The S&P 500 is down almost 4% since we last blogged about the increasing likelihood of renewed recession and market weakness. Unable to retake the flattening 200-day moving average a second time, the market sold off and is now 2.5% below the 50-day moving average. Further, the 20-day moving average is set to fall below the 50-day, which would put the four main moving averages (200, 100, 50, and 20) in bear market order. The Japanese Nikkei is already in a bear market. The S&P 500 was down almost 18% at its low in early July and looks increasingly likely to retest it - and fall below 1000 on a failed retest. Our forecast is based on our outlook for the economy, which continues to show every sign of falling back into recession.
Our December 2009 forecast of at least a 20% pullback in the S&P 500 sometime in 2010 looks increasingly like another solid win for the home team. We had written that the spring of 2010 was the most likely time (missed it slightly as the pullback stopped at 18%) and that the fall was next most likely. Our belief in a 2010 bear market stemmed from a few basic observations. First, the 2009 market recovery went further and faster than any bear market recovery since 1933, leaving the S&P 500 about 35% overvalued based on a number of long term valuation metrics (metrics Wall Street doesn't like to acknowledge because it gets in the way of them selling product to the unsuspecting public). Second, the economic recovery touted by the Fed and the Obama administration just wasn't supported by the numbers. Inventory swings were the main factor in the positive GDP numbers in Q4 of 2009 and Q1 of 2010. Final demand remained punk, as you would expect given the huge debt load born by the consumer, the lack of credit formation, and unbalanced make up of GDP (the consumers' share had grown to a record 72% during the spending orgy and is likely to fall back to a more sustainable 66% or so in the coming years).
Pair an overvalued, overbought market with an under performing economy and you are likely looking at poor market action going forward - which was our call in December 2009 and remains our call today. Market performance in 2010 has more than justified our cautious stance coming into the year. And unless the Federal Reserve gets busy printing more paper, the S&P 500 looks increasingly like it will sink to new lows for the year. The market is unlikely to test new lows for the secular bear market that began in March of 2000 however, because the Fed is clearly targeting the stock market now as a source of wealth and will eventually get around to supporting it. The Fed is likely to act sooner rather than later with renewed quantitative easing - given Bernanke's latest statements - and that just might give the market a lift into year end, but perhaps starting from the 850-900 level....
Biechele Royce Advisors continues to advocate proper diversification among all major asset classes with emphasis on blue-chip dividend paying stocks in the U.S., tangible assets, and nondollar assets. We continue to believe that inflation will pose a major threat to wealth preservation over the next ten years. Finally, we offer another reminder that secular bear markets require a focus on capital preservation first and capital appreciation second…
Posted by Chris Norwood, CFA(R) at 8:42 AM
Tuesday, August 31, 2010
Wednesday, August 18, 2010
Recession Looming
We did get the short term pullback predicted in our 14 July blog. We referenced the 20-day moving average sitting at about 1075 as a likely destination. The actual decline bottomed on 20 July at about 1060 before the S&P 500 motored higher once again, retaking the 200-day moving average in the process. Unfortunately, the S&P 500 was unable to maintain above that long term trend line, peaking at 1130ish in early August, before sliding back below the 200-day (We had written about strong resistance in the 1100-1130 area likely putting a lid on the stock market for the foreseeable future).
The stock market has essentially gone nowhere since last October, validating our concerns about an overpriced market that had climbed too far and too fast after the March 2009 bear market bottom. We have stated repeatedly since last October that it is a high risk market and investors should proceed cautiously. We are even more concerned today because the market has now put in a ten month top and a broad decline is increasingly likely in the fall, or next spring at the latest. It increasingly appears as if distribution is occurring whereby professional investors distribute shares to the public, leaving the public holding the bag when the market decline starts in earnest. One indication of distribution is On-Balance-Volume (OBV), which is showing a negative divergence over the last few months, portending coming weakness.
