July 9, 2014
Since I was getting new internet today and it took much longer than expected I actually watched some CNBC today (which I normally don’t do). Both Marc Faber and Bill Fleckenstein were on at different times in the day. Both suggested that there was a lot of risk in the markets at current levels and that the longer the market moves up without a correction the bigger the eventual downside reaction. Every single panelist and anchor essentially laughed at them and said the Fed wouldn’t let it happen (reporter Scott Cohn of CNBC was honestly laughing, no joke). Shows you where sentiment is.
So the Fed can print money forever and there are no consequences other than the stock market going up? Valuations? Who cares, all is good in Never Never Land seems to be the mantra. The clowns at CNBC have your back. The Fed minutes disclosed today that they intend to stop QE in October and since March 2009 any time QE was slated to end (summer 2010 and summer 2011) the market corrected. The only thing different now as opposed to then is that valuations are much higher. Why should we expect a different result this time?
Very reminiscent of 2007. Interestingly Marc Faber compared this market to 1987 as I did just yesterday. What makes it more interesting is that he correctly called the crash of October 1987 ahead of time. Another tidbit of information: Bill Fleckenstein ran a hedge fund that specifically shorted stocks. He closed it down at his discretion in March 2009 because he knew the bottom was near and the opportunities for shorting were nil. Now he is looking at re-opening his fund.
I really believe that a pretty good sized decline is on the way. Right now (July 2014) is one of my 9 month cycles, the Fed is going to see if the market can stand on its own two feet without QE (which hasn’t worked in the past and and the only difference is that stocks are more expensive than they were in 2010 or 2011), sentiment is extremely complacent (see above), the January barometer suggests that 2014 will be a down year, there has been at least an 8% correction in every mid-term election year dating back to 1962 (and it hasn’t happened yet this year), the average mid-term correction is 18%, second years of the Presidential Cycle are notoriously bad performers (See BIS Warning post from yesterday), and the potential upside in the market relative to the potential downside makes absolutely no logical sense at current levels.
My next 9 month cycle is due in October 2014 and I honestly expect it to be an important low. As I have mentioned before I think we have to see how big the decline eventually is, how the market reacts, and how the Fed reacts. If the market has a 10-15% correction I think the Fed stays on the sidelines and does no more QE. If we see a correction of 20%+ I think the Fed goes right back to QE and makes the bubble in equities even larger. That would suggest a market peak in the 2016 time frame and at that point it is QE or bust for the Fed.
The 32-35 year cycle is now in play from August 1982 as we are only a month away from an official 32 years from that low. Important market turning points have occurred in these 32-35 year windows. I will go more in depth on this cycle in another post as it deserves specific focus.
July 8, 2014
Looks like the BIS was reading my blog on Saturday (6/28/14) when I said that the gap between the equity market and the true underlying fundamentals today is the biggest it has been since 1999-2000. Same can be said for much of the world but I was simply speaking for the U.S. Of course all of this is being led by financial repression which is when central banks keep interest rates artificially low (far below the level of true inflation) which forces investors out on the risk spectrum. In other words a retired individual in their 80′s that may have once expected to live on risk free returns of 5% per year now has to go into the equity market or real estate to get those kinds of returns.
The only time I have seen anything like the market over the past 19 months was 1999-2000. The Dow nor the S&P 500 have seen more than a 7.5% correction since November 2012. The most amazing part to me is that 70% of the equity market gains in 2012 and 2013 came from the expansion of P/E multiples and only 30% came from actual earnings growth.
Note the following from the article:
“Growth has disappointed even as financial markets have roared: The transmission chain seems to be badly impaired,” the BIS said.”
And it warned that taking too long to do this could have potentially damaging consequences, by encouraging investors to take too much risk.
“Over time, policies lose their effectiveness and may end up fostering the very conditions they seek to prevent,” it said.
“The predominant risk is that central banks will find themselves behind the curve, exiting too late or too slowly,” it added.
