Dangerous Markets

In my last post, a while ago pre-vacation, I talked up AAPL's virtues.  Events proved this correct, in a funy way.  AAPL disappointed on sales and earnings, yet the stock is close to its all-time high.  IMO, AAPL is at best a weak hold now on a trading basis.  The fanbois are loving it that a new iPhone will be out soon.  LOL, that's a surprise?

If one compares the platinum ETF, PPLT, with the SPY for as long as PPLT has been in existence, and goes back to the platinum futures markets for prior history, one will see a close correlation between the two.  This has diverged over the past year or so.  Platinum, and even more so palladium, are priced on the margin largely because they are used in the real economy.  The ETFs are secondary in importance; they are not "money" a la gold and perhaps silver.  If the central banks were inflating everything so much, or about to, said inflation would include these very rare and essential metals.  I thus take them as proverbial canaries.  I "think" that stocks have been carried aloft on a similar mode as bonds.  If I saw real strength in copper, platinum, palladium prices etc., I would suppose that bonds were all wet and go with the growth stuff.  But I don't see that.  In fact, the last few months that the Billion Prices Project covers (up to June 30) shows no inflation.  (Note they do not cover services.)

The VIX was down today on a down day for stock prices.  This joins the metals in non-confirming the action.  Meanwhile, fundos matter.  The European recession, misnamed a debt crisis, continues on.  The sedative of the Olympics is over.  For some time I have been analogizing what's been going in in Europe the past few years to what was going on in the US beginning in about 2006.  Europe 2012 continues to have similarities to the US 2008 that trouble me. 

There have been a few times in my investing career in which I had an atypical sense that I was smarter than the markets or the pundits and actually was right (i.e. lucky).  In the 1990s, this sense was that the insanity would continue on until it didn't.  I was lucky to stay with the trend until 2000 and get very much out of stocks that year, to get back in in the spring of 2003.  In the summer of 2007, I got out of stocks and into cash and bonds around Dow 13000, and when it went to 14300+, I was untroubled.  A year later, it had been halved.

I have a similar feeling now about things.  As was the case in the US through August 2008, the markets were trading as if things were normal.  But they manifestly were not.  While the authorities were on the case, they were not gods, and they did the best they could.  But troubles are troubles, and Europe has troubles; and the US economy has continued to trail expectations.  The president's plans for the country to double exports in a five year span is not on track, as the ROW is not cooperating. 

The VIX is 14.  It is 1/3 below its 200 day sma.  14 on the VIX is support (resistance for stocks) for the past 5 years.  Either the economic news is about to turn sunny, or the VIX is overbought.  Right now, I continue to like ED and WGL over AAPL and the growth stuff.

We are finally seeing the VIX and VXO break decisively above 25.  Finally.  Boy, has this been an exhausting wait.  FB buyers and the like are capitulating.  Finally.

We only had 12 weeks in a row of the NAZ being up this year-- a record, it was said, a longer streak than even in 1999.  Reality can bite, n'est ce pas?

Note I'm not a short-seller.  I simply have owned Treasuries (and high grade munis) as a natural hedge against the stocks-down/interest rates-down trend we've seen the last few years.  Plus I own AAPL, and some OTC income stocks.  I've simply been blogging "forever" that stocks have fundamentally been overpriced based on historical norms, and relative to the risks.  I presume there are very good reasons why the Fed has been doing what it has been doing and why investors are finally focusing on return of principal.

The DoctoRx rule of thumb is that high-quality stocks can be bought when the above fear indices are above 25, though the timing may be terrible for a while.  Typicall, these moves above 25 carry to or above 30.  I would look for a BTD scenario around there. 

Support for the NAZ is around 2200.

The dividend-paying top-tier NAZ tech stocks are my long-term faves for growth and income.  I would look to scale into them on weakness in the bubble tech stocks (plus I own a fair amount of AAPL as a "permanent" holding).

More to say in a later post, perhaps Sunday night.  A busy weekend looms on more than one front.