But what is the fundamental case for a broad stock market decline? Well, how about a return to recession? The probability of another recession (or continuation of the one which started in early 2007) is quite high. Real M-3 (the broadest measure of money supply) is still contracting strongly year-over-year. Recession has followed 100% of the time when real money supply contracts on an annualized basis, typically with a six to nine month lag. As well, the ECRI is now contracting sharply and, again, recession has followed 100% of the time when the contraction is as sharp as now. Likewise, real retail sales are weakening with July real retail sales growth essentially zero - opening up the possibility that Q3 real retail sales will turn negative. Furthermore, a surprisingly bad June trade deficit number will result in a reduction in reported Q2 GDP. The deteriorating trade balance also increases the likelihood of a negative Q3 GDP number. Finally, a developing contraction in housing starts, along with deterioration in a slew of other housing numbers, adds further pressure to an economy already under siege.
Expect a retest of the recent 1010 low on the S&P 500 with a likely decline into the 800 to 900 area within the next six months. Investors should continue to proceed with extreme caution in a very high risk market.
(A major caveat: the Fed appears likely to initiate a new quantitative easing program sooner rather than later, which would provide major support to the stock market, at least in nominal terms.)
The stock market has essentially gone nowhere since last October, validating our concerns about an overpriced market that had climbed too far and too fast after the March 2009 bear market bottom. We have stated repeatedly since last October that it is a high risk market and investors should proceed cautiously. We are even more concerned today because the market has now put in a ten month top and a broad decline is increasingly likely in the fall, or next spring at the latest. It increasingly appears as if distribution is occurring whereby professional investors distribute shares to the public, leaving the public holding the bag when the market decline starts in earnest. One indication of distribution is On-Balance-Volume (OBV), which is showing a negative divergence over the last few months, portending coming weakness.
But what is the fundamental case for a broad stock market decline? Well, how about a return to recession? The probability of another recession (or continuation of the one which started in early 2007) is quite high. Real M-3 (the broadest measure of money supply) is still contracting strongly year-over-year. Recession has followed 100% of the time when real money supply contracts on an annualized basis, typically with a six to nine month lag. As well, the ECRI is now contracting sharply and, again, recession has followed 100% of the time when the contraction is as sharp as now. Likewise, real retail sales are weakening with July real retail sales growth essentially zero - opening up the possibility that Q3 real retail sales will turn negative. Furthermore, a surprisingly bad June trade deficit number will result in a reduction in reported Q2 GDP. The deteriorating trade balance also increases the likelihood of a negative Q3 GDP number. Finally, a developing contraction in housing starts, along with deterioration in a slew of other housing numbers, adds further pressure to an economy already under siege.
Expect a retest of the recent 1010 low on the S&P 500 with a likely decline into the 800 to 900 area within the next six months. Investors should continue to proceed with extreme caution in a very high risk market.
(A major caveat: the Fed appears likely to initiate a new quantitative easing program sooner rather than later, which would provide major support to the stock market, at least in nominal terms.)
Wednesday, July 14, 2010
Short Term Top
The S&P 500 continued to fall until finding support just above 1000 (big round number), which we suggested might happen in our 30 June blog. The S&P 500 then rallied furiously over the next nine days, gaining 9% before running smack into the leading edge of resistance yesterday. (Also noted in our last blog - 1100 to 1130). The S&P tested 1100 yesterday and again today but has been unable to punch through. A couple of positive earnings reports from Alcoa and Intel have probably helped hold the index aloft, but it certainly looks as if the market is getting ready to move lower very short term - likely back to the 20-day moving average sitting around 1075.
More broadly speaking, the S&P 500 is now firmly entrenched in a downtrend and would need to break above about 1130 to renew any semblance of short term upside momentum. To the downside, the recent low of 1010 is likely to be tested in the coming months as increasing weakness in the economy translates into disappointing earnings. We are maintaining our price discipline, selling stocks as they approach fair value and buying stocks only when we believe we have a sufficient margin of safety to warrant taking the risk of adding new positions in what remains a high risk market.
