationale applied above to the whole equity market, the gold and silver miners index fell below its 200 day moving average (decisively) in the middle of 2011, and has for the most part traded below this moving average since. More importantly, the 200 day moving average began to slope downward at the end of 2011. And this moving average has been falling ever since….for two straight years.

How far have prices fallen? Well, they’re now almost at their 2008 lows, when the global financial system was melting down and all stock markets, in the US and abroad, were down about 50%.

So does this mean that investors should rush in to buy gold and silver miners….today? There are two answers to this. One, if you don’t mind incurring some more near-term paper losses (which may or may not happen), then you’d be buying into the sector at prices 65% below their 2010 and 2011 highs. Two, if you do mind possible near-term losses, then a safer approach would be to wait for prices in this sector to first jump above the 200 day moving average, and then for the moving average itself to turn and become upward sloping. You’d miss the first 15%-20% of the upward move, but you’d have a lower risk of incurring intermediate paper losses.

So while most of the US equity markets are hovering at or near all-time highs, it’s nice to know that there are some sectors within the overall market that are truly on sale and could thus offer prospects of higher returns. Gold and silver miners, by virtue of dropping so far in percentage terms, may just be one such opportunity.

More Bubble Signs

December 9, 2013

Stop the presses! Something very unusual happened last week. The S&P500 did not rise, for the first time in many many weeks. But not to worry…..the stock market didn’t fall much either. It only slipped a teeny 0.04%. But tiny as it was, this drop made news. Volume rose, which means that whenever stocks don’t go up, sellers seem to pile in. This simply alerts astute investors that the recent rally is not built on strong conviction, but rather, it’s built on a foundation of buyers who may even understand they’re late to the party but join in anyway. Volatility rose a bit, which is another sign that buyers a somewhat concerned.

The technicals continue to paint a picture of an extremely over-bought market. Prices just keep on hugging upper bounds of a numerous bunch of indicators. That this is happening on daily, weekly and even monthly charts is an indication of how badly over-bought the equity markets are today.

Macro results in the US are mixed, as is typical lately. US GDP appeared to jump, but on closer inspection, most of the good news came from massive inventory builds, not organic jumps in consumption. So these inventory builds, if not matched by consumption rises soon, will likely lead to reversals in the near future. But for now, the markets loved the news. At the same time, construction spending, international trade, new home sales, ISM services, and personal income reports all disappointed. But ISM manufacturing, initial jobless claims, consumer sentiment and payrolls all beat expectations.

The critical question is what will all the economic reports do to the Fed’s unlimited QE program? And to the extent that the economic reports continue to project a mixed message, equity market participants continue to believe that the Fed will not taper. And if the Fed will not taper anytime soon, then it’s “all aboard” the US stock market express. Buy more; don’t sell. You can’t lose!

How badly are markets becoming distorted today? While we’ve already touched on valuations, technical signals and the lack of bearishness, John Hussman—in his latest letter to investors—make some interesting observations about today’s stock markets:

Among the litany of other classic features of a speculative bull market peak, margin debt on the NYSE has surged to the highest level in history, and at nearly 2.5% of GDP, exceeds all but two months in 2000 and 2007. The amount being borrowed to buy stocks on margin is now 26% the size of all commercial and industrial loans in the entire U.S. banking sector. As low-quality, high-risk borrowers rush to take advantage of the present speculative appetite, issuance of leveraged loans (particularly the junkier “covenant-lite” forms) has now hit a record high, already eclipsing the previous record in 2007 at the height of pre-crisis yield-seeking. New equity issuance is also running at the fastest pace since any point except the 2000 bubble peak. At the same time, Bloomberg reports that investors are plowing more into stock mutual funds than at any point since the 2000 bubble peak. Keep in mind how this works – every buyer is matched with a seller in equilibrium, so the same amount of stock is being sold by institutions and other non-retail investors. One doesn’t need to think long to answer who is likely to be the “smart money” in this trade, as the history of surges in retail participation provides a rather firm answer to that question.

So there you have it. The bubble signs just keep on piling up. So does this mean that we’re surely close to a major correction? Absolutely not. The distortions can keep on growing and the bubble can keep on getting bigger. History consistently teaches us this lesson. It’s almost impossible to call the ‘correction’ ahead of time.

But history also teaches us that a reversal is virtually inevitable. And that the smartest investor is the most patient investor. And he will be rewarded in the end.



Collapsing US Economic Growth

December 2, 2013

Last week the S&P500 crept up a tiny fraction of one percent. While almost unchanged, it did count as another positive week, taking the index even further into bubble territory. Volume was very light, as the Thanksgiving holiday shortened the week by almost two trading days. Swimming against the tide of rising prices, volatility jumped a bit, but not to levels far above those associated with complacency. It seems as though many investors wanted to take out some downside insurance.

Breadth was still fairly strong. So the euphoria that’s gripping the headline index is not limited to just a handful of stock leaders,  but appears to be spread out fairly broadly among may of the smaller cap stocks as well. Sentiment is still extremely bullish and bears are utterly missing. While last week we noted that the percent of bears among investment advisors had hit multi-year lows, at the same time the percent of bulls is now hitting mult-year highs. The differential between these two measures is striking; it’s at extremes almost always seen only at major market highs, usually very near to major subsequent corrections, if not outright crashes.

Technically, the over-stretched equity markets have simply become even more over-stretched. The S&P continues to hug the upper Bollinger bands on the daily, weekly and monthly charts, as has been the case for the last couple of months now. Can this condition persist, or become even more extreme? Of course it can, but the payback, if history repeats itself, will only be that much worse.

US economic data releases have now almost caught up from the delays incurred due to the partial government shutdown. And last week’s data was mixed, at best. Pending home sales fell, when they were supposed to rise. The Dallas Fed survey missed badly. The Richmond Fed survey beat expectations. The FHFA house price index fell, when it was expected to rise. The Case Shiller index just met expectations, after almost a year of monthly beats. Consumer confidence plunged, yet the consumer sentiment survey rose. Durable goods orders, excluding the volatile transportation sub-index, missed badly. Instead of rising 0.4%, it fell 0.1%. The Chicago Fed National Activity Index, a broad survey of national economic activity, fell when it was expected to jump. But the Chicago PMI beat expectations as did the leading indicators report.

So where does this leave us in terms of US economic growth? Well Goldman Sach’s economics department just updated its estimate of 4th quarter GDP growth and it’s ugly. Goldman is projecting that the Q4 result will come in at just 1.3%, well below the consensus figure of 1.8%.

How bad is this? Well just three months earlier, at the end of the summer, the consensus estimates for Q4 growth were about 2.6%. And more importantly, history tells us that whenever the growth rate falls beneath the magical 2.0% level (and both the consensus figure and Goldman’s lower figure are both below this), then a recession almost always follows about six months later.

Does this mean the US is finally entering a recession, four plus years after the Great Recession ended? Although it’s not definite, it seems that this already long, albeit anemic, recovery is probably coming to an end.