Caution in Defense of Capital Preservation Is a Virtue As European Economic Imbalances Roil Murky Waters

I am beginning to more seriously fear a liquidation event arising from the events in Europe.  This is not a prediction, as matters may muddle through, but those of us who manage money, either our own or OPM, must think of downside risks unless we happen to be portfolio managers for a Bill Gates and handle just a small part of his wealth.  But here's the updated set-up that I'm seeing based on today's headlines, and again, this is not a prediction, just a growing sense that the odds of a discontinuous downside event have increased to a level with which I am uncomfortable. 

First, I have a similar sense that Greece has a failed economy that I had by midyeaer 2008 that the U.S.housing bust could not be contained.  As evidence I present this article from eKathimerini titled General payments freeze takes hold.  Please consider reading in full and then coming back to this blog.

Scary.

Before going on to the second, let's remember that Greece has as many people as Illinois and had an economy the size of Wisconsin.  It has about as many people as Sweden.  A Greek national bankrupty has not been reserved for.  Again, my fear from a continent away is that Greece appears to have passed a similar tipping point as the U.S. housing market passed in 2008 once it became clear that the American national economy was in recession.  Shortly after that realization dawned, Fannie/Freddie were forced into conservatorship and the jig was up.  The banks could no longer pretend that their assets were worth anything close to what they were carrying them on their books at, all foreign investors closed their checkbooks, and the meltdown began.  Europe is now in recession, and there are no excess funds anymore readily available to absorb losses from Greek debt.

Second, the Spanish situation is unraveling due to recession.  The news today is that having rapidly increased the estimate of their bad bank Bankia's losses from a few billion euros to about 20 billion euros, the government is making more news:
Spain is considering using debt issued by the government or its bank-rescue fund instead of cash into the Bankia group, using a mechanism that would free it from raising the money from investors.
The government hasn’t made a decision on whether to use its debt to recapitalize the nationalized lender and will decide in two or three months, a spokesman for the Economy Ministry, who asked not to be named in line with its policy, said in a phone interview today.

This both appears to be a sign of weakness as well as dilatory.  No decision for 2-3 months?

Other news from Spain is also negative.  Spain is approaching or is on a knife's edge.  Again, my point is that general recessionary conditions turn a manageable situation into a crisis, as occurred in the U.S. in 2008.  Capital that would have been provided to tide matters over suddenly withdraws.

Now, let's turn to the U.S. stock market, which simply by approaching its 2007 highs has been about the best performer of any major global stock market on a 5-year basis.  My take is that the FaceBook IPO really does add to the public's disillusionment with the financial establishment.  It is more "in your face" (pun intended) perceived abuse of the public than something seemingly esoteric and relatively unpublicized such as the loss of customer money in the MF Global bankruptcy.

It is not only the quick collapse of the share price back to the level that the IPO was planned to have been done at, namely the low $30s per share.  It is not that the insiders increased the number of shares they sold at the $38 price.  These things happen.  I am thinking that the tipping point for the FB IPO is the credible charge that there was selective disclosure to institutional investors after the S-1 was published that FB's current pace of business was not looking as good as expected makes it difficult for the usual parties to say, well, markets and stocks go up and down.  Those who chose to buy at $38 did so.  Even assuming, as I do, that nothing illegal occurred, then even so, the charge of selective disclosure makes the FB IPO an easy target for those who want to advise the public that Wall Street exists primarily for its own good and those of its clients.  That can easily translate into:  sell stocks, who really knows what they are worth?

Major regional recessions tend to force balance sheet readjustments.  Those readjustments may be sudden, as I believe occurred after the U.S. government signaled exactly that when it acknowledged that Fannie and Freddie's assets were seriously overstated on their books.  Now the problem is centered in Europe.  European banks issue letters of credit for a large percentage of world trade.  Europe is a larger economic entity than the U.S. plus Canada.  China exports more to Europe than to the U.S.  China is already selectively canceling certain import orders.  If European economic output takes another lurch downward, look out below in China.  It will have its planned property correction going on simultaneous with an unexpected large drop in demand from Europe.

