Friday, April 26, 2013

Bond Speculators Jump On Board, May Even Bring Rates To New Lows

The FINVIZ charts I follow finally show that the large and small traders combined have taken a very small net long position in the 30 year bond.  This follows increasing interest amongst traders in the 10 year bond, which has now spread to the 30 year.  This all got going in mid-March with the Cyprus banking mess.  With the Bundesbank taking a public hard line on money-printing, ongoing depression in Spain, and several weeks of disappointing macro news in the US including multiple April Fed mfg surveys being punk, plus seasonal factors, bond markets are set up to make new lows in the summer for the fourth year in a row.  I'm working on different models and will note them when that effort is complete.

This is beginning to resemble the 5-year stock run between the historic Republican takeover of Congress in the 1994 election, after which gridlock allowed both spending growth to be nominal and tax cuts to be made.  This goosed stocks and bonds, stocks more so.  Following the brief inventory restocking after the "Great Recession",  the ongoing global macroeconomic weakness has led to the lowest interest rates globally in history.  As with interest rates on the upside in the '70s into the early '80s, and stocks in the '90s into Y2K, so it may be with interest rates.  Stocks look tired, and speculators have been heavily long them for 6 months.  This is about how long a major upside explosion tends to last to mark the end of a trend.  This was the pattern with silver in 2011, for example.

In any case, the powerful bond bull really got going, as mentioned, in mid-March with an upside gap.  The stock rally really got going Jan. 2 with an upside gap.  That breakout lasted over 3 months.  If indeed something similar occurs with bonds, then stocks will do well to consolidate rather than sell off.

As a reminder, earnings are coming in at best as expected, with a good deal of downside guidance for Q2, and the quantitative Value Line estimate made at the end of 2012 for this year was for an average Dow of 13,440, though with a wide error range.  This has had a good track record.  My bias is therefore that downside risks exceed upside opportunity now.  Thus we may see something that looks like 2011.

Monday, April 22, 2013

Stocks Continue on Thin Ice, Bonds Continue to Get Little Respect

Today's market action continues the pretense that stocks provide any security of receiving one's nominal money back, valued in US dollars or gold.  CAT is an example.  Disastrous quarterly results and similarly disastrous projections can't drop the stock again. It already is exactly where is was in October 2010.  It no longer matters that it was over $100.  CAT sells well above book value and has made poor acquisitions of Bucyrus (as it now appears) and the Chinese company that it now claims had fraudulent accounting.  Meanwhile the nonsense of KO and PEP "beating expectations" but with yoy sales growth trailing price increases, leading to sharp markups of the share price is indicative of distribution of stock to anxious retail clients searching for the magic bullet.  This "bullet" is supposed to triangulate triumphantly between the Scylla of low bond yields and the Charybdis of inflation.  This will work until it doesn't.  I "like" a couple of special situations such as YHOO and BLK, but my stock allocation is near record lows, i.e. close to zero.  I'm not at zero as I think that gradually stocks are becoming more attractive than bonds, even on a risk-adjusted basis-- but the history of the US post-Depression and of Japan post-ZIRP suggests that relative valuations of stock dividends vs. bond yields has more to go before stocks really bottom.

Meanwhile, on another front, about last June I penned a post on TDC about the Fed(s) blowing Housing Bubble 2.0; yet I was skeptical about the housing stocks.  And indeed, the housing stocks promptly correct 5+% and then surged.  Yet they are sinking due to vast over-valuation.  The cream of the crop, NVR, is down big on a "miss" today.  TOL is wildly overvalued based on analyst's EPS projections for 2013 and 2014.

I continue to believe that most retail money is best off in tax-exempts of quality, duration, character to suit.  The closed-end funds such as Nuveen (where I shop for CEFs) are where my more aggressive and "for sale" tax-exempts are allocated, but individually-owned bonds, while much less liquid, are much safer.  After all, they expire, possibly when stocks will be cheap again (could that actually occur?), and possibly when interest rates will appear more attractive.

Finally, it's unclear how unattractive bonds actually are now.  The stock GCC tracks an overall commodities index.  It is sinking.  It parallels realized inflation.  Between China and the euro mess, another period of "deflation" might just be occurring, vs. disinflation.  The bond market may be the current equivalent of the NAZ in the late '90s:  over-valued but with prices amazingly just moving on up.

Thursday, April 18, 2013

Are Bonds Going to Be the Next Investment Fad?

