Archive for August 20th, 2012
Monday, August 20th, 2012
The fact that the S&P 500 is back near multi-year highs is certainly enough to make bulls happy. That being said, the rally has hardly been broad. As one example, the Utilities sector, which is comprised of 31 stocks in the S&P 500, was down every day this week. Earlier in the week, we also noted that in the most recent leg higher, the Russell 2000 has been underperforming the S&P 500.
In terms of new highs, we have also seen a narrowing of the rally. Back in late March and early April when the S&P 500 made a new bull market high, the number of stocks in the S&P 500 hitting new highs got as high as 78, or 15.6% of the index. Today, however, the number of new highs was just a little more than half the peak reading we saw in the Spring. Of the 500 stocks in the S&P 500, there were 42 stocks that hit a new high (8.4% of the index).
The reason for the smaller number of new highs stems from the fact that the rally is being led by megacaps (like AAPL), which stocks with smaller market caps have lagged. This doesn’t necessarily mean that the rally is doomed. Rather, the less broad based nature of the rally means that it is imperative for investors to be in the right stocks. For a lot of us, just summoning up the courage to get into the market is hard enough. Now, we also have to worry about picking the right stocks!
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Monday, August 20th, 2012
by Michael ‘Mish’ Shedlock, Global Economic Analysis
Economic Times reports European Central Bank mulls caps on borrowing costs
The European Central Bank is considering buying the bonds of crisis-wracked eurozone countries to ensure borrowing costs do not rise beyond a pre-determined level, German newsweekly Der Spiegel said Sunday.
The bank will define an upper limit for borrowing costs in countries such as Spain and Italy and intervene in the markets to ensure it is not breached, Spiegel said, without citing its sources.
At the end of trade on Friday, Spain was paying 6.39 per cent to borrow for 10 years and Italy 5.76 per cent. In contrast, Germany was paying 1.49 per cent, as investors trust Europe’s top economy to repay them.
The so-called spread, or difference, between benchmark German bonds and the debt-wracked countries would be decisive for the proposed rate cap, Spiegel said.
ECB President Mario Draghi announced earlier in August that his institution “may” buy bonds of struggling countries if they first apply for EU bailout funds and accept tough conditions in return.
He said the details would be worked out before the next meeting of the ECB, scheduled for September 6. Spiegel said that ECB governors would decide then whether to implement the proposed borrowing cost cap.
Here is a link to a translated article in Der Spiegel: ECB is planning to challenge interest rate speculation
The European Central Bank (ECB) is considering to establish in its future bond purchases interest rate levels for each country. Thus, they would state papers of the crisis countries always buy when interest rates exceed a certain impact on their yields German Bunds. Sun investors would get a signal that interest rates, the ECB considers appropriate.
Because the Fed has unlimited funds – they can even print the money eventually – it would not succeed even more speculators to drive the returns of the targeted rate also. Thus, the ECB wants to keep not only the financial costs of ailing countries in check, but also to ensure that the general level of interest rates in the euro zone is not too much drifting apart.
At its next meeting in early September, the Governing Council will decide whether the interest rate target is actually installed. One thing is certain, that the ECB will continue to practice their bond purchases more transparent. In the future, they will announce each country, in which capacity she has taken the bonds from the market. This information should be released immediately after the purchases. So far, the ECB had only ever made known Monday how much money she spent on purchases in the previous week as a whole.
Can This Work?
It depends on the definition of “work”. In general, if central planners (and it is important to understand that is what we are talking about here) set prices too high there will be unlimited supply.
Likewise, if central planners set prices too low, there will be shortages.
When it comes to money, recall that Switzerland capped the rate of the Swiss Franc vs. the euro. To defend that cap the Swiss National Bank has to offer unlimited money at the target exchange rate.
When it comes to interest rates, the ECB must be willing to buy an unlimited number of bonds (up to the total supply of all bonds).
Theory vs. Practice
So yes, the ECB can “in theory” defend a price target on bonds, but only at the risk of owning every bond.
What about an exit mechanism? How will the ECB get rid of all those bonds down the road? To who, at what price?
Will Germany go along with this ridiculous scheme? For how long?
As is always the case, interference in the free market by central planning fools always fails in the long run.
