The Stock Market


Positioning Indicators at new Extremes

We are updating our suite of sentiment data again, mainly because it is so fascinating that a historically rarely seen bullish consensus has emerged – after a rally that has taken the SPX up by slightly over 210% from its low. Admittedly, a slew of such records has occurred in the course of the past year or so, and so far has not managed to derail the market in the slightest– in fact, since 2012, only a single correction has occurred that even deserves the designation “correction” (as opposed to “barely noticeable dip”).

While a number of positioning and survey data show a bullish consensus that easily dwarfs anything that has been seen before, this consensus is not reflected in expressions of exuberance by the broader public. “Anecdotal” sentiment seems more cautious and skeptical than the quantitatively measurable kind. Most likely this is because the vast bulk of the middle class has been so thoroughly fleeced in the last two boom-bust sequences that it finds itself in dire straits in spite of the reemergence of major asset bubbles across a wide swathe of assets. This includes by the way an astonishing revival of the bubble in real estate prices – see e.g. this 330 square foot shack in San Francisco, which recently sold for $765,000:


expensive SF shackYes, that tiny dark-brown thingy situated on a steep road sold for $765,000. The real estate bubble is back.

(Photo credit: SFARMLS)


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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.



(Photo credit: fmh)


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Keep it Simple

We began buying gold in the late 1990s, when it was still cheap. To illustrate just how cheap it was, for a brief moment in 1980 you could buy nearly all of the 30 Dow stocks for just 1 ounce.

By 1999, the Dow had risen so high that you would have needed 43 ounces to perform the same trick. At this point, you could scarcely go wrong buying gold and selling stocks. Stocks were expensive; gold was cheap.

We are too lazy to do real stock research. And we are too inattentive for trading or meticulous timing systems. We don’t aim to beat the market. “Live and let live” is one of our market mottos.

Here’s an easy way to do it – a refinement of our Simplified Trading System (STS) described in previous Diary entries. You are either in stocks. Or you are in real money – gold. You buy stocks when they are cheap. You sell them when they are dear.

And you use roundish numbers to make it easy. When the Dow components are selling for 5 ounces of gold or less, you buy the Dow. When they are worth more than 20 ounces, you sell.


Dow-Gold-ratio200 years of the Dow-gold ratio, via sharelynx – click to enlarge.


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Non-Confirmations Still Persist

The S&P 500 has recently made a new high, in short the rebound from the mid October low has not failed at a lower high. Therefore, the clock has so to speak been reset. However, as our updated comparison chart between SPX and the major euro-land indexes shows, there is now a third divergence in place between them, and this one is even more glaring than the first two. Keep in mind that there such divergences have not always been meaningful in the past. However, when global markets are drifting apart, it is a sign that the global economy is no longer well-synchronized. Given that the Fed’s “QE inf.” is in relative pause mode (we hesitate to say it has ended), the situation is certainly worth keeping an eye on.


1-Euroland vs. SPXA third divergence between the SPX and the major continental European stock markets is now in place – click to enlarge.


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A Brief Look at the Technical Backdrop

We can actually not answer the question posed above with certainty. We don’t know for sure whether the recent market decline was a “warning shot” or merely a short term shake-out. In this we are in good company: the whole world doesn’t know.

However, our guess at this juncture is that the decline was of the “warning shot” variety, as it has violated long-standing uptrend support lines – something that the market has managed to avoid in previous corrections over the past three years. There are also fundamental reasons for thinking so, which we discuss briefly further below. However, based on fundamentals alone, it cannot be determined whether the stock market is already “ripe” for a larger degree decline, or whether its uptrend will resume in the short/medium term.

To be sure, the technical picture certainly conveys no certainties about the future either. However, should the market peak at a “typical” retracement level or at a previous lateral support level (thereby confirming its new status as resistance) and resume its decline from a lower high, yet another change in character will be recorded. In that case, the probability that a larger degree decline is underway would accordingly increase further.

Below are charts of the most important indexes showing Fibonacci retracement levels of the recent correction and lateral resistance levels. Although it is unknowable why the market often finds support or runs into resistance at Fibonacci retracement levels (there is certainly no logical reason for this), it has happened quite often in the past, so it is useful to be aware of them. Possibly it has become a self-fulfilling prophecy, because so many traders use technical analysis nowadays.


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More Back-Pedaling – This Time by a “Hawk”

We already pointed out on Tuesday and again on Wednesday that numerous signs of back-pedaling by Fed officials recently emerged – no doubt in reaction to the sudden wobble in “risk” assets (what else could have been the motivation?). On Wednesday we asked rhetorically whether San Francisco Fed president John Williams was actually serious.

