Archive for January, 2012

Visualize: The European Super Highway of Debt


Tuesday, January 31st, 2012

These info-graphics shows how much banks loaned to Portugal, Ireland, Italy, Greece & Spain (PIIGS). Europe is in a deep crisis, and this shows how much must be repaid.

from demonocracy.info:

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Precisely Watson?! (Saut)


Tuesday, January 31st, 2012

“Precisely Watson?”

by Jeffrey Saut, Chief Equity Strategist, Raymond James

January 30, 2012

Sherlock Holmes: “And, then there was the event of the dog barking in the night.”

Dr. Watson: “But Holmes, there was no dog barking in the night!”

Sherlock Homes: “Precisely Watson!”

According to Wikipedia (as paraphrased by me):

It is precisely on this distinction that Holmes bases his insight. When the inspector asks, “Is there any point to which you would wish to draw my attention? Holmes responds, “To the curious incident of the dog in the night.” But, protests the inspector, “The dog did nothing in the night.” To which Holmes delivers the punch line, “That was the curious incident.”

For Holmes, the absence of barking is the turning point of the case: the dog must have known the intruder. Otherwise, he would have made a fuss. For us, the absence of barking is something that is all too easy to forget. We don’t even dismiss things that aren’t there; we don’t remark on them to begin with. But often, they are just as telling and just as important – and would make just as much difference to our decisions – as their present counterparts. How asking what isn’t there can help us make better decisions.

And, last week there was indeed a “dog barking in the night” as Chesapeake (CHK/$22.05/Market Perform) announced it was shutting down numerous natural gas wells due to low gas prices, a signpost coincident with many “bottoms.” On that announcement natural gas futures went from $2.23 per MMcf to $2.75 into last Friday’s closing price. That’s a 23% upside reversal and likely sets the low water mark for natural gas. While our Houston-based research team doesn’t believe it, and they have been more right than me, I think the “lows” for natural gas are “in.” Certainly, major corporations think there is a future for natural gas given the buyout activity over the past few years in the natural gas space. Names for your consideration that are favorably rated by our fundamental analysts include: Anadarko Petroleum (APC/$79.32/Strong Buy); EnCana (ECA/$19.60/Outperform); Williams Companies (WMB/$28.55/Outperform); and Devon Energy (DVN/$65.01/Outperform).

Speaking to Devon, I have mentioned this company before, sparked by my friends at the “must have” Bespoke Investment Group. To wit, January 17th’s missive stated:

“In business school they teach you that investing is all about earnings, and while I think fear, hope, and greed play a role in the investing equation, over the long term earnings indeed play the dominant role. Realizing this, the good folks at Bespoke have assembled a list of companies that have consistently reported the strongest earnings since March 2009 that report between now and February 24th. Names favorably rated by our fundamental analysts making said list include: Citrix Systems (CTXS/$65.14/Outperform); Devon Energy (DVN/$65.01/Outperform); and Tempur-Pedic (TPX/$70.09/Strong Buy).”

Most recently, our exploration and production analyst Andrew Coleman had this to say about Devon:

“On January 5th, we upgraded Devon to a Strong Buy from Outperform. Earlier this week, Devon announced a $2.2 billion joint venture with the Sinopec International Petroleum Exploration & Production Corporation (SIPC). The deal gives SIPC a 33% working interest in Devon’s 1.2 million acres across five New Venture plays (e.g. Niobrara, Ohio Utica, and Tuscaloosa Marine shales as well as the Mississippi Lime and the Michigan basin). We value the transaction at $5,500 per acre overall. As a result of the deal, we are raising our production growth expectations for 2012 from 7.5% to 10% (vs. peers at 16%).”

Interestingly, the reciprocal to my natural gas “dog barking in the night” theme is Apple (AAPL/$447.28), which had a “blow out” earnings quarter last week. Indeed, Apple reported 1Q12 sales of $46.33 billion and profits of $13.1 billion. That was the second highest quarterly profit for any company ever! Such metrics lifted the company’s cash hoard to $97.6 billion, making its cash position larger than the market capitalization of 448 of the companies in the S&P 500. Apple sold 37 million iPhones in the quarter for a y/y growth rate of 128%; and, has now sold a total of 315 million iPhones, iPads, and iPod Touch devices. On the earnings release Apple’s shares leapt from $420.41 (last Tuesday’s close) to Wednesday’s opening price of $454.44, making Apple the world’s most valuable company ($417 billion) by exceeding Exxon’s (XOM/$85.83/Market Perform) market capitalization of $413 billion. Clearly, an astounding quarterly report that caused one old Wall Street wag to exclaim, “When the news can’t get any better I sell.”

Turning to the stock market, in last week’s report I wrote:

“The recent rally has not been accompanied by a noticeable increase in Buying Demand as measured by Lowry’s Buying Power Index. Rather the rally has occurred more from a reduction in Selling, which is reflected in Lowry’s Selling Pressure Index. Then too, the percentage of stocks above their respective 10-day moving averages (DMAs) has failed to confirm the upside and the New High list is not expanding. In fact, 40% of my short-term indicators are now bearish and none are bullish. Meanwhile, the NYSE McClellan Oscillator is overbought, the stock market does not have much internal energy left for a big rally, the S&P 500 is three standard deviations above its 20-DMA, the Volatility Index is telegraphing too much complacency, and we have negative seasonality for the next few weeks. Nevertheless, I continue think it is a mistake to get too bearish because I believe any pullback in the various indices will be contained.”

