How To Play A Stock Market Bubble
NOTE: Every week or two I wrote a Client Note for my clients. I post the notes to my blog but with a time delay usually between 1 day and 1 week. To receive the Client Notes at the same time as my clients, sign up in the box in the right hand corner of the website.
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Two ways to protect our downside while profiting from a bubble are through position sizing and time frame. By reducing our position size and shortening our time frame, we reduce the risk of being fully exposed to a potential collapse.
Some Perspective On Gold
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If you can keep your head when all about you are losing theirs.- Rudyard Kipling “If”
Societe Generale wrote a piece titled “The End Of The Gold Era”. Goldman Sachs recommended shorting it. The New York Times ran a feature on Thursday (“Gold, Long A Secure Investment, Has Lost Its Luster”, Thursday, April 11, B1). Paul Krugman devoted his Friday op-ed to it. This morning, Josh Brown wrote an over the top obituary to the gold bull market while insinuating that belief in gold is equivalent to religious faith: “Where the $#!@ is your Gold Messiah now?” he bellowed.
Based on the quantity and tone of the chatter, you’d think gold was on its way out. In fact, it is down only 20% since its 2011 highs. Let me say that again: gold is down only 20% from its 2011 highs. A 10 year chart shows that gold is still up nearly 300% in that time period.
A longer term perspective suggests that this is merely a blip in an ongoing secular bull market. All of the factors that have driven gold higher the last 10 years are still in effect. Gold is a store of value that trades inversely to the supply of and confidence in paper money. The creation of new money by global central banks has never been greater at any time in history. The Federal Reserve, the ECB and now the BOJ.
Technically, volume in the GLD Friday exceeded 50 million shares for the first time since the peak in the Fall of 2011. Just as there are countless bearish stories on gold now, there were bullish stories back then. We are much closer to the end of this correction than to the beginning of a collapse.
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The best lack all conviction, while the worst are full of passionate intensity.
- William Butler Yeats, “The Second Coming”
For many of us this weekend is a good time to take a deep breathe and aim for some longer term perspective. I have spoken to investors who are panicked to get into the stock market and others who are completely despondent about the crash in the gold market. I have said it many times and it bears repeating: extreme emotion is the surest sign of a market turning point. It is at times like these that our mettle as investors is tested. The temptation is to act reactively and impulsively but that is always a losing investment strategy. Now, more than ever, conviction and patience are needed (“The Need For Conviction And Patience”, February 18).
The Road To 1600
NOTE: Every week or two I wrote a Client Note for my clients. I post the notes to my blog but with a time delay usually between 1 day and 1 week. To receive the Client Notes at the same time as my clients, sign up in the box in the right hand corner of the website.
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I have to admit it: I never thought we’d get here. New all-time highs on the S&P 500. Over the last four years, again and again I’ve learned the hard way the relentlessness of this bull market. I am humbled. The last time I felt this way was three years ago when I wrote a Client Note titled “I Was Wrong” (April 5, 2010).
Even traders who have been bullish are amazed. In a blog post from Tuesday night titled “The Big Challenge For Many Traders”, veteran trader Joe Fahmy wrote: “It feels like almost every time I see warning signs and turn cautious, the market magically picks up a bid and grinds higher. It is really amazing!” His advice: “Just stick with the terms uptrend or downtrend and stop trying to be an economist about the whole thing.”
Similarly, technician Andrew Thrasher wrote in a blog post Wednesday morning: “All the negative divergence is telling us is that the car tires are losing a little air. This doesn’t mean the car drives off into a ditch, it’s just a warning that the driver needs to be aware of…. They are warnings. They let us know something is happening ‘below ground’ so to speak” (“Technical Analysis Doesn’t Have To Be Difficult”, April 10).
In the last couple of weeks, even bad economic data have not been enough to derail this market for more than a day or two. Two of the most important – March ISM Manufacturing and BLS Jobs Report – both came in notably weak but were absorbed within a matter of hours. The Fed Minutes released today raise some concern about the Fed pulling back but no one cares.
Just this morning $15 billion bellwether industrial Fastenal (FAST), which sells all sorts of construction and industrial supplies, reported growing weakness in their business: “With the benefit of hindsight, we believe the economic activity of our customers slowed from January to February and slowed further from February to March” (Fastenal Earnings Release, April 10). A glance at their homepage shows the wide array of industrial supplies and equipment they sell to customers worldwide. As the S&P soars into uncharted territory, nobody seems to notice that FAST is down 4%.