CNBC "reports"  (LINK):
Get Ready to Play the Coming Deflation Trade
  What seemed like economic fantasy could soon become cold reality as the global economy wrestles with deflation despite hundreds of billions in central bank money creation.Investors have been fleeing assets normally linked with economic growth such as materials stocks, energy commodities and copper...
And one prominent Federal Reserve member this week openly discussed whether the U.S. central bank needs to accelerate, rather than pull back, its asset purchase program.
 Meanwhile, the intellectual underpinnings for minimal price inflation have been updated by Lacy Hunt of Hoisington Management (LINK) in a speech given last fall.  In it, he criticizes those who call themselves Keynesians, who simply want more and more government borrowing.  He raised the question of whether Keynes himself would have approved of this policy.  In any case, he makes the argument for the possibility of debt deflation.  In Hoisington's recent quarterly update (LINK), he and Van Hoisington reiterate a point they have made before.  They differentiate between base money at the Fed as a result of quantitative easing and M2.  They point to M2 acting very differently from base money and note that M2 has not been rising lately.  Both are good reads.

They are also relevant to the recent flap about Rogoff-Reinhart's 90% level for government debt.  They bring up other research that supports the concept.  It's really not the amount of debt that counts, it's how wisely it was lent and how well the borrowed funds were spent.  That said, it makes sense that there are usually only a certain percent of a country's wealth or yearly production that allow for sound investments.  The US clearly went beyond that point last decade, resulting in the multiple insolvencies and near-insolvencies.  Since 2008, some debts were written off, but most were not.  Numerous more debts have now been incurred.

With gold the yellow canary in the coal mine, and Dr. Copper the redbird acting the same way, and with Mr. Bond now singing a bearish song, the following economic portent from Goldman Sachs comes as no surprise (LINK):

Note this is global, not US.  But as the US shrinks its deficit spending as a share of GDP, its economy begins to revert to the mean.  The US does however have two identifiable tailwinds that many other countries lack.  One is the diminution in war-fighting from the Afghan stand-down.  The other is the well-publicized hydrocarbon output upsurge.  So it may be that the US will again outperform the global economy; but Europe could go from bad to worse post-Cyprus and this could be cold comfort.

If it pans out that Europe is finally the cause of a major global recession as the US was in 2008, then the US will be part of it, debt deflation will hit again, and bonds may actually become respected and even sought after.  If so, they will trade at undreamt of yields.

When CNBC starts banging the deflation gong, it may just mean something.

Wednesday, April 17, 2013

Jeremy Grantham Updates His Projections, Is Ultra-Bearish On US Stocks

Mr Grantham, of, yesterday provided his 7-year estimates for different asset classes based on data from the end of March.  He now gives US large cap and small cap stocks about a zero annual total return, including dividends, over this seven year span.  This brings him to where John Hussman has been for a while, using lower stock market averages.  But similar, indeed.

This appears reasonable to me, from a q and CAPE perspective and from looking at balance sheets.
Investors appear to have forgotten that financial asset value matters.  It's not all about earnings.

Where Grantham is mildly optimistic still is that he has an undefined category that he calls "High quality US stocks".  It's unclear which stocks these are.  Are they stocks of high quality companies, many of which are at very high valuations?  I'd be a bit skeptical that in a well-studied market, the average stock is poised to underperform a specified smallish group of equities by what comes out to 5% yearly (he assumes 2% price inflation).

His fundamental analysis thus is now in accord with my long-standing view that the average investor in taxable accounts should mostly just own tax-exempt bonds, which at least on a 7-year basis can return about the anticipated rate of CPI inflation.

In any case, with both interest rates and commodities in well-defined downtrends, and with gold's smash downward suggesting liquidity issues somewhere (eurozone/Cyprus?), the case for US stocks is weak perhaps for the next 6 months.

Stocks for the long run?  Maybe the very long run...

Monday, April 15, 2013

Much More Than Gold Going Down

Perhaps the amazing drop in gold relates to a forced seller or sellers.  And, perhaps the Cyprus bank closures are necessitating that.  Or course, that's a speculation.  In any case, platinum is plunging, and copper and oil are following the pattern of lower rally highs ever since their 2011 peaks.

