Investing, Posts

Less Than Zero

That’s the return investors should now expect from the stock market over the next decade… according to Warren Buffett’s favorite valuation measure: total stock market capitalization relative to GDP.

wmc140407cChart via John Hussman

The chart above shows the correlation between this valuation measure (blue line) and subsequent 10-year year returns (red line) and it’s pretty damn tight. I think the only possible argument one can make against “less than zero” returns over the next decade is something along the lines of, ‘companies are much more profitable now than they have ever been. For this reason, investors will be willing to pay higher valuations in the future so this correlation will break down.’ In other words, ‘its different this time.’ To those of us who have been around the block these are the four most dangerous words in the investment game. (See my thoughts on profit margins here.)

If investors are guaranteed to achieve nothing over the next ten years why would anyone in their right mind put money into the stock market right now? Or even keep a significant chunk invested right now? I keep asking myself this question because it just doesn’t make any sense to me.

I think there are two reasons. First, individual investors are deathly afraid to miss out on future profits EVEN if they understand that those profits are almost sure to be given back (and maybe they get off on the roller coaster ride). They just can’t stand to see their friends make money, even temporarily, and leave them behind. Second, professional investors are deathly afraid of underperforming because it may mean they get fired – even if they absolutely believe that the risk of owning stocks far outweighs the potential reward. They would rather lose money along with everyone else than forgo profits on their own.

It’s just very, very hard to put rational analysis above our natural “herding” instincts. In fact, for most people it’s nearly impossible which is why markets will never be efficient and we will always have booms and busts.

There’s only one reason I can think of for investors to keep money invested right now and to keep putting new money to work in stocks: you’ve got a time frame longer than 10 years AND you don’t have the time or wherewithal to pay attention to even the most basic investment merits of stocks as an asset class. In this case, dollar cost average into an index fund and put more into it every single month, without fail. Over 10, 20, 30 years you should do very well – the longer your time frame, the better.

Those who have a time frame less than 10 years or who can understand and pay attention to the investment merits of stocks as an asset class, however, have no excuse. There’s just no good reason to have undue exposure to stocks right now that I can think of.

Ultimately, the stock market right now is flying as high as Robert Downey, Jr.’s character in the movie that shares a title with this blog post. And now that the Fed is taking away its heroin (QE) it’s inevitably going to go through some painful withdrawals. And even if it doesn’t, you’d do better to put your money under the mattress.

Markets, Posts, Trading

Two Key Fibonacci Levels I’m Watching Right Now

There are two charts I’ve been watching for weeks now that I thought I would share today. Both represent critical Fibonacci levels in important indexes. For that reason they matter greatly to the broader stock market.

First is the Russell 2000 which represents small cap stocks. These little guys have just torn it up over the past few years – so much so that they are now trading at a valuation that is 26% above their late 90′s peak! A while back I labeled the breakout above $85 “the most bullish chart I’m watching right now.” Since then the index has soared nearly 40%. But now it’s running into the 1.618 Fibonacci extension within the context of a broken rising wedge (bearish) and diverging money flow and MACD (bearish):


This next chart shows the weekly performance of the Financial Sector ETF. It hasn’t performed nearly as well as the small caps over the past few years as it still has a long way to go to recover the losses it suffered during the financial crisis. it’s now running into the 61.8% Fibonacci retracement of that decline also within the context of a broken rising wedge (bearish) and divergences in RSI and MACD (bearish).


Small caps have led the broader rally over the past few years and finance now makes up a very large part of our economy so both of these charts are key “tells” in my book.

For more fun with Fibonacci see “Nature by Numbers.”

Charts, Economy, Investing, Posts

Don’t Believe The Hype Of Rising Interest Rates

“Best investments for a rising rate environment” “The coming crash in the bond market” “How to prepare for an interest rate spike”

I’m seeing these kinds of headlines and stories everywhere. Everyone and their mom is expecting long-term interest rates to rise now that the Fed is tapering its bond buying programs. (Actually, interest in the term “bond market crash” peaked last Summer, ironically right at the time bonds bottomed in price. See chart below.)

Screen Shot 2014-03-26 at 2.13.00 PMI have a couple of problems with this line of thinking. First, although it seems like reducing demand for a security (i.e. tapering QE) would result in a drop in price, when you really think about how quantitative easing works this makes no sense. Second, the market is telling us this makes no sense. Let me explain.

