The Big Picture (in Graphs) for Markets

Monday, June 4th, 2012

by Tiho Brkan, The Short Side of Long

Equities

Equities tend to move in long term generational cycles of about 17 years on averages. Strong upward trends that last about 17 years are called secular bull markets, while sideways trends that also last about 17 years are called secular bear markets. US equities are currently in a secular bear market and have been so since the year 2000.

We seem to be creating a similar outcome to the 1970s secular bear market, where we had a long sideways trading range for about a decade and half. S&P 500 is now approaching the upper range of its trading range, with the current cyclical bull market doubling from its March 2009 lows. Bull markets usually climb a wall of worry, but there is not too many things left to worry about.

Gross profit margins are now at record highs and a mean reversion will eventually follow. Mean reversion in gross profit margins will be fundamentally bad for S&P 500 company earnings, which are also at record highs, and therefore the overall stock market value. Let us remember that all the major buying opportunities since World War 2 have been as low gross profit margins, not at highs – especially record highs.

Bonds

Interest rates, and therefore bond prices, tend to move in very long term generational cycles known as the Kondratiev Long Waves. These waves tend to last about 50 to 60 years from trough to trough or from peak to peak. The last major inflection point occurred in 1981, as interest rates on the US Treasury 30 Year Long Bond peaked around 15%. Prior to that, rates were rising for about 30 years and since than we have experienced declining rates for about 30 years as well. At the next major inflection point, which is slowly approaching, interest rates and equities should bottom while commodity prices should peak.

Viewing the global macro situation from the closer point of view puts forward a strong correlation betweens stocks and bonds due to the de-leverging cycle Western world is currently facing. Periods or phases of turmoil have so far been associated with “flight to safety” or “risk off” trade, where investors buy bonds (lower interest rates) and sell stocks (or other riskier higher beta assets).

With the risk assets prone to further crisis events out of Europe and potential up-and-coming global recession, bond interest rates have most likely not properly bottomed just yet. Nevertheless, we are definitely in the last euphoric stage of a 30 year bond bull market (from 1981 until present). The final trough in rates will also be associated with a stock market bottom, just like in late 40s and early 50s.

Commodities

Commodities also tend to move in long term generational cycles and correlate in the opposite direction to the stock market. Here the same type of time frame also applies, where strong upward trends that last about 17 years are called secular bull markets, while sideways trends that also last about 17 years are called secular bear markets. Commodities are currently in a secular bull market and have been so since the year 1999.

While the S&P 500 has been moving sideways for about 12 years, Continuous Commodity Index has been rising over the last 13 years. During the current secular bull market, commodities have experienced two major corrective periods, first during 2001 recession and second during 2008 recession. Currently, commodities are once again experiencing a cyclical bear market correction, within the overall long term secular bull market.

Summary

Risk assets like equities and commodities should remain under pressure in coming quarters, while safe havens, even though extremely over stretches, could still benefit during the turmoil. World faces many problems coming into 2013, from US to European debt issues and now a meaningful economic slowdown in Asia, after years of powerful growth. China, the worlds largest consumer of many commodities and a fertile ground for many Western company expansions (especially luxury ones), could have huge implications on risk asset prices shall it suffer a major recession. Majority of the problems will definitely come to forefront as soon as the US elections finishes by the years end, if not sooner.

While many investors think they are doing the right thing being contrarians at present and buying risk assets due to sour negative sentiment, my view is that it will only be useful for a decently strong tradable rally, which I also plan to participate in. Furthermore, these same investors also believe central bankers will backstop any problems with money printing. However, that will most likely not be the case until the QE dosage increases substantially.

At present every major risk asset from Crude Oil to Australian Dollar, from DAX to Copper and from GEM equities to Gold has retraced 100% of their Twist / LTRO multi-month rally and has also failed to better their 2011 highs during the process. This is an extremely negative price action as these types of 100% re-tracements are not common at all, if one was to assume we are in strong cyclical bull market. Most likely the inflation trade from March 2009 lows has ended for some risk assets in May 2011, while for others it has ended just recently in May 2012.