U.S. investors are relatively sanguine.  The VIX is marginally above 20.  As 2008 moved along, I identified 25 as the cutoff point between true stock market panic and relative complacency.  Until Lehman sent the VIX sky-high, that worked well. I'm back to that pre-Lehman way of thinking, thus I'm cautious about stocks, though a strong kickback rally would (as previously stated) be completely unsurprising even if lower lows await.  Even after the recent stock market decline, quants such as Jeremy Grantham and John Hussman peg the U.S. stock market as highly unattractive.  Grantham gives the 7-year prospective return from U.S. stocks as roughly prices to yield total returns only equal to inflation.  And that's with a wide standard deviation.  Meanwhile, tax-free bonds yield about as much, with much greater certainty.  So when people ask, where else can money go expect stocks, I answer three ways:  cash, tax-frees, and beaten-down emerging markets stocks, where structurally their economies are in the higher-growth phase of development.  (Plus gold and U.S. homes.)

These periods where economic output is decelerating in most of the world and declining in absolute terms in a major part of it-- are the most dangerous times for stock investors.  The European situation has brought matters to this point.  When the Russian bankruptcy roiled markets in 1998, non-Asian stock markets were in sharp secular uptrends.  The ensuing selloff was but a blip in the ongoing stock market party.  Today's charts are different.  Every major market is seeing failed rallies off the 2007-8 highs.  Another general bear market will create yet uglier charts.  Chartists who are now comforted by the SPY may then say "sell". 

In other words, 2011 may have been a softening-up year, frightening though it was- perhaps something analogous to 2007 in the U.S.  There were no recessions then other than in small European countries.  Now the U.K. and Italy have entered at least mild recessions.  France's GDP was flat the past two quarters.  Not only are these very large economies, but please remember that they help drive China's economy.  Both through that mechanism and directly, then they also drive the economies of raw materials exporters such as those of Brazil, Canada, Australia, the Gulf States, etc.
Such a possible downward economic cascade will wreak havoc on President Obama's stated goal that the U.S. would/should double exports in a five-year time frame.

In other words, Europe's economic and financial issues are large enough to drive an economic and financial markets reset similar to those that occurred when the mild U.S. recession as of summer 2008 morphed into something much worse as the balance sheet holes of the large financial institutions were revealed to be irreparable (absent the extraordinary government action that ensured).

Thus these appear to be legitimately perilous times.  Investment discipline is paramount in these times.  Reacting to the latest headline or market moves is something I am going to try hard to resist.
As Chance the Gardener said, "I like to watch".  Whether this real-life movie has a happy ending is unknown; it is like Casablanca; even the scriptwriters have not determined the final scenes.

Turbulence is Here

The chart pattern on the TLT, a proxy for the long Treasury, looks marvelous. The angle of the ascent is much greater than the gentle slope of the downtrend, which on the descent from the high in price in December 2008 (low in yield) was much sharper.
Given that the Asian markets are collapsing and that risk assets such as silver and platinum are down while gold is up, it is easier and easier to look at the analogy of the dollar breakout against the Euro against general skepticism and project a counter-trend bull market in Treasuries.

Meanwhile, the S&) 500 volatility index (VIX) is nearly at 25, a level which a simple review of the long-term VIX chart suggests is average for turbulent periods. Much above 25 presents the intrepid stock picker a tradeable entry point.

The evils of too much debt and too much financial complexity are making themselves obvious. Gold continues to shine, dully, in this sort of environment.

Postings continue light due to travel and will resume normally in a week or less.

Copyright (C) Long Lake LLC 2010

VIX Showing a Lot of Optimism but Is not Necessarily Signaling a Market Top

The S&P 500 volatility index, VIX, more or less hit new lows for this move, closing at 17.66. What the VIX actually measures is more complex than the common interpretation, which is that is acts as a fear index. At the peak of what now looks to have been a credit bubble, the VIX briefly went under 10, which was perhaps as extreme a sign of optimism as the post-Lehman panic highs in the VIX were signs of fear.

A 5-year snapshot of the VIX is shown; click on it to enlarge.

Also shown is a Yahoo/Finance chart of the VIX since 1988.

The prior pattern has been for a post-recession multi-year drop in the VIX, followed by a turn upward before the next recession.