The ECB has been a deflationary force.  It has not opened the monetary floodgates, instead forcing internal deflation on the improvident borrowing, debtor countries.  Those chickens may be coming home to roost now.  If so, look out below for US stocks.  A 20% haircut would be a gift if another deflationary recession comes now to America.  50% down is possible based on fair value around 100 on the SPY.  One of these days, history suggests that stocks will actually be undervalued again.  I went virtually out of stocks last week, mostly on Friday as I took gold's plunge as suggesting price deflation and/or illiquidity problems (they are similar problems).  So stocks, which have been discounting both lower interest rates and hedging inflation may have to be stuck with lower interest rates for a good reason-- i.e. 2008 all over again.  Though, this time the acute problem is palpably the eurozone.  Just as the US problems harmed the global economy in 2008, the eurozone and Europe as an entity could be doing something similar now.

Timing of events, and certainty, is impossible.  But as we are seeing with gold, things happen on a Friday and then a Monday, and poof.  This is what happened in the crash of 1987, BTW.

Friday, April 12, 2013

A Top Approaches?

Everything is relative in the markets.  A mediocre economic performance despite large fiscal deficits and gobs of new money creation by the central bank deserves a low P/E.  Yet we have very high Shiller P/E's now.  Probably the dominant view now is typified by ilene, posting on ZH today.  The capsule teaser reads:

ilene04/12/2013 - 01:00Typically the public enters the market after a large run up, in time to buy at the top. Not there yet. 
The actual article (LINK) provides the conventional view:

Typically the public enters the market only after a large run up, just in time to buy at the top. Investors might get luckier in today's situation if American stocks start behaving more like the Nikkei 225 index. US equities have plenty of room to run simply as hedges against massive money-printing by Chairman Bernanke. 
But this view is demonstrably incorrect.  If Fed actions require hedging, presumably because they are inflationary (by definition under Austrian economics), then soon enough interest rates will do what they did in the US in the 1960s and '70s and rise.  This will bring down P/E's and the inflation tends to lead to shrinking profit margins.  So all you can predict in that scenario is that stocks will outperform long-term bonds.  

Reluctant bulls, but bulls nonetheless, are everywhere.  ECRI is one.  A competitor, RecessionAlert, presents a variant of that stance.  While showing a long-term chart of its (back-tested) forecasting tools, it makes sure to denigrate any recession that the US might be in as "technical".  Sorry for the formatting of the next chart, see link:


The chart above shows the current "recovery" as the only one never to have the chance of the economy actually being in a recession go to zero.  (The economist estimates that the US actually has, or recently had, a 24% chance of being in a recession.  Do you think the stock market thinks so?)  Perhaps the 1930s had that pattern.  In any case, this economist's view is reassuring.  Sure, the US might be in a technical recession, but don't worry, his cyclical indicators show that it will be mild.

And then all shall be well forever?  Or will there just be another period of moderate growth, inventory replenishment, etc., as in the past 4 years, all fueled again by Fed largesse?  What P/E do those profits merit?  Recession Alert is probably giving you a similar message to ilene.  Yes, the economy isn't so good, but things will turn around.  Why lose ground to inflation in bonds or cash/trash?  (Note please that I'm guessing, as I'm not a subscriber.  But in general, whenever a stock-oriented economist tells you that his short and long leading indicators are looking up and that a recession will be technical (not even "mild", just "technical"), I assume that he's basically a bull.

In summary, the latest "hook" for the stock market as a whole is that it is so close to its old highs, and people aren't boasting over the dinner table about XYZ stock making them a lot of money, so it doesn't smell like a top.  Meanwhile, the old standby of Smithers et al looks like now a poor time to put money into the market from a longer-term perspective, though we might indeed by in a 1928/9 or 1998/9 era with yet higher highs for a period:

With the publication of the Flow of Funds data up to 31st December, 2012 (on 7th March, 2013) we have updated our calculations for q and CAPE. Over the past year net worth has risen by 7.6%, with the most significant rise being in the value ascribed to real estate (+ 5.9%). Interest-bearing assets have risen by 5.8% while interest-bearing liabilities have risen by 8.2%. 
Both q and CAPE include data for the year ending 31st December, 2012. At that date the S&P 500 was at 1426 and US non-financials were overvalued by 44% according to q and quoted shares, including financials, were overvalued by 52% according to CAPE. (It should be noted that we use geometric rather than arithmetic means in our calculations.) 
As at 12th March, 2013 with the S&P 500 at 1552 the overvaluation by the relevant measures was 57% for non-financials and 65% for quoted shares. 
Although the overvaluation of the stock market is well short of the extremes reached at the year ends of 1929 and 1999, it has reached the other previous peaks of 1906, 1936 and 1968. 
All we have standing behind this level of overvaluation and going to cash, or munis, is the fact that the Fed is "easy".  Given what's happened to Japanese stocks between 1995 and 2012, when the Bank of Japan was almost always "easy", that's a thin reed.