To the first point, quantitative easing has been effective in supporting the economy through the wealth effect. It has encouraged investors to shun low-risk, low-yielding investments for higher-risk investments (if you can even classify them as investments). This has resulted in a surge in the prices of stocks, corporate bonds, real estate, etc. over the past five years with a greater effect on the riskiest categories within those asset classes: money-losing tech and biotech stocks, junk bonds and leveraged loans, etc. As a result investors feel wealthier and thus they spend more. They’re happy and the Fed’s happy because the economy’s happy.

But now that all of this is ending what should we reasonably expect as a result? To my mind, if QE is an inflationary force, intended to boost the economy, its removal can only have a net deflationary effect on the economy. For those unaware, inflation is bearish for bonds (rising rates = lower bond prices) and deflation is bullish (lower rates = higher bond prices).

To the second point, this isn’t just my personal opinion. This is exactly what the market is telling us. I’ve shared this chart before. It shows the history of quantitative easing and how various assets have been affected:


At the end of the prior QE programs it’s plain to see that not only did bonds fail to “crash” they actually surged in price. I believe investors fled to bonds in these two prior circumstances for two reasons: First, many traders were heavily short bonds anticipating a fall in price as the Fed ended purchases:


All these shorts were forced to cover when… Second, the economy showed brief signs of weakness, aka deflation, which sent bond prices higher/rates lower inspiring the Fed to take up QE yet again. (This is probably what Richard Koo means when he says the Fed is in a “QE trap.” They can’t end their bond purchases without harming the economy.)

Notice that traders are once again heavily short the long bond. In the past this sort of positioning has led to strong moves higher as traders cover their shorts.

Now the Fed isn’t technically ending QE right now; it’s merely tapering it’s purchases. I think this is why this trade has been a bit messier than those QE end trades of the past few years. Bonds have risen but they haven’t quite “surged” as they have in the past. Still, Janet Yellen has said that the Fed intends to continue tapering until the bond buying is ceased entirely so the result should eventually be the same. (Time will tell if they are actually capable of removing this stimulus completely without seeing the economy stumble.)

This is exactly what the charts are saying. JC Parets, of All Star Charts, recently called the daily chart of the long bond, “one of my favorite charts in the world,” as it looks like it is now breaking out to new highs, a very bullish development:


Conversely a long-term look at the yield on the 10-year treasury bond shows it is still well within a very clear downtrend:


I wouldn’t consider this a “rising rate environment” until this downtrend is convincingly broken. In fact, the only rates that seem to be rising lately are on the short end of the yield curve which has flattened considerably since the Fed began its tapering its QE program:


Note that, “the slope of the yield curve is one of the most powerful predictors of economic growth, inflation and recessions.” The curve is still positive but the fact that it’s flattening suggests we should be more worried about a reduction in “economic growth” and “inflation” than the opposite.

The bottom line is I just don’t see any evidence to suggest that we are in anything resembling a “rising rate environment” or that one is even anywhere on the horizon. This is not to say that somewhere down the road there may be consequences for the Fed’s easy policies and one of those may be rising rates. It’s just not happening right now.

Featured, Investing, Posts

ATTN: DUMB MONEY – The Smart Money Is Selling To You (Yet Again)

Near major turning points in the stock market there is always the fascinating dichotomy of smart money doing one thing and dumb money doing the exact opposite. And by smart money I’m not talking about analysts or brokers or newsletter writers, hardly; I’m talking about corporate insiders. As for the dumb money, I’m talking about Joe Retail trader, your average Wall Street sucker. Without fail the smart money is buying at market bottoms while dumb money is selling and vice versa.

To take off on a brief tangent, for those of you offended by the term “dumb money” know that, in the words of Warren Buffett “when ‘dumb money’ acknowledges is limitations, it ceases to be dumb.” The trouble is that most dumb money doesn’t ever acknowledge the fact that market timing is outside of its abilities. It continues to think it’s smart and buy high and sell low and regard itself as merely unlucky. End of tangent.

Recent sentiment surveys show that investors haven’t been this net bullish in a very long time. This is valuable to us as a contrarian indicator but these are still just surveys. They reveal what people are saying they’re doing with their money. Looking at what investors are actually doing with their money the picture becomes downright scary.

