The Stock Market


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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IPOs and Secondaries Surge

Alibaba’s IPO last week – which amounted to $21 billion in value – was the biggest in history. It was also wildly successful, as the stock surged by 38% on its first trading day. However, the US IPO market was already heating up before Alibaba’s debut: Q2 2014 saw the heaviest issuance since Q4 2007.

Recall that in spite of the fact that NBER later dated the beginning of the recession to Q4 2007, there was zero awareness that a recession might even be in store at the time. In October of 2007, shares in companies that would be bankrupt and in need of bailouts a few months later were still trading in the stratosphere (Fannie Mae’s common stock changed hands for $70, shares in mortgage insurer Ambac did likewise – the latter eventually fell to less that 2 cents). The opinion of the bien pensants at the time was that the “sub-prime mortgage credit crisis was well contained”, and the DJ Transportation Average even climbed to a new all time high in May of 2008. So Q4 2007 was definitely still a fairly good time to flog IPOs.

The time is even better now – in the wake of Alibaba’s IPO, 2014 is already all but certain to break previous issuance records. Here is a chart showing the pre-Alibaba situation as of Q2:


q2-2014-ipo-watch-press-release--value-and-volume-of-ipos-by-quarterBy Q2 2014, 160 IPOs had been issued – almost as many as in the 7 quarters Q1 2009-Q3 2010. 2011 and 2012 were relatively quiet years, but that has changed in 2013 as the market continued to surge. 2014 is well on its way to becoming a record year – click to enlarge.

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The Danger of Reaching for Apples High Up in the Tree

The Dow has risen back above 17,000. All clear. US stock market investors: Your money will probably not die today. Maybe tomorrow. But does it really make sense to be in the US stock market now?

There may be apples higher up in this tree, but it is dangerous to reach for them. We came up with our Simplified Trading System (STS) a long time ago as a way to tell us when it was time to put away the ladder. We weren’t completely serious about it then… and still aren’t now.

Still, it’s a great system … but only for people with the life expectancy of Methuselah and boundless patience. The original idea was that there was a time to be in stocks and a time to be out.

When you were out … you just stayed in cash. And because we’re talking about long periods of being in cash, you should be in the “cash” that holds up over time: gold.


P/E < 10 = Buy stocks.

P/E > 20 = Sell stocks.

Otherwise = Gold.


Simple? Well, yes and no. You have to decide how you’re going to calculate the P/E ratio, for example. And therein hangs a long and complicated tale …


123Fur traders in Canada, trading with First Nations, 1777

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Actions and Consequences

October is coming. Excess liquidity is disappearing. And with the S&P 500 on a trailing P/E of 19.7, the index is fast approaching “sell territory.” Watch out.

We finished our series on investment theory last week. Now we turn to practical application. There are three parts to the investment world. The first part is Aristotelian, Cartesian, Pythagorean. It is a world of logic and calculations. He who calculates best wins.

The second part is Socratic and Emersonian. The investment world, like the rest of the world, follows moral rules. When you do something “wrong” you will pay the consequences.


Aristotle_Altemps_Inv8575-1-1024x533Aristotle, hewn in stone


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A Test of Broken Trendlines from Below?

The divergence between US and European stock markets which we discussed in late August continues to persist. This happens in spite of the fact that major European markets have been somewhat stronger than US markets in recent weeks, no doubt due to further easing by the ECB – which was first anticipated, and then became reality. In fact, the measures announced by the ECB “exceeded expectations”.

Below is an updated version of the chart we showed previously. Germany’s DAX and France’s CAC-40 have rallied back to their previously broken trendlines and appear to be turning down from there. If they fail to exceed the recent interim peaks, their divergence with the SPX will so to speak have been “perfected”. Note though that we have seen similar short term divergences between these markets before (it happened e.g. in the summer of 2013), so it remains to be seen if they are meaningful this time.