It must be said that there are some crash-callers out there.  But the media has to look hard to find them.  There were also housing crash-callers who got some publicity as the bubble got very large.  The problem with crash-callers is that they get excited too soon, then they get ignored.

The metals are collapsing, including both gold and copper.  That tells me a lot about the state of global liquidity (gold) and industrial vigor (copper).  This could be another 2011, at the least.

Cash may no longer be trash.

Tuesday, April 9, 2013

NFIB Reports Disappointing March Survey Results

From the NFIB report today on small business (LINK):

Small business job creation plans

And earnings trends (3-month average):

Small business earnings

And the overall picture:

Small business optimism report for April 2013

Starting from a lower baseline than the 2001-3 recessionary/depressed time, the 2008-9 very depressed period now shows a 4-year post-recession period that continues to look similar to the 2003-7 period.

Most small businesspeople are not seeing inflation, so to them, the Fed's ZIRP makes sense.  Many investors, however, refuse to believe that the pace of business may wax and wane on its own cycle.  They insist that substantial and sustained nominal sales and earnings growth is coming.

Ever since the Fed became operational in peacetime, say from 1920 on, or in the post-WW II period, a new recession has occurred about every 5 1/2 years.  It is now 5 1/3 years since the onset of the Great Recession.

Anything of course can occur.  The US can be Australia or Chile and go 20 years between recessions.  Or it can be more like Japan and have a recession while short-term interest rates are near zero.

The small business sector is seeing no price inflation.  Absent Federal deficits backed by QE from the Fed, I would think that it would be seeing price deflation.

Thus, the current interest rate structure has justification from what small businesses are experiencing.  The renewed downtrend in several parameters shown by the charts above are similar to what started to be seen in 2006, as the real economy turned down but a combination of bubble housing activities and exports buoyed the aggregates.  Is past prologue?

Friday, April 5, 2013

The Counter-Attack on Irrational Exuberance May Be Beginning in Merrie Olde England

Back to basics from at least one part of the Bank of England?  (LINK):

BOE Says Investors May Be Taking ‘Too Rosy’ a View of Stress 

The Bank of England said rising equity markets don’t reflect the underlying economic situation and warned that investors may be underestimating risks in the financial system. 
Gains by equities since mid-2012 “in part reflected exceptionally accommodative monetary policies by many central banks,” the BOE’s Financial Policy Committee said today in London in the minutes of its March 19 meeting. “It was also consistent with a perception among some contacts that the most significant downside risks had attenuated. But market sentiment may be taking too rosy a view of the underlying stresses.”... 
The FPC’s comments on the advance in equity markets echo remarks last month by UBS AG Chairman Axel Weber, who said the economy hasn’t kept up with investor sentiment. 
“I fear the recent rally in financial markets could be a misleading signal,” Weber, a former European Central Bank Governing Council member, said at an event in London with BOE Governor Mervyn King and Federal Reserve President Ben S. Bernanke. “We’re not really out of the woods yet.”...

They focus on the US :
“This was evident in the re-emergence of some elements of behavior in financial markets not seen since before the financial crisis, including a relaxation in some U.S. credit markets of non-price terms and increased issuance of synthetic products,” the committee said. “At this stage, they did not appear indicative of widespread exuberance in markets. But developments would need to be monitored closely.”

And on the UK.  Fractionally-reserved banking remains risky under all current proposed capital regimes:
The FPC also said that banks’ leverage ratios, a measure of their debt to equity level, would remain “very high” even after the new recommendations were met. It said there would be “little margin for error against a backdrop of low growth in the advanced economies.”
There's not a lot to argue with in the above.  Though one might quibble with Dr. Weber.  What stocks are doing is rational.  They are rising in price as the quantity of currency units in which corporations do business increases rapidly.  The major risk to this market view is that these currency units are debt-based.  Their underlying value is based on confidence, which can change.