More broadly speaking, the S&P 500 is now firmly entrenched in a downtrend and would need to break above about 1130 to renew any semblance of short term upside momentum. To the downside, the recent low of 1010 is likely to be tested in the coming months as increasing weakness in the economy translates into disappointing earnings. We are maintaining our price discipline, selling stocks as they approach fair value and buying stocks only when we believe we have a sufficient margin of safety to warrant taking the risk of adding new positions in what remains a high risk market.
Wednesday, June 30, 2010
Market Top
We warned in our 1 June blog that the market was likely to test 1000 (big round number) and then 950 (top of the bear market base) by the fall. We think the evidence, both fundamentally and technically, has grown stronger for more downside testing since our warning. Real money supply, as measured by M-3, is still contracting sharply (May annual real contraction 7.9%). Real retail sales are softening, falling in May by 1.0%. There are indications that the housing market is softening once again and that home prices are likely to turn lower. For instance, May's existing home sales according to the National Association of Realtors (NAR) showed a monthly contraction of 2.2% when a strong upside gain had been expected. The Federal Reserve has taken note of the softening economy by inserting language in its most recent communique that, "Financial conditions have become less supportive of economic growth on balance, largely reflecting developments abroad."
Rumors are already surfacing that the Fed is preparing to reinstate quantitative easing (QE), which would continue to sow the seeds of future strong inflation, but also put a floor under the stock market once again...
Quantitative easing is the process of buying our own debt in order to force more paper money into the economy. The Treasury issues bonds and the Fed buys them with money it prints expressly for that purpose. It is a sure fire way to create inflation.
Technically the market continues to weaken, with a breach of the 1042 level occurring Monday, 29 June. Tops take more time to form than bottoms typically, and the topping action is now about six months old, sufficient time to build up overhead supply to the point where the market is no longer capable of pushing higher without first selling off more substantively. Specifically, there is now stiff resistance in place in the 1100 to 1125 area that isn't likely to give way anytime soon. Meanwhile, downside risk is 800-900 at some point either later this year or by early next year, assuming our forecast of another recession is accurate AND the Fed doesn't go back into full blown QE mode. (Normally, I would acknowledge the likelihood of the S&P 500 moving below fair value - 850ish - as the secular bear market finally plays itself out completely and the market hits its ultimate low, but our activist Fed makes that scenario a remote one)
Investors should continue to proceed with caution in what continues to be a high risk market....
Rumors are already surfacing that the Fed is preparing to reinstate quantitative easing (QE), which would continue to sow the seeds of future strong inflation, but also put a floor under the stock market once again...
Quantitative easing is the process of buying our own debt in order to force more paper money into the economy. The Treasury issues bonds and the Fed buys them with money it prints expressly for that purpose. It is a sure fire way to create inflation.
Technically the market continues to weaken, with a breach of the 1042 level occurring Monday, 29 June. Tops take more time to form than bottoms typically, and the topping action is now about six months old, sufficient time to build up overhead supply to the point where the market is no longer capable of pushing higher without first selling off more substantively. Specifically, there is now stiff resistance in place in the 1100 to 1125 area that isn't likely to give way anytime soon. Meanwhile, downside risk is 800-900 at some point either later this year or by early next year, assuming our forecast of another recession is accurate AND the Fed doesn't go back into full blown QE mode. (Normally, I would acknowledge the likelihood of the S&P 500 moving below fair value - 850ish - as the secular bear market finally plays itself out completely and the market hits its ultimate low, but our activist Fed makes that scenario a remote one)
Investors should continue to proceed with caution in what continues to be a high risk market....