Even though one cannot be certain yet whether it is an important signal, it is something we are keeping an eye on, especially as all these markets are far more stretched to the upside than they were previously. We have picked the DAX and CAC-40 on purpose, because they are the stock markets of the euro zone’s “core” countries. Moreover, the DAX has been Europe’s strongest market, the only one that has managed to reach new all time highs since the 2008 crisis. To be sure, the divergence is relatively small at this juncture, due to the recent strength in European stocks. Obviously though, no-one is going to ring a bell and shout “this time it means something”, even if it later turns out that it did. So it probably pays to be aware of these things in good time. If the divergences are going to be invalidated, it is in any case likely to happen soon, as it would require only very little by way of an additional advance.

Another reason why these divergences may actually be more meaningful this time around is that a very similar divergence between SPX and HYG (an ETF serving as a proxy for high yield debt) has recently formed.


1-european-DivergenceDAX, CAC-40 and SPX – the former are still diverging from the latter and may just have put in a lower high right at their previous trendline support – click to enlarge.


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That Tattered Flag

Yesterday, we took part in an “Ask Me Anything” session related to our latest book, Hormegeddon, on social news site Reddit. The format – the public writes in with questions and the interviewee (your editor in this case) answers them in “real time” – was new to me. So, many thanks to all those who tuned in. And many more thanks to all those who had cheerful words of encouragement.

One of the questions to come to us yesterday: What happened to our old, tattered “Crash Alert” flag? The answer is we had to take it down. The ol’ Black ‘n Blue flag had been up for so long – battered by wind, rain, sun… and trampled by stampeding bulls – that there was barely anything left of it.

It was becoming embarrassing. But it should be flying high again now… warning of the danger of a surprise bear market.

October is coming. And according to one of our favorite economists, Richard Duncan, the risk of heightened volatility is rising … as excess liquidity disappears from the marketplace. Beware.



tattered flag, unrec-newMaybe it will become a little less tattered soon …

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Investing Simplified

Still nothing much to write home about on Wall Street. No big selloff. No big boom. It’s late summer. US stocks are high and mama’s good lookin’ …

When we left off our series yesterday, we had run through the basics of the Efficient Market Hypothesis (EMH)… the reasons it is flawed… and how you can benefit from other investors’ mistakes.

Just do the math. When a stock is worth more than the market price, sell. When it is worth less, buy. When it is in between, just sit tight. There, what could be simpler?


security The Graham & Dodd classic on value investing

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We’ll Have to Add Them to the Endangered Species List …


bearThe kind of bad-ass bear that inhabits nightmares. You don’t want to meet this one when he’s in a bad mood

(Photo via


As we recently pointed out, stock market bears are a dying breed (see “Total Capitulation of the Bears” for details). The WWF’s official endangered species list contains only a handful of members of the family Ursidae, which range from “vulnerable” (polar bear) to “least concern” (brown bear). The Wall Street bear clearly is in a lot more danger.

What prompts this missive is news that yet another prominent bear has apparently given up. The thing is, this bear – Wells Fargo analyst Gina Martin Adams – wasn’t even a bear, but merely a somewhat reluctant bull, whose targets got taken out a few times. It is interesting from a psychological perspective that a not overly foaming-at-the-mouth bull is considered a “bear” by the financial media, a “famous bear” even. She has now recanted, and has apparently been preceded by several others. An SPX target of 1850 points apparently made her the “most bearish strategist” on Wall Street!


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Newsletter Writers Turn Very Bearish

This is a little addendum to our recent gold update. Shortly after we had posted it, Mark Hulbert published an article at Marketwatch regarding the recent moves in the Gold Newsletter Writer Sentiment Index (HGNSI). Note here that this sentiment measure must be seen in the context of market action. As we have pointed out previously, there have been a number of very significant ‘misses’ of this indicator, especially in early 2003 and early 2004, when following its message would have been a grave mistake.

However, there is also the fact to consider that today’s gold-focused newsletter writers are probably not the same bunch that was active 10 years ago. Many of those who were active in 2003 had survived a 20 year long bear market, so their collective judgment was at times actually quite good.

To Mr. Hulbert’s credit, we must concede that his indicator has worked better in recent years, and his interpretations of it in the course of this year have largely been on the mark. That’s actually a good thing, as the indicator is currently showing an extreme in negative sentiment.

Here is the chart:


1-HGNSIHulbert Gold Newsletter Writer Sentiment Index – currently it stands at – 40.6% – click to enlarge.