The VIX has correlated very well with the Fed funds rate with a substantial lag, perhaps up to 2 years.

This correlation is well known and emboldens the bulls.

My sense is that this trend is your friend till it is not. Numerous stocks look rich on various measures; others look OK such as those mentioned here recently (TJX, for example).

Overall, though, my sense is that this labor market is much less V-shaped than is GDP. For whatever reason(s), I suspect that uncertainty over the Obama agenda is contributing to a freezing of hiring in small business, which has plenty of business reasons to be cautious anyway.

With the S&P 500 having a dividend yield about 2%, I have this nagging sense that people who are not good stockpickers will ultimately do as well purchasing 3-5 year secure debt obligations and buying in when the VIX finally moves up. It won't matter, unless dividends soar, if the indices soar on speculative buying. There is a lot of drop that can happen again, either in absolute numbers or adjusted for whatever inflation is coming.

Now that the VIX is finally reported on the CNBC ticker, it is guaranteed to be less useful as a tool in understanding the stock market than previously. It is not, however, anywhere close to a household index, so it still makes sense to time one's stock portfolio by using surges up in the VIX to buy and big drops to sell. If in March or April the VIX drops to 15, selling in or before May and going away till it at least moves up to 20 may be a smart strategy for non-core positions.

In other words, we of course may be at a market top, but the VIX is merely in a zone which has allowed multi-year advances in stock prices and should not be used as more than a timing tool.

Copyright (C) Long Lake LLC 2010

Political Markets

On the one hand, the drop in stocks and commodities- with platinum off 6% in 3 days--associated with a rise in the VIX volatility index to above 25 (and therefore contrarianly somewhat bullish) appears to be a buying opportunity. After all, the various pronouncements and "sort of" plans by the administration coincided with the upcoming (bank tax proposal) and actual (Volcker Plan) Senate loss in Massachusetts and were therefore political more than serious proposals for which the President would fight.

On the other hand, the President's defenders are saying silly things, witness the first paragraph of Frank Rich's column in today's NYT, After the Massachusetts Massacre:

It was not a referendum on Barack Obama, who in every poll remains one of the most popular politicians in America. It was not a rejection of universal health care, which Massachusetts mandated (with Scott Brown’s State Senate vote) in 2006. It was not a harbinger of a resurgent G.O.P., whose numbers remain in the toilet.

Wrong on all 3 counts. Clearly, polls and focus groups show that voters were consciously treating the election as a nationalized vote. Second, and a more subtle issue, polls show that healthcare "reform" was front and center in the vote, and that Mass. voters are similar to the rest of the country's in opposing "Obamacare". Of course, their opposition includes double-payment because Mass. gets the stick but no carrot unlike Neb. or La.; and Mass. has a huge biotech and medical tech industry that stand to suffer from Obamacare. Third, only a few people can deny that the GOP has surged more than the economy. If a devastating win in Virginia despite real efforts from the President in that race, and then decisive wins in the deep blue states of NJ and Mass. are not persuasive, then the finding from Rasmussen Reports might be a shocker: Republicans Post Eight-Point Lead in Generic Ballot (from Jan. 19).

On the other side of the political spectrum, the points are more fact-based and the point of view of the writer has clearly gained ground since one-party rule began one year ago. You may consider Rich Lowry's The New Catechism.

In other words, the administration is on defense and the quarterback is scrambling. Meanwhile bulls such as David Kotok of Cumberland Advisors point to zero interest rates as cause for a further rise in the stock averages (but Dr. Kotok believes we are in a secular bear market and his bullish call is tactical); but the obvious paradox is that zero interest rates only can be sustained at a time of gigantic Federal deficits and horrible state and local finances by a combination of a weak underlying economy and gigantic unrealized bank losses. The mortgage market is a phony, caused by Fed money-printing.

To paraphrase Yeats, the center is not holding. A resurgence of an unreformed Republican party is unappealing. A liberal majority that can hold Frank Rich's view is insane, expects us to be idiots, or is otherwise playing some strange PR game.

