Chart Update

 

Money Supply Growth Accelerates, Credit to Private Sector Still in Decline

While money supply growth is slowing down in the US, it has recently continued to accelerate somewhat in the euro area. The effects of the ECB’s “QE”-type debt monetization activities in the form of covered bond and ABS purchases have not yet impacted aggregate money supply data much as of yet, but the 12-month growth rate of the narrow money supply aggregate M1 (currency and demand deposits, essentially equivalent to money TMS-1) has nevertheless continued to increase:

 

 

 

1-M1, euro area,annThe 12-month growth rate of the euro area’s money supply supply has recently accelerated from an interim low of 5% to approx. 6.5% – click to enlarge.

 

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Sentiment on Stocks and Ratio Charts

Below is a brief update of a few stock market related data points we frequently discuss in these pages. Sentiment on stocks continues to be a mirror image of the gold market. Investor complacency is quite pronounced, to put it mildly.

The first chart shows Rydex ratios – with bear assets throughout 2014 stuck at historical lows, the bull-bear asset ratio has recently hit a new record high above the 20 level (i.e., 20 times more Rydex assets were invested in bull and sector funds than in bear funds). This is incidentally quite a distance from the (then) record highs set in February-March 2000.

The second chart shows HYG, the HYG-SPX ratio and the TLT-HYG ratio. The most important takeaway from this chart is that the underperformance of high yield bonds relative to big cap stocks has reached a new annual extreme. A history of past occurrences of this phenomenon was recently shown at Zerohedge. Obviously, the lead times are highly variable, so this is not a timing indicator, but it certainly is a warning.

 

77392849

(Photo credit: fmh)

 

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A Strong Rebound, but Resistance Not Overcome Yet

Here is a brief summary of the technical backdrop in gold and gold stocks as it evolved last week. A week ago we noted that there was a panic sell-off occurring in gold stocks, a kind of “reverse blow-off” (see: “An Anti-Bubble Blow-Off in the Gold Sector” for details). Initially kicked off by tax loss selling, the weakness in gold stocks began feeding on itself after gold broke below the medium term support level at $1,180 that had held since 2013.

As often happens, the US payrolls report on Friday turned out to be a trigger for a short term reversal in the gold market. Although the report was widely characterized as having “missed expectations”, it should be pointed out that it was by no means a weak jobs report. Quite on the contrary, as Mish points out in his detailed analysis, a closer look at the details reveals that it was actually quite a strong report. The headline number is actually not so important in this context. The salient points are the strong household survey and the fact the the employment population ratio increased for a change. However, there are also weak spots in the report, as once again low-paying job categories seem to have experienced the strongest growth.

 

philharmoniker(Image credit: fmh)

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What Can Possibly Go Wrong?

 

“Wet sand makes for a better sandcastle
Inhale, exhale, just take a breath
I know that things don’t always happen like they should
Gotta learn to roll with the punches
And just say it’s all good”

NE-YO & Cher Lloyd – “It’s All Good”

 

Apparently, nothing can. At least that is the impression we get from various sentiment and positioning data relating to the stock market and risk assets more generally.

Below we show a number of pertinent charts of both short and long term indicators. Note here that as always, not every sentiment and positioning indicator is locked at an extreme. In fact, there are subtle divergences visible in several of them.

For instance, net long exposure according to the NAAIM survey is “only” 75%, which is down from a the record 104% of late 2013, as well as down from some of the reading we have seen since. Note however that the admittedly short history of this indicator shows that the net exposure of the fund managers surveyed tends to peak well before the market gets into trouble.

Anyway, similar small divergences usually occur in other indicators as well, such as total margin debt, a variety of sentiment surveys, volume put-call ratios and so forth.

We do however have a new weekly record high in the Rydex bull/bear asset ratio – currently 18.6 times as many assets are in bull and sector funds than in bear funds. However, even in this complex of data there is a subtle divergence visible. Bear assets have for instance collapsed again, but remain slightly above the record low recorded earlier this year. The same goes for money market assets, which have recently seen a sharp decline, but have failed to fall back to the 17 year lows seen earlier this year.