The conclusion to last Monday’s missive was to look for a short-term trading peak followed by either a pause or a correction that could pull the S&P 500 (SPX/1316.33) down to the 1280 – 1290 level. And, the week turned out to be just a “pause” saved by a rally attempt on the more dovish than expected FOMC statement. While the pause didn’t really correct the overbought nature of the NYSE McClellan Oscillator (see the chart on page 3), it has somewhat rebuilt the stock market’s internal energy. It should be noted the D-J Industrial Average (INDU/12660.46) edged above its July 2011 closing high on an intraday basis last Thursday, as well as that the new rally highs in the INDU and SPX have been confirmed by new rally highs in the Cumulative Net Points and Cumulative Volume Indices. Meanwhile, the NYSE Advance/Decline Line continues to move to new all-time highs. Interestingly, given the year-to-date strength, there have been no 90% Upside Days, a reflection of the aforementioned reduced volatility. Also of interest is that unlike prior quarters fundamental analysts are not raising their earnings estimates as earnings season is underway. This could be because the current earnings “beat rate” is not nearly as robust as past quarters.

To be sure, I have repeatedly commented that earnings comparisons were going to get more difficult because the trailing four quarter’s earnings reports have been so strong; and, that’s precisely what is happening. For example, with 180 of the S&P 500 companies reporting, there has been 1.81 upside earnings surprises for each disappointment versus a more normal ratio of 3:1. Accordingly, it makes sense to screen for companies producing “Triple Plays” – that would be companies beating earnings and revenue estimates and also raising forward earnings guidance. Three names from our research universe that qualify as Triple Plays and are favorably rated by our fundamental analysts for your consideration, include: Arctic Cat (ACAT/$30.65/Strong Buy); Caterpillar (CAT/$111.28/Outperform); and Xilinx (XLNX/$35.99/Outperform).

The call for this week: Well, I am traveling the balance of this week to see institutional accounts, speak at an Investment Banking Conference, and present at a handful of retail seminars. Consequently, there will be no verbal strategy comments for the rest of the week. Therefore, I will leave you with these thoughts. The January Barometer has sounded the “all clear” signal with a monthly gain for the INDU of 3.36% and a 4.67% rise in the SPX. History suggests double-digit returns for the rest of the year with positive returns occurring more than 80% of the time. Two sectors have been the main drivers of this January Jump, namely Consumer Discretionary and Technology. Unsurprisingly, the Consumer Discretionary, Technology, Industrial, and the Materials sectors are all beating earnings estimates at the highest “beat rate,” while Consumer Staples, Energy, Financials, and Healthcare are not. While I remain somewhat timid on a short-term trading basis, I continue to believe the year of the Water Dragon will bestow the five Chinese blessings of harmony, virtue, riches, fulfillment, and longevity. That adds even more weight to my growing belief that 2012 will be about breakthroughs, not disasters.

P.S. – As an aside, maybe participants should consider that Warren Buffett is not paying too little a percent of income tax, but rather his secretary is paying too high a percent!


Click here to enlarge

Copyright © Raymond James

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Dissecting Today’s Bull Market (Koesterich)


Tuesday, January 31st, 2012

In recent weeks, the European Central Bank and the Fed have announced new monetary stimulus and appear ready to act to prop up the global economy.

In response, some investors have apparently rediscovered their appetite for risk. Since November 29th lows, global stocks are up roughly 9% and emerging market equities have gained about 12%. And during the past eight weeks, high yield bonds have risen roughly 5%.

In fact, this week some market watchers have declared that we’re in the midst of a bull market. For example, the WSJ’s MarketBeat blog, noting that bullish sentiment is on the rise, says “Welcome to the New Bull Market,” or at least welcome to a continuation of the bull market it says started in March 2009.

It’s important, however, to put the current “bull market” in context. There’s a big difference between various types of bull markets. In secular bull markets (like the one we experienced from 1982 to 2000), stock prices rise over a long period of time thanks to ongoing improving fundamentals. Cyclical bull markets, on the other hand, can occur within both secular bull and secular bear markets, but tend to be shorter in duration.

In my opinion, we aren’t in – and aren’t entering — a new secular bull market. Instead, we’re still stuck in a long-term secular bear market that began in 2000. It’s not as if the problems that haunted investors last November — a European crisis, a political divide in Washington, slow growth in developed markets and a potential banking crisis in China — have gone away.

Equity performance from 2003 to 2007, however, shows us that there can be relatively long rallies in secular bear markets. I believe the rally we’re experiencing now is actually a cyclical bull market that could easily go on for the remainder of 2012, assuming the European crisis doesn’t take a turn for the worse and we don’t experience other unforeseen market shocks.