Right now we are witnessing the most extreme example of this dichotomy between smart and dumb money that has ever been recorded. Rydex traders now have nearly 8 times a much money in bullish funds as bearish ones. This is an all-time high:

sentiment_05via SentimenTrader

At the same time, “in-the-know insiders,” corporate officers and directors, have never been more bearish on their own shares. Marketwatch reports:

[blockquote2]Corporate officers and directors in recent weeks have sold an average of six shares of their company’s stock for every one that they bought. That is more than double the average adjusted ratio since 1990, which is when Seyhun’s data begin…. The current message of the insider data “is as pessimistic as I’ve ever seen over the last 25 years,” he says. What makes this development so ominous, he adds, is that, while no indicator is perfect, his research has shown that “the adjusted insider ratio does a better job predicting year-ahead returns than almost all of the better-known indicators that are popular on Wall Street.” There have been two prior occasions when the adjusted insider ratio got almost as bearish as it is today — early 2007 and early 2011. The first came a half a year before the beginning of the worst bear market since the 1930s. While the market didn’t fall as much following the second of these two instances, the May-October decline in 2011 did satisfy — based on intraday levels of the S&P 500 index — the semiofficial definition of a bear market as a 20% drop.[/blockquote2]

When the smart money talks, I listen. And if there’s any dumb money out there reading this I hope this helps you ‘cease to be dumb.’

Featured, Investing, Markets, Posts, Trading

For Everyone Who Thinks Tom DeMark’s 1929 Analog Is A Joke…

If you can keep your head when all about you
Are losing theirs and blaming it on you,
If you can trust yourself when all men doubt you,
But make allowance for their doubting too;


Tom DeMark has been absolutely lambasted since he first proposed his 1929 analog a few months ago. It suggests stocks might be following a similar pattern today as they did back then, ultimately headed for a crash. Even many market watchers I deeply respect have turned the study into a joke on social media.

To these folks I’d just like to point them in the direction of Paul Tudor Jones II, one of the most successful hedge fund managers in history. Anyone who has read the original “Market Wizards” should be familiar with his story. It begins, “October 1987 was a devastating month for most investors as the world stock markets witnessed a collapse that rivaled 1929. That same month, the Tudor Futures Fund, managed by Paul Tudor Jones, registered an incredible 62 percent return.”

How did he do it? How did he manage to profit so handily from an event nobody saw coming? Jones answers, “our analog model to 1929 had the collapse perfectly nailed. [Paul Jones' analog model, developed by his research director, Peter Borish, super-imposed the 1980s market over the 1920s market. The two markets demonstrated a remarkable degree of correlation. This model was a key tool in Jones' stock index trading during 1987.]” The 1929 analog was the “key” that helped him predict and prepare for the crash.

Screen Shot 2014-03-13 at 7.31.03 AMphoto via “Trader” (chart title reads “The Dow in the Eighties and Twenties”)

The documentary, “Trader,” also verifies this account. It was filmed in the months leading up to the 1987 crash. There are many scenes in the film in which Jones and Borish discuss the analog and how it provides the foundation for their daily trading. “At times like this, what gives these two confidence is a theory that says the stock market moves in cycles, in patterns, and Paul and Peter subscribe to the Elliott Wave Theory which says to them what happened 49 years ago, in the late 1920s, is happening again now.” Sadly, Mr. Jones has removed the film from circulation. His reason for doing so is anyone’s guess but witnessing the ridicule that DeMark has suffered recently I can’t blame him.

Jones and DeMark are two of the men I respect most in this business. I believe that one of the main reasons behind their success is their ability to, ‘keep their heads and have faith in their own convictions when all about them are losing theirs and doubting them.’ To me, this latest 1929 analog is still valid until the Dow Industrials make a new high. Until then, I’ll take the ridicule as a contrarian sign that Tom is onto something.