Wednesday, June 23, 2010
Picking Stocks Revisited
A friend suggested that I write about how to pick stocks in which to invest. Regular readers are aware that I frequently write about the economy and the markets (and have correctly forecast the current market turmoil in 2010). The reason that I shy away from writing about individual stocks is because I don't want my readers going out and purchasing them on their own. Knowing when to buy a stock is only half the investing equation. It is also important to know when to sell, and I can't be there to make that call for you - unless you are already a client of course. Nevertheless, I will update you on a stock I wrote about back in October of 2008 in order to better illustrate the art of stock picking, but first an update on the market.
Our most likely scenario for the remainder of the year is the continuation of an oversold bounce that takes the S&P 500 back to the 1150-1175 area before renewed selling takes us lower into the fall. Of course, it is also possible that the bounce is over already and we are headed lower now. Regardless of the eventual path, it is quite likely that the S&P 500 will test 1000 (big round number) and then 950 (top of the bear market base) before the year is over. Why? Well because it is quite likely that we are headed back into recession as the effect of the fiscal stimulus runs its course and the tremendous burden of U.S. debt reasserts itself. The stock market is merely a reflection of the underlying economy. A weak economy will eventually lead to a weak stock market - absent additional stimulus from the government (which can't be ruled out). Okay, now on to individual stock picking...
Below is an analysis I wrote of Intel in October of 2008. It well illustrates the thought process involved in seeking out good businesses at great prices. (Please skip down to the last couple of paragraphs of the blog for a summary if you aren't into the nitty gritty of analysis).
Our most likely scenario for the remainder of the year is the continuation of an oversold bounce that takes the S&P 500 back to the 1150-1175 area before renewed selling takes us lower into the fall. Of course, it is also possible that the bounce is over already and we are headed lower now. Regardless of the eventual path, it is quite likely that the S&P 500 will test 1000 (big round number) and then 950 (top of the bear market base) before the year is over. Why? Well because it is quite likely that we are headed back into recession as the effect of the fiscal stimulus runs its course and the tremendous burden of U.S. debt reasserts itself. The stock market is merely a reflection of the underlying economy. A weak economy will eventually lead to a weak stock market - absent additional stimulus from the government (which can't be ruled out). Okay, now on to individual stock picking...
Below is an analysis I wrote of Intel in October of 2008. It well illustrates the thought process involved in seeking out good businesses at great prices. (Please skip down to the last couple of paragraphs of the blog for a summary if you aren't into the nitty gritty of analysis).
INTC $14.28 Intel closed today at $14.28 per share, but not before touching $13.37 intraday – a new 52-week low. The company is paying a dividend of $0.55 per share for a current yield of 3.85% and is expected to raise its dividend to $0.61 per share in 2009, according to Value Line – should reality meet expectations INTC will yield 4.27% for anyone buying at the current price, or some 40 basis points or so more than the 10-year Treasury. Now, of course, Intel common stock is riskier than holding a 10-year Treasury to maturity (although that premise seems increasingly uncertain given our government’s loose spending habits). On the other hand, we get much more than a debt instrument that pays par upon maturity when we buy part ownership of a company. We also get a growing stream of shareholder cash flow that can be returned to us by management either with increasing dividends, share buy backs or both.In fact, INTC will pay out around $1.19 per share in 10 years if management raises the dividend 8% per annum during that period – only one quarter the growth rate of the last 5 years. Anyone buying and hold Intel’s stock for the decade will then be earning 8.3% per annum on their original investment. Now compare that juicy 8.3% to the measly 3.85% you can currently earn holding the U.S. 10-year note… and you quickly get it – Intel is a raging buy at the current price as long as the company is around in 10 years and as long as management is able to continue to grow the dividend. And our analysis doesn’t yet include the possibility of additional cash that might be available to oh, say, buy in stock, resulting in the dividend yield rising even faster.In Intel’s case, a quick check of current year estimates reveals that the company will have approximately $0.55 per share in excess cash after paying its dividend and meeting its capital expenditure requirements. A three year average is often useful in ascertaining a company’s ability to throw off excess cash consistently. According