Distinguishing between secular and cyclical bull and bear markets is so important because of their different investment implications. In secular bull markets, investors can rely on a traditional buy-and-hold strategy. In secular bear markets and accompanying cyclical bull markets, however, having a more tactical approach (i.e. a timeframe of five years or less) can help investors take advantage of market peaks and valleys and potentially avoid having investments merely move sideways.

So what’s a tactical investing idea for the current cyclical bull market? Well, let’s look at the investment implications of the Fed’s announcement this week. First, it suggests that nominal rates and real rates will stay low for a long time. This further buttresses the case for gold. Second, if US interest rates are going to be anchored at zero for an extended period, people are going to need to take some risk — in one form or another — to generate a decent return.

Source: Bloomberg

 

Past performance does not guarantee future results.

Gold and other precious metal prices may be highly volatile. The production and sale of precious metals by governments, central banks or other larger holders can be affected by various economic, financial, social and political factors, which may be unpredictable and may have a significant impact on the supply and prices of precious metals.

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The “January Effect” and the probabilities for 2012


Tuesday, January 31st, 2012

Market Minute: January 29, 2012: The “January Effect” and the probabilities for 2012

by Donald W. Dony, FCSI , MFTA, The Technical Speculator

 

The strength in the S&P 500 this month tells more about the performance for the rest of the year than most investors realise. Over the last 40 years, whenever the US market has had a return above 3.75% in January, the S&P 500 finished the year higher. Currently, the index is up 4.44%.

Since 1970, there has been 13 times when the US market has been above 3.75% in January. Every time the index completed the year with a substantial gain.

The 13 Januarys with returns of 3.75% or greater were in 1971, 72, 75, 76, 79, 83, 85, 87, 88, 89, 91, 97 and 99.

The average gain for the rest of the year was a surprising 19.6%. This means that if this January can finish above 1307.25, then there is a very strong probability of the index going higher in 2012. And as there are only two more trading days left this month, the US market would have to drop 10.77 points or more to cancel out the effect.

Bottom line: The S&P 500 has gained 4.44% in January. With two days remaining, the probability of a good performing 2012 is building. If the US index can close out the month above 1307.25, then there is a strong likelihood of another 15% gain by year-end based on 40 years of data.

Investment approach: The odds for a promising 2012 are mounting. If the S&P 500 does perform well, as the last 13 Januarys with a 3.75% would suggest, then investors may wish to remain fully invested this year to take advantage of the anticipated rise.

From an intermarket perspective, it is also worth noting what happens when the US markets moves up. The US dollar index and bond prices normally move in the opposite direction to the S&P 500. Commodities are closely coordinated with equities. If the stock market advances this year, so should base metal, gold, silver, oil and agricultural grain prices.

Also, there is a shift out of defensive sectors such as consumer staples, healthcare and utilities and a move to growth industries like technology, energy, mining, consumer discretionaries, construction and basic industry.

More research on commodities and the markets will be in the upcoming February newsletter.

Donald W. Dony, FCSI , MFTA

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Will Seasonal Slump Drive Derisking?


Tuesday, January 31st, 2012

The so-called January-Effect is almost at an end and if the market closes near these levels, the S&P 500 will have managed a 4.4% gain or its 20th best January since 1928 (84 years) and best since 1997. The outperformance of banks and sovereigns (LTRO) and the worst-of-the-worst quality names (most-shorted Russell 3000 stocks +9% YTD vs Russell 3000 +5.2%), as Morgan Stanley noted recently, is not entirely surprising since the January effect is considerably larger in mid-cap and junk quality names than any other size or quality cohorts. We have pointed to the seasonal positives in high-yield credit and volatility and along with the obvious short squeeze in S&P futures (which has seen net spec shorts come back to balance recently), we, like MS, are concerned that the tailwinds of exuberance that virtuously reflect from seemingly pivotal securities (such as short-dated BTPs now or Greek Cash-CDS basis previously) very quickly revert to a sense of reality (earnings and outlook changes) and perhaps the slowing rally and rising volatility of the last few days is the start of that turbulence.

The most-shorted stocks (tracked by the red lines on the above chart) have dramatically outperformed the broad markets they are part of with the Russell 3000 most-shorted (thick red) massively outperforming (almost 400bps in the month!).

Morgan Stanley: January Effect

January is often a month for risk taking since optimistic investors believe that any underperformance during the month can be reversed by year-end.

In light of the sharp rally in the equity market thus far this year, we took some time to study the concept of a “January Effect.” Since 1901, the S&P 500 has averaged a 1.2% return during January with a standard variation of 4.3%. In the remaining eleven months of the year, the index has averaged a 0.5% monthly return with a 5.2% standard variation (Exhibit 2).

After accounting for the standard deviations, the return spread between January and the remaining eleven months is marginally statistically significant: With a T-stat of 1.73, it is significant at the 10%-level but insignificant at the 5%-level. In fact, 2012’s rally to date is only a 0.8 standard deviation event, and studying history, we would expect such a move to occur in slightly over 20% of January’s. We studied the “January Effect” by market cap cohort, quality-junk status, and value-growth status. Since 1970, the spread between the January return and the return for February through December has been highest in mid-cap stocks (Exhibit 3). None of the three cap cohort’s return spread is statistically significant—the mid-cap spread has the highest T-stat at 1.46. Year-to-date performance so far this year by cap cohort is consistent with smaller-cap outperformance.

