bull market ending

At the top of this post you will see the September 23 cover of Time Magazine. Right below it is an image of today's New York Times front page. And below that is an image of the May 17 Economist cover.

I learned from Paul Montgomery, the inventor of the magazine cover indicator,  that the image of a bull on the cover of Time Magazine has bearish implications for the next 12 months (although the market may well rally for 4-8 weeks after the appearance of the cover). In this regard it is also interesting to recall the May 17 cover of The Economist which also depicted a bull, just a week before the May 22 top in the S&P at a level almost equal to last Friday's close.

I think today's New York Times headline reinforces this bearish warning. Why? It tells us that the economist and Obama associate Larry Summers has withdrawn his name as a possible nominee for Fed chairman. Summers has been an enemy of the Fed's quantitative easing program and has no special expertise in monetary economics. Last night when Summers' withdrawal was announced the S&P jumped more than 1% showing how much the market likes the Fed's QE program. But the headline makes me think that the beneficial effects of the Fed's QE program are now pretty much priced into the market. This doesn't mean that the S&P won't go higher - the economy is improving after all. But it does mean than one prop under the market has now been kicked away.

When the S&P reached the 1540 level I took a guess that the market would have a hard time moving above its 2007 top and on this basis suggested that conservative contrarians cut back on their stock market exposure. Such a cut-back normally would require a 2% drop in the 200 day moving average (the red line on the bottom chart). This moving average is currently at 1575. However I think that while this cut-back was early these magazine covers and headlines suggest that it will turn out to be as good an exit point as any subsequent moving average signal.

The bottom line is that the odds now favor a lower S&P 500 index 12 months from now.

bubble in Japan ?

As you may know the Japanese stock market has more than doubled in the last seven months. Last week The Economist featured the Japanese prime minister on its cover as superman. A couple of days later the New York times published a front page, above-the-fold story on the Japanese economic recovery. During the following two days Nikkei average of Japanese stocks dropped 13%.

A bullish magazine cover story right at the top of a big run-up in stock prices makes one reasonably wonder whether or not the Japanese equity party is over. My answer? Not by a long shot.

From the point of view of contrarian theory the cover of The Economist is not as significant a long-term contrarian indicator as it may appear to be at first glance. Tale a look at the top chart which shows the Nikkei stock average on a monthly basis going back to its all time high (red line) in December 1989. As you can see, despite rhe recent run-up, this average is still trading 60% lower than it was at its 1989 high. As I explained in my book it is very unlikely that a bullish investment crowd will grow to bubble-popping size until the market is at all time highs. So I conclude that the bullish cover actually marks the birth of a bullish investment crowd in the Japanese stock market, not the end of the growth of such a crowd.

I have another reason for doubting that this cover marks any sort of important top in the Nikkei or low in the yen. The Bank of Japan has embarked on a massive quantitative easing program which is scheduled to run for two years. I for one think the BOJ now means business and I expect its purchases of Japanese bonds to continue. But given the BOJ's track record many investors doubt that it will continue its QE program. So I think there is a lot of room on the upside in the Nikkei and on the downside in the yen which will be occupied by the charts as skeptical investors start believing in the BOJ's announced intentions.

It is worth mentioning that QE in Japan is bullish for the US stock market too as it is for the rest of the world's markets. The same can be said for the Fed's QE program. So short term fluctuations aside world stock markets are almost certainly headed higher from current levels.

Bull

Here is the latest cover of The Economist. It shows an imagage of a bull breaking through a wall, presumably the wall represented by the previous all time high points the Dow and the S&P had reached in 2007. The top chart is a daily chart of the S&P 500 and the horizontal green line is the 2007 top at 1576.

According to Paul Montgomery's magazine cover theory this bullish cover is a definite negative for the stock market going forward. However, such covers on average preceded bull market tops by 4 months or so. This means that prices are likely to move still higher before anything resembling a bear market begins.

I would add that this cover is less representative of the investing public's mood than a similar cover on a general circulation magazine. I don't think there is anything like a bullish investment crowd operating in the US stock market right now. If fact I would characterize investors' attitudes towards the stock market as skeptical.The low levels of trading volume and volatility also testify in support of my conclusion.

However the rally of nearly 10% during the past month has caught investor's attention. Measured by the five day moving average of the CBOE equity put-call ratio there is more bullishness in the market than has been seen in more than a year.

The coupling of the fast, one month rally, a bullish magazine cover, and a relatively low put-call ratio suggests that a temporary interruption of this bull market is imminent. But I don't think it will be a very big interruption. The most likely development would be a drop to the vicinity of the S&P's 50 day moving average (green wavy line) and possibly to the level of the 2007 top at 1576.