Enter St. Louis Fed president James Bullard on Thursday, who only a few weeks ago was talking about wanting to alter the FOMC statement toward indicating a more hawkish tone. Nothing but a less than 10% dip in the spoos to completely change a monetary bureaucrat’s views these days. According to the FT:


“From the transcript of St Louis Fed president James Bullard’s interview with Bloomberg Television:

“I also think that inflation expectations are dropping in the U.S. And that is something that a central bank cannot abide. We have to make sure that inflation and inflation expectations remain near our target. And for that reason I think a reasonable response of the Fed in this situation would be to invoke the clause on the taper that said that the taper was data dependent. And we could go on pause on the taper at this juncture and wait until we see how the data shakes out into December. So… continue with QE at a very low level as we have it right now. And then assess our options going forward. …

My forecast is for rising inflation. That’s why I’m concerned about declining inflation expectations, the five-year TIPS in particular has declined below one and a half percent. The five-year forward is down from its previous levels. And the central bank has to guard against any expectations in the market that would suggest that the central bank is not going to hit its inflation target. So you have to be credible on your inflation target. So a simple – what I’m saying is that a simple step that we may be able to take or maybe the committee might consider at its October meeting would be to just take a pause on the taper, let more data accumulate and see how the U.S. is going to evolve over the rest of the year and into next year. …

I think you should quit numbering the QEs. I’ve been an advocate of having an open-ended program. I do think QE is our most powerful tool when the policy rate is at zero. And I think it’s far more powerful than forward guidance for instance. And I think we saw that during the taper tantrum of 2013. And therefore I think I’ve been for having an open-ended program that reacts to economic data. And so far we’ve been able to taper the program down on the face of really dramatically improving labor markets this year, but maybe this is a juncture where we’d want to invoke that clause about it being data dependent.”

The remarks follow the comments earlier this week by John Williams of the San Francisco Fed, who signaled his willingness to consider a new round of asset purchases if “a sustained, disinflationary forecast” emerges.


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Autumn Blues

The Dow ended the session down 173 points On Thursday, after falling more than 300 points during the day.

Press reports told us that investors were worried about weak US consumer sales and falling producer prices. Combined with falling crude oil prices, these make it look as though a European-style slump is coming to the whole world. But what did you expect?

It is autumn. The days dwindle down … life closes in on you. It comes as a shock. Like when you turn 60 and you suddenly realize that you are … alas … mortal.

You will not make an infinite amount of money in your lifetime; in fact, you’ve already made most of what you’re likely to make. You will not drink an infinite number of martinis… or have an infinite number of friends… or hear an infinite number of concerts.

Au contraire, the numbers in your life are limited… and probably already undergoing some shrinkage. Your height. Your savings. The years left to you … the number of times you’ll get sick or fall down drunk.

They’re all getting smaller. Then you have to think more carefully about what you’re going to do with the numbers you’ve got left.



Saint Petersburg

(Photo credit: fmh)

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Liquidity Dries Up

The Dow Transports managed a bounce on Tuesday. The Dow Industrials just couldn’t get in the mood. They ended the day with a small decline. From financial commentator Wolf Richter:


“80% of the stocks in the Russell 3000 [a good proxy for the entire US stock market] are 10% or more below their highs, according to Bloomberg. Many of them have gotten demolished. Some have gone bankrupt as the appetite for high-risk debt at these low yields is drying up.”


Whether this is the beginning of a major correction or not, we don’t know. We haven’t gotten the email.

But with the Fed ending QE this month, it seems likely that something will give. Zero interest rates and QE bailed out the financial sector, stabilized housing and helped send the S&P 500 up 130% from its March 2009 low. What will the end of QE do? We don’t know, but we’re eager to find out.

Japan and Europe are pumping out trillions of yen and euro in new credit. In the US, Janet Yellen hopes and prays this will be enough to hold off trouble worldwide. Without substantial global liquidity, the US stock market is likely to keep going down.


RUA Russell 3000 Index and percentage of NYSE stocks above their 200 day moving average – via StockCharts, click to enlarge.

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SPX Slices Through 200-dma

On Monday, the stock market tried to put together a rally all day long – then it fell completely apart in the final hour of trading. In the process, the S&P 500 index sliced through its 200 day moving average for the first time since late 2012 – without even making a pit stop. The intra-day action can be seen below:


1-SPX-intradaySPX, intra-day: a bad final hour of trading – click to enlarge.


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Getting Worried

New England is stunning this time of year. Just what you’d expect. The leaves turn brown, yellow and red, putting on their best outfits and strutting their stuff in the cool autumn air.

Autumn, especially in New England, is the loveliest time of the year. The sun barely clears the tops of the trees, even at noon. The light, filtered through the colored leaves, gives the earth the rich and heavy air of a funeral parlor.

Perhaps that is why there are market crashes in the fall. Investors feel the approach of death. The stock market fell hard on Thursday … and then kept falling on Friday. Before the week was over, investors were worried.

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A Major Move Lower for Stocks

Wow! Dow down 334 on Thursday. Talk about volatility. Things are getting interesting. Meanwhile, what’s wrong with the Bowery?

We search high and low. We can’t find a bum or an alcoholic. The area no longer looks anything like the old down-and-out Bowery of the 1960s and 1970s. Everywhere you look you see the latest fashions… chic New Yorkers… and $600-a-night hotel rooms.

Last night at dinner, our companion nodded toward a nearby table and said, “Look, there’s Michelle Pfeiffer.”

The name sounded familiar, but we couldn’t place her. So we were not as impressed as we should have been. But the Bowery has definitely gone upscale.