Tags: Article In Der Spiegel, Bailout, Borrowing Cost, Crisis Countries, Ecb President, Economic Times, German Bonds, Global Economic Analysis, Governors, India, Interest Rate Caps, interest rates, Investors, Mario Draghi, Michael Mish, Mish Shedlock, Rate Cap, Speculation, Speculators, Spiegel
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Monday, August 20th, 2012
by Don Vialoux, TechTalk
Economic News This Week
FOMC minutes for the July 31st /August 1st meeting are released at 2:00 PM EDT on Tuesday.
June Canadian Retail Sales to be released at 8:30 AM EDT on Wednesday are expected to increase 0.1% versus a gain of 0.3% in June.
July Existing Home Sales to be released at 10:00 AM EDT on Wednesday are expected to increase to 4.55 million units from 4.37 million units in June.
Weekly Initial Jobless Claims to be released at 8:30 AM EDT on Thursday are expected slip to 365,000 from 366,000 last week.
July New Home Sales to be released at 10:00 AM EDT on Thursday are expected to increase to 368,000 from 350,000 in June.
July Durable Goods Orders to be released at 8:30 AM EDT on Friday are expected to increase 2.5% versus a gain of 1.3% in June. Excluding transportation, Goods are expected to increase 0.5% versus a decline of 1.4% in June.
Earnings Reports This Week
The S&P 500 Index added 12.29 points (0.87%) last week. Intermediate trend changed from down to neutral on a break above resistance at 1,415.23. Next resistance is at 1,422.38. The Index remains above its 20, 50 and 200 day moving averages. Short term momentum indicators are overbought, but have yet to show signs of peaking.
Percent of S&P 500 stocks trading above their 50 day moving average increased last week to 81.40% from 80.20%. Percent is intermediate overbought, but has yet to show signs of peaking. Percent has reached a level where an intermediate peak above the 80% level normally leads to at least a short term correction.
Percent of S&P 500 stocks trading above their 200 day moving average increased last week to 73.40% from 70.60%. Percent remains intermediate overbought, but has yet to show signs of peaking
The ratio of S&P 500 stocks in an uptrend to a downtrend (i.e. the Up/Down ratio) increased last week to (289/128=) 2.26 from 1.92. The ratio is intermediate overbought, but has yet to show signs of peaking.
Bullish Percent Index for S&P 500 stocks increased last week to 70.00% from 67.80% and remained above its 15 day moving average. The Index remains intermediate overbought, but has yet to show signs of peaking.
The Up/Down ratio for TSX Composite stocks increased last week to (139/81=) 1.72 from 1.46. The ratio is intermediate overbought, but has yet to show signs of peaking.
Bullish Percent Index for TSX Composite stocks increased last week to 60.57% from 56.91% and remained above its 15 day moving average. The Index remains intermediate overbought, but has yet to show signs of peaking.
The TSX Composite Index gained another 199.00 points (1.67%) last week. Intermediate trend changed from down to up on a break above resistance at 11,936.16. The Index remains above its 20, 50 and 200 day moving averages. Short term momentum indicators are overbought, but have yet to show signs of peaking. Strength relative to the S&P 500 Index remains negative.
Percent of TSX stocks trading above their 50 day moving average increased last week to 69.92% from 66.26%. Percent is intermediate overbought, but has yet to show signs of peaking. Peaks near the 70% level normally lead to at least a short term correction by the Index.
Percent of TSX stocks trading above their 200 day moving average increased last week to 48.37% from 40.65%. Percent continues to trend higher.
The Dow Jones Industrial Average gained another 67.25 points (0.51%) last week. Intermediate trend is up. Next resistance is at 13,338.66. The Average remains above its 20, 50 and 200 day moving averages. Short term momentum indicators are overbought, but have yet to show signs of peaking. Strength relative to the S&P 500 Index remains negative.
Bullish Percent Index for Dow Jones Industrial Average stocks increased last week to 86.67% from 83.33% and remained above its 15 day moving average. The Index remains intermediate overbought, but has yet to show signs of peaking.
Bullish Percent Index for NASDAQ Composite stocks increased last week to 53.69% from 52.42% and remained above its 15 day moving average. The Index continues to trend higher.
