June 17, 2013
Here is a good piece from Sy Harding in which he makes some very similar points to what I wrote on 6/3/13. Namely that if the secular bear market ended in 2009 this would be the shortest secular bear market in 110 years. In addition the second year of the presidential cycle (due in 2014) historically isn’t good for stocks.
Review my piece from 6/3/13:
Below is the updated annual performance for the S&P 500 dating back to 1961. Note that the second year (due in 2014) is by far the worst year of the 4 year cycle. Also worth noting which I have pointed out earlier is that better than normal second years usually borrow performance from the normally good 3rd years. I have bolded these 2nd and 3rd years. We have seen two consecutive solid 2nd years of the presidential cycle (2006 and 2010) which led to weakness in 2007 and 2011. This shows up in my other cycle studies which show that there had never been two minor 4 year cycles in a row prior to 2010. Minor cycle lows mean declines from peak to trough of less than 20% before the 4 year cycle low. The next 4 year cycle low is due in 2014 and I have a lot of doubt that we will 3 consecutive minor 4 year cycles in a row.
Here is my updated 4 year cycle low study which was originally posted on 4/21/10. I have added the important market lows of 2010 and 2011. Next 4 year cycle low is due in 2014. The odds would favor that it will be major which means a decline of more than 20% from the peak as a decline of less than 20% would be 3 minor 4 year cycles in a row. With 2006 and 2010 uncharacteristically posting double digit returns for the second year the odds would favor a reversion to the mean in 2014.
June 11, 2013
As I mentioned last Wednesday if the Yen broke above its 50 day moving average it could mean trouble for the equity markets. We will see if there is any follow through in the days to come but I still think the market is vulnerable here. Market posted a nice reversal for Thursday and Friday but I’m not sure that it sticks. 1687 still remains key resistance for the S&P 500.
I’m on the road for an annual shareholders meeting for the next 3 days. Should anything significant occur in the market I will update as time permits.
June 5, 2013
The stock market has been in a strong uptrend since November and a strong driver of the market has been two different carry trades. In other words investors are borrowing one asset and selling it to fund purchases of the US equity market. As long as the assets borrowed and sold depreciate all is well. If those assets begin to rise it creates a scramble for the shorts to cover….aka a short covering rally. It is clear this is what is going on with both gold and the Japanese Yen. Borrow/sell short both the Yen and gold. Then use the proceeds to buy the S&P 500.
Note below the strong uptrend in the S&P 500 since November.
Now note the weakness in:
Neither gold nor the Yen have been able to break above their 50 day moving averages for more than one session since November. I believe both of these trades to be very crowded. Therefore if gold or the Yen were to have a strong break above their 50 day moving averages it would seem logical to me that it would negatively impact the S&P 500. Logical support for the S&P 500 remains 1600, 1576, and 1540. I still consider 1600 and 1540 to be the most likely downside objectives for this correction because there are just too many eyes on 1576 since it was the breakout point for the S&P 500. Remember that the market always does what confuses the majority of participants and simply back-testing the previous breakout point seems too easy.
As I noted recently the Yen and gold/SPX have been down 8 months in a row. Needless to say those declines seem quite long in the tooth and at the very least should see some kind of bounce in the not too distant future.
June 3, 2013
This gentleman and I are on the same page. Some very compelling valuation charts worth looking at in this piece.
Note where previous major market bottoms have occurred with regard to valuation. Then note that we haven’t come anywhere close to that in this secular bear cycle that began in 2000.
Mr. Short describes the P/E10 with the following:
Legendary economist and value investor Benjamin Graham noticed the same bizarre P/E behavior during the Roaring Twenties and subsequent market crash. Graham collaborated with David Dodd to devise a more accurate way to calculate the market’s value, which they discussed in their 1934 classic book, Security Analysis. They attributed the illogical P/E ratios to temporary and sometimes extreme fluctuations in the business cycle. Their solution was to divide the price by a multi-year average of earnings and suggested 5, 7 or 10-years. In recent years, Yale professor Robert Shiller, the author of Irrational Exuberance, has reintroduced the concept to a wider audience of investors and has selected the 10-year average of “real” (inflation-adjusted) earnings as the denominator. Shiller refers to this ratio as the Cyclically Adjusted Price Earnings Ratio, abbreviated as CAPE, or the more precise P/E10, which is my preferred abbreviation.
Now look at this chart and you can see where valuations are relative to some important historical peaks.