The one bullish development which may be driving this latest leg up is the bazooka unveiled last Thursday by the Bank Of Japan. The BOJ has declared war on deflation and will aim to double Japan’s monetary base over a two year period primarily by buying Japanese Government Bonds (JGBs) at a pace of 50¥ trillion/year. That’s $500 billion for an economy one third the size of the US. Japan has become “the most interesting story in global economics” (Neil Irwin WonkBlog, April 8). The whole world is watching because they are only doing to a higher degree what everyone else is. It won’t be long when we have to start talking about quadrillions when discussing the Japanese economy tweeted CNBC’s Kelly Evans. It makes our Quantitative Easing policies look like a squirt gun.
While today’s action probably paves the path to 1600 in the next couple of days, I remain extremely cautious.
Market Internals: A Look Beneath The Surface
NOTE: Every week or two I wrote a Client Note for my clients. I post the notes to my blog but with a time delay usually between 1 day and 1 week. To receive the Client Notes at the same time as my clients, sign up in the box in the right hand corner of the website.
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While the overall S&P closed at a new record Tuesday (1570), the small cap Russell 2000 was down 0.5% and is down 1.8% the first two days of April. As a result, overall breadth on Tuesday was quite weak. Less than 50% of NYSE traded securities were positive on the day and advancing volume not much above 40%. What that means is that a very select group of mega cap stocks are now carrying the entire market on their shoulders.
This leadership is not the kind that suggests robust global economic growth. Healthcare and Consumer Staples are the far and away leaders while Materials and Technology trail significantly YTD. Defensive names like Johnson & Johnson (JNJ), General Mills (GIS) and Pfizer (PFE) are powering the market higher. “You can’t stop Celgene (CELG), it’s the key to this market”, quipped Jim Cramer to open CNBC’s Squawk on the Street Monday morning. Indeed, healthcare stocks are the new momentum plays with the S&P Health Care ETF (XLV) closing above its upper Bollinger band each of the last three days. Commodities – which are levered to global economic growth – have not kept pace with the S&P so far this year.
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Even the most bullish of market participants, Wall Street strategists, have their doubts about the rally. “Markets have blown past what fundamentals dictate they should be doing,” Barclay’s Barry Knapp told The Wall Street Journal. “This is really a story where the fundamentals are not driving the market,” said UBS’s Jonathan Golub (both quoted in “Growls Keep Coming From the Bear’s Den” , WSJ, April 1, R1).
Meanwhile, the media focus on the stock market’s new highs is causing individual investors to come back. The Wall Street Journal ran a story about this on Saturday (“Mom and Pop Run With The Bulls”, WSJ, March 30, B1). Lucie White and her husband, both doctors, put money into the market last week for the first time since pulling everything out in 2008. “We just didn’t want to be left on the sidelines,” said Mrs. White.
This is the set up as we head into an earnings season that looks to be quite weak (see my “A Preview of 1st Quarter Earnings”, SeekingAlpha, March 26). 86 S&P companies have issued negative guidance compared to just 24 issuing positive guidance – a ratio of 3.58 to 1, the highest since FactSet began tracking it in 2006. While the S&P makes new records daily, a look beneath the surface shows all is not well.
A Preview of 1st Quarter Earnings
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There was a lot going on last week. While everyone was focused on the drama in Cyprus, a number of bellwether companies whose quarters ended in February reported earnings. Developments in Cyprus will likely dominate the headlines and market action this week. However, attention will soon turn to 1st quarter earnings. Studying these early reporters can give us clues into what to expect when earnings season gets underway in a few weeks.
While Nike (NKE) reported a strong quarter after the close on Thursday, it was driven by North America and masked weakness in China. North America sales and profits were up 18% and 24% year over year, respectively, contributing to a strong overall report that drove shares up 11% on heavy volume. However, Greater China sales and profits were down 9% and 20%, respectively.
Also reporting last week was global transportation bellwether FedEx (FDX). FDX’s report was notably weak with only 2% revenue growth in its core Express Division. Domestic volumes and yields were each up about 1%, while a 4% increase in International Export volumes was offset by a 3% decrease in yield. Combined with an increase in expenses, Express Division operating margin decreased to 1.8% from 5.3% a year ago. Customers continue to select slower, less expensive shipping options, squeezing FDX’s profit.
One conclusion we can draw from these three reports is an accelerating slowdown in China. Things seem only to have gotten worse since I wrote about this last year (“The Chinese Slowdown”, July 9, 2012). This is the primary reason we are short YUM Brands (YUM) which is more directly concentrated in China than any other S&P 500 company.
Finally, leading business software maker Oracle (ORCL) reported earnings Wednesday afternoon. Non-GAAP revenue, operating income and net income were all down 1% in a tepid quarter. Weakness was driven by sales of new software and hardware which are more sensitive to economic growth than revenues from updates and support. Oracle shares lost more than 10% on Thursday and Friday.
