Shooting from the hip - topical, informed and opinionated posts each & every day!
We’ve recently been treated to two mutually exclusive forecasts: that the Great Bull Market will run until 2016 or 2018, so no worries; and that markets are exhibiting bubble-like characteristics that presage another crash.
So which forecast is more likely the correct one?
Analysts of every stripe—fundamental, quantitative and technical—pump out reams of data and charts to support one forecast or another, and economists (behavioral, macro, etc.) weigh in with their prognostications as well. All sorts of complexities are spun as a by-product of producing research that’s worth paying for, and it all becomes as clear as…mud.
As an experiment, let’s strip away as much of the complexity as possible and look at a few charts of what many observers see as the key components of the U.S. economy and stock market.
Let’s start with a basic chart of the S&P 500 (SPX), a broad measure of U.S. stocks:
Without getting fancy, we can discern three basic phases: what we might term “the old normal,” from the late 1950s to 1982; an amazing Bull Market from 1982 to 1994 that saw the SPX more than double; and a third phase that some consider “the new normal,” a leap to the stratosphere in the 1990s, followed by sharp declines and equally sharp rises to new highs.
This third phase of extreme volatility does not look like the previous phases; that much is clear. Is this a new form of volatile stability; i.e., are extreme bubbles and crashes now “normal”? Or are these extremes evidence of systemic instability? About the only things we can say with confidence is that this phase is noticeably different from the previous decades and that it is characterized by repeating bubbles and crashes.
Let’s zoom in on this “new normal” from 1994 to the present. Does any pattern pop out at us?
Once again, without getting too fancy, we can’t help but notice that this phase is characterized by steeply ascending Bull markets that last around five years. These then collapse and retrace much of the previous rise within a few years.
The reasons why these Bull phases only last about five years are of course open to debate, but what is clear is that some causal factors arise at about the five-year mark that cause the market to reverse sharply.
The ensuing Bear markets have lasted between 2.5 and 1.5 years. We only have three advances and two declines to date, but the regularity of these advances and declines is noteworthy.
Next, let’s consider other potential influences on this “new normal” of wild swings up and down. Some have observed a correlation between the cycles of the sun’s activity and the stock market, and indeed, there does seem to be a close correlation—not so much with the amplitude of the market’s recent moves but with the economic tidal forces of recession and Bull/Bear sentiment.
But there is nothing here to explain why the highs and lows in the stock market have become so exaggerated in the “new normal.”
Many have attempted to correlate key dynamics in the U.S. and global economy to the stock market’s gyrations. Let’s look at a handful that are often offered up as important to the U.S. markets: the bond market (TLT, the 20-year bond index), the Japanese yen, gold, and the U.S. dollar.
If there is some correlation between the SPX and the TLT, it isn’t very visible.
How about the Japanese yen? Once again, there is no correlation to the SPX that is obvious enough to be useful.
Some analysts see the yen and gold as tightly correlated; here is GLD, a proxy for gold:
There is a clear correlation here, but as we all know, correlation is not causation, which means that some underlying forces could be causing the yen and gold to act in a similar fashion. Alternatively, the yen is acting on gold in a causal role.
In either case, the problem with correlations is that they can end without warning. Since neither the yen nor gold correlate with the S&P 500, neither one helps us forecast a continuing Bull or a crash.
Lastly, let’s look at the U.S. dollar (DXY).
As I have noted elsewhere, the dollar doesn’t share any meaningful correlation with the S&P 500, yen, gold, or bonds in terms of trends, highs, or lows. Here is a longer-term view of the Dollar Index, and once again we see no useful correlation to the SPX:
Proponents of cycles (17.6 years, for example) claim a high degree of correlation with actual highs and lows, but these cycles do not exhibit the fine-grained accuracy we might hope for in terms of deciding to buy, short, or sell stocks.
Analyst Sean Corrigan has described a remarkable 33-year cycle of highs and lows in the SPX: lows in 1949, 1982, and (forecast) 2015, and highs in 1967 and 2000, (forecast of next high, 2033). While interesting on multiple levels, these cyclical data points are rather sparse foundations for decisions on whether to sell or hold major positions in the stock market, and they do not provide a forecast of the amplitude of any high or low. Given the extremes of the “new normal,” we would prefer a forecast, not just of time, but also of amplitude.
Though it is unsatisfyingly imprecise, the “new normal” phase strongly implies that future declines will be as dramatic as the advances and that the five-year clock is ticking on the current Bull market. Forecasting an advance that lasts years beyond this five-year pattern is equivalent to forecasting that the “new normal” phase is now ending and a new phase of much longer Bull advances is beginning.
