The Stock Market

 

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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CPI and the “Wealth Effect”

In Poker, to go all in means to bet everything you have. I do not think it is an exaggeration to say that, at least so far as the mainstream audience is concerned, we gold advocates have gone all in. We have made one argument: we should adopt the gold standard, because inflation. By inflation, it is generally meant rising consumer prices (this is not my definition), again at least so far as the mainstream audience goes.

It’s true. Prices have been rising relentlessly since the Federal Reserve Act of 1913. We certainly have made the argument that inflation happens in paper money, but not in gold. I think most people believe that, despite the obfuscations of the diehard apologists for the Fed.

I think people care about inflation—but not that much. People who work for wages mostly get mad at their boss for not giving them a big enough raise. People who are retired on a pension mostly get mad at the politicians for the same reason. They complain that the cost of living adjustment is not enough.

What about the rich? This graph explains why the rich are not at all unhappy.

 

chart-1-stocks-vs-CPIThe SPX vs. CPI, via Monetary Metals, click to enlarge.

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Purely Technical Conclusions

In the past, Rick’s Picks has shunned year-end predictions because there are far too many variables to handicap accurately. I’ve decided to take a crack at it anyway this year because I was curious to see what conclusions purely technical analysis would yield for some widely followed issues.

I’m no seer, just a chartist, and I’ll say up front that the question of whether the Dow Industrials are trading at 23,000 at the end of 2015, or at 14,000, is probably no better than a coin-toss bet. Also, because the stock market is a house of cards and only distantly connected to economic reality, only a fool would try to predict the timing of The Big One that we all know is coming.

Stocks could collapse at any moment, to be sure, and although I doubt this will occur next year, the odds are hardly remote. If you absolutely need to know when calamity will strike, I recommend checking the year-end predictions of Bob Prechter, Martin Armstrong and Ross Clark, since they are the very best timers in the guru world.

 

Forecasts-fpr-2015-and-beyondRick Ackerman’s stock market picks with the most bullish, most bearish, and “outrageous” target price alternatives

 

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A Brief Update of Rydex Ratios

There is no need to say much to this, except to state that the Rydex ratio indicator has reached fresh heights of absurdity … almost 25 times more assets are now invested in bull & sector funds than in bear funds. This is a full seven times more than at the peak in early 2000, and frankly, at the time we thought we would never see such data points again. As we noted in a previous update already, the recent surge in the bull-bear ratio could only be achieved with sizable inflows – price gains alone cannot possibly explain it. We conclude that everybody was, or rather remains, absolutely certain that the market will rally into year-end and beyond, because that is what it almost always does.

Naturally, no-one has ever seen the market decline sharply in December (although a few major market peaks have indeed occurred in early December, but even that is rare), not least because the last time it happened was exactly a century ago, in 1914. At the time it was decided to simply close the exchange for a few months instead of risking even more carnage. Meanwhile, the “war to end all wars” was raging and laid the foundation for another, even bigger war.

First a look at the leveraged Rydex ratio (comparing assets in leveraged bull vs. leveraged bear funds). This particular ratio has just pulled back a bit from the record high recorded less than two weeks ago:

 

1-Leveraged Rydex ratioPulling back from the December 1 record high of 15 – which was approximately a million light years from every previous record except the one made at the end of 2013 – click to enlarge.

 

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New York Lumberjacks

It’s cold here in Manhattan. We’ve never lived in New York. And every previous visit had left us unenthusiastic.

The city is not pretty …  at least not compared to Paris. And Lower Manhattan always seemed gritty, dirty and unkempt. Like a homely man or a homeless woman.

But a lot has changed. New York is now full of foreigners. Enter our hotel lobby and you hear a din of strange and familiar accents: English, French, Russian… and many we’ve never heard before (We make a small contribution to the cacophony by taking Portuguese lessons in the tearoom).

Soho is full of young people – often dressed in country duds. Almost all the men below 40 have facial hair. One man at a fancy restaurant we were eating in wore a plaid shirt and had a full beard. He looked like a lumberjack.

“That’s the style,” said our 26-year-old son, Jules. Here on the Bowery the pace is fast… and there are new shops, luxury stores and chic restaurants on every street. Just a few blocks away is Wall Street. Thanks largely to the feds, more and more of the world’s wealth runs through the US financial industry.

 

lumberjack

He’s a lumberjack and he’s OK … (non-NY lumberjack)

Screenshot taken from Monty Python’s ‘Flying Circus’

 

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Still too Much Debt

A faint breeze blew through the US stock exchanges on Friday. A few leaves fluttered. But Diary readers want to know: When is the next hurricane coming?

Alas, we get the newspaper no earlier than anyone else. It always has yesterday’s news… not tomorrow’s. That leaves us wondering and guessing and trying to figure out what comes next.

The storm that raged in 2008 was fundamentally deflationary. It was so predictable that we didn’t need tomorrow’s headlines; the weather forecast was obvious.

After decades of taking on debt, Americans started to stagger under the weight of their debt-service costs. When house prices fell, their knees buckled and their backs broke.

Households cut spending and reduced borrowing. But they are still heavily in debt. In 1971 – before the big credit bubble began inflating under the new fiat currency regime – American households had $5 of income for every $4 of debt.

Now, for every $5 of household income they have $12 of debt. That’s down from the “peak debt” of 2007 – at $13 for every $5 of disposable income – but still much more than the historic average.

 

debt-to-income

Household debt-to-income ratios of US and Canada (Canada’s housing bubble hasn’t burst yet, hence the divergence in trends) – click to enlarge.

 

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The River of No Returns

E-commerce giant Amazon.com has raised $6 billion in debt financing. Investors readily throw their money into the River of No Returns.

Lenders are demanding a yield of 3.8% for Amazon’s 10-year bonds. That’s 150 basis points over the US Treasury’s 10-year borrowing costs. (A basis point is 1/100th of one percentage point.)

Amazon’s bond buyers worry neither about the return on their money nor the return of their money.

Holders of the company’s stock are even more  sans souci. If you look up Amazon’s P/E ratio, you’ll find it listed as N/A – for “non-applicable.” That’s because the company is losing money.

After 20 years, Jeff Bezos’s online marketplace has never learned how to make a profit. The last quarterly report showed it with losses of about $1 a share – or about $2.50 on every hundred dollars of sales.

 

1204-dre-blogPhoto credit: Amazon.com

 

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