Of course Alan Greenspan warned of “Irrational Exuberance” in a famous speech on 12/5/96 and the market continued to run for another 3 years beyond that. I just know that the risk levels are getting quite elevated with the market at current levels.
Note the presidential cycle below. These are the annual returns for the S&P 500 dating back to 1960. As you can see below, the second year of the cycle is by far the worst performer of the 4 as the uncertainty of the mid-term elections looms and policies enacted since the last Presidential election are implemented. Prior to 2008 the evidence was quite clear that the first two years of the cycle tended to be the weakest and the last two years tended to be the strongest with year #3 by far posting the best gains with an average return of 17.1%. However, note the extreme distortion of the numbers we have seen with the past 2 first years. The returns were 23.5% and 29.6% which is extremely unusual and has actually brought the average 1st year return above the average 4th year return (2008 badly distorted the average 4th year return). Something else worth noting is that the past two second year cycles (2006 and 2010) have been unusually strong. Aside from the second year kickoff of the secular bull market in 1982 (so 1986, 1998, 2006, 2010) the second year performances of greater than 10% had a tendency to steal gains from the normally strong 3rd year. See 1986-1987, 2006-2007, and 2010-2011. The only exception was 1998-1999 which was during another period of “irrational exuberance”. So 75% of the time aside from 1982 gains of greater than 10% in year #2 stole returns from year #3.
Here is another interesting statistic. Add up the returns from 1982-1986 and note the similarities of 2009-2013. Note that 1987 ended up essentially flat after being up big into August.
1982-1986: (14.8+17.3+1.4+26.3+14.2)= 74.0
2009-2013: (23.5+12.8+0+13.4+29.6)= 79.3
The total percentages (added) are almost exactly the same. Even note that there was one year in the middle (1984 and 2011) of each 5 year move that was essentially unchanged. The market then went nuts into August 1987 and then crashed in October 1987. That crash wiped out the prior 18 months of gains. Could we see something similar this year? I’m not counting on a crash but the complacency and extreme valuations relative to history are suggestive that we should be on our toes. See the chart of 1986-1987 below.
To put this into perspective while the Dow did finish 1987 up for the year it had to recover ~20% from the low in October to do so.
November 2012-October 2014 ?? The total % move up isn’t as large as 1986-1987 so the % drop wouldn’t be as large to wipe out the same time period worth of gains. This is just a hypothetical scenario for the time being but it fits my July and October time cycles, would finally set the 2nd year of the Presidential Cycle right, and put in a nice 4 year cycle low. Note that if the S&P 500 was coming from ~2000 a decline to 1,550-1,600 (~18-20 months of gains) would only be a correction of ~20-22.5%. I continue to believe that 1,687 and 1,560 are important levels to watch. 1,687 was the breadth and momentum peak for the big caps in May 2013 and 1,560 not only marks the bottom of the largest correction of the past 18+ months but it is also the breakout point over the highs of 2000 and 2007 (1,553 and 1,576). Equivalent levels in the Dow are 15,542 and 14,198.
Just for reference 2013 ended the year at 1,849. Thus the official up 10% mark for the year would come into play right around 2,035. That is only 75 points or ~3.8% from current levels. Aside from the correction in January/February the big caps have essentially been running for almost 5 months now. Seasonally the market tends to show weakness between May and October so a correction of some degree should occur over the summer. I have taken note that the Dow is having a tremendous amount of difficulty with 17,000 and the S&P 500 is approaching its own round # at 2,000.
What are the odds that we get a third straight stronger than normal second year of the Presidential Cycle? Not very good in my view. Also worth noting is that dating back to 1962 there has been a correction of at least 8% in the second year of every Presidential Election Cycle. We haven’t seen it yet and we are now in July. Between July and October would be the optimal time period for this to occur.
Another observation is that while there was a nasty correction in techs and small caps from March to May the large caps held up quite well. Should techs and small caps get hit again I don’t think the big caps will be able to continue running against the tide.