All in all, it is hard to draw much encouragement about the global economy from the testimony of these four global bellwethers.
Extreme Technicals And Sentiment
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Timing the market is extremely difficult. Indeed, it is almost a dogma that it is impossible to do. It cannot be done perfectly and is more art than science. Further, it is not a question of timing it to the day or being All In or All Out but a matter of degree. Nevertheless, with these qualifications, it can be done profitably and is the crowning skill of great trading. (See Barry Ritholtz, “The Truth About Market Timing”, March 13, for another recent take on market timing).
In this context, current conditions suggest that we may be very close to a major market top. Most importantly, we are now at the highs of the 2000 and 2007 bull markets. Since 2000, most market observers acknowledge that we have been in a secular bear market in which alternating cyclical bear and bull markets have resulted in no overall progress for the market. For stocks to continue higher, we will have to break through resistance that has capped the previous two bull markets and served as resistance for 13 years.
In addition to this serious overhead resistance, sentiment has entered euphoric territory. An excellent measure of sentiment is margin debt or the amount of money investors are borrowing from their brokers on margin. Looking at the attached chart of margin debt and the S&P 500 going back to 1999, note two things. First, the rise and fall of margin debt is highly correlated with rises and falls in the S&P. Second, current margin debt is now approaching the levels it reached at the 2007 top.
Also consider the Volatility Index or VIX, which measures options prices, closed at a 6 year low Monday. The last time the VIX was this low was February 26, 2007 and the very next day saw the largest spike in history (“Lowest VIX Close Since Day Before Biggest VIX Spike Ever”, Bill Luby, March 11).
The most recent Investor’s Intelligence survey also shows extreme bullishness. The number of bears dropped below 20% which Ryan Detrick, Chief Technician at Schaeffer’s, tweeted has correlated with intermediate market tops the last few years.
In addition to the extreme sentiment and technicals, seasonality and fundamentals also suggest we may be at a turning point. Michael Santoli wrote in a blog post yesterday that each of the last three years have had Spring tops followed by nasty corrections (“Will Stocks Third Time Around Be A Charm Or Hex?”, Michael Santoli, March 13).
Fundamentally, on Monday The Wall Street Journal’s Ahead of the Tape column noted how weak revenues have been: down 1% in last year’s 3rd quarter, up 4% in the 4th and forecast to be up just 1% in this year’s 1st quarter (“Investors Take A Rosy View Of Earnings”, Ahead of the Tape, March 11, C1).
Put all this technical, sentiment, seasonal and fundamental data together and it is my sense that we are very near a major market top.
The Message Of The Market
NOTE: Every week or two I wrote a Client Note for my clients. I post the notes to my blog but with a time delay usually between 1 day and 1 week. To receive the Client Notes at the same time as my clients, sign up in the box in the right hand corner of the website.
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To the surprise of investors who were becoming used to the markets steady grind higher, last week brought the first real selling of the year. On Wednesday and Thursday, the S&P dropped 29 points (1.9%) on NYSE Composite volume about 20% higher than the year’s average. 28% of the S&P’s YTD gain which took 33 trading days to build was wiped out in two. Behind the indexes, many of the leading stocks such as Bank of America (BAC, -6.3%), Goldman Sachs (GS, -4.9%) and the S&P Homebuilders (XHB, -4.9%) got hit much harder. As they say: stocks take the stairs up and the elevator down.
It is fitting that the primary catalyst for the decline was the release of the Fed Minutes from the previous FOMC meeting. Since the flood of liquidity is generally acknowledged to be one of the primary drivers of the bull market, any whiff that the Fed is even thinking about taking away the punch bowl is a source of concern. Consider that the upcoming $85 billion sequester is equal to what the Fed injects into financial markets every month. Combined with the significantly overbought technical condition of the market, it set off a rapid unwinding.
The most comical aspect of the week was the appearance of St. Louis Fed President and FOMC voting member James Bullard on CNBC’s Squawk Box Friday morning. Bullard made his purpose for being there completely transparent saying that: “Fed policy is very easy and it’s going to stay easy for a long time.” In other words, he was there to reassure the market. Anybody who thinks that the Fed doesn’t pay close attention to financial markets should be disabused of that notion by Bullard’s appearance.
Because the market is a reflection of the mass psychology of its participants according to their weight and activity, the action of the market itself is of preeminent importance. Hence that illusive Wall Street cliche to listen to the message of the market. Despite a decent bounce on Friday, last week’s action suggests to me there is a good chance things have changed and the market’s slow grind higher may be coming to an end. T3 Live’s master swing trader Scott Redler called Wednesday’s action a “key inflection point”. While we can never know with certainty what the market will do, everybody will now be paying increasingly close attention in the days ahead.