The NASDAQ Composite Index gained another 57.74 points (1.81%) last week. Intermediate trend is up. Next resistance is at 3,134.17. The Index remains above its 20, 50 and 200 day moving averages. Short term momentum indicators are overbought, but have yet to show signs of peaking. Strength relative to the S&P 500 Index has changed from negative to at least neutral.
The Russell 2000 Index added 18.34 points (2.29%) last week. Intermediate trend is down, but turns positive on a break above resistance at 820.44. The Index remains above its 20, 50 and 200 day moving averages. Short term momentum indicators are overbought, but have yet to show signs of peaking. Strength relative to the S&P 500 Index has changed from negative to at least neutral.
The Dow Jones Transportation Average gained 130.83 points (2.58%) last week. Intermediate trend is down. Resistance is at 5,290.06. The Average moved back above its 20, 50 and 200 day moving averages. Short term momentum indicators are overbought, but have yet to show signs of peaking. Strength relative to the S&P 500 Index remains negative.
The Australia All Ordinaries Composite Index added 91.02 points (2.12%) last week. Intermediate trend is down. Support is at 4,033.40 and resistance is at 4,515.00. The Index remains above its 20, 50 and 200 day moving averages. Short term momentum indicators are overbought, but have yet to show signs of peaking. Strength relative to the S&P 500 Index remains neutral.
The Nikkei Average gained another 271.06 points (3.05%) last week. Intermediate trend changed from down to up on a break above resistance at 9,136.02 on Friday. The Average remains above its 20 and 50 day moving averages and moved above its 200 day moving average last week. Short term momentum indicators are overbought, but have yet to show signs of peaking. Strength relative to the S&P 500 Index has changed from negative to at least neutral.
The Shanghai Composite Index slipped another 53.92 points (2.49%) last week. Intermediate trend is down. The Index remains below its 50 and 200 day moving averages and fell below its 20 day moving averages last week. Short term momentum indicators are trending down. Strength relative to the S&P 500 Index remains negative.
The London FT Index added 0.91 (0.02%), the Frankfurt DAX Index improved 75.89 points (1.09%) and the Paris CAC Index gained 31.67 points (0.92%) last week.
The Athens Index added 21.04 points (3.40%) last week. The Index remained above its 20 and 50 day moving averages. Short term momentum indicators are overbought, but have yet to show signs of peaking. Strength relative to the S&P 500 Index remains slightly negative.
The U.S. Dollar Index added 0.05 (0.06%) last week. Intermediate trend is up. Support is at 81.16 and resistance is at 84.10. The Index remains just below its 20 and 50 day moving averages. Short term momentum indicators are trending down. Stochastics already are oversold.
The Euro added 0.42 (0.34%) last week. Intermediate trend is down. Support is at 120.42 and resistance is at 126.93. The Euro remains below its 50 and 200 averages, but remains above its 20 day moving average. Short term momentum indicators are trending higher. Stochastics already are overbought.
The Canadian Dollar added 0.18 U.S. cents (0.17%) last week. Intermediate trend is neutral. Support is at 95.76 and resistance is at 102.05. The Dollar remains above its 20, 50 and 200 day moving averages. Short term momentum indicators are overbought, but have yet to show signs of peaking.
The Japanese Yen fell 2.07 (1.62%) last week. Intermediate trend is down. Support is at 124.12 and resistance is at 128.77. The Yen fell below its 20, 50 and 200 day moving averages. Short term momentum indicators are trending down. Stochastics already are oversold.
The CRB Index added 1.67 points (0.55%) last week. Intermediate trend is up. The Index remains above its 20, 50 and 200 day moving averages. Strength relative to the S&P 500 Index has turned neutral.
Gasoline dropped $0.11 (3.65%) when the futures contract rolled over. Gasoline remains above its 20, 50 and 200 day moving averages. Strength relative to the S&P 500 Index remains positive.
Crude oil gained another $2.39 per barrel (2.56%) last week. Intermediate trend is up. Crude remains above its 20 and 50 day moving averages and just below its 200 day moving average. Short term momentum indicators are overbought, but have yet to show signs of peaking. Strength relative to the S&P 500 Index remains positive.
Natural Gas fell another $0.06 per MBtu (2.15%) last week. Intermediate trend is up. Resistance has formed at $3.28. Gas remains below its 50 day moving average and fell below its 20 day moving average last week. Short term momentum indicators are trending down. Strength relative to the S&P 500 Index has changed from up to at least neutral.