June 28, 2014
Here is an update from Tom McClellan on the “only chart that matters”. Essentially QE is driving the stock market higher and in my view the gap between where the stock market is relative to the true underlying economic fundamentals is the biggest it has been since 1999-2000.
I continue to believe that the Fed will end QE by the end of the year (likely September or October) and the anticipation of this transition will lead to the biggest correction in the equity market in at least 18 months. How the Fed reacts to that correction will be key.
June 25, 2014
The Nasdaq Composite broke above the March high of 4,372 yesterday but saw a hard reversal and closed below it. The trendline I mentioned last week also came into play yesterday.
New highs on the Nasdaq Composite continue to show a negative divergence relative to October 2013 as I posted last week. In fact there were less new highs yesterday than there were earlier in the month despite the index printing a new post-2009 high intra-day.
Previous resistance becomes support. Based on the wedge below support comes into play around 1,930. 1,928 is the 38% retracement from yesterday’s high of 1,968 to the May low of 1,862. Yesterday was a key reversal day so I am expecting some near term weakness but ideally I would like to see more sideways action followed by another push higher into July.
The Japanese Yen remains key on my radar for the direction of the market as a whole. See below from January.
Since the Yen began to bounce at the beginning of the year the US equity market has generally had a tough time making progress on the upside. Yes, the S&P 500 is higher but only by ~100 points. The Dow is essentially flat. The Nasdaq and Russell 2000 have essentially made no progress since their January highs. The bollinger bands are compressing big time on the weekly chart which suggests that a large move is coming. As I have mentioned in the past, low volatility breeds high volatility. I had honestly expected more of a bounce in the Yen by now. The Bank of Japan meets this Friday and will likely end this quiet range bound trading. If the Yen moves lower it is good for the US equity market. If it moves higher, not so good.
In the chart below it is evident how wound up this is. RSI has yet to break above 50 on this rally which is bearish. ADX remains bearish. Plus the fact that despite the whole rally the MACD remains below zero. 99.24-99.55 remains key resistance. A break above there would open the door for upside potential to 103.44-110.00. Note that the Yen hasn’t been above its 200dma/50 week moving average in almost 2 years….October 2012. With the BOJ meeting the next week should be key for the Yen.
June 19, 2014
June 19, 2014
Despite the fact that the Nasdaq Composite tested its March peak of 4,372 this morning the new highs are telling a different story. Note that they have been declining at each new high since October 2013. This isn’t the internal action of a healthy market.
While the S&P 600 hasn’t quite tested its high from March it is close enough to be worth noting the huge divergence in new highs relative to the performance of the index.
While the new high data looks different in the S&P 500 a healthy market should be led by techs and small caps. The fact that there are such extreme negative divergences in those two indexes is of concern. This indicates to me that investors are rotating into large caps which they perceive as “safe”. That complacency combined with the lack of participation as seen above concerns me.
June 19, 2014
Right now the performance of global equity markets has absolutely nothing to do with economic fundamentals. It is all about global QE (quantitative easing). Here in the US, every time the Fed was about to end QE, the stock market anticipated it about 2-3 months ahead of time and a market correction followed. This happened in the summer of 2010 and the summer of 2011. Since the bottom in 2011 the Fed has had its foot on the accelerator with Operation Twist and then the market really took off in late-2012 when the Bank of Japan went to QE on steroids (3x what we are doing here in the US relative to GDP) and the Fed here began QE III. The Fed has been tapering $10 billion per meeting since December and they are now down to $35 billion per month. So assuming that they continue at the current pace within 2-3 months we should have a pretty good idea of when QE will end.
See the chart below from Doug Short showing how important QE has been to the US equity market.
Wow! Look at those profits in Europe driving market returns! Earnings peaked in 2011 yet the European Stoxx 600 is at a post-crisis peak.