 

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Technical Conditions

Last week the gold market was ambushed twice in close succession – first by the Fed’s “everything is fine” statement (no-one can have been surprised by the well-telegraphed temporary end of “QE”) and then by the BoJ’s surprise assault on the yen. Since both events helped to boost both the US dollar and risk asset prices, gold’s fundamental drivers worsened again. Another potential bump in the road awaits this week, namely the payrolls report.

In our update on gold sentiment in late September we noted that it was definitely possible that the support in gold would break, but that the support break was unlikely to be sustained in view of extremely lopsided negative sentiment. Since the support break has occurred last week, we will soon know how “sustainable” it turns out to be. Unfortunately, sentiment extremes have hitherto not really helped the gold market much, while support breaks have regularly led to additional selling.

Moreover, gold stocks have been extremely weak of late, which is usually not a good sign. However, the weakness was at least part likely due to institutional tax loss selling and the decline has the characteristics of a “reverse blow-off” (the term “anti-bubble” was coined by Didier Sornette). Trading volume has been very high and the move in prices last week has been quite large as well. In fact, it was one of the fastest decline in gold stocks relative to gold we can remember. To the extent that this reflects current sentiment, it is certainly at a negative extreme (gold stocks are currently trading at an all time low relative to gold).

 

P1280892

 (Photo credit: fmh)

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The BoJ Goes Even Crazier

It has been clear for a while now that the lunatics are running the asylum in Japan, so perhaps one shouldn’t be too surprised by what happened overnight. Bloomberg informs us that Kuroda Jolts Markets With Assault on Deflation Mindset.

The policy hasn’t worked so far, in fact, it demonstrably hasn’t worked in Japan in a quarter of a century. Therefore, according to the Keynesian mindset, we need more of it. Mr. Kuroda therefore delivered a surprise spiking of the punchbowl that immediately impoverished Japan’s consumers further by causing a sharp decline in the yen:

 

“Today’s decision to expand Japan’s monetary stimulus may be regarded as shock treatment in the central bank’s effort to affect confidence levels. Bank of Japan Governor Haruhiko Kuroda’s remedy to reflate the world’s third-largest economy through influencing expectations saw the yen sliding and stocks climbing.

Kuroda led a divided board in Tokyo in a surprise decision to expand unprecedented monetary stimulus. Bank officials hadn’t provided any hints in recent weeks that additional easing was on the cards to help reach the BOJ’s inflation goal. Kuroda, 70, repeatedly indicated confidence this month that Japan was on a path to reaching his 2 percent target in the coming fiscal year. Just three of 32 economists surveyed by Bloomberg News predicted extra easing.

“We have to admit that this is sort of a second shock — after we had the first shock in April last year,” said Masaaki Kanno, chief Japan economist at JPMorgan Chase & Co. in Tokyo, referring to the first round of stimulus rolled out by Kuroda in 2013. Kanno, who used to work at the BOJ, said “this is very effective,” especially because it comes the same day as the government pension fund said it will buy more of the nation’s stocks.

 

(emphasis added)

So why is there allegedly a “need to combat the deflation mindset”? Below is a chart of the recent increases in Japan’s CPI.

In actual practice, it matters little how they have come about – the fact that CPI was inter alia boosted by a hike in consumption taxes does not alter the fact that every consumer in Japan is now getting fewer goods and services for his income and savings than before. No consumer is going to a shop and saying to himself “the fact that things are now vastly more expensive than before somehow shows we are still in deflation, because it has happened for transitory reasons”. All he knows is that he is getting less for his hard-earned money. Mr. Kuroda is evidently not moved by such considerations.

  1-japan-inflation-cpiJapan’s CPI is recently growing at a 3.2% annual rate. Obviously, this means one must “combat the deflation mindset” – click to enlarge.

 

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A Fount of Originality and Contrarian Thinking …

Just pulling your leg, dear reader. The Barron’s big money poll contains about as much originality and contrarian thinking as you can find on CNBC … slightly less, actually.

So what are the big money’s big ideas this time around? They continue exhibit a huge bearish consensus on bonds, which we have in the past flagged as a big contrary indicator (you will notice that we also pointed out their bearish consensus on the Nikkei in this past article – the Nikkei promptly had an explosive rally right after the survey was published). Otherwise they are still “investing by ruler” – in other words, they are simply extrapolating what has happened in the recent past into the future, which is precisely what most Wall Street strategists and most mainstream economists do as well. Not one of these groups will ever identify a turning point in a timely manner.