The bull market which followed the bursting of the dot.com bubble lasted five full years. By that clock the current bull market could easily last until March of 2014 although I think a top sooner than that, perhaps in the fall of 2013, is more likely.

things can always get worse - but will they?

Here is a daily bar chart of the euro priced in dollars.

The EUR.USD is very much on the markets' mind now with the Cyprus banking system hanging by a thread. But after a downard adjustment to this news last Sunday night the euro has managed to hold its own as mini-waves of optimism and pessimism have washed across the markets.

I think this steadiness in the euro in the face of bad news is interesting for three reasons. First, the market has dropped for nearly 7 weeks from its early February top. Second, this decline has brought it to a point slightly below the midpoint of the rally from the July 2012 low (blue line). Third, the spring equinox is upon us. According to Paul Montgomery of contrarian Time Magazine cover fame this year's equinox is likely to bring the lunatics out in force this week and next, giving us volatile markets and making a dramatic change in market sentiment more likely now than at other times.

And all of this is occurring in a monetary context which suggests to me that the euro is going to  appreciate against the dollar because ECB monetary policy is much tighter than the Fed's. My conservative upside target is 1.40.

So I have a strong suspicion that this chart is going to look a lot different a couple of weeks from now. I think a big rally is about to start. The first sign of an up trend in the euro will be a move above the 20 day moving average which appears in this chart as a wavy red line.

Conservative Contrarians Take Note

The bottom two images are today's front pages from the Chicago Tribune and the New York Times. Both note that yesterday the Dow closed at historical highs. I think the Tribune headline captures the spirit of this market pretty well. I think investors are happy to see the Dow at new highs but that skepticism about economic conditions and US economic prospects remains strong.

The top image appears on page 1 of the Tribune's business section today. It suggests a little more optimism but in my judgement "Dow 20,000" projections are not very common right now.

I don't think we are seeing a bullish information cascade here, at least not yet. Yet the Dow is at historical highs and the S&P is not far behind. In fact the S&P is just below the levels it reached at the 2000 and 2007 bull market tops. And this bull market has already lasted 4 years.

There certainly has not yet been a 200 day moving average sell signal for conservative contrarians. Nonetheless I think it makes sense for conservative contrarians to cut back stock market exposure to below normal levels now. There was no bullish information cascade visible at the 2007 top either, but we still saw a more than 50% drop from that top.

I don't like to deviate from standard operating procedure like I am doing now. But I think it makes sense to substantially lighten long positions at the top of a 13 year trading range after a bull market has lasted four years and newspaper headlines are starting to suggest increasingly bull sentiment.

Hyperinflation ahead? Not.

In this post I explained why I thought that fears of imminent high inflation resulting from the Fed's quantitative easing policy were misplaced.

Here is a post by Mark Perry which reports the latest estimate by the Federal Reserve Bank of Cleveland of expected inflation. Their number is an average of 1.53% annual inflation over the next 10 years. This is what they come up with after examining both bond market data as well as survey data from investors and consumers.

Of course expectations can always change. But this survey tells us that that there is no reason to think inflation will increase in any significant way base on the evidence at hand which includes the Fed's current QE policy.

Buy ? Maybe not.

Thanks to Paul Montgomery and Elliott Wave International for bringing my attention to the latest cover of a special, February 18 issue, of Maclean's magazine. Maclean's is the Canadian equivalent of Time magazine here in the US. But the cover story is all about the US stock market.

The cover story quotes Ralph Acampora, a noted US market technician, as asserting that the current bull market is climbing a classic wall of worry. He further more observes that since the public has yet to return to stocks in any significant way (as measured, say, by mutual fund money net inflows) there is a lot of upside potential even from current levels. To be fair, he also says that a "correction" now would be healthy and help to repair any cracks which have developed in the worry wall.

Frankly I am in more or less agreement with Acampora as far as the long term prospects for the US stock market go. However shorter term cracks (like this cover story) have started to appear. This is another piece of evidence which suggests that the US stock market is vulnerable to a correction which easily could take it below its November 2012 and even below its June 2012 low point.

At this juncture I think it makes sense for aggressive contrarian traders to move their stock market exposure down to below average levels. The plan would be to restore average or above average levels of stock market exposure after a drop of 5-10% (or more) in the averages, a drop which I think is coming sooner rather than later.

Doom and Gloom about the US economy

A few days ago I received an e-mail from a friend of mine which asked my opinion about the prospects for the US dollar and the US economy. Below is his e-mail (in italics) and my reply.

Carl,

I have been reading more and more about the currency wars and getting concerned. 

Many people say that between the Fed printing USD and oil being priced in Chinese yuan the US dollar is doomed. This will eventually lead to hyperinflation here in the US as the USD loses its global currency reserve status.

I personally have no idea if this will actually happen.  I have read about Russia & China coming to an agreement where China will buy oil from Russia paying in Yuan and the views that other oil producing countries will begin selling oil in currencies other than the USD.