The S&P Energy Index slipped 0.78 points (0.14%) last week. The Index is testing resistance at 544.25. The Index remains above its 20, 50 and 200 day moving averages. Short term momentum indicators are overbought, but have yet to show signs of peaking. Strength relative to the S&P 500 Index remains positive.
The Philadelphia Oil Services Index gained 0.97 (0.42%) last week. The move above a reverse head and shoulder pattern continues. The Index remains above its 20, 50 and 200 day moving averages. Strength relative to the S&P 500 Index remains positive.
Gold slipped $4.00 per ounce (0.25%) last week. Intermediate trend is down. Support is at $1,526.70 and resistance is at $1,642.40. Gold remains above its 20 and 50 day moving averages and below its 200 day moving averages. Short term momentum indicators are neutral. Strength relative to the S&P 500 Index remains neutral.
The AMEX Gold Bug Index added 4.88 points (1.13%) last week. Intermediate trend is down. Support is at 372.74 and resistance is at 464.76. The Index remains above its 20 and 50 day moving averages. Short term momentum indicators are trending higher. Strength relative to gold remains positive.
Silver added $0.01 per ounce (0.04%) last week. Intermediate trend is down. Support is at $26.10 and resistance is at $28.44. Silver remains below its 200 day moving average and above its 20 and 50 day moving averages. Short term momentum indicators are trending higher. Strength relative to gold remains neutral.
Platinum jumped $68.90 per ounce (4.92%) last week following labor strife at Lonvin, the world’s third largest platinum mine. Strength relative to gold turned from negative to positive. Platinum moved above its 20 and 50 day moving average.
Palladium jumped $23.75 (4.00%) last week. Nice breakout on Friday on a Leibovit Volume Reversal! Strength relative to the S&P 500 Index had turned from negative to positive.
Copper was unchanged last week. Intermediate trend is down. Support is at $3.24 and resistance is at $3.56. Copper moved back above its 20 and 50 day moving averages on Friday. Short term momentum indicators are neutral. Strength relative to the S&P 500 Index remains negative.
The TSX Global Metals and Mining Index eased 8.48 points (0.97%) last week. Intermediate trend is down. Support is at 781.13. The Index remains above its 20 and 50 day moving averages. Short term momentum indicators are trending higher. Stochastics already are overbought. Strength relative to the S&P 500 Index has been negative and showing early signs of change.
Lumber gained another 6.89 points (2.29%) last week. Lumber remains above its 20, 50 and 200 day moving averages. Strength relative to the S&P 500 Index remains positive.
The Grain ETN slipped $0.22 (0.35%) last week. Units remain above their 20, 50 and 200 day moving averages. Strength relative to the S&P 500 Index has turned negative.
The Agriculture ETF added $0.23 (0.46%) last week. Intermediate trend is up. Units remain above their 20, 50 and 200 day moving averages. Short term momentum indicators are overbought and showing early signs of peaking. Strength relative to the S&P 500 Index remains negative.
The yield on 10 year Treasuries increase 16.7 basis points (1.01%) last week. Short term momentum indicators are overbought, but have yet to show signs of peaking.
Conversely, price of the long term Treasury ETF fell another $4.10 (3.26%) last week.
The VIX Index fell another 1.29 (8.75%) last week. It broke support at 13.66 to reach a five year low. Short term momentum indicators are oversold, but have yet to show signs of bottoming.
Earnings reports to be released this week are unlikely to have a significant impact on equity markets.
Economic reports this week are expected to be neutral/positive this week. Next major event is the Jackson Hole Economic conference where Benanke and Draghi are scheduled to speak.
Macro news heats up this week. China and the Eurozone release their PMI reports on Thursday. Mid-east tensions continue to ramp up.
Short and intermediate technical indicators for most equity markets and sectors are overbought, but have yet to show signs of peaking.
North American equity markets have a history of moving flat to lower in mid-August. September historically is the weakest month of the year. Seasonality turns positive after mid-October.
Cash on the sidelines on both sides of the border is substantial and growing. However, political uncertainties (including the Fiscal Cliff) preclude major commitments by investors and corporation. The selection of Paul Ryan as the Republican Vice President candidate has boosted Romney’s ratings on the polls, but the polls continue to show a tight race.