The US has done better than Europe but the vast majority of the rally over the past 2 years has come on expansion of P/E multiples. As per Paul Hickey of Bespoke Investment Group revenues for the S&P 500 have grown at an annual rate of 4% since 2011. Reported profits are up 7%. However, when one narrows this down to just since the beginning of 2013 the top line number falls from 4% to 3% yet the profits rise 12%. How does this happen? Financial engineering. For example, many large companies like IBM and AAPL are issuing 5 year debt at less than 1% and subsequently using those funds to buy back stock. Earnings could technically stay the same but if they reduce the amount of shares outstanding, earnings per share go up. So this isn’t really a true reflection of what is going on in the economy. Simply financial engineering.
See the quote and chart below from:
“Better growth is probably the most crucial missing element of the equity rally. SPX is up 5.5% YTD, but less than half of this is due to earnings growth. This follows a similar pattern from the past 2 years: P/E expansion accounted for 80% of last year’s market gains and 60% of the gains in SPX in 2012. Historically, that has not been sustainable.”
Note the periods that they circled. Eventually the earnings growth will have to improve or the market will have to decline to create lower P/E multiples. Note a similar to period to 2012-2013 was 1985 and 1986. While earnings did finally play catch up in 1987 P/E multiples declined substantially due to the crash in October of 1987. 1997 and 1998 also massive P/E expansion without earnings expansion. The earnings came in 1999 and 2000 but multiples began to contract in 2000 when the secular bear market began. 2012 and 2013 are a question mark at the moment. It does appear that earnings will show a fairly decent bump this year if they hit expectations but at some point the multiples will have to contract from current levels which would leave the market gains purely up to earnings growth. Considering that much of it is artificial in the form of financial engineering one has to question the staying power of such earnings.
Will QE actually end? I think the Fed wants to find out of the economy can stand on its own two feet at this point and will give it a chance. If I’m right and we start to get the visibility that they are truly going to pull out on QE I think it opens up the door for the largest market correction since at least 2012 if not 2011. I have repeatedly been talking about July and October being my next 9 month cycles which are due this year. Current expectation would be a top in July followed by a bottom in October.
So just how deep will the correction be and what is the importance? Here is the key. If the market suffers a correction of say 10-15% and begins to move north again I think the Fed will stand on the sidelines. However, if the market falls 20-25% I think the Fed could very well panic and go right back to QE to prop the market up. This will work for a while and it could very well produce another bubble/mania that lasts into 2015/2016. The problem is that QE continues to see the law of diminishing returns and the Fed can’t keep this up forever. Eventually I believe that market participants will call economic policy into question. I think they will eventually question whether the stock market rising is sustainable simply due to Fed Policy. Plus there is the risk that valuations eventually reach a point that it just becomes absolute lunacy and the smart money begins to bail. I see this as a 2015/2016 event. With the next 32-34 year cycle being due between 2014 and 2016 this time period will be key. I’m currently expecting a major peak in the equity market in either 2015 or 2016 with a bottom in either 2017 or 2018. If the market suffers a correction of only 10-15% later this year and then begins moving north again I think the market could top out sometime next year. On the other hand, if we see a correction of 20-25%, the Fed panics, and goes back to QE I could make the argument that the market will continue higher into 2016.
June 19, 2014
Up until 2012, the 10 day moving average of the OEX put/call ratio was one of the most accurate indicators that I followed. I started noticing around 2000-2001 that the OEX put/call ratio tended to be the smart money and that they had a tendency to buy puts right before major market peaks or corrections. When the OEX put/call ratio was low and the CBOE/Equity put/call ratios were high, it was time to start looking for a bottom. Note below that pretty much any time the 10dma moved above 1.50 from 2000-2011 a correction or a major peak usually followed. Since then it hasn’t been as reliable as it has remained elevated for the past few years and has been of very little value.
But what has happened in the past few weeks has to be worth noting. I am seeing record levels on the 10 day moving average of the put/call ratio. See the spike below. This wasn’t just one day of activity. In fact, it has remained extremely elevated for over two weeks with a record high daily reading of close to 9.0 and another day that it hit 4.0. At the same time the equity put/call ratio has posted its lowest daily readings in at least 3 years. Yesterday it hit .38 which means that the dumb money is buying 5 calls for every 2 puts. That is some extreme optimism.