We analyzed returns by quality cohort since 1981 and found that both quality and moderate quality, on average, perform worse in January than during the remainder of the year. Low quality slightly outperforms in January, while junk is by far the largest outperformer on average (Exhibit 4). The more positive performance of junk relative to the other quality quintiles is not surprising given that junk stocks are generally smaller than quality stocks, and the January effect is stronger in these small stocks. Still, none of the quality cohorts’ return spreads are statistically significant after accounting for volatility and the number of observations.

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Ryan Lewenza: Investment Outlook (January 27, 2012)


Tuesday, January 31st, 2012

Look to Increase Equity Exposure Following an Expected Near-Term Pullback

by Ryan Lewenza, VP, Senior U.S. Equity Analyst, TD Waterhouse

January 27, 2012

TD’s (TD Waterhouse) Ryan Lewenza has just released (late last week) his U.S. Equity Strategy team’s strategy report. In it he/they detail their case for increasing equity exposure following their call for a near-term pullback.

Highlights
- With the S&P 500 Index (S&P 500) up 5.5% since the beginning of the year and over 20% since its October 2011 low, the U.S. equity market looks technically overbought, and susceptible to some near-term profit taking, in our view. In determining whether the equity markets are overbought/oversold we look at a number of technical indicators, which at present, are painting a rather clear picture of a stretched and overbought market. While we see the potential for some near-term pressure over the next few weeks, we believe investors should take advantage of the potential weakness and look to add to their equity exposure, given an improving U.S. economy and the recent liquidity injection from the European Central Bank.

- One of our preferred market indicators in isolating extreme overbought/oversold market conditions is the percentage of New York Stock Exchange (NYSE) stocks above their 50-day moving average. Generally, when this indicator is above 80, it indicates an overbought market, and oversold when below 20. Currently, this indicator stands at 87, a level last seen in late October 2011, and just before the S&P 500 corrected 10% over the following month.

- After hitting an economic soft patch last summer, the U.S economy has shown some resiliency, especially in light of the headwinds emanating from Europe. ISM manufacturing has ticked higher recently, and with the sub-component New Order Index surging in recent months (57.6 in December, up from 49 in summer 2011), we believe there may be more upside for the ISM index over the next few months, which if correct, could continue to support a higher stock market.

- With the recent strength in the U.S. economy and stock market we are tweaking our sector recommendations, by adding some cyclicality to our investment strategy. In particular, we are downgrading utilities from overweight to market weight, and upgrading the materials sector from underweight to market weight.

- While we are downgrading utilities, we still believe investors should have some exposure to the sector, given their defensive qualities and high dividend yields. One name that stands out is Exelon Corp. (EXC-N). Exelon is one of the largest utility companies in the U.S. and is the country’s largest nuclear operator.

You can read/download Ryan Lewenza’s report in full, in the slidedeck below; Fullscreen for the larger read:

U.S. Equity Strategy (Look to Increase Equity Exposure Following an Expected Near-Term Pullback) – Janaury …

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Eurozone Remains In Jeopardy – Rogers, Soros, Altman, Lagarde, Weinberg


Tuesday, January 31st, 2012



Perspectives from the Euro Crisis, Week 4, January 2012

For the complete interviews, visit the following sources:

Jim Rogers:
Jim Rogers – January 30, 2012 – CNBC.com – No country will exit the euro zone this year but a solution to the debt crisis remains elusive, Jim Rogers, CEO and Chairman at Rogers Holdings, told CNBC Monday. Rogers elaborated that because there are around 40 prominent elections happening around the world this year, that nothing is going to be allowed to happen this year, however, he is not so confident about 2013, or 2014.

George Soros:
George Soros – January 25, 2012 – CNBC.com – Despite some improvement in the euro zone crisis after the European Central Bank’s recent actions, billionaire investor George Soros told CNBC on Wednesday that more is needed to safeguard the region in the face of a possible Greek default and rising national debts.

Roger Altman:
Roger Altman – January 27, 2012 – CNBC.com – The turning point in the Europe crisis was when the ECB made a very American-like step by lending 450-billion euros and providing liquidity to the banking system, says Roger Altman, Evercore Partners.

IMF’s Christine Lagarde:
Christine Lagarde – Jan. 27 (Bloomberg) — International Monetary Fund Managing Director Christine Lagarde discusses Greece’s progress on structural overhauls and the role of the IMF in avoiding a default. She speaks with Maryam Nemazee and John Fraher on Bloomberg Television’s “The Pulse” from the World Economic Forum’s annual meeting in Davos, Switzerland, telling them that her critical objective at this moment is to get Greece debt under control, down to a level that is equal to 120% of GDP. (Source: Bloomberg)