The Bottom Line
Equity markets on both sides of the border have had a good ride since their lows set on June 4th. The Dow Jones Industrial Average is up 10.3%, the S&P 500 Index has gained 12.0% and the TSX Composite has increased 7.9%. Investing in equity markets has become less attractive. Accumulation of seasonal trades on weakness continues to make sense as long as the seasonal trades are outperforming the market. Sectors in this category include agriculture, energy, leisure & entertainment, software and gold. A cautious bullish stance appears appropriate.
Tom Rogers’ Weekly Elliott Wave Blog
Following is a link:
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Leibovit Volume Reversal Signal on Palladium
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Disclaimer: Comments and opinions offered in this report at www.timingthemarket.ca are for information only. They should not be considered as advice to purchase or to sell mentioned securities. Data offered in this report is believed to be accurate, but is not guaranteed.
Don and Jon Vialoux are research analysts for Horizons Investment Management Inc. All of the views expressed herein are the personal views of the authors and are not necessarily the views of Horizons Investment Management Inc., although any of the recommendations found herein may be reflected in positions or transactions in the various client portfolios managed by Horizons Investment Management Inc
Horizons Seasonal Rotation ETF HAC August 17th 2012
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Monday, August 20th, 2012
by Don Vialoux, EquityClock.com
Upcoming US Events for Today:
- The Chicago Fed National Activity Index for July will be released at 8:30am.
Upcoming International Events for Today:
- The Reserve Bank of Australia Board Minutes for August will be released at 9:30pm EST.
Markets pushed marginally higher on Friday, helped by improving data pertaining to Consumer Sentiment. The University of Michigan’s Consumer Survey provided a reading of 73.6, beating estimates of 72.0 and improving over last month’s read of 72.3. This is important as we are entering the big season for retail sales into the end of the year with back-to-school spending already underway, followed by a series of holidays, including Thanksgiving and Christmas, which are often crucial for overall year-over-year profitability of companies. Strong consumer sentiment often translates into robust retail sales numbers into the remaining months of the year.
Looking at equity markets, the bullish trend that began in June continues to prevail, not only maintaining a positive bias, but also showing signs of improving. Risk sentiment continues to improve, as gauged by the performance of high beta benchmarks, such as the Russell 2000 Small Cap Index, relative to market benchmarks, such as the S&P 500. Cyclical Sectors, such as Energy and Industrials, are leading the market higher, while recent crowd favourites in Defensive sectors are lagging market performance, trading flat to negative as a result.
In another optimistic sign, breadth is also showing signs of improvement, reaffirming the strength in the overall market. The S&P 500 Equally Weighted Index is starting to outpace the Capitalization Weighted index and the Cumulative Advance-Decline line across the benchmarks are also improving.
A recent setup in the US Dollar Index suggests that equity markets may still have a little way to go before topping out. The currency, often an inversely correlated asset to equity market strength, continues to show a short-term head-and-shoulders top combined with a bear-flag formation. The target of each formation points to a low at 81, a target that would keep the intermediate positive trend intact, which has negative longer-term implications for equity markets, assuming the negative correlation to equities continues.
All of this data suggests that equities continue to maintain a Hold rating, following the Buy signals that were initiated over two months ago. With that being said, given how mature this rally has become and the levels of overhead resistance above, provided by previous significant highs and long-term trendlines, a correction of some magnitude appears inevitable. As such, a certain amount of skepticism of the recent positive price action is warranted, especially given the significantly low volumes and surging complacency, which is sitting at the highest levels of the year. Seasonal tendencies turn particularly weak into September and October, so we are well within a window in which a correction is probable.
Sentiment on Friday, as gauged by the put-call ratio, ended at 0.75, one of the lowest ratios of the year. Complacency is at an extreme, a fact that is also evidenced via the volatility index (VIX) which hit the lowest level since 2007. Volatility remains seasonally positive through to October, so the recent decline that is counter to the seasonal trend may not persist unimpeded.