to Value Line, Intel has generated approximately $5.66 in cash flow from 2006 to 2008, while making $2.76 per share in capital expenditures and paying out $1.41 per share in dividends, leaving approximately $1.49 per share in excess cash available to buy back shares, or $0.50 per share per annum. Adding the $0.50 in excess cash to the current $0.55 dividend gives you a current dividend yield of 7.35% (what the dividend yield would be if INTC management devoted all of its excess cash to the dividend). Unfortunately, Intel, like many management teams, often choose to buy back shares with excess cash. We think it unfortunate, because managements tend to pay top dollar for their own shares rather than waiting to buy in shares after their stock takes a dive. Nevertheless, buying in $0.50 per share per annum retires 3.5% of the outstanding shares at the current stock price (call it 2.0% net of stock option issuance), raising current and future dividends accordingly.Yet another way to do the math without the distortion of a changing share count: Intel generated $34.2 billion in Cash Flow After Taxes (CFAT) during the three years ending in 2007, against $17 billion in Capital Expenditures (CAPEX), leaving $17.2 billion available to shareholders. The entire company was available for purchase for a mere $154 billion at the beginning of 2008 (you could buy it lock stock and barrel right now for $82.8 billion). Taking the three year average shareholder cash number of $5.7 billion and dividing it into the current fully diluted shares outstanding gets you $0.99 per share in stockholder available cash – a nice current yield of 6.9%, some 3.1% better than the 10-year’s current yield.A couple ways then of looking at the yield to shareholders currently and a decade into the future in comparison to the 10-year Treasury – all favorable. We just need to make a judgment on whether INTC is likely to be around and prospering a decade from now.The company is currently the world’s largest semiconductor chip maker based on revenue, according to its 2007 10K SEC filing. INTC develops advanced integrated digital technology products, primarily integrated circuits, for industries such as computing and communications. Intel also develops platforms, which they define as integrated suites of digital computing technologies that are designed and configured to work together to provide an optimized user computing solution compared to separately. Intel currently controls about 80% of the PC processor market.For starters, Intel has grown revenues from $30.1 billion in 2003 to an estimated $40.4 billion in 2008, or a little over 34% during the five year period. Net profit is forecast to hit $7.3 billion in 2008, up from $7.0 billion in 2007 but well off the company’s peak profit logged in 2000 ($10.7 billion). Nevertheless, profit has grown steadily, albeit erratically, since the bottom fell out during the last recession in 2001 (profits bottomed in 2002 at $3.5 billion).Clearly the company is likely to still be in business and growing earnings given its dominating position in the microprocessor industry and strong balance sheet (almost 13 billion in cash on the balance sheet at the end of 2007). On the other hand, just looking at the increasing variability in earnings leads one to the conclusion that the company is no longer a true growth company and should be bought after business conditions (and the stock price) have weakened and sold when investor enthusiasm carries the share price outside of the realm of reasonable valuation. We believe the current valuation is in the buying zone, given our discussion of dividend and shareholder yields.
Whew! So what did Intel do in the 20 months since I wrote that analysis? Well, it bottomed at around $12 per share
in November of 2008 and retested that low in March of 2009, before marching to a 52-week high of $24.36 in April of 2010. Investors who bought INTC on my recommendation in October of 2008 would have made a pretty penny, earning over 50% on their investment (including the dividend) during the 20-month holding period (assuming they still owned the stock, which currently trades at $20.81). Had they sold the stock last fall when the return hit 50%, they would have earned approximately 55% annualized on their Intel investment. (My personal investment hurdle is the likelihood of earning 50% within two years. I regularly take my profits when I hit my target because business valuations simply don't change that quickly, making it highly likely that my initially undervalued business is no longer cheap enough to hold for the long-term without taking on too much price risk).
One other thing about investing in individual stocks....
You don't find good businesses at great prices among stocks hitting 52-week highs. You do find them among stocks hitting 52-week lows. I'm currently building a rather large position in a big blue chip S&P 500 company that recently lost over half its value due to a short term (in my opinion) problem with its business. My math tells me that I have a high likelihood of earning my 50% hurdle over the next few years.....