Carl Weinberg:
Carl Weinberg – Jan. 30 (Bloomberg) — Carl Weinberg, founder and chief economist at High Frequency Economics, talks about a European Union leaders’ summit in Brussels, that starts today and the euro zone debt crisis. Weinberg told Betty Liu on Bloomberg Television’s “In the Loop,” that the EU needs to step up and fund the EFSF (European Financial Stability Fund) to the tune of an additional 300-billion euros to match the funding agreement reached by the ECB, because even the big-name banks like Unicredit, are struggling, and this is the only way to safeguard the European banking system. In addition, he added they are spending too much time addressing the wrong issues. (Source: Bloomberg)

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Guest Post: Baltic Dry Index Signals Renewed Market Decline


Monday, January 30th, 2012

Submitted by Brandon Smith from Alt Market

Baltic Dry Index Signals Renewed Market Collapse

Much has been said about the Baltic Dry Index over the course of the last four years, especially in light of the credit crisis and the effects it has had on the frequency of global shipping.  Importing and exporting has never been quite the same since 2008, and this change is made most obvious through one of the few statistical measures left in the world that is not subject to direct manipulation by international corporate interests; the BDI.  Today, the BDI is on the verge of making headlines once again, being that is plummeting like a wingless 747 into the swampy mire of what I believe will soon be historical lows.

The problem with the BDI is that it is little understood and often dismissed by less thoughtful economic analysts as a “volatile index” that is too “sensitive” to be used as a realistic indicator of future trends.  What these analysts consistently seem to ignore is that regardless of their narrow opinion, the BDI has been proven to lead economic derision in the market movements of the past.  That is to say, the BDI has been volatile exactly BECAUSE markets have been volatile and unstable, and is a far more accurate thermometer than those that most mainstream economists currently rely on.  If only they would look back at the numbers further than one year ago, they might see their own folly more clearly.

Introduced in 1985, the Baltic Dry Index first and foremost is a measure of the global shipping rates of dry bulk goods, mostly consisting of vital raw materials used in the creation of other products.  However, it is also a measure of demand for said materials in comparison to previous months and years.  This is where we get into the predictive nature of the BDI…

In late 1986, for instance, the BDI fell to its lowest level on record, then, began a slow crawl towards moderate recovery, just before the Black Monday crash of 1987.

Coincidence?  Not a chance.  From 2001 to 2002, a similar sharp collapse in the BDI preceded a progressive drop in the Dow of around 4000 points, ending in a highly suspect (Fed engineered) illegitimate recovery.  In 2008, the index fell to near record lows once again just before the derivatives and credit crisis hit stocks full force.  To imply that the BDI is not a useful measure of future economic trends seems like an astonishingly ignorant proposition when one examines its very predictable behavior just before major financial downturns.

This is not to suggest that the BDI can be used as a way to play the stock market from day to day, or often even month to month.  MSM analysts rarely look further than the next quarter when considering any financial issue, and that is why they don’t understand the BDI.  If an index cannot be used by daytraders to make a quick buck in a short afternoon, then why bother with it at all, right?  The BDI is not an accurate measure of the daily market gamble.  It is, though, an accurate measure of where markets are headed in the long run and under extreme circumstances.

Over the course of the past month, the BDI has fallen around 65% from above 1600 to 726.  Mainstream economists argue that the BDI’s fall in 2008 was a much higher percentage, and thus, a 65% drop is nothing to worry about.  They fail to mention that shipping rates never recovered from the 2008 collapse, and have hovered in a sickly manner near lows reached during the initial credit bubble burst.  By their logic, if the BDI was at 2, and fell to 1, this 50% drop should be shrugged off as inconsequential because it is not a substantial percentage of decline when compared to that which occurred in 2008, even though the index is standing at rock bottom.  Yes, the useful idiots strike again…

Looking at the rate and the speed of decline this past month, it’s hard to argue that the current 65% drop is meaningless:

Another subversive argument against the BDI is the suggestion that it is not the demand for raw materials that is in decline, but the number of shipping vessels out of use that is growing.  A smart person might suggest that these two problems are mutually connected.  An MSM pundit would not.

In 2008, many ships were left to wallow in port without cargo, but this was due in large part to two circumstances.  First, demand had fallen so much that too many ships were left to carry too little raw materials.  Second, credit markets had sunk so intensely that many ships could not find trade financing necessary to take on cargo.  In either case, the BDI still falls, and in either case, it still signals economic danger.  The only way that the BDI could signal a major decline in shipping demand artificially or inaccurately is if a considerable number of ships under construction were suddenly released onto the market while there is no demand for them.  There have been no mass increases or extreme changes in cargo fleets this past month, or at all since 2008, which means, the BDI’s decline has NOTHING to do with the number of ships in operation, and everything to do with decline in global demand.

What is the bottom line?  The stark decline in the BDI today should be taken very seriously.  Most similar declines have occurred right before or in tandem with economic instability and stock market upheaval.  All the average person need do is look around themselves, and they will find a European Union in the midst of detrimental credit downgrades and on the verge of dissolving.  They will find the U.S. on the brink of yet another national debt battle and hostage to a private Federal Reserve which has announced the possibility of a third QE stimulus package which will likely be the last before foreign creditors begin dumping our treasuries and our currency in protest.  They will find BRIC and ASEAN nations moving quietly into multiple bilateral trade agreements which cut out the use of the dollar as a world reserve completely.  Is it any wonder that the Baltic Dry Index is in such steep deterioration?