The biggest bullish consensus is on US large cap stocks with 84% bulls, the biggest bearish consensus (certain to be wrong for the umpteenth year in a row) is on US treasury bonds with 91% bears (!).

Gold aficionados will be pleased to learn that there is a 76% bearish consensus on gold, which provides a nice contrast to the 69% bullish consensus that pertained in October of 2012, just as gold was getting ready to tank big.

 

1-big money poll, BarronsA good road map of what to do and what not to do – avoid the areas with the biggest bullish consensus, instead buy whatever they hate with a passion – click to enlarge.

 

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Asia “Not Helped” by Chinese Data, Fed Officials Back-Pedaling

We wanted to see if there were any signs of concern in the mainstream financial press over the recent market decline (which is still small in terms of the major indexes, although this can no longer be claimed of the “average stock”).

We would characterize the mood as one of “mild concern” – generally it seems to be held that the decline is just another of the periodic (and ever smaller) corrections we have seen over the past few years. It is noteworthy though that the recent decline is referred to as a “growth scare”. For instance, Reuters reports on overnight weakness in Asian markets – which actually didn’t entail any overly big moves:

 

“Asian stocks stumbled to seven-month lows on Monday, while crude oil prices were pinned near a four-year trough as promising trade numbers out of China failed to cheer a market still worried about faltering global growth.

MSCI’s broadest index of Asia-Pacific shares outside Japan fell 0.8 percent, extending last week’s 1.1 percent drop. Mainland Chinese stocks skidded 1.1 percent and Hong Kong’s Hang Seng shed 0.7 percent. Australia’s S&P/ASX 200 index and South Korea’s KOSPI both slipped 0.6 percent. Tokyo’s Nikkei was spared the pain for now thanks to a public holiday in Japan. The declines in Asian markets came after U.S. stocks skidded 1.2 percent on Friday and Wall Street’s fear gauge, the CBOE Volatility Index, jumped to a near two-year high.”

 

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Market Reaction to Payrolls Data

Payrolls and unemployment reports should normally be regarded to be among the least useful economic data, as they are lagging indicators of the economy. Insofar the recent improvement in employment data only confirms what has already happened: economic activity has increased (note that this tells us nothing about the quality of said activity). It tells us absolutely nothing about the future.

The reason why the markets tend to react strongly to these data is mainly the Federal Reserve’s nonsensical “dual mandate”. Enacted in the heyday of Keynesianism, the mandate is based on the belief that both prices and employment can be successfully centrally planned by manipulating interest rates.

 

1-Employment dataCumulative non-farm payrolls, initial unemployment claims and the U3 unemployment rate (which excludes about half of the people who are actually unemployed). If we had asserted a few years ago that the Federal Funds rate would be at zero with the unemployment rate at 5.9%, we’d have been declared insane – click to enlarge.

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The Many Errors of His Ways …

An editorial by well-known leftist economist Joseph Stiglitz has recently been published in the Guardian, entitledAusterity has been an utter disaster for the euro zone”.

Before we are taking a closer look at it, we want to stress that we also believe that the EU’s approach to economic policy is worth criticizing in many respects. Just because we believe that Mr. Stiglitz is essentially an economic crank doesn’t mean that we disagree with every criticism of the so-called “austerity” policy as pursued by the EU. Below are several excerpts from his article with our comments interspersed.

 

“If the facts don’t fit the theory, change the theory,” goes the old adage. But too often it is easier to keep the theory and change the facts – or so German chancellor Angela Merkel and other pro-austerity European leaders appear to believe. Though facts keep staring them in the face, they continue to deny reality.”

 

The “old adage” is actually a well-known bonmot by J.M. Keynes – curiously, Stiglitz doesn’t mention that. Although it has merit with respect to the natural sciences, it does not apply to economic theory, which is a science of human action and not a study of inanimate objects without volition. Theorems of economics cannot be proved or disproved with “empirical data”. We do e.g. not need empirical data to prove the truth of the theorem of marginal utility, or to create a price or value theory, or to prove the truth of the law of association, etc.,etc..

