‘The Waiting Is The Hardest Part’


I don’t have much to write about this weekend as we are basically waiting on the Fed’s “taper” decision next week and watching the Syria diplomatic debate as we creep closer and closer to the debt ceiling. I will direct your attention, however, to a few other posts I’ve written over the past couple of weeks that may have flown under your radar:

Have a great weekend.


8 Reasons This Selloff Is More Than Your Average Correction

yogiNow that stocks have finally started to pull back from record highs investors are probably asking themselves, ‘is this a standard correction or something more than that?’ I believe we are in the process of forming a major top and here’s why:

  • Earnings in the retail sector have come in weak. Abercrombie & Fitch, Dick’s Sporting Goods, JC Penney, Macy’s, Nordstrom, Target and Wal-Mart have all reported weaker than expected sales recently. This kind of pervasive weakness in consumer spending suggests the economy may be decelerating at a faster pace than most investors or economists currently believe.
  • Long-term technical indicators are flashing warnings. Multiple Hindenburg Omens have been triggered over the past few months and on the monthly charts both the Nasdaq and the S&P 500 have triggered DeMark sell signals. Notice that the Nasdaq 13 triggered just as it ran into the 61.8% Fibonacci retracement of the bursting of the internet bubble. And we also have an interesting 13-year (and 6.5-year) cycle peaking right now that lines up with the 1987, 2000 and 2007 stock market peaks.
  • We look to be far closer to the greed side of the sentiment cycle than the fear side. It has been over 2 years since the VIX “fear index” has risen above 40. The demand for put option protection is nearly nonexistent as investors see no need to protect their portfolios when stocks just go straight up like they have for most of this year. Finally, margin debt has exploded this year, reaching levels not seen since the stock market’s prior peaks in 2007 and 2000 suggesting investors are just as euphoric today as they were then.
  • Stocks are currently valued at levels seen only at prior major market peaks. What’s more the historically high valuations are based on record high profit margins. Should profit margins simply revert to mean levels along with valuations stocks could easily lose half their value as they did after the 2000 and 2007 peaks.
  • The rise in interest rates could have major repercussions on economies and financial markets around the world. The 1987 crash came on the heels of an interest rate surge that is very similar to what we have seen over the past couple of months. As I wrote last week, these types of events typically have all kinds of unforeseen “butterfly effect” consequences in markets around the world.
  • Emerging markets are already showing cracks and this could be the canary in the coal mine for developed markets like ours. The last time we saw the sort of market action we are now seeing in Asia was during the 1997 and 1998 “financial contagion” events. Investors have typically been wise to heed these kinds of warnings in the past.
  • Another area that looks vulnerable to the interest rate rise is housing, which has been a major source of economic strength recently. Robert Shiller, Yale professor and author of “Irrational Exuberance,” recently said he sees excessive speculation in housing once again that will inevitably be reversed. Should this crucial sector begin to weaken due to the run up in interest rates it could once again become the economy’s “achilles heel.” This surely would not be a boon to financial markets.
  • Finally, investors appear to be losing confidence in the Fed’s ability to support asset markets of all kinds (stocks, bonds, real estate, etc.) via quantitative easing. This could result in investors abandoning risk assets, a shift that would surely mean a major bear market is underway.

My advice? In the words of Yogi Berra, “you can observe a lot just by watching.” Investors would do well to take some risk off and simply watch how this unfolds.


Is The Fed’s Grand Confidence Game Coming To An End?

I was dead wrong when I recently wrote “how I stopped worrying about interest rates and learned to love the long bond.” Since that time long bonds have dropped almost 10% in response to the Fed disclosing it wishes to “taper” is $85 billion per month in bond purchases. In fact, my timing could hardly have been worse. I will say I’m glad I took my losses quickly and avoided the majority of the decline over the past couple of months.

Still, I’m watching the bond market like a hawk these days. Since Bernanke started the “taper” talk the surge in interest rates has been dramatic and it has all sorts of implications for other asset classes.

tnxLet’s put it into context. The rate on the 10-year Treasury bond has risen from 1.65% at the end of April to 2.9% today. This may not seem like much but when you consider that this rise amounts to a 75% increase in our government’s cost of capital over a period of three months you start to understand how significant it really is.

In addition to the government, it’s also been significant to investors. Income-based investment classes that have appealed to more conservative investors like REITs, preferred stocks and utility stocks have all been negatively affected by the surge in rates handing these investors losses they probably didn’t imagine were possible.

There are hints that Asian markets may be affected, as well. After surging through the first few months of the year Japan’s Nikkei now looks vulnerable to a significant decline and emerging Asian markets like Indonesia (fell nearly 10% this week) have already begun to show serious signs of distress. I can’t say for sure that these are related to the interest rate surge but it’s very possible that it’s more than coincidence. We are a world economy and you know what they say about a “butterfly flapping it’s wings in the Treasury bond market….”

What I find most fascinating is that beginning soon after the “taper” talk the Fed became much more dovish in its communications and rates STILL continued to climb. On Wednesday, for example, the Fed minutes included this statement: “Almost all committee members agreed that a change in the purchase programme was not yet appropriate” making it fairly clear the committee doesn’t intend to taper its bond purchases. STILL rates surged on the announcement.

This market action suggests to me that “Bernanke’s Grand Confidence Game” may be coming to an abrupt end. Over the past few years it’s very clear the Fed’s bond buying programs gave investors the confidence to push all sorts of risk assets to record highs. It’s very possible, however, that these same investors are now losing confidence in the Fed’s willingness, and perhaps its ability, to backstop them. In fact, it looks to me like they now have decided to front run the Fed’s unwinding of its bond buying programs and this is a very dangerous game.

I recently wrote, ‘should stocks and bonds begin to fall in tandem I’ll begin to worry that the marginal demand for risk assets that has been inspired by the Fed’s actions could evaporate very quickly.’ This is exactly what’s begun to happen over the past couple of weeks. Stocks have peaked as bonds have been slaughtered and I have indeed begun to worry that the end game is near.