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Stocks Yanked Back and Forth by Fed “Jawboning”

Back in mid September we presented an update of our chart comparing the stock markets of the euro area’s two largest economies with the S&P 500 (originally our main concern were the glaring divergences between them) and wondered aloud if the DAX and CAC 40 had just “back-kissed” their broken trend lines.

This is what the situation looks like as of Thursday’s close – we left our annotations from September 15 (in blue) on the chart – the added wording is in green.


1-Back-kiss-updateThe “trendline back-kiss” idea has in the meantime been fully confirmed – click to enlarge.


One thing we would like to point out here is that no divergence exists as of yet with respect to the recent lows – neither the European indexes nor the SPX have as of yet undercut the previous short term low made in August.

The same can not be said of the downside leader Russell 2000, which landed at a new low for the year on Thursday. Along similar lines, the broad-based NYA has undercut its August low clearly by now. It is also worth noting that market internals continue to exhibit significant deterioration – e.g. new lows expanded to 2 – 3 year highs this week, depending on the index one cared to look at.


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What If …

When we left off yesterday we were worried. What if we have seen the highs in US stocks and bonds – not just for the next five or 10 years… but for the rest of our lifetimes?

On Tuesday, the Dow fell 272 points. No big deal, of course. But what if it continues?

Just six years ago it fell 51%. It could easily do so again – back down to, say, 8,000. There would be nothing unusual about it. Fifty percent corrections are normal. You know what would happen, don’t you?

Ever since the “Black Monday” stock market crash in 1987 it has been standard procedure for the Fed to react quickly.

But what if Yellen & Co. got out the party favors… set up the booze on the counter … laid out some dishes with pretzels and olives …  and nobody came? What if the stock market stayed down for 30 years, as it has in Japan?



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A Blast from the Past

In his most recent commentary on the stock market, John Hussman makes a few important observations. Very often, bubble-like advances in financial asset prices can become far more extended than rational, sober observers think possible. One result of this is that those who are warning that the situation is inherently unsustainable are often dismissed as “perma-bears” not worth heeding anymore. It is certainly a label Hussman has been stuck with, although it is simply not true (he is known for taking constructive stances on the market when valuations and /or constructive market internals suggest they are appropriate).

The important point is however this: the warnings (which are both fundamentally and technically based in Hussman’s case) do not become less important when a bubble stretches further, but more so. Moreover, a greater overshoot does not create a “cushion” that ensures that one cannot lose. It merely creates conditions that are more likely to eventually produce an all the more pronounced reaction. Here are a few pertinent excerpts from Hussman’s update:


“The lesson we’ve drawn from recent years is not that historically reliable valuation measures are no longer useful. It’s  not  that overvalued, overbought, overbullish conditions can persist indefinitely without awful consequences. It’s not that “this time is different” in some way that cannot be accounted for with historically-informed methods.

The primary difference between the half-cycle since 2009 and prior market cycles across history is that overvalued, overbought, overbullish conditions have been extended to further extremes, without a material correction, for a much longer period than usual as a result of yield-seeking speculation. The central lesson we’ve drawn is about the criteria that distinguish when the consequences of overvalued, overbought, overbullish extremes may be deferred, and when those consequences are likely to emerge with a vengeance.


We now observe conditions under which the belief that “this time is different” has historically been most likely to implode.

There’s really no point in trying to convert anyone to our viewpoint. Somebody will have to hold stocks over the completion of the present cycle, and encouraging one investor to reduce risk simply means that someone else will have to bear it instead. But for those who understand the narrative of the recent half-cycle, where our challenges have been, and how we’ve addressed them, I do encourage reviewing all risk exposures from the standpoint of the losses that have repeatedly occurred over the completion of market cycles that have reached valuations anywhere near current levels (1929, 1972, 1987, 2000, and 2007). The point is not to discourage stock holdings entirely, but rather to ensure that exposure is not so large that a steep market loss would be intolerable. It’s important to recognize that the market is not only at a point where unusually rich valuations are already in place, but also where market internals and our measures of trend uniformity have clearly deteriorated. This is the most hostile set of market conditions we identify, and it closely overlaps periods in which the stock market has been vulnerable to abrupt air-pockets, free-falls, and crashes.


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The Mantra

Yesterday, gold climbed back above $1,200 an ounce. US stocks went nowhere. Meanwhile, a chill went down our spine. A sense of dread filled our frontal cortex.

We read a report that was designed to give investors courage and hope. Instead, it felt to us like a guilty verdict in a murder trial. Even with good behavior, our sentence would probably last longer than we would.

A chart told the story. It showed three bull markets over the last 20 years. In the 1990s, the S&P 500 total return was 227%. Then from 2002 to 2007, another bull market. The total return this time: 108%. And from 2009 to 2014, the S&P 500 returned another 195%.

The lesson is unmistakable. It tells you to get in stocks… and stay in. If the market has a fainting spell, don’t get dizzy. Stick with stocks!


1-SPXDon’t let the occasional 50-60% crashes disturb your peace of mind! You will always win in the long run! Long term bear markets don’t exist…well, maybe except in Japan. And much of the 18th century. But other than that, nothing can go wrong – click to enlarge.

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