Given the unprecedented times, fundamental come into play. Please consider two more resources, one a simply chart and one an analysis of Treasury's funding needs. The first demonstrates on 2 measures that the stock market is fundamentally overvalued; see: http://www.smithers.co.uk/page.php?id=34. For the Zero Hedge article, see:
http://www.zerohedge.com/article/700-billion-us-funding-hole-desperately-seeking-very-indiscriminate-treasury-buyer

Meanwhile, Citi's Tobias Lefkovich points out that bond buying by the public is in a bubble.

And Gallup.com continues to show no hiring going on, consistent with the Govt's JOLTS survey and the recent stagnation of new unemployment claims at an unsatisfactory level.

If the best argument for stocks is gridlock due to an administration that is debating a mid-course adjustment and aggressive money-printing by the Fed, it's a weak argument. Please remember that as late as Oct. 1, 2008 Bank of America traded at $38 per share. By early March, it was at $3. This occurred with the Fed already in easing mode for quite some time. Why had it been at $38? In large part, the SEC had eliminated short selling in the stock.

When the Government can borrow for one year at 0.27% and at 3 months for essentially nothing, something is very wrong. One cannot look at a stock with a 1% dividend and say it's a bargain. If you buy the S&P 500 for a 5-year planned period, you can expect to receive at most $15 in dividends, about as much as for a 5-year Treasury. If you agree with the current bull Dr. Kotok that this is a secular bear market in stocks, then you do not want to own stocks: not enough return.

This is the opposite of the early 1980s and much more like Japan, which coddled its banks until it finally let some fail. And re Japan, Mr. Smithers' site points out that it turned bearish on fundamental grounds on Japan at Nikkei about 12,000 about 2years ago, well before the Great Financial Crisis drove it back into recession. This was almost 20 years after the peak of the Japanese bubble and Nikkei 39,000. So anyone who thinks that the S&P 500 being about where it was a decade ago means that it is cheap or undervalued has another think coming.

The screenwriter William Goldman famously said about Hollywood that no one knows anything. This is now true about Wall Street, given the politicization of markets. What you think you know may be what you do not know (think of the geniuses at LTCM circa summer 1998). Since everybody who knows anything knows the above, buying surges and selling surges of any security can occur based on fear that the unknown trend is changing.

Direct ownership of a diversified portfolio of high-quality securities for those who can afford such a thing thus makes sense. Those with fewer financial assets may be best off simply keeping money in the bank or a bank-like equivalent and focus on job, friend and family.

Copyright (C) Long Lake LLC 2010

Tuesday Afternoon Update: Focus on VIX

As suggested yesterday could be in the offing, TLT is up a bit today, meaning that long Treasury rates are down a bit, besting the stock market, which is trading heavy and a bit to the downside. Gold is rising adjusted for the mildly stronger dollar.

The volatility index (VIX) is lower, which is the opposite of what one typically sees with the Dow off 40 points and the S&P 500 down. VIX is under 21. The past 2 years, 20 or slightly under that has been the lower bound; and in the 1998-2003 period, 20 was also the effective lower bound (a low VIX correlates with generally rising stock prices). The last time the VIX dropped while the stock market dropped, a brief but sharp correction ensued, and the VIX rose to over 30. Could this disparity be a sign of complacency?

Copyright (C) Long Lake LLC 2009

The Long Bond: An Interesting Speculation

The single most surprising financial event that could occur soon might well be a significant drop in Treasury rates. A drop in rates would correlate with a rise in the ETF 'TLT', as TLT owns Treasury bonds in the 20+ year maturity range. The chart on TLT is actually promising. Click on it to enlarge; the red line is the simple 50 day moving average.

Since the early June low in price at longer-term support, we see a successful retest of that low in late July, then a pattern of higher highs and higher lows. In addition, the shape of the up and down moves looks reasonably promising, as well.

Meanwhile, stocks made new highs in some indices, but the VIX did not fall to a new low. Is it bottoming, implying a down move for stocks?

TLT opened down Monday but then worked its way higher, very quietly, as gold and stocks took the spotlight. Yours truly went long TLT on the open today. Now, this is in the context of holding lots and lots of gold, to be sure. Nonetheless, the structural bull market in Treasury prices (downtrend in yields) remains in force on the charts. And I believe that we are following the Japanese trajectory. So much lower lolng Treasury rates are possible, even if they make little sense on a total return after likely inflation.