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Looking at the Big Picture

Step back. Look at the big picture. Stocks are near record highs. Investor sentiment has never been more bullish. The VIX, which shows the options market’s expectation of 30-day volatility in stocks, is near record lows.

But the US stock market – broadly measured by the S&P 500 – is “above the line” of our Simplified Trading System (STS). It’s trading above 20 times reported earnings. The index could go much higher. But our simple approach tells us that the safe gains are behind us. It is better to be out than in.



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You’re Not Over the Hill If You Don’t Remember Any Hill …

Yesterday, we turned 66 years old. When did we get so old? We can’t remember. But 66 is still young. Everybody says so. Especially mother, who is 93, and our uncle, who is 96.

For our birthday, we went with Elizabeth to Le Dôme du Marais – a nice restaurant in the Marais district of Paris. It’s housed in a handsome round building that was once a pawnshop.

The pawnshop had been set up, explained the menu, by Louis IX to combat usury. In the days before credit cards, people could come to the pawnshop, rather than going to loan sharks, for their financing needs. Le Marais is a charming part of the city. Narrow streets. Ancient buildings. Chic shops. It is much more fashionable and cosmopolitan than our neighborhood.

At one table was a group of young professionals (perhaps in finance) – some from England, some Americans, an Asian… and others. It looked very much like a group you’d see in London or New York. At another table was a couple we took to be Scandinavian… or Russian. An American couple sat at yet another table but left early.

“That didn’t seem like Paris,” said Elizabeth. “It could have been anywhere.” Now, the small talk out of the way, let us return to our main subject: how to invest intelligently in an uncertain world.

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One of Wall Street’s “Biggest Bears” Throws the Towel

Recently we have come across one of those forecasts that are a dime a dozen these days, and usually escape our attention. The article at Marketwatch, entitled Bull could run 5 more years, carry S&P 500 close to 3,000only seemed interesting because the forecast sounded a bit extreme. We quickly scanned the headline, thinking that whoever was making this assertion surely hadn’t breathed a word about this when the SPX traded at just below 670 points in March of 2009. Such wildly bullish forecasts are strictly a function of SPX 2000 in our opinion, on a par with the “Dow 36,000” forecast, which gained some notoriety in the late 90s. One of the reasons behind the SPX 3000 forecast mentioned in the article did amuse us greatly though, namely the following:


They cite extensive deleveraging in the U.S. as well as the uneven global recovery among other reasons why “this could prove to be the longest U.S. expansion – ever.”


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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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Political Troubles in Bulgaria

We have previously written about “Bulgaria's Strange Bank Run”, but is appears the saga is not quite over yet, so we are providing an update on the  developments since then. Keep also the curious temporal synchronicity with the most recent developments in the South Stream saga in mind. We have wondered if there could be a connection between these events. We don't know obviously, and have as of yet not seen the possibility mentioned anywhere. It wouldn't surprise us though.

There have been extensive protests against the government of technocrat Plamen Oresharski in Sofia in 2013 that were originally triggered by the appointment of Bulgarian media mogul Delyan Peevski to the post of chief of the National Security Agency. The parliamentary debate on his nomination reportedly took a mere 15 minutes. The protests then forced the government to fire Peevsky from his post again a month later (officially, he withdrew voluntarily). However, the protests still continued thereafter.



Protests against the appointment of Peevsky as head of the State Agency of National Security began in Sofia in mid 2013. The demonstrations had been organized via Facebook. A number of academics declared themselves appalled at the anti-communist slant of the protests. For instance, the chairman of the Institute for Modern Politics, Borislav Tsekov, reportedly deplored the "primitive anti-communism" espoused by the protesters. However, there also were rumors that the usual suspect Western NGOs were behind the protests. The demonstrations curiously dwindled right after the government indicated it would greenlight the construction of a nuclear power plant by Westinghouse. This has subsequently indeed happened (see the preceding article on South Stream).

(Photo via Wikimedia Commons, by AlexaHR)


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THE GOLD CARTEL: Government Intervention on Gold, the Mega Bubble in Paper and What This Means for Your Future