Let me be perfectly clear. I do NOT believe that the secular bear market that began in 2000 is over. Did we see the nominal low in March 2009? Very likely. But bear markets have traditionally had two bottoms. First is the nominal low (in terms of price). Then down the road there is the valuation low as measured by P/E and dividend yield.
Let’s look at the last two secular bear markets and see how they compare to the current secular bear.
After the Dow peaked at 386 in 1929 the nominal price low of 40 was achieved in 1932. However, the valuation low came 6-10 years later as one could argue that the valuation low was either 1938 or 1942. P/E’s were below 10 at both of those lows and the dividend yields were over 8% at both of those lows. Also keep in mind that the Dow didn’t surpass its 1929 peak for good until 1955. That was 26 years later.
Now look at the secular bear of 1966-1982. The Dow hit a peak near 1000 in 1966. Then in 1973 the Dow finally broke above 1000 and peaked at around 1050 before a nasty 40%+ decline into the bottom in December 1974. Then after testing the 1000 level again in January 1977 the market the market then became range bound between 750 and 1000 until August of 1982. So, 7 years after the secular bull market hit a peak that was marginally above the previous high (very similar to the S&P 500 in 2007 vs. 2000 with a high of 1553 in 2000 and 1576 in 2007) and then tanked into 1974. Very similar to 2007-2009. The valuation low didn’t come until August of 1982 when P/E’s were well below 10 and dividend yields were over 6%. In all it took over 16 years before the 1966 peak of 1000 was officially surpassed for good.
Historical S&P 500 P/E with dividend yields:
So look at the prior two secular bear cycles. The first saw the valuation low 6-10 years after the nominal low and didn’t move sustainably above its prior peak for 26 years. The second secular bear of the 20th century saw the nominal low 8 years into the bear cycle but the actual valuation low didn’t come for another 8 years. The peak of 1966 wasn’t surpassed for good until 1982.
So after looking at the prior two cycles does it seem wise to believe that the secular bear market is over after just 9 years (March 2000-March 2009) and that the S&P 500 isn’t going back below its peaks of 2000 and 2007? I think not. March 2009 was the nominal low in my view. It aligns very well with December 1974. However, since March 2009 the market has essentially gone straight up. So where is the valuation low? The valuation low was 6-10 years after the nominal low in the first secular bear and it was 8 years after the nominal low in the second bear. This sets up for an interesting 2014-2016 period. We are now over 4 years into this cyclical bull cycle and as I have pointed out on this blog in the past these cyclical cycles that last over 4 years and more towards 5 years generally don’t end well. Examples include 1924-1929 which ended in the crash of 1929 but the bottom didn’t come until July of 1932. Then after the big run from 1932-1937 (which feels very similar to what we have now) the market fell close to 50% between 1937 and 1938. 1982-1987 ended in the crash of 1987 which was a 40% correction from peak to trough. 2002-2007 ended with the horrendous 50%+ bear market into March 2009. So today we have 2009-present and we still don’t have the valuation low. 2014 is the second year of the presidential cycle which is notoriously the weakest of the 4 years. I would also note that we have had two mild 4 year cycles in a row (2006 and 2010). Prior to 2010 there had never been two minor (minor meaning corrections of less than 20% from peak to trough) and thus it would seem likely to me that the odds of having 3 in a row are pretty slim. I would also point out that 2015-2016 also aligns with the 33-34 year cycle I have discussed before. 2015-2016 aligns with the market bottom of 1982.
So what does all of this mean? While the S&P 500 and Dow have broken above their 2000 and 2007 highs I do not believe that they have broken above those highs for good. This would be the shortest secular bear cycle on record if another secular bull has indeed begun and the market isn’t going back below the peaks of 2000 and 2007. I think the evidence is quite compelling that 2009 was the secular bear market low in nominal terms (price). However, I think the evidence is quite strong that 6-10 years from the nominal low (1938 and 1942 were 6-10 years from 1932 and 1982 was 8 years from 1974) we will see the valuation low. This would imply that we should be looking for the valuation low of this secular bear to come anywhere between 2015 and 2019 (6-10 years from the nominal low). As for 2014 we have multiple headwinds facing the market:
1. Through history we had never seen two consecutive minor 4 year cycle lows in a row. We have had two in a row with 2006 and 2010. Needless to say there have never been three minor 4 year cycles in a row and after such a big move off of the 2009 lows the market is going to be quite vulnerable to a decline of greater than 20%.
2. 2014 is the second year of the Presidential cycle and historically by far the worst performing year of the cycle.