Copyright (C) Long Lake LLC 2009

VIX and Gold have Gap Days: Implications

The above charts show GLD and the Chicago Board Options Exchange Volatility Index = VIX. Note that Monday morning, both had a gap opening and stayed above the prior day's trading range all day. The VIX petered out after a huge run from under 20 to over 30 in a week or so on little news. Gold surged dramatically today, along with silver. Treasuries sold off.

More likely than not, the VIX and gold will settle back, though gold has so much momentum, who knows? I did take a modest sum off the table in gold today at the close.

Not shown re the VIX is the sudden turning of the 50 day moving average at a fairly elevated level near 25. If, as I now suspect is more likely than not, this moving average turns up, that would correlate with a correction of stock prices downward.

Furthermore, Treasury prices have trended down and now look to be in a definitive downtrend. With the economic cycle pointing upward (though in a ragged manner), Treasury prices down (yields up), gold and silver surging, a correction in stocks would be more likely than not a buying opportunity for traders.

Longer term, the belief here is that most financial assets are too high-priced relative to the most important price, which is wages. They're just stocks and bonds, after all; they're not gold!

Copyright (C) Long Lake LLC 2009

Trick, not Treat for Stocks as the VIX Soars

The stock market is way down, the VIX has for now had at least a short-term bearish trend reversal, and gold continues its pattern of accumulation. Once again, it is going down less than stocks on down days, while rising about as much on up days for stocks. Furthermore, the weak rebound in the dollar today has affected the price of gold as follows, per Kitco:

Gold price down $7.40;

$2.10 of that decline was calculated to be due to intrinsic selling; the other $5.30 decline was directly due to their calculation of the amount the dollar declined against a basket of major foreign currencies.

In other words, the major stock indices are, as I write, down 2+% (intrinsic selling), but intrinsic selling in gold is only 0.2% of its price, and total percent price decline is about 0.7%.

Stocks are farther above their 200 day moving average than gold and are also percentagewise farther from their 12-month lows than gold; and are vastly farther above their year-to-date lows than gold.

In other words, the current message of the markets is that owners of gold are less motivated to sell than are owners of stock, as there is less selling pressure on down days; but when there is buying pressure on stocks, there is about as much buying urgency toward gold.

Gold can rise in nominal terms even if the economy is going down (think the past 2 years). Silver is much less likely to do so. If silver (or the more-difficult-t0-buy platinum) drops a lot and you believe that cyclical and other factors will make the real global economy grow, then silver will have more upside.

As an aside, one of my friends is a commodities trader who, let us say, retired young and lives and breathes markets so much that he keeps more than one TV on during the trading day in his house. He was bullish on silver from the first time we met about 7 years ago. Silver was then well under $5. He told me that his long-term chart analysis suggested an ultimate target of $100/ounce. Since then we have seen the first 5X move to over $20 with consolidation for many months. If we have a major pullback in silver without a major economic downturn, then investors/speculators interested in tangible assets may want to consider it, but only with pure risk capital.

Given my greater optimism for real global economic growth than for real rise in U. S. financial asset prices (stocks and bonds), my risk capital is increasingly oriented to real things than financial assets that I believe in my heart of hearts are at best fairly valued (think McDonald's).

Back to the VIX. Short-term, I believe it's too late to sell. Look for a snapback rally unless Citi goes under or something else fundamental makes the headlines.

Copyright (C) Long Lake LLC

The VIX in Relation to the Stock Market

Empirically, it is observed that volatility of stock price movements correlates positively with declining prices and negatively with rising prices. The mathematics do not make it necessarily so, but the relationship keeps on holding cycle after cycle. A common measure of the volatility of stocks is the volatility index, symbol VIX. In typical bull markets following bear markets, volatility declines below 20 and if the bull is sustained, may reach or drop below 10. In the turbulence of the late 1990s through 2003, the VIX was however range-bound between 20 and 40. Last year, the VIX went to an ultra-high level above 60. The peak of the recent rally took it almost to 20. I noted recently on this blog that the famed second derivative of the VIX had turned positive, meaning that the rate of decline was continuing to slow. Above are one-year and long-term views of the VIX.

