The Stock Market

 

“Oh”, or Aiming for a Career on Wall Street

Fátima, our new 10-year-old English-language student, is a stranger to modern economics… as well as to vernacular English.

“What do you think of central bank policies?” we asked.

“What’s a central bank?”

“It’s the bank that provides money to the other banks.”

“Where do they get the money?”

“They create it out of nothing.”

“Oh.”

“Would you like some money from the central bank?”

“I guess so.”

Fátima must be aiming for a career on Wall Street.

 

yellen teaching draghi how to print money funny photoRecent developments indicate he’s got it …

Cartoon via tradingblog.nl

 

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Stock Market Volatility in the 1950s vs. Today

Market volatility has been of concern for many market participants for several years. There are ways to exploit volatility for profit, but it generally is the bane of long-term trend followers. Implicit in concerns about volatility is the notion that it has been unusually high recently, and that in past years was not a major concern.

Some may be tempted to imagine that things were nearly ideal in the sleepy, tortoise-paced years of the 1950s, including the stock market, when scary volatility must have been virtually nonexistent.

I decided to illustrate a few facts about volatility via the accompanying chart. It plots the S&P 500 over two periods, both a little over two years in length. These are plots of the weekly close, and this is my first point: If one can ignore all market activity except the weekly closing prices, most scary volatility all but vanishes.

 

Slot-Machine-Winner

Image credit: Mircea Maties

 

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The Game Is Up

Today … a warning concerning the new highs in the Nasdaq. Stocks fell hard on Friday. The Dow saw a massive sell-off of 278 points – or 1.5%. Gold was flat. You’ve heard by now why stocks fell – because of Friday’s Employment Situation report. Nonfarm payrolls rose 295,000 in February versus expectations of the consensus forecast of 230,000 new jobs added.

Investors took this “good news” to mean that maybe the Fed would allow interest rates to return to normal sooner rather than later. After all, the crisis that led to its zero-interest-rate policy (ZIRP) is plainly over.

 

NASDAQ_stock_market_display

Photo credit: bfishadow / flickr

 

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Everybody Agrees: Stocks Can Only Go Up More …

We have recently come across a paragraph contained in a Marketwatch “need to know” summary that strikes us rather ominous. The title was: “Corporate America and retail investors agree: We love equities”. It goes on to say:

 

“A box of chocolates, some Barry White and a stock market that just won’t quit. Whatever the aphrodisiac, love was in the air last month as investors embraced the Valentine’s Day spirit.

If there’s any fear of an imminent retreat in the markets, you wouldn’t know it by how enamored individual investors have been with equities lately. Stock and stock-fund allocations grew to 68.3% in February, marking the second-highest level since the financial crisis, according to the American Association of Individual Investors. We’re now going on 23 months in a row of equity portfolio allocations above the historical average of 60%.

Corporate America is every bit as smitten with equities. Its own equities, to be precise. Buybacks surged to the highest level ever recorded by TrimTabs, which started tracking the data in 1995. In February, CEOs announced $104.3 billion in repurchase plans.

A year earlier, that number was $55 billion. A contrarian might see that as reason to sell. But it wouldn’t have worked the last time buybacks took out a monthly record. That was $99.8 billion in July 2006, and the S&P 500 surged 23% the following 14 months before hitting an all-time high, Bloomberg data showed.”

 

(emphasis added)

 

moma soundings

Photo credit: Stephen Vitiello

 

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Oil Production and Consumption

 

oilstock

Image via Taylor Russell

 

The first chart shows global oil production, by month, based on latest EIA data.  2014 saw significant production increases after fairly flat production in ’12 and ’13.

 

1-global oil productionGlobal crude oil production (source, EIA) – click to enlarge.

 

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The King of Lydia

“Count no man happy until he be dead,” said Athenian statesman and poet Solon.

The man to whom Solon gave the advice was the richest man alive at the time (the 6th century B.C.) – the king of Lydia, Croesus.

Croesus considered himself to be the happiest man alive. But he discovered that fortune could turn against you, no matter how rich and powerful you were. His son died in an accident. His wife committed suicide. And he was captured and burned alive by Cyrus, king of Persia.

And now, poor Warren Buffett must be feeling the heat. He’s 84 years old and the most successful investor of all time. Respected. Admired. Beloved, especially by the thousands of people he has made into millionaires. And “as rich as Croesus” himself. Buffett celebrated the golden anniversary of his investment conglomerate, Berkshire Hathaway, last week. And what a success!