3. Cyclical bull markets that extend beyond 4 years and towards 5 years (without official cyclical bear markets of 20%+ in between) have not ended well when one looks back through history. We are now 4 years and 3 months into this cyclical bull within the context of a secular bear market. History suggests this one won’t end well either.
Where are current valuations? The S&P 500 is trading at ~15x estimated forward operating earnings (16.5x trailing earnings) and is yielding less than 2%. The Dow Jones Industrial Average is currently trading at a P/E of 15-16x forward operating EPS and is only yielding 2.5%. Note that at previous valuation lows in secular bear markets P/E’s were below 10 and dividend yields were north of 6%. To get to those valuations the stock market would have to drop 50% from where it is now. That would assume that there would be no contraction in earnings which would be a generous assumption.
I’m not saying that the market can’t go a bit higher from here. All I’m saying is that one really needs to look back at history and wonder “is it really different this time”? Is chasing the broad market here for maybe another 10% or so worth the potential downside risk of 30-50%? I personally don’t like those odds and I don’t think any savvy investors should either. The media and Wall Street are trying to sell the investing public on the story that happy times are here again but history argues otherwise. The entire rally from 1267 on the S&P 500 in June of 2012 to today hasn’t come from an improving economy but simply P/E multiple expansion. In other words a chase for yield. I continue to contend that this cyclical bull market is in its latter stages and that the valuation low of the secular bear that began in 2000 still lies ahead in 2015-2019. My cycle analysis also argues that 2014 could be a particularly ominous year for the market.
Much of the data used for this came from a previous cycle analysis piece that I published on 4/21/10. See the link below. I hope to have the updated tables up and posted in the not too distant future.
June 3, 2013
Further evidence that the Fed isn’t going anywhere anytime soon. Given the overall weakness in commodity prices over the past 18 months (aside from oil, natural gas, and livestock prices) they have plenty of room to continue easing. I guess the big question is whether the stock market truly gets out of control on the upside.
Another translation of his commentary is that they want higher inflation to push higher nominal economic growth (GDP).
As stated over the weekend the biggest threat to economic growth at the moment in my view is a continued rise in interest rates. Wouldn’t be surprised to see the Fed specifically target durations of 10 years or less.
It really shows just how strong the deflationary forces facing the domestic economy truly are when $85 billion in asset purchases monthly by the Fed can’t get nominal economic growth much above 2.0%. Remember that the underlying problems are deflationary. The Fed and central banks around the globe are responding with inflationary monetary policy in an attempt to not only offset the deflationary forces but actually create inflation. It is like a tug of war. One side is deflation and the other side is inflation. At this point both sides are pulling as hard as they can but neither side is really budging.
June 1, 2013
The huge spike in interest rates on the longer end of the curve (5-30 year) in the month of May needs to be noted. This presents a huge issue for the U.S. government as each 1% rise in interest rates across the board increases their fiscal expenditures by more than $160 billion annually. That is a big burden to the U.S. which only took in about $2.5 trillion in revenues for FY2012 and ran a budget deficit of close to $1.1 trillion (meaning they spent $3.6-$3.7 trilion). Even if the economy were to grow 2.0-2.5% this year ($16 trillion economy x 2.0-2.5%= $320-$400 billion) it would only take a 2% increase in rates across the board to wipe out the improvement in the economy. I would further argue that the economy is still so weak that higher interest rates would without a doubt throw the economy right back into a full blown recession. Given these thoughts I don’t expect the Fed to go anywhere anytime soon and I believe the “tapering talk” is nothing more than noise. Bernanke will be around until January 2014 and then it appears his most likely successor would be Janet Yellen who in comparison would make Bernanke look conservative in the dovish camp. The only way I can see the Fed tapering back on QE is if the employment picture improves dramatically, the economy improves dramatically, or the stock market gets into another full blown bubble. With regard to bubbles I think we are getting awfully close in certain areas, particularly utilities and other defensive plays like JNJ, PG, etc. Growing earnings at 5% annually and trading at P/E’s of 17+ is just insanity. As for the latter two scenarios I just don’t see it happening. The unemployment rate is only dropping because people are dropping out of the labor force. The labor force participation rate is the lowest in 30 years. As for the economy it sure feels to me like we are in a stagflationary environment and honestly if we were going to get a full blown economic recovery one would think that we would already have it by now after 4 years of massive fiscal stimulus. Instead the economy is limping along with nominal GDP at 2% and tops 2.5%.