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Tags: Activity Index, Advance Decline Line, Bank Of Australia, Board Minutes, Bullish Trend, Cap Index, Chicago Fed, Consumer Sentiment, Consumer Survey, Don Vialoux, Industrials, Market Benchmarks, Market Performance, Market Strength, Months Of The Year, Reserve Bank Of Australia, Russell 2000, Sales Numbers, Small Cap, Thackray, Us Dollar Index, Volatility, Weighted Index
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Monday, August 20th, 2012
by John Hussman, Hussman Funds
The present confidence and enthusiasm of investors about the ability of monetary policy to avoid all negative outcomes mirrors the confidence and enthusiasm that investors had in 2000 about the permanence of technology-driven productivity, and in 2007 about the durability of housing gains and leverage-driven prosperity. Market history is littered with unfounded faith in new economic eras, and hopes that “this time is different.” Those periods can be difficult, at least for a while, for investors who are less willing to abandon evidence and lessons of history, not to mention basic principles of economics and valuation. We endured similar discomfort in periods like 2000 and 2007, before hard reality set in.
The recent market cycle has required two changes to our hedging approach. One was in 2009, when our existing approach was dramatically ahead of the S&P 500, but I insisted on making our methods robust to the worst of Depression era data. The other was earlier this year, when we imposed criteria to restrict the frequency of defensive “staggered strike” option positions in Strategic Growth Fund, requiring not only strongly negative expected returns, but also either unfavorable trend-following measures or the presence of unusually hostile indicator syndromes. There’s little doubt that massive central bank interventions have pushed off economic and market difficulties that might have occurred more quickly. The tighter criteria help adapt to that reality, without foregoing the benefit that defensive option positions would have historically had over the course of the market cycle.
These hedging changes would clearly have altered many of our investment positions during the most recent cycle, particularly during the 2009-early 2010 period, but would not alter the strongly defensive position we’ve maintained since early March (see Warning: A New Who’s Who of Awful Times to Invest). Based on a blend of investment horizons from 2 weeks to 18 months, we presently estimate the prospective return/risk profile of the market as being among the most negative 0.5% of historical instances. On the technical front, the S&P 500 is either at or just short of its upper Bollinger band on nearly every resolution (daily, weekly, monthly), while numerous divergences are already in place, including the failure of many sectors and indices to confirm the recent high.
Valuations remain unusually rich on our measures, and only seem benign to Wall Street because profit margins are nearly 70% above their historical norms as a result of depressed savings rates and unsustainable government deficits (see Too Little to Lock In). On that note, it should be of some concern (though it is clearly not) that the price/revenue multiple of the S&P 500 is now above any level seen prior to the late-1990’s market bubble. Prior to that time, the highest post-war peaks were in 1965 (which was not followed by a deep or immediate decline, but marked the onset of what would ultimately become a 17-year secular bear market), and 1972, just before the S&P 500 lost nearly half of its value. Stocks are emphatically not a claim on next year’s projected earnings. They are a claim on a very long-term stream of cash flows that will be delivered to investors over time, and however speculative hopes or fears might move prices in the short-term, the factors that drive long-term prospective returns have remained durable for a century.
We presently estimate that the S&P 500 is likely to achieve a 10-year total return (nominal) of about 4.5% annually, but that alone is not what concerns us. We generally target an exposure to market risk that is proportional to the expected return/risk profile of the market on a blended horizon of 2 weeks to 18 months. Valuations exert a significant effect on those estimates, but numerous other considerations such as broad market action, trend-following measures, and a variety of indicator syndromes (e.g. overvalued, overbought, overbullish) also have significant effect. It is the full combination of evidence that concerns us.
As a side-note, our exposures are generally not directly proportional to the prospective 10-year return that we estimate on the basis of valuations alone. The difficulty with setting an exposure proportional to the 10-year prospective return is that there is little to stop a 10% prospective return from turning into a 15% or even 20% prospective return as a result of much steeper market losses (which we saw in the 1930’s, 1950’s, 1970’s and early 1980’s). Indeed, in 1931, the stock market’s dividend yield exceeded 6%, the Shiller P/E was well below prior and subsequent historical norms, and the market’s prospective 10-year return was above 10% annually, by our methodology. Yet this did not stop the stock market from losing two-thirds of its value over the following year, for an overall Depression-era loss of about -85%, taking the stock market – on a total return basis – to one-seventh of its 1929 level. That said, we certainly don’t require clear undervaluation in order to reduce hedges and establish a constructive position. Absence of severe overvaluation coupled with a shift to favorable market action on our measures is typically sufficient, as was the case in 2003, and might have been possible in 2009 had we not faced the “two data sets” uncertainty.