Greg Feirman
Founder & CEO
Top Gun Financial (www.topgunfp.com)
A Registered Investment Advisor
Bay Area, CA
(916) 224-0113
ENGAGE WITH ME ON SeekingAlpha AND FOLLOW ME ON Twitter!
The Need For Conviction And Patience
NOTE: Every week or two I wrote a Client Note for my clients. I post the notes to my blog but with a time delay usually between 1 day and 1 week. To receive the Client Notes at the same time as my clients, sign up in the box in the right hand corner of the website.
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Jason Zweig wrote an important article about the great value investor Jean Marie Eveillard in this weekend’s Wall Street Journal (“Value Stocks Are Hot – But Most Investors Will Burn Out”). Despite being one of the great investors of his time, investors pulled two-thirds of their assets from his mutual fund when he underperformed from 1997 to early 2000. “After one bad year investors were upset. After two they were mad, and after three they were gone,” he recalls. As a result, they missed out when he subsequently outperformed.
This an especially important lesson at times like this when the market is making new highs and the fear of missing out is pervasive. The pressure not to be left behind can be especially strong for professional money managers who are judged based on their performance relative to the market and their peers. As Jean Marie Eveillard’s story shows, no matter how strong your overall record, extended underperformance can cost you your job. As a result, the urge to conform is almost irresistible.
There was a surprising example of this last week. David Rosenberg, the notorious permabear, told CNBC’s Fast Money that he is now more constructive on the market. (It’s not like Rosenberg has become a bull, but the change in his tone is revealing nevertheless). What was his reason? The market is riding a wave of central bank liquidity. A moment’s reflection, however, suggests that this can’t be the real reason. Central bank liquidity has been driving this market for years and everyone knows it. The real reason is almost certainly the pressure he feels from being wrong and missing out for so long as the market again makes new highs.
The greatest profits come when you have a disparate view from the consensus which turns out to be right. An excellent recent example of this is John Paulson’s shorting of the mortgage market detailed masterfully in The Greatest Trade Ever. Paulson’s investors fought him every step of the way and many pulled their money. However, Paulson was convinced he was right and stood firm. When the market came over to his point of view, he realized windfall gains in a very short amount of time.
It is now two weeks since I called for the end of the bull market that began in 2009 in “When You Least Expect It” (sent to clients February 1). During that time, the market has mostly chopped around, with the S&P up about 0.5%. Last week the S&P traded in a 10 point range. “Flat is the new pullback” quipped Charles Kirk in his Weekend Chart Show. It is not easy to maintain discipline under these conditions but experience teaches that it is the right thing to do.
When You Least Expect It
NOTE: Every few weeks I wrote a Client Note for my clients. I post the notes to my blog but with a time delay usually between 1 day and 1 week. To receive the Client Notes at the same time as my clients, sign up in the box in the right hand corner of the website.
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CTRL+SQUEEEEZE (10:04am EST)
You are either long here, or you are not #timestamps (10:05am EST)
net short crowd, #crickets (10:14am EST)
- Tweets by @KeithMcCullough, February 1
The last few weeks represent the belief that there will be no existential threat to any large global economy in 2013.
- Nicholas Colas, Chief Market Strategist, BNY ConvergEx Group, quoted in “As Worries Ebb, Small Investors Propel Markets”, The New York Times, January 26, A1
There can be few fields of human endeavor in which history counts for so little as in the world of finance. Past experience, to the extent that it is part of memory at all, is dismissed as the primitive refuge of those who do not have the insight to appreciate the incredible wonders of the present.
- John Kenneth Galbraith
A few minutes after 10am EST Friday morning the Dow hit 14,000. The previous Friday, the S&P closed above 1500. Two Saturdays ago, The New York Times ran a front page story about small investors returning to the market. “I just bought some more stock this morning [Friday],” said Jim Cole, a 52 year old employee at The Bank of the West in San Francisco. “There doesn’t seem to be this swirl of impending doom hanging over the US economy or the world economy looking out 6 to 12 months from now.”
Small investors aren’t the only ones becoming more bullish of late. B of A/Merrill Lynch’s January survey of professional money managers showed them as bullish as any other time during the current bull market. A net 59% expect the global economy to strengthen this year, the highest reading since April 2010. “Following the resolution of the US fiscal cliff, sentiment has surged,” said Michael Hartnett, Chief Investment Strategist at B of A/Merrill Lynch. “Half of investors now tell us that they would sell government bonds to buy higher beta stocks, which is consistent with our call for a “Great Rotation” to start in 2013.”