Tuesday, June 1, 2010
Bear Market?
We warned in December of 2009 of a likely correction in 2010 that could reach 20%, writing that it was most likely to occur in the first couple of quarters of 2010. "To summarize, we see a correction in the stock market sometime next year that could hit 20% and is likely to occur sometime in the next few quarters." (December 19th 2009). The S&P 500 has fallen just shy of 15% so far at its May 25th low.
We wrote about the high risk nature of the current U.S. stock market, first in February of 2010 and then again in March. On February 18th we wrote, "Further deterioration in the chart - in particular a breach of the recent 1042 low - will likely cause additional profit taking that could lead to our predicted 20%-30% 2010 decline." Finally, we wrote on May 19th that, "Prudent investors would do well to heed the warning shot that was fired on 6 May 2010, it quite likely presages more trouble to come...." (Six days later the S&P 500 hit a new low for the correction of 1040 inter-day, after falling almost 7% in just four trading days).
The wise guy traders (which includes just about everyone these days it seems like) bounced the market hard off the 1040 level on 25 May, making the 1040 area a line in the sand, a breach of which is likely to trigger a further round of selling. The bad news is that the S&P 500 recently failed to take back the 200-day moving average during last week's three day bounce and is setting up for another test of the now critical 1040 area. A close below 1040 opens the way for further declines, first to the big round number (1,000) and then to support at 950. It is possible that the market will rally out of its current very oversold condition first, which would delay any sell off to the 950-1000 level likely until the fall. (Even if an oversold rally does materialize, taking the S&P 500 back to the 1200 level, it is likely that the market will eventually test 1000 and perhaps 950 in the fall as the stalling economy pressures stocks.)
Now, the technical mumbo jumbo is a useful guide primarily because so many professional money managers utilize it. Mutual funds are speculative vehicles these days, turning their portfolios over 80% per year on average. The short term focus puts pressure on managers to track the technicals, making them a self fulfilling prophecy to some extent. It was no coincidence that the market bounced hard from the 1040 level. Everyone can read a chart and everyone could see that the February 1042 low was sitting out there as support. Likewise, it is no coincidence that the S&P 500 recently traded back to the 200-day and failed. Mutual fund managers see the 200-day there and place sell orders accordingly, creating resistance.
Fair value for the S&P 500 is still in the 850-900 area. A return to that level by the fall is still a real possibility and a decline to 950-1000 a fairly high probability event. Hopefully your advisors haven't ignored the high risk market and kept you fully invested over the last few months. Hopefully they too recognized, by late last year, that risk levels were building and prudent risk management was in order. Wouldn't it be nice if you had some cash built up already with which to buy good companies at great prices? Biechele Royce Advisors values price discipline above all else, knowing that the only sure way to outperform is by consistently buying assets for less than they are actually worth. Cash builds up on our clients balance sheets when we can't find undervalued assets to buy - that cash is available to put to work when assets sell off and good companies can be had again for great prices.... perhaps by this fall.
We wrote about the high risk nature of the current U.S. stock market, first in February of 2010 and then again in March. On February 18th we wrote, "Further deterioration in the chart - in particular a breach of the recent 1042 low - will likely cause additional profit taking that could lead to our predicted 20%-30% 2010 decline." Finally, we wrote on May 19th that, "Prudent investors would do well to heed the warning shot that was fired on 6 May 2010, it quite likely presages more trouble to come...." (Six days later the S&P 500 hit a new low for the correction of 1040 inter-day, after falling almost 7% in just four trading days).