Along with this decline in global demand is tied another trend which many traditional deflationists and Keynesians find bewildering; inflation in commodities.  Ultimately, the BDI is valuable because it shows an extreme faltering in the demand for typical industrial materials and bulk items, which allows us to contrast the increase in the prices of necessities.  Global demand is waning, yet prices are holding at considerably high levels or are rising (a blatant sign of monetary devaluation).  Indeed, the most practical conclusion would be that the monster of stagflation has been brought to life through the dark alchemy of criminal debt creation and uncontrolled fiat stimulus.  Without the BDI, such disaster would be much more difficult to foresee, and far more shocking when its full weight finally falls upon us.  It must be watched with care and vigilance…

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John Hussman: Investment Outlook (01/30/12)


Monday, January 30th, 2012

Investment Outlook, January 30, 2012
Warning: Goat Rodeo

by John P. Hussman, Ph.D.

Goat Rodeo – Appalachian slang for a chaotic, high-risk, or unmanageable scenario requiring countless things to go right in order to walk away unharmed.

Over the years, of the most frequent phrases in these weekly comments has been “on average.” Most of the investment conditions we observe are associated with a mix of positive and negative outcomes, so rather than making specific forecasts about future market direction, we generally align our investment position in proportion to the average return/risk outcome, recognizing that the actual outcome may be different than that average in any particular instance.

Increasingly however, we have observed sets of conditions that are so heavily skewed toward bad outcomes that they deserve the word “warning” (see Extreme Conditions and Typical Outcomes near the 2011 peak, Don’t Mess with Aunt Minnie before the 2010 market break, Expecting a Recession in late 2007, A Who’s Who of Awful Times to Invest at the 2007 market peak, and our shift from a modestly constructive investment position to a Crash Warning in October of 2000). While the downturns that followed have provoked increasingly large and desperate actions of central banks to kick the can down the road by preventing debt restructuring and financial deleveraging (in some cases by violating legal constraints – see The Case Against the Fed ), the fact is that the S&P 500 has achieved a total return of just 1.2% annually over the past 12 years, as a predictable outcome of rich valuations and still-unresolved economic imbalances.

I could admittedly do better, and would certainly have captured more upside from temporary speculation, had I committed myself to the principle that central banks will act strictly to defend the bondholders of the banks they represent, even if it means trespassing into fiscal policy, subordinating public interest, empowering the worst stewards of capital, violating legal restrictions, and inviting long-term instability. Still, none of those actions improve the long-term outcome for the markets, and more importantly, none have prevented repeated and serious downturns from occurring, despite all the can-kicking.

Once again, we now have a set of market conditions that is associated almost exclusively with steeply negative outcomes. In this case, we’re observing an “exhaustion” syndrome that has typically been followed by market losses on the order of 25% over the following 6-7 month period (not a typo). Worse, this is coupled with evidence from leading economic measures that continue to be associated with a very high risk of oncoming recession in the U.S. – despite a modest firming in various lagging and coincident economic indicators, at still-tepid levels. Compound this with unresolved credit strains and an effectively insolvent banking system in Europe, and we face a likely outcome aptly described as a Goat Rodeo.

My concern is that an improbably large number of things will have to go right in order to avoid a major decline in stock market value in the months ahead. We presently estimate that the S&P 500 is likely to achieve a 10-year total return (nominal) of only about 4.7% annually, which reduces the likelihood that further gains will be durable even if they persist for a while longer. In the context of present valuations and a probable Goat Rodeo in the months ahead, my impression is that the recent market advance may be a transitory gift.

Whipsaws, Noise and Exhaustion

In nearly all real-world data, there are short-term fluctuations, random effects, and other influences that create “noise” in the values that we observe. Typically, those sources of noise confound the “signal” that we want to identify, so unless the noise is filtered away, there is a risk of being misled by meaningless short-term fluctuations. In finance, there are countless approaches that essentially involve noise reduction. For example, a moving average is just a simple noise-reduction technique, where very short-term fluctuations (“high frequency components”) are averaged away, leaving the smoother influence of longer-term fluctuations. Similarly, the Coppock Curve – the 10-month exponential smoothing of the averaged 11-month and 14-month rate of change of the market – is really just a “low-pass” filter that cuts away high frequency fluctuations and allows the market’s long-term (low frequency) cycles to pass through.

In late October, I noted a condition that we characterize as a Whipsaw Trap – which essentially involves a breakdown in a broad set of market internals, followed by a recovery driven by some of the more volatile components (sectors such as financials and transportation stocks are good examples). I noted that only about 30% of these whipsaw traps were followed by further advances – a statistic that was based on subsequent market action over the following 6-8 week period. The real question is “What then?” The answer is both straightforward and troublesome. Specifically, whenever we’ve observed a whipsaw trap that then advances enough to a) drive the S&P 500 earnings yield below its level of 6 months earlier and b) raise advisory bullishness beyond 45% – or bearishness below 30%, the result has almost always been hostile. Essentially, what this combination picks up is an already fragile set of market internals that has enjoyed an “exhaustion rally” that both exceeds earnings growth and is met with overbullish sentiment.