While the Fed hasn’t come out and said it quite yet they want nominal GDP growth north of 3% and despite over $1 trillion in asset purchases annually they still haven’t been able to achieve that goal. Thus it seems they have two choices. The first would be to admit that they were wrong and stop QE. Good luck there. Second would be to either increase the size of QE or keep the current $85 billion per month going much longer than most expect. I’m thinking that the latter is the most likely as the whole developed world is mired in debt and is monetizing. Anyone that stops monetizing would see interest rates rise with a sure recession to follow. Global QE/Currency wars aren’t going anywhere anytime soon. Keep an eye on the German elections slated for 9/22/13. With Europe in a recession that is finally beginning to hit Germany don’t be surprised if Angela Merkel loses. Considering that austerity clearly isn’t working in the peripheral countries such as Spain, Italy, and Greece I wouldn’t be surprised if Merkel’s successor takes a difference stance regarding the monetization of debt as something clearly needs to be done in the Eurozone that is pro-growth.
Rising rates are also impacting corporate bonds as well. In the past year or so we have seen quite a few signs that this sector is nearing a peak. AAPL recently sold 10 year bonds that yielded 2.4% annually. Think about it this way. Their common stock yields over 3%. That is as easy as arbitrage gets. If they buy their own stock on the open market at an earnings yield of 10% they are making over 7.5%. I want to say that INTC did something similar within the last year in which they sold bonds at an obscenely low interest rate and then turned around and used the proceeds to buy back stock on the open market. Now think about what would happen if corporate interest rates rise. No more arbitrage for these companies. Stock buybacks wouldn’t be nearly as plentiful and I would argue that these stock buybacks have been a big backer for this rally in the market over the past year which has come on nothing more than multiple expansion. End result would be trouble for the equity market.
June 1, 2013
I remember back when gold was peaking in the summer of 2011 and the gold bears asking the gold bulls what would make gold go down. The arguments by the gold bulls was that if the economy improved we would see inflation which would be good for gold. On the other hand if we continued to see negative news the Fed would simply take QE to the next level which would also be good for gold as it would eventually lead to inflation down the road.
Now fast forward to today and the equity market. Same EXACT thing. Good news and it is happy times are here again and the market can go higher. On the other hand if there is any bad news it means that the Fed isn’t going anywhere and thus the market will continue higher. Both sides can’t be right and eventually one side will be wrong and the top will be in.
While an intermediate term top may very well be in place I still think the odds favor that this bull has a bit further to run. I have cycles due in October 2013 and January 2014. October, January, March, and April seem to be the months that market tops most commonly occur. Therefore it would seem logical to me that the top for this cyclical bull cycle comes between October 2013 and April 2014. From there I expect the secular bear cycle to take over again. I continue to expect trouble for the market in 2014 and it is hard for me to really see the market really getting rolling on the upside until after we get out of this 33-34 year cycle which is due in 2015-2016 and aligns with the Dow low of 1982.
May 30, 2013
When USA Today declares that the bull market is on solid footing it is time to start thinking the opposite. After the huge gains since 2009 and more importantly the fact that this bull market is now well over 4 years old I continue to contend that this cyclical bull market is much closer to the end than the beginning. I also stand by my belief that the potential upside from where we are now relative to the potential downside when the next bear gets started is not favorable at all. Maybe 10% upside left and then 30-50% downside from there?
Here is the flip side. 13 years into the last secular bear market the famous “Death of Equities” magazine cover was published in August 1979. It took another 3 years before the bottom was in and the market took off but the point is that investors need to look at magazine/newspaper headlines/covers as contrarian indicator.
In closing I hardly think it is going to take another 3 years for this market to peak and enter the next cyclical bear market. I give it 12 months tops. Dow 17,000 and 1,800 or so on the S&P 500 sound like realistic upside objectives.
May 22, 2013
May 22, 2013
There are a few points worth making here. First of all gold relative to the S&P 500 is working on being down for the 8th month in a row. Anytime an index reaches what is called 8-10 record sessions it is time to begin watching for a reversal. Gold is extremely oversold and it is quite obvious from looking at this chart that investors are selling gold to chase the market. There is good support around .78 and .58. Keep in mind that .76 is the 62% retracement of the entire bull market from .18 in 2000 to the peak of 1.70 in 2011.
I’m not arguing to go out and buy gold here. The chart is still quite bearish and after such a big breakdown like we saw in April it will take some time to repair the technical damage. However, it is clear that the trade of selling gold to buy the S&P 500 is getting awfully long in the tooth here. Also worth noting that sentiment for precious metals is the worst I have seen in over a decade. Expecting some kind of bounce in the ratio here in the not too distant future.