The wise guy traders (which includes just about everyone these days it seems like) bounced the market hard off the 1040 level on 25 May, making the 1040 area a line in the sand, a breach of which is likely to trigger a further round of selling. The bad news is that the S&P 500 recently failed to take back the 200-day moving average during last week's three day bounce and is setting up for another test of the now critical 1040 area. A close below 1040 opens the way for further declines, first to the big round number (1,000) and then to support at 950. It is possible that the market will rally out of its current very oversold condition first, which would delay any sell off to the 950-1000 level likely until the fall. (Even if an oversold rally does materialize, taking the S&P 500 back to the 1200 level, it is likely that the market will eventually test 1000 and perhaps 950 in the fall as the stalling economy pressures stocks.)
Now, the technical mumbo jumbo is a useful guide primarily because so many professional money managers utilize it. Mutual funds are speculative vehicles these days, turning their portfolios over 80% per year on average. The short term focus puts pressure on managers to track the technicals, making them a self fulfilling prophecy to some extent. It was no coincidence that the market bounced hard from the 1040 level. Everyone can read a chart and everyone could see that the February 1042 low was sitting out there as support. Likewise, it is no coincidence that the S&P 500 recently traded back to the 200-day and failed. Mutual fund managers see the 200-day there and place sell orders accordingly, creating resistance.
Fair value for the S&P 500 is still in the 850-900 area. A return to that level by the fall is still a real possibility and a decline to 950-1000 a fairly high probability event. Hopefully your advisors haven't ignored the high risk market and kept you fully invested over the last few months. Hopefully they too recognized, by late last year, that risk levels were building and prudent risk management was in order. Wouldn't it be nice if you had some cash built up already with which to buy good companies at great prices? Biechele Royce Advisors values price discipline above all else, knowing that the only sure way to outperform is by consistently buying assets for less than they are actually worth. Cash builds up on our clients balance sheets when we can't find undervalued assets to buy - that cash is available to put to work when assets sell off and good companies can be had again for great prices.... perhaps by this fall.
Wednesday, May 19, 2010
A Thousand Point Warning Shot
Many of you have probably heard that the Dow took a thousand point dive a few weeks ago. You might have also heard that a fat fingered trader might have been responsible for pushing the wrong button and setting the mini-crash in motion. Hopefully you aren't buying the urban legend...
First of all, real life trading doesn't work that way. It is not possible for a single, inadvertent keystroke to set off a market meltdown. Wall Street knows it and the political weenies likely know it as well. However, it does make for a good cover story to distract the masses from a far more worrisome reality - that the market is running on vapors and is increasingly exposed to the reality of an impending worldwide economic slowdown.
The government's search for a fat-fingered trader is a comical and ironic distraction. Of course, it is serving a purpose - keeping the masses entertained while also keeping the public from wondering if perhaps there is a fundamental reason for the market's brief crash. After all, it is far less worrisome to many to pin the meltdown on an "accident" than it is having to acknowledge that perhaps there is a pervasive, deep-seated rot setting in.
But where's the irony? Well, try this on for size. The government's witch hunt is focused on who might have pushed the wrong button to send the Dow careening 600 points lower in a matter of minutes (it was already down 400 points or so as a result of the steady, heavy selling that led up to the meltdown) rather than on who might have ridden to the rescue with heavy blasts of futures buying. Profit seeking traders are not known for a willingness to catch a falling knife, nor are they likely to willing place themselves in the way of a massive market meltdown. Who, then, stepped up and turned the tide with relentless, massive futures buying, even as the Dow's decline accelerated to four-digits? Perhaps the government should look into who jacked the market up 600 points in a matter of minutes? Perhaps the government already knows....
No, Fat-fingered Freddie didn't cause the market to plunge. What did do it was steady, heavy selling from nervous money managers who are beginning to see the writing on the wall. Tops take time to form and we may have started doing just that over the last few months. Sure the S&P 500 exceeded it's January high in April, but it has already retraced that gain and is currently trading below the January high and just above a flattening 200-day moving average. Furthermore, the 20-day has recently dropped below the 50-day moving average, portending continued market weakness, at least for a few more weeks. The 200-day lies in the vicinity of 1100, a big round number in its own right, making that level very important to traders (and that's most everyone these days). Finally, we've had ten days of well above average down volume since the middle of April, a sign that smart money is exiting. All in all the weight of the evidence suggests a very cautious stance is warranted from a technical point of view.