All of these economic laws have been discovered by inner reflection and the process of logical deduction. They are only “empirical” in a Thomist or Aristotelian sense (for a detailed explanation of this point of view, we refer readers to Rothbard’s monograph In Defense of Extreme Apriorism -pdf).

To put it differently: one can use economic theory to explain the facts of economic history, but one cannot use economic history to argue for or against points of economic theory. If we look at economic statistics, we see that every slice of history is slightly different, as the contingent data, which are always extremely complex and varied, are different in every case. And yet, the same economic laws have time and place-invariantly operated in every instance and will continue to do so for all eternity, or at least as long as there are human beings who can act with purpose. Stiglitz continues:

 

Austerity has failed.But its defenders are willing to claim victory on the basis of the weakest possible evidence: the economy is no longer collapsing, so austerity must be working! But if that is the benchmark, we could say that jumping off a cliff is the best way to get down from a mountain; after all, the descent has been stopped.

But every downturn comes to an end. Success should not be measured by the fact that recovery eventually occurs, but by how quickly it takes hold and how extensive the damage caused by the slump.

Viewed in these terms, austerity has been an utter and unmitigated disaster, which has become increasingly apparent as European Union economies once again face stagnation, if not a triple-dip recession, with unemployment persisting at record highs and per capita real (inflation-adjusted) GDP in many countries remaining below pre-recession levels. In even the best-performing economies, such as Germany, growth since the 2008 crisis has been so slow that, in any other circumstance, it would be rated as dismal.

The most afflicted countries are in a depression. There is no other word to describe an economy like that of Spain or Greece, where nearly one in four people – and more than 50% of young people – cannot find work.

 

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Greek Government Worried About Its Survival

Antonis Samaras has a problem: just as the relatively tough austerity medicine Greece was forced to take seems to be beginning to bear some fruit (Greece is the one euro area country where nominal government spending has indeed declined significantly), his shaky coalition government may soon be stumbling over the country’s upcoming presidential election. The problem in a nutshell is that if Samaras fails to get his presidential candidate elected, new parliamentary elections would be triggered – and according to current polls, the coalition would lose against SYRIZA.

 

1-greece-government-spendingGreek government spending has declined significantly in nominal terms (though not as a percentage of GDP, as GDP has declined a lot) – click to enlarge.

 

SYRIZA as readers may recall, once was a smallish coalition of tiny left-wing parties to the left of the social democrats that didn’t really have a lot of electoral support. After the financial crisis and the bankruptcy of the Greek government, it quickly became the country’s largest party. SYRIZA is anti-bailout, whereby we are not quite sure what this stance actually entails. Presumably, a SYRIZA victory would mean a Greek exit from the euro, as Greece’s creditors would have to accept the country’s bankruptcy, and its banking system would lose the ECB’s support (since it would be instantly bankrupt, and hence no longer eligible to receive ECB funding). Moreover, tearing up the agreements with the “troika” would definitely lead to Greece being made into a pariah, so as to discourage others from following suit.

 

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Downturn in High Yield Bonds Continues

On Thursday the stock market had a down day that was actually not very remarkable in terms of its extent – it was only remarkable because even such relatively middling down days have become rare these days. Another thing that made it remarkable is that there was no “obvious” trigger for the selling, which started right out of the gate.

However, as we have previously discussed, market internals have weakened all year long (see “Market Internals Are Weakening” for a recent update) and most recently we have pointed out a number of divergences that have occurred, including the long term downshift in the ratio of HYG to the SPX (see this chart). High yield debt has recently continued to weaken, after a rebound rally that appears to have failed at a lower high. Along with this event, an attempt by treasury yields to break higher seems to have failed as well:

 

1-HYGHYG (a high yield bond ETF) suffers its biggest correction in a long time, and treasury note yields turn lower again (admittedly this may turn out to be just a brief pullback in t-note yields) – click to enlarge.

 

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Mark Hulbert on the HGNSI

As an addendum to Dan Popescu’s article on the state of gold sentiment, we want to show an update of the indicators we follow. Coincidendally, Mark Hulbert has also just published an update on his HGNSI measure (Hulbert Gold Newsletter Sentiment Index). The Index measures the percentage newsletter writers recommend to allocate to gold-related investments on average – either on the long or the short side. As it turns out, the current level of the HGNSI stands at nearly minus 47%, which happens to be the second-highest bearish sentiment expression in 30 years (the highest was recorded in June 2013).