 

975px-Honthorst_solon_and_croesus Croesus and Solon , painting by Gerard van Honthorst,  1624

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The Market Isn’t Cheap

We frequently run across assertions that the US stock market is allegedly “cheap”, because the trailing P/E of the S&P 500 Index has not yet reached the dizzy heights of 1929 or 2000 (of course, quite often the “forward P/E” is cited rather than the trailing P/E. We believe this to be a worthless indicator, as it relies on overoptimistic analyst estimates that are continually revised lower as time passes).

Apart from the fact that the valuation peaks of the two biggest stock market manias in history hardly represent a useful yardstick for determining whether the market is attractively valued or not, these assertions are focused on an index that is capitalization weighted and the average P/E of which is greatly influenced by a small number of momentum stocks. In 2000, the extreme valuations accorded to technology stocks ended up producing a trailing P/E for the S&P 500 in cloud cuckoo land – however, the market as a whole was actually noticeably cheaper than it is today.

 

buborek

 

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Consolidation or Topping Pattern?

From a technical perspective, the recent trading range in the US stock market is not really telling us much about what to expect next. It is possible to regard it as a drawn-out consolidation pattern prior to a renewed surge, but it is just as likely that it is in fact a distribution pattern.

We have discussed the sentiment backdrop a number of times recently. Although the public exuberance that was visible in 2000 is largely absent, virtually every other measure of sentiment, whether in terms of positioning, surveys or of the anecdotal variety, seems stretched like rarely before. In many ways it is the exact opposite of what was seen near the 2009 lows. Anecdotal evidence includes items like the stock market valuation accorded to a company that owns four mobile grilled cheese dispensers in the OTC market (a cool $100m.), which is discussed in more detail by Barry Ritholtz here.

 

uniformity

Image credit: fmh

 

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A Disturbance in the Farce?

We usually like to keep an eye on indicators that are not getting a lot of attention, in an attempt to circumvent the “what everybody knows isn’t worth knowing” problem. Recently, several noteworthy things have happened with the $VIX, or rather, the derivatives traded on the VIX. The VIX is a measure of implied volatility, referring to front month options on the S&P 500 Index (it used to be the S&P 100 back when OEX options were still the most liquid index options – the OEX version is these days called VXO). While the first OEX version used only at-the-money options expiring 30 days hence, the calculation has been expanded over time. Now it is a blend of front and second-month at-the-money and out-of-the-money options. Those interested in the precise calculation procedure can take a look at it here: CBOE VIX White Paper (PDF). The aim is to calculate the expected 30-day volatility of the SPX at a 68% probability (one std. deviation) as expressed by the options market.

 

gi-takingstock01rb1

Image credit: James Steidl / Thinkstock)

 

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Helpful Analysts

As we have occasionally mentioned, it is often hard to fathom why sell-side analysts exist at all. After all, in a bear market you don’t want them, and in a bull market you certainly don’t need them. However, as Brett Arends informs us, there is a sure-fire way to make a lot of money from analyst recommendations: at the beginning of the year, simply make a list of the 10 stocks they hate most, buy them in equal weightings and watch your net worth soar. Easy-peasy.

Below is a chart of three stocks that inhabited the “10 most hated” list at the beginning of 2014 – they returned 30% or more each (dividends included). The entire list returned 19%, beating the S&P 500 Index by one third, and featured just one loser (DE), which lost a mere 1%.

 

Hated StocksThree exceptional performers from the 2014 “10 most hated by Wall Street analysts” list, returning 30% + each over the year, including dividends – via StockCharts, click to enlarge.

 

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Still “Patient”, but too Upbeat for the Stock Market

As a look at the WSJ’s FOMC statement tracker reveals, the Fed currently sounds quite upbeat about the US economy. Given that organs of the State are usually the last to recognize a trend (in this case the trend of a subdued, but better than elsewhere US economic performance), this should be taken as a warning sign that the trend may be close to reversing.

There was only one word for liquidity junkies in the statement: the term “patient”, in the context of the widely anticipated, but continually postponed, rate hike. While the Fed ponders rate hikes, US macro data have begun to weaken rather noticeably of late. Not to an extent yet that would be worrisome, but they offer a strange contrast to the upbeat FOMC statement. Also, the Fed keeps stressing that it sees the recent collapse in inflation expectations as “transitory” (it may well turn out to be), again removing a reason for waiting much longer with a rate hike. Meanwhile, central banks from Canada to Singapore are cutting their administered interest rates, or are adopting a dovish stance (New Zealand, Australia), or are engaging in outright money printing (ECB, BoJ). Bond yields keep plummeting all over the show, including those on treasuries, which benefit from still offering a sizable spread pick-up in today’s world of ZIRP, NIRP and negative yields on government bonds.