It may seem overly cautious that I demanded that our hedging models should perform well in cross-validation (“holdout”) data from both post-war data and more extreme Depression-era periods. My view is that the arithmetic of deep losses is devastating to long-term returns, and the behavior of the market and the economy in 2008 and early 2009 was simply out-of-sample from a post-war perspective. I don’t share the confidence and enthusiasm of investors about the ability of central banks to make recessions, debt crises, and major market losses a thing of the past. Again, while the resulting changes in our methods (ensemble models, more restrictive criteria on staggered-strike positions) would have produced substantially different investment positions over the most recent cycle than we took in practice – particularly during the 2009-early 2010 period – the fact is that our defensive stance here is fully intentional, and the “heat” that we experience during points of investor enthusiasm is something that this same discipline would have occasionally experienced in numerous prior cycles.
In Strategic Growth Fund, part of the setback in recent months has been due to hedging costs, and part has been due to a modest lag in our stock holdings, relative to the indices we use to hedge. Neither outcome is extremely rare, or even particularly deep relative to the volatility regularly experienced by a passive buy-and-hold approach, but it’s uncomfortable to experience erosion in both aspects of our approach at the same time. That said, I doubt that this fairly run-of-the mill setback – especially since March – would feel nearly as uncomfortable if it did not blend in with our “miss” of 2009 through early-2010 (which I would not expect to be repeated in future cycles even under identical conditions).
In any event, I believe that the challenges we experienced during the recent, extraordinary cycle have been addressed. We’ll always work to learn new things and to bring new knowledge into practice, but unless we go back to the South Sea Bubble or the Dutch Tulip Mania, there isn’t a great deal of historical context available to augment what we’ve already incorporated into our methods. On the question of whether I believe our present methods require additional stress-testing or remediation, the answer is no, because I am satisfied that these methods would have strongly navigated not only the most recent cycle, but also post-war data, and also Depression-era data (without the exposure to significant periodic losses that our pre-2010 methods would have experienced during the Depression). On the question of whether I believe it was necessary to make our methods so robust to extreme outcomes and economic risks, my answer unfortunately remains an emphatic yes. I believe that investors should be prepared for far greater turbulence than present valuations and complacent sentiment seem to envision.
In my view, this time is not different. It may be more drawn out, but it bears repeating that the 2008-2009 market decline, when it arrived, wiped out the entire total return that the S&P 500 had achieved, in excess of Treasury bill returns, all the way back to June 1995. Regardless of any immediate relief from the Federal Reserve or the European Central Bank (both which I suspect are largely priced into the markets, and leave investors vulnerable to disappointments), I expect that stocks will achieve weak overall returns over the next few market cycles, and I am confident that we are well-prepared to navigate the full course of those cycles, if not always shorter segments (particularly the richly valued portion of mature bull advances, which is where I believe we are today).
What Merkel actually said
What’s fascinating about the present confidence and enthusiasm about central bank intervention is that investors have stopped actually listening for fact, and are increasingly hearing only what they want to hear. A good example of this is the notion last week that German Chancellor Angela Merkel now supports a major round of distressed debt purchases by the European Central Bank. As background, recall that ECB head Mario Draghi indicated a few weeks ago that the central bank was prepared to do “everything” to support the Euro, “and believe me, it will be enough.” Yet immediately after these words, the ECB had a meeting in which it initiated – nothing.
Germany’s position on ECB purchases of distressed country debt (Greece, Spain, Italy) has always been that this support must be conditional on the imposition of centralized control over the fiscal policies of those countries. This is what Germany calls “political” action, and that is why when Germany talks about its willingness to do everything necessary to save the euro, it typically uses the phrase “everything politically necessary.” Merkel’s most concise summary of this position – “Liability and control belong together.”
Fast-forward to last week, when Merkel was in Canada discussing trade issues. There, she gave a statement that was widely reported as suggesting that ECB action is “completely in line with what we’ve said all along.” That phrase was then reported as if Merkel was endorsing a massive and unconditional ECB intervention, which is what Wall Street now seems to be anticipating.
The problem is that here is what Merkel actually said: “The European Central Bank, although it is of course independent, is completely in line with what we’ve said all along. And the results of the meeting of the central bank and their decisions, actually shows that the European Central Bank is counting on political action in the form of conditionality as the precondition for a positive development of the Euro.”