Do you have any thoughts on this? There is no shortage of websites pushing this end of the US dollar and USA coming soon but of course each website is also selling something to profit from this coming doom!

Otto:

There will be no hyperinflation without the Fed's cooperation. They seem very reluctant to let the inflation rate move much above 2%. The 10 year Tips - note spread predicts 2.6% annual inflation for the next 10 years so the market has a lot of confidence in the Fed's commitment to keep inflation low.

That said I think the Fed is much more concerned about domestic economic conditions than about the value of the dollar. But notice how they have dragged the Bank of Japan and the Swiss along in the QE compaign. The rest of Europe will soon follow or fall into the economic abyss. Since all the big powers will evntually embrace some version of QE and follow the Fed I don't see how the dollar is going to drop much in the long run because of monetary expansion.

The US is the strongest economic power in the world. Soon it will be the biggest oil producer and is already the biggest natural gas producer. It has the  freest market system and is home to the  most innovative business entrepreneurs. And you say that there is a danger that people might prefer to trade in yuan, not dollars?

  Apparently the message has not gotten through to the world's criminal classes - who spit on payments denominated in any restricted currency like the yuan. Free traders trade in dollars or euros or yen and trade in dollars is the biggest by far in volume.

China looks strong because they are getting up to speed after being impoverished by the 1949- 1984 experiment with central planning and communist repression. Russia looked strong in the 1950's because they were starting from a very low base, just like China today.

But if history offers any lessons it is that government controlled economies (of which China is an example even now) eventually hit a ceiling beyond which progress is no longer possible. This led to the collapse of the Soviet Union. It also happened in China starting around 1400 when the combination of the European Renaissance and Chinese imperial repression of  creative thought and action started China's long slide into poverty from which she is only just emerging.

The doomsters always have something to worry about and this has been true as long as I have been active in markets, a period of nearly 50 years now. Experience teaches that in the long run the doomsters are always wrong and are either forgotten or become a laughing stock for sensible people. I don't see any reason for thinking the fate of the current crop of doom predictors will be different.

I had a friend once who thought that the doomsters were all secretly financed by the Trilateral commission to scare the little guy into making stupid choices. I don't share his cynicism but it is certainly consistent with the facts.

Carl

more reasons for concern

Here is an image of the Chicago Tribune's front page today. It is really about the stock market, not the economy. The graph to the right shows the Dow industrials for the past 7 years.

This article also observes that stock market mutual fund inflows for US base funds were the highest ever in January 2013. This after actually being negative for a good part of 2011 and 2012.

Another interesting fact is that the weekly survey National Association of Active Investment Managers (NAAIM) shows a commitment to the stock market of over 100%, the first time this number has been over 100% since January 2007 (at which point the 2002-2007 bull market still had 9 months to go).

I think these observations adds to a growing body of evidence that this 47 month old bull market is getting close to its end. But I don't think this end is here just yet.Typically the maximum bullish sentiment occurs a few months before the highs in the market averages.

interest rates and the economy

What determines the level of the 10 year note yield (top chart)? I'd say that this yield depends on investor expectations about two things: the real rate of growth in the economy and the rate of inflation over the next 10 years. We can simplify this idea even further by saying that the level of 10 year note yields should roughly equal investor forecasts of the average annual rate of growth in NOMINAL (no inflation adjustment) gross domestic product  over the next 10 years.

As you can see in the chart investors are expecting nominal GDP to grow at about a 2% annual rate for the next 10 years. Since people expect inflation rates of at least 2% as far as the eye can see, this level of interest rates suggests that investors think that the real economy will not grow at all during the next 10 years!

You can get another read on this expectation by looking at the yield on the 10 year TIPS (inflation protected treasury notes) which were auctioned at a rate of a NEGATVE 0.63% a few days ago. People who bought these notes are paying the US treasury to take their money and spend it!!!  From a purely mechanical point of view the difference between the yields on the 10 year note and the 10 year tips represents investor's expectation of the rate of inflation over the next 10 years. In this case the difference is 2.60%. Put another way, the 10 year TIPS yield suggests that investors think the real economy will shrink by 0.60% per year over the next 10 years while inflation averages 2.00% per year! Of course there is probably a fairly big risk premium built into the negative TIPS yield so the forecast is not really as pessimistic as this. Even so I still think this is an incredible forecast for the US economy.

Is this forecast likely to be close to the mark? I don't think so. I think people are grossly underestimating the likely effects of the Fed's quantitative easing policy and the Fed's commitment to pursue that policy at least until the US unemployment rate drops below 6.5% (it is currently 7.8%). The Fed's policy is having an effect on the Euro which is steadily rising against the dollar (middle chart). The Euro is above it rising 200 day moving average as well as above its rising 50 day moving average, a bullish configuration if there ever was one. The market is pricing in not just the survival of the Euro currency but also the fact that the Fed's monetary policy is relatively loose compare with that of the European Central Bank. Liquidity in the US is increasing relative to Europe's. This will inevitably lead to a pick up in US economic activity relative to that of the EU and a further advance in the Euro against the dollar.