What my eye sees from the one-year chart is unfavorable for the stock market, except that short-term, the rapid move up on the VIX the past 2 days is "too far, too fast" and "deserves" a pullback, implying a rally in stocks. The long-term chart is also worrying. Correlating with geopolitics and the economy, the volatility at the end of the 1980s (not shown) and into the recession of 1990 and Iraq War of 1991 was followed by a decade of peace and prosperity. The average stock peaked in 1997-8 concomitant with the then-current global financial crisis. The Fake Recovery that began after the 2001 recession ended also had a massive drop in the VIX, followed by an even more massive record sustained rise in it.

The VIX over the past few months is making the same sort of bottom that many stocks and markets have made this year. Of course, one never knows, I respect evolving trends, especially ones that the media do not discuss. As a guidepost, I have noted the past 2 years that for some reason, 25 is a VIX number to respect. Under 25, stocks do poorly. Over 25, look for a bounce.

Because I believe that the charts suggest that stocks are in a structural bear market, I am inclined toward the hypothesis that the VIX has entered another multi-year period similar to 1998-2003. There were two single-best investment strategies in that time period. One was to buy Treasuries when yields rose. The other was to go with the hot sector that appeared to have good fundamentals. That meant buying not value but the breakout to new highs, whether it was the tech sector in early 1999 or the Russell 2000 in 2002. The safer and simpler approach was to avoid stocks and stick with gold, bonds and cash. I am still mostly doing that now, though that was a time of governmental fiscal restraint following the Perot movement.

People who own more stocks than they would be comfortable owning if the stock market dropped another 10-15% from here may want to lower their exposure the next time the VIX drops under 25.

Copyright (C) Long Lake LLC 2009

The '500' Fills the Gap

While many individual stocks look reasonably valued on a price-earnings basis, the market as a whole is looking more and more tired and more and more like a "sell" rather than a venue for gamblers.

The chart nearby (click on to enlarge) shows the S&P 500 for the past two years. It has now filled the gap around 100 created when things began to implode late in September.

Not shown is that the index is slightly more than 20% above its 200 day moving average. On the one hand, this reflects the dramatic turnaround in corporate profits. Teleologically, companies cut back inventory "too much", especially in view of all the government stimulative measures. Worse, companies cut back staff and are reluctant to hire; though, they will eventually hire if profits hold up.

Moving on, the VIX, an index that reflects actual or feared volatility and in practice correlates with the perceived trend of stock prices, has collapsed 25% from about 28 to about 21 in only two weeks. This is a large decline in a short time. In the rally since March, this situation has either been followed by a correction in stock prices or some stability in prices offset by a rise in the VIX (a rising VIX means rising volatility, and generally reflects bearish sentiment). Of course, past performance doesn't predict future . . . you know the rest. But it's nice to have precedent on your side.

From a technical standpoint, the financials, which led this rally, lagged today even as a bullish event happened over the past two days, which is a significant widening in the 2-10 year Treasury spread. Higher quality, boring stocks that have not participated in the rally began to participate, such as MCD and GSK. Might the fast money be "tired of" financials?

Nokia before the opening and IBM after the close each saw their stocks fall on bad news, which is what happens in an average market. Meanwhile, Intel had a legitimate beat-and-raise and the stock did not do much, even though it is depressed on a 2-year basis. And Alcoa, with a less impressive earnings beat, has also done little since an exuberant day; in fact it has trended down over the past week. So, under cover of rising averages, we are seeing lots of new 12-month highs, little but rising earnings estimates, and other bull market action, but evidence of fatigue.

What happens in a wild bull market is that you see stocks trading way above their 200 day moving averages. We are seeing this. When these stocks have the worst fundamentals, many prudent investors simply stand back. MU and AMD are two of many examples. Not counting its recent minor drop, GS is about 40% above its moving average and is quite the momentum stock these days. Meanwhile, there has been nearly zero corporate insider buying for several months. These guys are almost always right, though with a lag.