Unfortunately, this statement out of the MPC comes in March 2013, not March 2009.  And it's a bit of a damp squib for any dreamer who thinks there's any near-term hope of a seriously sound, unleveraged financial system.  But better late that they say this than never.

Wednesday, April 3, 2013

A Regional Fed Head Hints at Taking the Punch Bowl Away

Forget Cyprus.  The best sign that the current stock rally is in trouble came from SF Fed president John Williams today (LINK):

 "Assuming my economic forecast holds true, I expect we will meet the test for substantial improvement in the outlook for the labor market by this summer," Williams said. "If that happens we could start tapering our purchases then. If all goes as hoped, we could end the purchase program sometime late this year," he added.
That's the beginning of the end for the speculators.  What do I know, I'm not an economist, but looking at the slow pace of both nominal and real GDP growth, to the extent they are measurable, I would guess that unfortunately the country is in recession or something close to it if one subtracts the Fed's bond-buying programs.

Currently, though the Fed is super-easy and the Federal government is stimulative, though the second derivative of the deficit has turned sharply negative.  However, once that adjustment is made, both the bank and the Fed are stimulating, which makes it difficult to have a major bear market in stocks.  Overvalued as stocks are by many traditional criteria, so are bonds, and stocks were vastly more overvalued than today between 1998 and 2001-2.  So, yes, they can go (much) higher.

Monday, April 1, 2013

More Stress in Global Markets As Interest Rates and Copper Continue to Break Down

I've been out of pocket for several days and am getting over an injury, so this will be the first post in a bit and will be brief.  I do hope that anyone interested in my thoughts is following me on Seeking Alpha.   A number of articles there are very good quality, and the comment section doesn't allow trolls through as Blogger's usual format does, and as was the case with The Daily Capitalist, the comments on my articles are often learning experiences for me.

In any case, as we begin to move away from the crisis events of 2008 and their aftermath, a lot is similar to the ending of The Great Gatsby.  In it, Fitzgerald describes himself (Nick Carraway) always being dragged back into the past.  We, he suggests, are boats trying to go upstream against the current (i.e., into the future), but we are "borne back ceaselessly into the past".  To wit:  one financial crisis is similar to another:

My long-standing analogy, which I discussed during the semi-crisis summer of 2011 and then several times last year, is that the European mess is similar in many ways to the US mess of 2006-9 in that the insolvencies never seemed to end.  Some people forget numerous small mortgage brokers going under in 2006 pursuant to the housing bubble bursting around the end of 2005.  And people forget the rumblings of trouble in finance-land when the auction rate securities mess began in the fall of 2007.  So the US crisis went on a good while, as is the eurozone mess.  After the Cyprus banking fiasco (which continues), stress in financial markets continues to intensify as the depression in so many European countries contines.

Dr. Copper is breaking support, Treasuries and gold are well-bid, but Treasuries are better-bid than gold.  These are signs of a deflationary bust..

US stock and bond markets are, meanwhile, following the script they followed during the Asian contagion, meaning they are being supported by chaos elsewhere in the globe.  There's nothing like being able to buy your own bonds and have all the economic and other advantages that the US has.  Thus I continue with a Fortress America investing outlook, as I introduced in the late summer or early fall in 2011.

This extends to Apple's problems in China and Europe.  It includes all multinationals.  Caterpillar has had problems in China, as well.

Eventually, the Asian contagion came to America.  Why should this time be different?  (Though we can hope.)

A possible template for US stock markets is as follows:

I can reasonably see the Russell 2000 (IWM is the major ETF) acting like the NAZ of 1998-2000 and having a blowoff top (it's toppy enough already on valuation) and peaking anywhere from last Friday (it was down today) to two years from now.  But let's say it's so overvalued already (it is) that it peaks this year.  In that case, I would expect the S&P 500 and the Dow 30 to peak or nearly peak some months later.  This was the pattern in Y2K as the NAZ peaked in March, crashed, half-recovered, and the SPY made a double top half a year after the NAZ topped.

This environment would continue to be, as they say on the Street, "constructive" for Treasuries.  I'm positioned heavily with bonds right now.  It's been an amazing bond rally since Y2K and again since 2007.  Can bonds three-peat?

My best answer for now is that speculators on the 30-year T-bond in the futures pits now show their longest/largest sustained net negative positioning since the first half of 2011:  the best time to own zero-coupon Treasuries since the fall of 2008.

I'm watching Mr. Bond and Dr. Copper closely.