 

Mark Hulbert notes:

 

“[…] the average recommended gold market exposure level among a subset of short-term gold market timers tracked by the Hulbert Financial Digest (as measured by the Hulbert Gold Newsletter Sentiment Index, or HGNSI). This average currently stands at minus 46.9%, which means that the average short-term gold timer is now allocating nearly half his clients’ gold-oriented portfolios to going short.

That is an aggressively bearish posture, which is unlikely to be profitable according to contrarian analysis.

There’s been only one time in the past 30 years when the HGNSI got any lower than it is today. That came in June 2013, when the HGNSI fell to minus 56.7%. As you can see from the accompanying chart, gold soon — within a matter of a couple weeks — began a rally that, by late August, had tacked more than $200 on to the price of an ounce of gold.

Notice that gold’s 2013 summer rally didn’t begin immediately after the HGNSI dropped to the levels we’re seeing today. That’s hardly a criticism, of course, since no trading system can pick the market’s turning points with pinpoint accuracy. Nevertheless, according to the econometric tests to which I have subjected the 30 years’ worth of my sentiment data, the gold market performs appreciably better following low HGNSI readings rather than it does high ones. Contrarian analysis hasn’t always worked, needless to say, but it’s more successful than it is a failure.”

 

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Gold Stocks Reach New High Relative to Gold

As we have mentioned in previous updates on the gold sector, few things are more important for its likely future performance than how gold stocks are performing relative to gold. The action in the stock market this year is in many ways increasingly reminiscent of the final phase of the technology bubble of the late 1990s. Concurrently, the recent action in gold, silver and gold stocks is also exhibiting similarities to the lows that were made at the time.

To elaborate a bit on this: the action in the stock market and the fundamental backdrop are of course only similar to the 1999/2000 period in certain respects; no two historical periods are ever completely similar. From a technical perspective, the parallels are the following: relative weakness in small cap stocks, an increasingly narrow advance driven by fewer and fewer stocks during each new rally leg over recent months, new all time highs in the Rydex bull/bear asset ratio and a noticeable increase in volatility in the ratio, multiple intra-market divergences over recent months with strength focused on the tech sector, and extremely lop-sided bullish sentiment readings in both positioning and survey data over recent months.

Fundamentally, the main similarity is a tightening of policy by the Fed. Note here that even though the Federal Funds rate remains pegged at the 0-0.25% corridor (and due to the mass of excess reserved held by banks effectively trades just below 0.1%), the so-called “tapering” of QE still amounts to a tightening of monetary policy. However, while the Fed has reduced its monetization activities, commercial banks have stepped up their inflationary lending. As a result, y/y money supply growth (TMS-2) has oscillated around the 8% mark since mid 2013. This is still quite brisk, and as such is a fundamental datum that can be considered as supportive for the market. Note though that it represents a sharp slowdown from the peak growth rates recorded in 2010 (approx. 17%) and 2011 (approx. 16%) and that the willingness of banks to continue to expand credit greatly depends on the economy's performance (there is a feedback loop between the two).

 

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The Nature of the Latest Rally Leg

Keeping in mind that a number of important historical market peaks have been recorded in late August/early September, here is a brief look at how the most recent rally leg stacks up in terms of its internals. It can definitely be stated that the technical condition of the market has weakened further (the same happened already on the preceding rally leg, but it has become even more pronounced now).

Specifically, it can be seen that the market is carried higher by fewer and fewer stocks. The underperformance of the small cap vs. the big cap sector has continued, but that is not the only evidence of narrowing we have.

Whenever a stock market rally becomes narrower, it essentially conveys the information that market liquidity is becoming less ample. There is no longer enough additional liquidity entering the market to enable the tide to lift all boats concurrently. Given the fact that most indexes are capitalization-weighted, their performance can easily mask underlying deterioration. It makes therefore sense to keep an eye on the market's innards.

Small caps on average sport higher valuations than big caps, and generally need more plentiful liquidity to rally. Moreover, they tend to be more economically sensitive, as smaller companies are likely to largely depend on the performance of the domestic economy.

 

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