 

FOMC

 

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Taking Full Advantage of Winners

Investors returned from a three-day holiday and found stocks and gold right where they wanted them. Neither registered any change. So let’s return to the nuts and bolts of investing…

Take a look at your portfolio. Imagine how much better off you’d be if all those 50%… 60%… 80% losses were removed. Unless you’re a true “deep value” investor, and happy to ride out these drawdowns, you could do that by using a trailing stop. That’s the easy part.

“More important,” says TradeStops.com’s Dr. Richard Smith, “is that trailing stops allow you to take full advantage of your winners.”

You buy a stock. It doubles. What do you do? Many investors would sell, feeling that they had made a good profit. Why be greedy?

Often, they then watch as the stock goes higher and higher, as they sit on the sidelines grousing about having gotten out too soon. Old-timer Richard Russell, of Dow Theory Letters fame, tells the story of how he invested in Buffett’s Berkshire Hathaway in the early 1970s.

The stock doubled and he sold. He has been kicking himself ever since. Class A Berkshire Hathaway shares, which Buffett bought for $11 in 1962, are now worth $222,636.

 

Philippine-stock-market-board

Photo credit: Katrina Tuliao

 

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It’s Tough to Make Predictions, Especially About the Future

Markets were closed in the US on Monday for Martin Luther King Jr. Day. So, today, we really are going to talk about stop losses.

Mathematician Dr. Richard Smith, who runs TradeStops.com, was kind enough to visit us in Nicaragua and allow us to buy him a drink or two. He explained how they worked. And he told us about how he’s made them work even better.

“The world is much more uncertain than people think,” began the man with a Ph.D. in the subject.

“There are always far more potential outcomes than you can imagine. So, you’re going to be wrong about the future more often than you will be right.”

We have demonstrated that often enough ourselves. We needed no more proof. But Richard wouldn’t let up:

“Just look at the price of oil. There must be thousands of analysts and economists following the price of oil. Do you remember a single one forecasting $40 oil?”

 

buffett-uke

Warren Buffett: plays the Ukulele and has so much money he doesn’t need to worry about stops. Not to mention, when push comes to shove, his portfolio is also prone to becoming the beneficiary of bailouts, as demonstrated in 2008.

Photo credit: Dexter Shoes

 

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Sitting Tight

 

“If you don’t know who you are, this is an expensive place to find out.”

Adam Smith, The Money Game

 

On Thursday, the Dow slid 106 points, or 0.6%. Gold rose $30, or 2.5%, to settle at $1,264 an ounce – its highest level in four months. As commodities and energy fall, gold goes up. Hmmm ….

Today, we continue our series on investing. Our lunch yesterday was enjoyed in the company of Dr. Richard Smith, the mathematician behind TradeStops.com. He reminded us that investing is more than just numbers; it is flesh and blood… nerves and gut instincts.

“Guess who are the world’s best investors?” he asked.

“Rich people. And it’s not because they have more information or better advisers. It’s because they are calmer. They are not like the little guy who is worried about losing his retirement money.

“They can take the long view. They can follow the best old-timer advice on Wall Street: ‘Get right and sit tight.’”

 

Gold-commoditiesGold relative to commodities: a strong uptrend is underway – click to enlarge.

 

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Trends Can Change …

We saw the old year out in business class on Air France. We feted it with champagne and woke up in 2015 thinking about you. Many dear readers wrote to offer best wishes for the New Year. Others wrote with compliments on our book or new newsletter. Thanks to all… and best wishes to you for 2015. We hope to help make it a good year for you.

Often, readers accuse us of “negativity” or “excessive pessimism.” Typically, they also ask for “solutions.”

Perhaps the beginning of a new year would be a good time to address the issue. Chris presented a list of possible market surprises in 2015. Although oil at $40 a barrel and gold at $1,000 may sound shocking, for the most part these trends are already under way.

Trends continue until they end… which often takes many years. “More of the same” is usually what happens. But that doesn’t make it the best bet. The best bet has to take into account the consequences of being wrong. That’s where the negativity comes in.

The stock market may continue to go up in 2015. Investors may continue praying to Saint Janet, with positive results. US economic growth may continue.

But what if they don’t?

 

breadlines

Photo via Wikimedia Commons

 

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