The previous observations of this exhaustion syndrome, and the deepest decline from that point to the low of the next 7 months, on a weekly closing basis, were: November 1961 (-25%), August 1987 (-33%), July 1998 (-18%), July 1999 (-12%), August 2000 (-22%), May 2001 (-24%), March 2002 (-32%) and May 2008 (-43%). There were also two instances of this syndrome that were not associated with a market plunge: January 2006 during the housing bubble (which ultimately led to a market collapse well below those levels), and November 2010, just as the Fed was initiating QE2 (which still did not prevent the market from trading at lower levels about 9 months later).

If we think in terms of “exhaustion rallies,” the syndrome we’re observing here is a multiple indicator version of signals like the Coppock “killer wave” – which occurs when the Coppock Curve reaches a peak, declines, and the market then recruits an advance large enough to establish a second wave higher. Some technicians have debated how best to define the signal (e.g. the decline required to define a negative shift) – in our view, it’s not a good idea to use a single indicator in the first place – but in any event, the selloffs from those exhaustion waves have often been brutal, and a few overlap the syndrome outlined here.

In short, market action is presently showing features associated with “exhaustion rallies”, which have often been followed by deep losses over the following 6-7 month period.

As a side note, we’ve seen an similar whipsaw in various economic statistics recently, where I continue to view the modest but tepid “recovery” as a reflection of high-frequency noise. Here too, the underlying “signal” remains weak, but the more volatile components have been positive. Unfortunately, the typical result is that the divergence snaps shut in the direction of the signal.

[Geek's Note: What I call a "Whipsaw Trap" is basically a breakdown in a broad range of market internals, followed by an advance in more volatile, high-frequency components that isn't enough to survive moving averages and other low-pass filters. It's difficult to draw a true signal from noisy data unless you have a lot it, and unfortunately, the more data you need to use to infer a signal, the greater the "lag" there is in recognizing that signal. Think again of a moving average - the longer-term the moving average, the more it lags behind recent action. The better you want a microphone to cancel noise, the longer the delay you have to endure between the input and the output. Generally speaking, we get better and more rapid information about the true, underlying "signal" if we can draw that signal out of multiple indicators, each which carries part of that information. Methods to distinguish "signal" from "noise" run through much of my financial, economic, and scientific work, for example Market Efficiency and Inefficiency in Rational Expectations Equilibria , and A Noise-Reduction GWAS Analysis Implicates Altered Regulation of Neurite Outgrowth and Guidance in Autism . The benefit of inferring signals from multiple sources is why the rational expectations paper used vector ARMA models for inference, why the GWAS paper exploited the local correlation of association signals within the same chromosomal region across multiple data sets, and why good leading economic indices combine multiple series rather than using any single indicator as an acid test].

Recession risk remains high

Last week contained very little to alter our view that a global economic downturn is likely here. While we recognize the modest, low-level improvement in a variety of indicators (see Dodging a Bullet, from a Machine Gun ), and also estimate that recession risk is something less than 100%, this is far from a suspension of our recession concerns. To the contrary, a concerted global downturn that includes the U.S. remains the most likely outcome.

Last week, the Conference Board released its revised version of Leading Economic Indicators, which shows a sharply weaker trajectory than the former version if the LEI. Indeed, the revised LEI has already turned down, though to a lesser degree than just before previous recessions.

A few economic notes. In early 2010, we examined the seasonal adjustment factors used by the Bureau of Labor Statistics in the monthly employment report (see Notes on a Difficult Employment Outlook ). While we didn’t observe any striking divergences between the BLS adjustment factors and our own estimates, I noted that the effect of those seasonal adjustments typically amounted to anywhere between +1.9 and -1.3 million jobs, depending on the month. Presently, we estimate that the effect of these adjustments range between +2.1 million and -1.1 million jobs in any given month (see When Positive Surprises are Surprisingly Meaningless ). These are strikingly large numbers compared with the typical range of forecasts that often surround the monthly employment numbers.

Think of it this way – if there is typically a great deal of temporary job creation in the fourth quarter of the year (and there is), the effect of seasonal adjustment will be to subtract off a certain proportion of actual employment in order to smooth that bulge down. Accordingly the October-December adjustment factors range between -0.6% and -0.8% of total non-seasonally adjusted employment. In contrast, if there is a great deal of job destruction in January and February (and there is), the effect of seasonal adjustment will be to add back some amount of phantom employment, amounting to between 1.1% and 1.6% of total nonfarm payroll jobs.

Given that virtually all economic series undergoes some amount of seasonal adjustment, it isn’t difficult to see how the extraordinarily weak economic data in late 2008 and early 2009 may have produced an upward bump in a wide variety of seasonal adjustment factors for data around the turn of the year, adding to the short-term noise we’re already observing in various economic series. In any event, even without any skewed seasonal factors, the broad ensemble of leading economic evidence remains unfavorable here.