I could cite countless other facts showing the same thing: the VIX at 13, junk bond spreads, short interest, etc… The sentiment of the global economy’s elite in Davos last week is that we have escaped the shadow of the 2008 financial crisis. “I was riding around in a van last night with two guys whose names you’d recognize,” Scott Minerd, CIO of Guggenheim Partners in Santa Monica told Bloomberg BusinessWeek. “They were comparing notes and hearing the same thing. The conclusion has sort of gone viral. There’s a crystallization of thought that the financial crisis is over.”
In my last Client Note, I wrote about the one stock that is not working in the current environment: Apple (AAPL). A stock that is working and is in certain respects the opposite of Apple is Facebook (FB). While Apple has declined from $700 to $450 in recent months and now trades for about 7 times earnings, Facebook has climbed from $20 to $30 and trades for about 50 times earnings.* This is just another example of how out of whack the current market is.
The paradox of financial markets is that this sort of sentiment is highly correlated with market tops. When everybody least expects it, that’s when the bottom tends to drop out. That’s because the market is a reflection of mass psychology in the form of supply and demand. It is my belief that the bull market which began in March 2009 is on the verge of ending.
It is worth pointing out that I have a decent track record recently of calling tops and bottoms such as “Get Ready For A Nasty Correction” (February 16, 2011), “The Case for a 4th Quarter Rally” (October 3, 2011) and “The Fiscal Cliff And The Roadmap Into Year End” (November 19, 2012) in which I called for a year end rally.
* These P/E ratios are on trailing earnings after backing out net cash and investments.
After The Cliff
NOTE: Every week or two I wrote a Client Note for my clients. I post the notes to my blog but with a time delay usually between 1 day and 1 week. To receive the Client Notes at the same time as my clients, sign up in the box in the right hand corner of the website.
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About 7 weeks ago in “The Fiscal Cliff And The Roadmap Into Year End” (e-mailed November 19th, not published on website), I recapped the correction which had taken place since QE Infinity in mid-September, singled out and overviewed the fiscal cliff as the most important issue into year end, and made the case for a year end rally based on sentiment, seasonality and a fiscal cliff deal as catalyst. Happily, things played out mostly as I expected – though I didn’t anticipate the political drama going down to the wire the way it did.
The market is subject to unreasoning waves of optimism and pessimism to paraphrase Keynes (“Keynes Critique Of Wall Street”, March 20, 2012). The deal reached on New Year’s Day has created a burst of enthusiasm and looking forward it is now time to take a fresh look at how things stand.
Negotiations centered on where the line would be drawn to define the wealthy whose taxes would rise. The two sides met in the middle deciding that singles earning $400,000 or more and couples earning $450,000 or more will have their marginal income tax rate increase from 35% to 39.6%. Some deductions will also be phased out above $250k/$300k. Everyone below those thresholds will have the same marginal rate.
The capital gains and dividend tax rate will increase to 20% for those above the $400k/$450k threshold and remain at 15% for those below. The 3.8% ObamaCare tax on investment income will also take effect for those above $200k/$250k. The Wall Street Journal created a nice table summarizing the tax increases.
While not a Grand Bargain addressing the long term unsustainability of our debt and deficits, the deal suits Wall Street’s short term mentality just fine. As a result, the S&P 500 is up more than 100 points from the mid-November lows and on the verge of making new bull market highs. Indeed, 88% of S&P stocks are currently trading above their 50 DMA according to BeSpoke Investment Group. With the market overbought and the much anticipated catalyst behind us, caution is in order.
One stock notably not participating in the recent move is Apple (AAPL). After making new highs around $700 in mid-September in correlation with the rest of the market, Apple has lagged in recent weeks. At $530, it is off about 25% and has become a battleground stock.
Legendary bond investor Jeff Gundlach has been bearish and yesterday on CNBC predicted $425. On the other hand, the hedge fund leaders continue to be bullish as far as we know. David Einhorn’s Greenlight Capital had a $728 million position out of $6 billion in total holdings and David Tepper’s Appaloosa Capital Management $348 million out of $4 billion as of Sept 30, 2012.
An article in the most recent Barron’s showed how cheap shares are (“No Matter How You Look At It, Apple Shares Are Cheap”, Tiernan Ray, December 29), but I am worried about the brutal comps they are up against in the first half of the year. The right policy has been to give the stock the benefit of the doubt since the skeptics have always been proved wrong and that is what I intend to do with our position. But as always the spotlight will shine brightly when they report December quarter earnings on January 23rd.
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