These sorts of stocks, even if the fundamentals are strong, have so much profit in them that in a normal bull market, one not fueled by short covering or hot money, that they move up more slowly.

Eventually, financial markets are weighing machines. The weights comprise return of capital or dividend payouts. A rising stock price for 2 decades did AIG shareholders no good when it went near zero, given the lack of meaningful dividend payouts along the way. With the S&P 500 once again yielding more or less exactly 2.0%, and with old Wall Street hand remembering when a normal (wide) fluctuating range of dividend yields was 3% at bull market tops and 6% at bear market bottoms, what we are seeing is levitation ahead of proven fundamentals.

Unfortunately, indicators such as Gallup.com's polling shows that consumer spending has not risen at all.

Based on 14-day averages of responses to smooth out weekend and other variations, Gallup found that in May 2008, consumers spent as much as $112/day above and beyond fixed costs such as mortgages (!).

Two months ago, that had rebounded from below $60/day to as high as $72 (Aug. 18). The index has dropped back to $60. Where are the money printers when we need them?

The same polling continues to detect no net hiring, which has been quite accurate in predicting the BLS monthly data. Employment is almost undoubtedly shrinking at a significant pace, and initial unemployment claims are probably understating the case due to reluctance of large and small companies to hire. And when they can hire overseas, they are doing so. There are no healthcare benefits and few if any payroll taxes in China!

The 10-year Treasury yield is back to 3.47% at a time when the CPI is negative and rents are falling for the first time in 17 years. The real yield is very high. As the peak momentum of the economic move off the bottom inevitably arrives--some week-- measured in various ways--it is likely that the media will start talking of a growth slowdown. Not only are Treasuries a buy for real return, if you ask virtually anyone which asset class will provide a better return over, say, two years or ten years, choosing between stocks, gold and Treasuries, how many people do you know who will say Treasuries? (I would also suspect that if people were asked to choose between all cash for 10 years vs. a 10-year Treasury, most people would take cash over a 3.47% annual yield.)

Gold was down on a day when oil surged. This smacks of profit-taking, given that the dollar was unchanged against a basket of other currencies.

The stock averages look vulnerable here, and many individual issues probably are more likely to drop than rise. However, the boring stocks such as MCD, GSK and WMT that have done little or nothing since March could rise even if the averages have what might be a pause that refreshes a/k/a a correction.

In a confusing world in which the financial crisis remains unresolved, yours truly remains long government securities, dividend stocks with strong long-term charts, gold and cash. Dynamic it's not. But given an outperformance over stocks by 40% last year by being in bonds and cash and out of stocks, I don't feel that aggressiveness is needed right now. Avoiding losses and investing for income and/or capital gains when they appear low risk is the DoctoRx watchword in managing money.

NOTE: Nothing said herein is investment advice for any individual. Econblog Review and DoctoRx are NOT professional money managers.

Copyright (C) Long Lake LLC 2009

The VIX Stabilizes: Implications

The nearby 2-year chart of the stock market's "volatility index" (VIX), also imprecisely called a fear index, shows the fabled second derivative of the trend turning bearish (i.e., less bullish as the decline is in abeyance for now). The VIX peaked in the fall as the worst part of the advance-decline number of stocks occurred, and had a secondary peak into the current bear market bottom in March, then declined steadily as the stock market marched upward with few pauses.

Mais voila! The VIX has more or less flattened the past 2 months and is well within its trading range of the past 2 years. From the beginning of 1997 till the end of 2003, the VIX probably averaged about 25--exactly where it closed Thursday. Stocks traditionally fall when the VIX rises, though the mathematics of calculating VIX do not necessarily imply that relationship.

Even if a new bull market is underway, a simple view of the chart suggests that a spike in the VIX to 40 would be an ordinary test of "resistance". Patient and brave bulls might find that a convenient entry point.

Of course, there is nothing in the chart to suggest an actual trend change, but we are now for the first time since the major bear market took hold a year or more ago both at longer-term "support" for the VIX with as much chart suggestion of a move up as a move down.

Copyright (C) Long Lake LLC 2009