Here are the daily readings.
Is the OEX put/call ratio going to reclaim its former glory? Time will tell but the huge discrepancy between the readings on the dumb money CBOE/Equity put/call ratios relative to the OEX put/call ratio is worth noting here.
June 18, 2014
I thought it was pretty funny when Janet Yellen said she was a bit concerned about the complacency and lack of volatility in US equity markets. Uh….just look in the mirror. Your concern is because of policy that YOU are implementing. I don’t know why but I find this comical.
June 18, 2014
The two biggest concerns I have for the market right now are energy prices and the expected end of QE around September or October. For this piece I will focus on energy prices.
Each $.01 increase in a gallon of gas decreases consumption here in the US by $1 billion annually. Thus if we saw a $1.00 increase at the pump, $100 billion in lost consumption. $2.00 would be $200 billion. This also doesn’t take into account the lost purchasing power of consumers as businesses would be forced to pass on increased energy prices to consumers.
I will look at both Brent and WTI. WTI is the most commonly quoted price here in the US but gasoline prices off of Brent. Since gasoline prices off of Brent that is the key to focus on at the moment.
Note the huge surge in Brent into early 2012 when it topped at $128. Since then it has traded in a range. This does not look like a topping pattern. This looks like a continuation pattern. Specifically it looks like a symmetrical triangle. Also note that the ADX has already crossed over to bullish, the MACD is starting to turn up, and the stochastics are also turning up. Another key here is the compression of the Bollinger Bands. As I recently said periods of low volatility breed periods of high volatility. It looks like the volatility here is about to pick up and unfortunately it look like it is going to happen on the upside.
To get a potential upside objective from here I will simply use consolidation theory. The trading range has been $88-$128. The mid-point of that range is $108. The previous low was $36. A difference of $72. Add that difference to the mid-point of the range and it yields a potential price target of $180.
WTI looks very similar. About the only difference is that it peaked in early-2011 as opposed to Brent which topped in early-2012. RSI has consistently been above 40 which is bullish. ADX is clearly bullish. We have a symmetrical triangle here as well. MACD has already had the bullish cross. Plus one could look at the consolidation as a completed A-E pattern. A down was the initial wave down to $75.71, B was up to $110.55, C down was to $77.28, D up was to $112.24, and the final E wave to complete the pattern ended at $91.24. If this analysis is correct the consolidation is complete and price is ready to move higher. In this case the range is $115-$76. So a mid-point of the range would be ~$96. The prior low was ~$34. $62 difference. This would imply an upside target for WTI of $158.
How about gasoline? Part of this has to do with crack spreads and this isn’t up my alley but I can give a perspective purely from a technical point of view. Similar situation as Brent and WTI. It topped in early-2012 and has remained range bound since then. Range is essentially $2.44-$3.44. Mid-point is $2.98. Low in 2008 was $.79. So $2.19 difference. That would yield an upside target of $5.17 per gallon. Keep in mind that this would not include all of the taxes etc. If this came to fruition gas at the pump would be north of $6.00 per gallon and cripple the US and global economies.
For quite some time I have been reading that based on true supply and demand WTI oil should be trading at $50 or $60. The rest is risk premium. Then there is the fact that I live in the energy hub they call Houston, TX and have lots of friends in the energy industry. The vast majority of them believe that oil isn’t going back below $70 ever again. So are they right or is sentiment too one sided? I have gone along with the latter for a while and thought that oil was topping but the charts above tell a different story.
With my 9 month cycles coming up in July and October the energy situation is definitely important. If we see a big spike in energy prices combined with the Fed finally ending QE III in October or so the pieces are in place for a market top of some degree. Sentiment is very complacent and I personally don’t think the economy or the market can stand on its own feet without QE. This will be discussed is another piece to come.