That is a bold claim, and there is little historical data to give it much weight. Stripped of complexity, the charts suggest that the current run will top out within the next few months and retrace most of the advance from 2009; i.e., a crash of significant amplitude.
In Part II: The Case for Cash, we analyze the indicators that help us determine the likelihood of a coming crash similar in magnitude to 2000-02 and 2008-09, and why a strategy of selling risk assets now, and holding the cash until income-producing assets “go on sale” at the trough of the next market decline, seems especially prudent at this time.
From Peak Prosperity
This week’s Investor’s Intelligence poll nearly tips over with bulls - the Bulls minus Bears read rising to a nose-bleed 43.9%, the 96th percentile of reads going back to 1972. In fact this measure is the highest since just before the crash of 87…
2 tables will vie for supremacy over the next few weeks.
Table 1 is a measure of typical monthly returns. We can see December has ended up 3/4 of the time.
Below is a table depicting what the subsequent weeks returns have been when the II measure has printed a figure in the range that has been seen today.
Be interesting which prevails as we enter the traditional Santa Claus rally period…
After several tumultuous years of political and economic instability, Greece is finally getting back on track, at least according to publicity from the incumbent government over their budget surplus. It seems they are close to balancing public accounts as the budget deficit turned into a primary surplus and revenues, for once, exceeded expenditures, albeit before interest expenses had been factored into the equation. Unfortunately, interest expenses are still a thorn in Greece’s side and will continue to be so for many years. Or possibly not…
We should applaud the Greek Government for their persistence in the face of adversity. After years of tough political negotiations and social unrest, the country’s finances are, finally, nearing a balanced state. There is still a mountain of debt to erode away, but stemming the seemingly terminable spending more of than it can generate was a top priority set by Greece’s creditors – the troika.
Of course, there is a flip-side to this success story when such achievements are viewed through the Greek population’s lens. The average woman and man on the street see an unemployment rate still near record highs of 27%, making it virtually impossible to find a job. Among the youth, this elevated rate changes to an unprecedented figure above 50% - one in two under 25’s without paid employ. Also, consider that the economy went through an extremely harsh period with GDP declining as much as 7.1% in 2011 and 6.4% in 2012 as a direct consequence of the austerity policies applied. During the last 9 years the Greek economy has declined at an average annual rate of 0.6%, which I would say puts the current recession at a similar level to that of the Great Depression of 1929.
Despite this, public finances have improved and so it seems that the economic picture is on the up. Well hang on a minute. Many people don’t realise that the present economic scenario is not necessarily beneficial for creditors and general stability. Bear with me. If you believe that Greece is now more unlikely to default on debt obligations, you are likely completely wrong. It may seem contradictory, but as Greece enters into a primary debt surplus, there is the possibility it could stop actually paying its creditors, particularly if political instability rises once again, which isn’t improbable given that the current government hardly survived the latest no-confidence vote.
Yes, a primary budget surplus means the government is no longer reliant on creditors to survive its day-to-day activities. And as long as expenditures are more than covered by revenues, the Greek government can continue paying pensioners, soldiers and public sector workers. And yes, there is less of a need for outside credit. However, there remains the need to pay for interest expenses as a result of the vast quantities borrowed in the past.
In contrast to its vulnerability over the past few years, Greece now has the negotiating power and new financial muscle growth to discontinue answering to the whims of its creditors. The austerity packages of recent years may now be near an end. She is now in a position to potentially renegotiate some of the more onerous bail out terms. Considering the harsh and insensitive measures imposed by the IMF and EU, and with the current government collation once more close to dissolution, I wonder what the end result will… Like it or not, one thing is certain: risk is likely to increase once more in the country and as a potential theme for 2014, spread throughout Southern Europe. The Grexit story is here again.
For practitioners of Schadenfreude, seeing high-profile investors losing their shirts is always amusing.
But for the true connoisseur, the finest expression of the art comes when a high-profile investor identifies a bubble, perhaps even makes money out of it, exits in time – and then gets sucked back in only to lose everything in the resultant bust.
An early example is the case of Sir Isaac Newton and the South Sea Company, which was established in the early 18th Century and granted a monopoly on trade in the South Seas in exchange for assuming England’s war debt.
Investors warmed to the appeal of this monopoly and the company’s shares began their rise.
Britain’s most celebrated scientist was not immune to the monetary charms of the South Sea Company, and in early 1720 he profited handsomely from his stake. Having cashed in his chips, he then watched with some perturbation as stock in the company continued to rise.