The market thinks that the Fed will also be getting help from the Japanese central bank in pushing upward world economic activity. The bottom chart shows the yen priced in dollars. This bear market in the yen is a forecast of a big expansion in yen liquidity relative to dollar liquidity (which of course is itself increasing). This would be an enormous change in policy by the Bank of Japan (if it occurs) and will have very positive effects on the Japanese and the world economies.

All in all I think the market forecast of only 2% annual growth in nominal US GDP over the next 10 years is plain silly. My own guess is that this number will come in closer to 5% or even higher. If I am right 10 year note yields are in the early stages of an advance which will last several years. You can see that the 50 day moving average of this yield has finally climbed above the 200 day moving average, the first time this has happened in years. This I think is a harbinger of a long term bear market in bond prices.

I' mmmmm baaack!

It's been more than a year since I have updated this blog. I have been dealing with a number of personal issues and consequently updates for this blog have been low on my list of priorities. Of more significance is the paucity of contrarian material in the news media over the past year. There have been lots of economic and political headlines but none directly mentioning the markets. So it has been hard to identify any new bullish or bearish information cascades.

I want to point out one change to which we contrarians will have to adjust. The print media, the mainstay of my approach to identifying information cascades, are rapidly declining in significance relative to electronic sources of information. This is going to make it harder to identify information cascades, especially the bearish ones which typically come and go quickly. As a concrete instance of this trend one can point to the demise of Newsweek's print edition. Time magazine is evolving into a tabloid and so I think its usefullness is diminishing too.

A big part of the art of investing, and particularly of contrarian investing, is the ability to adjust to changing circumstances and market environments. So going forward I will be trying to incorporate more electronic sources of information as indicators of market sentiment to supplement my readings of newpaper headlines and magazine covers.

My last post on this blog was in December 2011. In it I said that pessimism about the US and European stock markets was thick and that this meant that higher prices were ahead. A few days after that post long term contrarian traders were confronted with a mechanical sell signal on December 20 in the S&P 500 when its 200 day moving average dropped 2% from its high point reached earlier in 2011 (chart is above this post). I personally ignored this signal as a matter of contrarian logic - if pessimism dominated the markets at the time then this sell signal would turn out to be wrong (and it was).

There were other technical reasons to doubt the signal. First, the Dow industrials never got even close to generating a similar sell signal. Secondly, when the S&P's 200 day moving average achieved its 2% decline on December 20 the S&P was actually above its rising 50 day moving average (wavy green line on the chart above). At the very least this would have been reason to delay acting on the mechanical sell signal. The next time the S&P traded below its 50 day moving average was in mid-2012 after the 200 day moving average had resumed its strong up trend.

Aggressive contrarians had abandoned long positions in late August 2011 near 1200 in the S&P. Needless to say I repurchased my own aggressive contrarian long position on the one day dip right after Christmas of 2011 at about the 1255 level. It has remained undisturbed since then.

At the top of this post is an image of the January 26 front page of the New York Times. For the first time in a very long while there is a headline about bullish stock market performance pointing out that the S&P has closed above the 1500 level for the first time in five years.

Is this a sign of a bullish information cascade? I am doubtful about this possibility. I think the man on the street is still pretty much out of the stock market and pessimistic about the US economy.

Nonetheless, one must recognize that S&P average has been moving generally upward for 46 months, an unusually long time for a market advance. And the average is approaching the levels of two big tops at 1553 in 2000 and 1576 in 2007. There was a lot of pessimism around at the time of the 2007 top. This fooled me then into thinking that the worst that was likely on the downside then would be a 20% or so drop.But things got a lot worse than I imagined they could.  I don't plan to make this same mistake again. This is another reason for contrarians to take the headline above this post as an early warning of a possible storm ahead.

I think that both conservative and aggressive contrarians should now be looking for reasons to reduce the size of their long positions. Personally I think the advance from the November 2012 low point has further to go. I am looking for a move up to 1546 in the S&P. Once the market gets there, or if other bearish signs develop in the interim, I think it will be appropriate for aggressive contrarians to cut way back on their long postitions.

Conservative contrarians dodged a bullet in December 2011 when the S&P generated a mechanical sell signal which I ignored. I think it will be appropriate to take advantage of this fortunate circumstance to sell long positions at the same time that aggressive contrarians do even though this would violate the mechanical guidelines for conservative contrarians whichI set down in my book.

I will keep you posted on my thinking about these possibilities going forward.