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Tags: Bear Markets, Bond Prices, Bull Markets, Commodity Prices, Company Earnings, energy, Generational Cycles, Global Macro, Gold, Gross Profit Margins, Inflection Point, Long Waves, Lows, Mean Reversion, Record Highs, Secular Bear Market, Stock Market Value, Stocks And Bonds, Tiho, Upward Trends, Us Treasury, World War 2
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Drachma! (Kotok)

Wednesday, May 30th, 2012

Drachma!
May 29, 2012
by David R. Kotok, Cumberland Advisors

The drachma, the Greek currency name, is over 3000 years old. It was the most widely circulated coin in the world prior to the time of Alexander the Great. Readers may enjoy a few minutes of study about Alexander the Great. His was the Macedonian conquest of Greece and the rest of the ancient world. His education came from Aristotle who was his tutor. He changed the political geography of the Balkans and the Mediterranean. See a few notes at the very end of this commentary.

Back to the drachma.

Since reintroduction in 1832, all modern Grecian drachma forms have ended badly. The single exception WAS the exchange of the drachma for the euro in 2001. That chapter of Greek history is being re-written now.

The worst Greek hyperinflation was during World War 2. At its extreme, the Nazi-Fascist occupation Greek government inflated at rates similar to recent Zimbabwe or the infamous Weimar Republic. At one point Greece issued a 100,000,000,000-drachma note. Greek monetary history also includes one previous failure in a currency union (The pre-World War 1, Latin Currency Union).

After WW2, Greeks attempted to halt inflation with entry into the Bretton Woods fixed currency regime. They created a new version of the drachma by replacing the old one at a ratio of one new drachma for every 1000 old. When the Bretton Woods structure reached its demise in 1973, the then new version of the drachma declined in value. The post WW2, revalued drachma was 30 drachma to 1 US dollar at Bretton Woods entry (1954). The drachma reached about 400-to-1 US dollar prior to Greece joining the euro in 2001. In 2001, when Greece was admitted to the Eurozone, the official exchange rate was 340 drachma to 1 euro.

Will there be a “new” drachma? If yes, what will it look like?

Money has three basic characteristics. They are: (1) unit of account. This is how we enumerate a price or a debt. (2) Store of value. This is the issue of “trust.” Does money hold its value or does it lose the value to inflation. (3) Medium of exchange. This means acceptance, by others, of the money as a form of payment.

Nothing in modern Greek history suggests that a new drachma will qualify on any of these three measures. Modern Greek monetary history is one of default, inflation and destruction of wealth when the wealth preservation was entrusted to the government. Centuries of history support this statement.

Of course, any new Greek government can “force” its citizens to accept a new drachma as payment of obligations issued by that government. Greece may elect such a government on June 17. Argentina imposed force with the peso after it repudiated its governmental promise to maintain the peso at parity with the US dollar. In the Argentine case, the peso quickly went from one to the dollar to three to the dollar. Years later, Argentine citizens are still paying the price for their government’s monetary failure.

If Greece leaves the Eurozone and launches the new drachma, the internal outlook for a post-Greek exit of the euro is destruction of remaining Greek wealth, confiscation through taxation, high inflation and monetary turmoil. That is what would happen within the post-euro Greece. That is a repeat of Greek history.

The external (outside of Greece) outlook is worse. The private holders and investors in Greece have already been crushed and burned. They are no longer involved in the decision-making. They avoid any Greek obligations. They function on a cash basis only or with secured or hedged letters of credit. The Greek stock market has been decimated; its percentage decline exceeds the losses of American markets during the Great Depression.

The Greeks owe several hundred billion Euros to European and international institutions. That debt cannot be paid. The Greeks do not have the money. Holders of those obligations are mostly governmental institutions now. Those institutions can hold obligations for a long time and can negotiate political changes in the structure of those obligations. Meanwhile the related institutions can also defer the default impact by postponing recognition of it while they negotiate. In sum, we are not worried about losses on Greek debt by the ECB, IMF or others.

If Greece were to leave the Eurozone unilaterally, we expect that the post-euro Greece will have no market access for years. Greeks, with a new drachma, would function on a mostly cash basis in making their external payments.

Were Greece to exit, other European commercial and banking holders of Greek obligations would have to take more losses. They already know these exist in principal. They would need to mark-to-market. That means they will have charges against their capital and may need infusions of new capital. The equity owners of those commercial institutions will suffer losses. Many already have lost as the markets are adjusting prices to reflect this risk. These losers are the banks in Europe, the insurance companies in Europe and others who are involved in the finance of the Eurozone.

Tags: Aristotle, Balkans, Bretton Woods, Currency Name, Currency Union, Demise, ETF, ETFs, Eurozone, Fascist Occupation, Greek Currency, Greek Government, Greek History, Greeks, Hyperinflation, Joining The Euro, Monetary History, Official Exchange, Political Geography, Weimar Republic, World War 1, World War 2
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