In the words of Lord Overstone, no warning on earth can save people determined to grow suddenly rich.
Newton went on to repurchase a good deal more South Sea Company shares at more than three times the price of his original stake, and then proceeded to lose £20,000 (which, in 1720, amounted to almost all his life savings).
This prompted him to add, allegedly, that “I can calculate the movement of stars, but not the madness of men.”
The chart of the South Sea Company’s stock price, and effectively of Newton’s emotional journey from greed to satisfaction and then from envy and more greed, ending in despair, is shown above.
A more recent example would be that of the highly successful fund manager Stanley Druckenmiller who, whilst working for George Soros in 1999, maintained a significant short position in Internet stocks that he (rightly) considered massively overvalued.
But as Nasdaq continued to soar into the wide blue yonder (not altogether dissimilar to South Sea Company shares), he proceeded to cover those shorts and subsequently went long the technology market.
Although this trade ended quickly, it did not end well. Three quarters of the Internet stocks that Druckenmiller bought eventually went to zero. The remainder fell between 90% and 99%.
And now we have another convert to the bull cause.
Fund manager Hugh Hendry has hardly nurtured the image of a shy retiring violet during the course of his career to date, so his recent volte-face on markets garnered a fair degree of attention. In his December letter to investors he wrote the following:
“This is what I fear most today: being bearish and so continuing to not make any money even as the monetary authorities shower us with the ill thought-out generosity of their stance and markets melt up. Our resistance of Fed generosity has been pretty costly for all of us so far. To keep resisting could end up being unforgivably costly.”
Hendry sums up his new acceptance of risk in six words: “Just be long. Pretty much anything.”
Will Hendry’s surrender to monetary forces equate to Newton’s re-entry into South Sea shares or Druckenmiller’s dotcom capitulation in the face of crowd hysteria ? Time will tell, but what’s for sure. is that with the plethora of market top signals out there the odds are against our favourite hedge fund manager not eating schadenfreude in the next 12 months…
I have to admit that the insurance sector is not one that fascinates me in any way, in fact the whole area appears deadly dull! Indeed, the only real source of interest that I can muster is the way that behind all the mathematical mumbo-jumbo of premiums / actuaries (yes those highly paid dullards!) etc. we are looking at a sector which I am sure is ultimately something of a rip off for the end user! But of course, given the way that the Great British consumer has shown him / herself to be quite happy in being ripped off by banks, supermarkets and utilities, a little stealth robbery when it comes to home or health insurance probably does not do anyone too much harm eh? In fact, just blame it all on the EU…
Let’s kick off with the charting picture at Aviva (AV.) and it can be seen that we are looking at a position now where the trend is being maintained to the upside via a rising channel from June and with its support line projection running at £4.20. If you add in the way that the bull run was backed by a 50 day/200 day moving average golden cross buy signal in July, it is difficult not to be sucked into the idea that further upside will be seen here sooner rather than later.
In fact, to me, whilst the 2013 uptrend line is held at £4.20 on an end of day close basis, we should be treated to a 1 to 2 month price target as high as £4.80 sight of the June resistance line projection. Only cautious traders would wait on a weekly close back above the 50 day moving average at £4.30 before taking the plunge on the long side.
It is helpful that as far as the Legal and General Group (LGEN) daily chart is concerned that we are looking at a position which is remarkably similar to that seen with Aviva described above. Here there is also a rising trend channel from June, with most of the price action being seen in terms of the support points coming in at, or just below, the 50 day moving average level at 208p currently.
The view at this point is that we would expect to see further upside, certainly at least while there is no end of day close back below the June uptrend line at 202p but that a buy trigger is probably required before Bulls go all in again. The ideal scenario for this buy signal would be an end of day close back above the 50 day moving average, ideally combining with a break back above neutral 50 for the RSI oscillator currently at 41. But whatever trigger is used to go long in the near-term, the perceived upside here is as high as the 2013 price channel top at £2.30, a level which makes for a decent 4 to 6 week price target to me.
If nothing else, it can be seen that on the daily chart of RSA Insurance Group (RSA), that there is a stark contrast in the charting configuration when compared to the two companies described above. November witnessed two massive unfilled gaps to the downside through the 200 day moving average currently at 117p, and the misery was compounded by the way that there was a dead cross sell signal between the 50 day and 200 day moving averages soon after the double gaps to the downside were delivered. Indeed, the aftermath of last month’s shenanigans is bearish enough to suggest that while there is no end of day close back above the November resistance line/10 day moving average at 102p we could still see further downside towards a July support line projection heading as low as 94p as soon as the end of December.