UPDATE: After I shared this post with Tom via email he shared this response with me:

[blockquote2]In regard to the 1929 comparison it was taken entirely out of context and was merely a talking point. It originated from an interview with a business week reporter in early October. At that time, she was asking about the market and I forecast it would likely bottom October 7 or 8—interview was October 7 i believe—and it would rally 12.6% and a likely market top would appear. She asked if it would be a major market top and I replied anecdotally among the charts we were following at the time was a comparison between 1929 and the current market and I sent the chart to her. It showed the rally from the August 1929 low to the September 3, 1929 peak was also 12.6%. She asked if I expected the same outcome and my one sentence response which she quoted in the article and appeared beneath the gold chart– “I’m (the analog) not afraid I’m going to be wrong,” DeMark says. “I’m just saying it’s something to consider.”  See link http://www.businessweek.com/articles/2013-10-14/hedge-fund-chart-guru-tom-demark-sees-dark-days-ahead [/blockquote2]

[blockquote2]Subsequent to the article we received various congrats as the both DJIA and SPX rallied 12.6-12.7% into their respective december 31 and Janaury 14 highs. Then the market declined and unexpectedly we received interview requests from virtually around the world. The casual comparison between the two periods surprisingly had taken on a life of its own. Late Novenber and December tv interviews served to fuel the fire of this analog. Finally when I appeared on CNBC at the february bottom the topic of conversation, just as it had been throughout the decline and in interviews, was the comparison and I was very clear it was unlikely to occur and assigned 10% likelihood and this was also mentioned on Glenn Beck interview about the same time.[/blockquote2]

[blockquote2]Now you have the background of how a casual remark erupted into something more than intended. Agree with your assessment that DJIA has not yet cancelled the comparison. In fact the following report by Goldman Sachs seems to agree with you as they conducted their own research of comparable market periods and the one with the strongest correlation was actually identical to what we off-handedly referenced in an interview early last Ocotber—see below for Goldman update.[/blockquote2]

[blockquote2]BY the way, the gold forecast made in same interview and numerous times on tv late last year forecasting December 31, 2013 as the low in advance and which has been very accurate has been given little or no notice whatsoever. Strange.[/blockquote2]Here’s an excerpt from the Goldman note:

[blockquote2]Recently, Tom DeMark brought up 1929 as a possible analog for today’s market.  In discussing sentiment, I also showed how the idea of that analog was mocked in the media.  In light of the fact that the Dow Industrial did not make a new high in tandem with SPX, I feel it is appropriate to make my contribution to the discussion.[/blockquote2]

[blockquote2]Using a historical software product, I asked for the historical best match for the last 2.5 year (~500 days) of action in the Dow. Combing the Dow’s entire history, the best match was 1929 (Chart 6). The charts match up right in October of that year. The program uses a term “correlation” to judge the quality of the match. The correlation for the match is 97.5%.  I have been using this software since 1997, and a match of that quality over a period of 500 days is relatively rare.[/blockquote2]

[blockquote2]Bottom Line: My opinion is that it might be a good idea to protect yourself from a further decline in SPX.[/blockquote2]

To put the 97.5% correlation into context, in the “Trader” documentary, Peter Borish says that the 1987 correlation with the 1929 chart was roughly 92%.

Solent News & Photo Agency
Investing, Links, Markets, Posts

Why I’m Nearly As Bearish As I Was Bullish 5 Years Ago

I’ve been pretty bearish (and wrong – or early depending on your time frame) in these pages for a few months now. This week the stock market marks it’s 5-year bull market anniversary and what an impressive run its been. Five years ago I was rip-snorting bullish (and also wrong – or early – for a few months):

sc[blockquote2]To quote Charles Dickens, we are currently facing “the worst of times.” By any measure, this is the worst economy America has witnessed in decades. However, for prudent investors in both stocks and real estate, “it is the best of times,” as we are now faced with a once-in-a-lifetime opportunity. -Fortitude in the Face of Crisis, 3/12/09[/blockquote2]

[blockquote2]All three time frames [daily, weekly and monthly] are now aligned with [DeMark] Buy Signals. -TD Indicators: Another Tool for the Trader’s Toolbox, 3/10/09[/blockquote2]

[blockquote2]All in all, there are many signs that the indexes are close to forming a major market bottom. -A Bird’s Eye View of the Bull and the Bear, 3/6/09[/blockquote2]

[blockquote2]Stocks haven’t been this cheap in over 20 years. -Cheapest Stock Market in Decades, Part Deux, 3/4/09[/blockquote2]

Reading back through this stuff I can’t help but feel like I’ve stepped through the looking glass into exactly the opposite situation, as all of these signs have now reversed making this one of the worst times to buy stocks in decades.