So look at the “results of the meeting of the central bank, and their decisions” that Merkel mentions. The ECB decided to do nothing. No unconditional bailout. No liability without control. That result was indeed completely in line with what Germany has said all along. It just wasn’t what investors wanted to hear, so they heard something else entirely.
Meanwhile, nonperforming loans in Spanish banks surged from 8.96% in May to a record 9.42% in June. There remains an urgent but fully-denied need for broad receivership and restructuring of undercapitalized Spanish banks. It is important to recognize that bailing out the debt of insolvent entities is not a loan, because it is money that can’t be paid back. It is either a direct fiscal expenditure or it is permanent money creation – which is effectively indirect fiscal expenditure since the proceeds of money creation could otherwise be used to finance new government spending. The simple way to understand the Euro crisis is to understand that countries like Germany and Finland expect to be paid back, and failing that expectation, they are unwilling to transfer more fiscal resources than they already have. As the German finance minister said over the weekend, “It is not responsible to throw money into a bottomless pit.” That’s hardly a tone that indicates a willingness to accept unconditional ECB bailouts. All of this will remain very interesting, and most likely very turbulent. In any event, my impression is that the confidence and enthusiasm about easy central bank fixes is sorely misplaced.
As of last week, our estimates of prospective stock market return/risk on a blended horizon from 2 weeks to 18 months remains in the most negative 0.5% of historical instances. It’s easy to blur our present defensiveness in response to extreme conditions we’ve observed since early March into a much longer period of defensiveness : our strategic and intentional defensiveness in anticipation of the 2008-2009 credit crisis, our stress-testing period in 2009-early 2010 which was “non-strategic” in that we would expect to be similarly defensive in future cycles even under identical conditions, and our strategic and intentional defensiveness since April 2010 (though tighter criteria on staggered strike index option positions would have avoided some amount of hedging costs during much of this period). Still, the fact is that present conditions correspond to less than half of one percent of historical observations going back nearly a century.
The issue now is what we should do going forward. In my view, we’ve wholly addressed the “two data sets” problem that we had to address in 2009, and as a result, I am convinced that our approach is well-suited to navigate both run-of-the-mill and very extreme market behavior over the course of future market cycles. I am also convinced that investors should not easily dismiss conditions that are more negative than more than 99% of market history, particularly when they are accompanied with evidence of emerging global recession, overbought conditions at the upper band of daily, weekly and monthly Bollinger channels, and a variety of historically hostile indicator syndromes (Aunt Minnies such as “overvalued, overbought, overbullish” conditions, and evidence of technical divergence and exhaustion).
There is no reason to expect that the Fed will refrain from periodic interventions aimed at encouraging speculation for some period of time. But the effect of previous rounds of quantitative easing have typically been restricted to little more than a recovery of decline in stock prices over the preceding 6-month period, and I am doubtful that we will see much effect when the market is already near the top of its Bollinger channels (2 standard deviations above 20-period moving averages at daily, weekly and monthly resolutions). I am even more doubtful that Fed purchases of Treasury securities to create an even deeper ocean of zero-interest currency and reserves – when banks hold trillions of idle currency and reserves already – will have any material effect on a global recession that we view as already quietly in progress. In any case, our approach is always focused on the average outcomes associated with a given set of market conditions, and individual instances may deviate from the average. Suffice it to say that we continue to adhere to our investment discipline here.
We are presently in an environment that has historically been associated with the overvalued segment of late-stage bull markets. This segment of the market cycle has been frustrating for us before, and that frustration may not be over. Yet in each instance, our defensiveness was overwhelmingly vindicated. The drum-beat of investors is that “this time is different.” Simply put, I doubt that this time is different.
Strategic Growth Fund remains fully hedged, with a staggered-strike position representing about 1.6% in additional option premium cost (versus a standard matched-strike long-put/short-call hedge), looking out to year-end. Strategic International remains fully hedged. Strategic Dividend Value fund remains hedged at close to 50% of the value of its stock holdings (its most defensive stance), and Strategic Total Return carries a fairly conservative duration of about 1.8 years in Treasury securities, with about 10% of assets in precious metals shares, and a few percent of assets in utility shares and foreign currencies.
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