Finally, while we typically discourage drawing inferences from any single indicator, it’s at least worth noting that with the release of Q4 GDP figures, the year-over-year growth rate of real U.S. GDP remains below 1.6% (denoted by the red line below). A decline in GDP growth to this level has always been associated with recession, usually coincident with that decline, though with a two-quarter lag in two instances (1956 and 2007), and with one post-recession dip in growth during the first quarter of 2003. As it happens, the GDP growth rate dropped below 1.6% in the third quarter of 2011.

Given the strong and rather obvious relationship between the most recent year-over-year rate of GDP growth and the prospect of oncoming recession, it’s difficult to understand why Wall Street so completely rejects the likelihood of an economic downturn. Then again, that’s exactly why we’re expecting a Goat Rodeo.

Market Climate

As of last week, the Market Climate for stocks was characterized by conditions we associate with a “whipsaw trap,” coupled with overvalued, overbought, overbullish conditions and evidence of exhaustion that has only a handful of generally awful historical peers. Strategic Growth and Strategic International remain tightly hedged, though in both funds, we’ve clipped a few percent from our hedges to reflect the more defensive composition of our holdings. Though steep market declines tend to be indiscriminate (with even defensive stocks often acting as if they have a beta of 1.0), we recognize that “risk on” days can also be very uncomfortable when defensives lag the market and our hedges bite with full force. The modest change to our hedge is intended to maintain our downside protection while hopefully producing a little bit less day-to-day discomfort on days when Wall Street suddenly goes “risk on” and chases banks, financials, materials, and high-debt cyclicals, all of which we hold with smaller weight than the major indices reflect. Overall, however, we would still characterize our investment position as strongly defensive.

In Strategic Total Return, we’re seeing some moderate shifts in the Market Climates for bonds versus precious metals. We used last week’s weakness in bonds to increase the duration of the Fund toward a still moderate 4.5 years, while using the strength in precious metals shares to clip back our holdings below 10% of assets. Given the volatility of precious metals shares relative to bonds, the overall effect is to move the Fund to a somewhat more conservative stance, in the sense that day-to-day volatility is likely to be lower than it has been with a more significant precious metals position. While the Market Climate for precious metals shares remains positive, we observed a discrete reduction in our projected return estimates, and are aligning our investment stance proportionately.

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Average Age of U.S. Vehicles Hits Record 10.8 Years


Monday, January 30th, 2012

Some combination of better made cars, and less Americans able to pay new car prices has conspired to push up the average age of U.S. vehicles to a new record high.  Reflecting this sea change, one of the best investment groups the past 3-4 years has been the automotive aftermarket retailers, headlined by Autozone (AZO).

Traditionally these stocks would rally more during recessions and then weaken in recoveries.  But as a bevy of issues has changed the long term fortunes of the American middle class (plus the removal of the “house ATM” i.e. cash out withdrawal from mortgages), we appear to have a change in this group from a cyclical growth story to secular.  It is also further proof that much of the economic ‘recovery’ is happening in the upper 20-30% of the population, who derive about half the spending in the country.

Ford (F) reported this morning and while EPS missed estimates, revenue came in sharply (10%) over estimates.  During the heydey of the house ATM mid decade, the U.S. car market was north of 16M in annual sales.  That dipped to about 10M in the depths of the Great Recession, and has now rebounded to a 12-13M range.  Auto makers of course have responded (along with the cutting of costs during the bailouts) and now are quite profitable even at this much lower range of auto sales.  If we can even see a rebound to the 14-15M range, the U.S. automakers should be spitting out profits.  (Keep in mind the new wage system in place is replacing a lot of $28-35+/hour type of works with $14 new hires)

  • The average age of a car or truck in the U.S. hit a record 10.8 years last year as job security and other economic worries kept many people from making big-ticket purchases such as a new car.   That’s up from the old record of 10.6 years in 2010
  • ….in 1995…. the average age of a car was 8.4 years.
  • However, Polk Vice President Mark Seng says that a rebound in sales last year and expected growth for the next couple of years is likely to slow the growth rate in the age of cars as a whole in America. Polk has not predicted if or when the age will start to drop, but Seng doesn’t see that happening for at least two or three years, if not longer.  “It’s going to take the good economy several years of very high sales again, and people being willing to let go of those older vehicles that they’ve been holding onto,” Seng said.
  • Last year, auto sales rebounded a bit to 12.8 million vehicles, especially in November and December, when sales were unusually strong. In 2010, U.S. sales totaled 11.6 million after hitting a 30-year low of 10.4 million in 2009.
  • But even a 1 million per year sales increase will have little impact on the average age because there are more than 240 million cars and trucks on the roads in the U.S., Seng says.
  • Shares of major auto parts stores, such as AutoZone Inc., O’Reilly Automotive Inc. and Advance Auto Parts Inc., have easily outpaced the S&P 500 index since late 2007 when the recession began.

 

Disclosure Notice

Any securities mentioned on this page are not held by the author in his personal portfolio. Securities mentioned may or may not be held by the author in the mutual fund he manages, the Paladin Long Short Fund (PALFX). For a list of the aforementioned fund’s holdings at the end of the prior quarter, visit the Paladin Funds website at http://www.paladinfunds.com/holdings/blog

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