Fundamentally, the picture is even more worrisome. Europe is in trouble and contractionary forces there are likely to intensify in the coming quarters. The effects of the EU's self described Bazooka (the pledge of a 750 billion Euro backstop to Europe's banks) are already fading as the Euro is weakening again and approaching four-year lows, even as sovereign risk spreads have started to widen, despite intervention from the European Central Bank (ECB). The massive rescue package is as ill-conceived as the U.S. TARP effort (which led to a short term bounce in the stock market but saw an eventual 50% additional decline in the S&P 500 after the short-covering rally faded).
The ECB's proposed 750 billion Euro bomb is a declaration that they stand ready to buy almost $1 trillion dollars worth of distressed Euro-area debt in order to preserve the Euro. Of course, they are also on record as stating that they will sterilize the transactions to prevent the Euro from debasement (750 billion Euros let loose in the EU could create inflation on a massive scale if the transactions were left unsterilized). But that means the ECB is planning to, "debase the quality of its balance sheet by exchanging higher quality Euro-area debt with lower-quality debt of countries that are ultimately likely to default," according to Dr. John Hussman.
Now if that M.O. sounds familiar, well it should, since that is exactly what the Federal Reserve has done over the last couple years in the U.S. The Fed has exchanged U.S. Treasuries for the toxic assets residing on U.S. bank balance sheets, prostituting its own balance sheet in the process and setting the U.S. dollar up for a massive decline in value going forward.
But the worldwide debasement of paper currencies and the ultimate high inflation rates that will follow is for later. For now, it is likely that the EU economy will slow and eventually fall back into recession. Likewise, China is showing early warning signs of an impending slowdown. Finally, the U.S. economy is very likely to return to recession within the next quarter or two, based on the ongoing contraction in real money supply that began last December. Which gets us back to a much more reasonable explaination of what caused the Dow's thousand point drop. Rather than pointing to Fat-Fingered Freddie, we should instead be acknowledging that the professional money managers, who have composed the bulk of the historic rally off of the March 2009 lows, are beginning to edge toward the exit, and that their selling temporarily overwhelmed buying from the public. It's well known among traders that when an overcrowded trade reverses it often does so violently and to excess. Prudent investors would do well to heed the warning shot that was fired on 6 May 2010, it quite likely presages more trouble to come....
First of all, real life trading doesn't work that way. It is not possible for a single, inadvertent keystroke to set off a market meltdown. Wall Street knows it and the political weenies likely know it as well. However, it does make for a good cover story to distract the masses from a far more worrisome reality - that the market is running on vapors and is increasingly exposed to the reality of an impending worldwide economic slowdown.
The government's search for a fat-fingered trader is a comical and ironic distraction. Of course, it is serving a purpose - keeping the masses entertained while also keeping the public from wondering if perhaps there is a fundamental reason for the market's brief crash. After all, it is far less worrisome to many to pin the meltdown on an "accident" than it is having to acknowledge that perhaps there is a pervasive, deep-seated rot setting in.
But where's the irony? Well, try this on for size. The government's witch hunt is focused on who might have pushed the wrong button to send the Dow careening 600 points lower in a matter of minutes (it was already down 400 points or so as a result of the steady, heavy selling that led up to the meltdown) rather than on who might have ridden to the rescue with heavy blasts of futures buying. Profit seeking traders are not known for a willingness to catch a falling knife, nor are they likely to willing place themselves in the way of a massive market meltdown. Who, then, stepped up and turned the tide with relentless, massive futures buying, even as the Dow's decline accelerated to four-digits? Perhaps the government should look into who jacked the market up 600 points in a matter of minutes? Perhaps the government already knows....
No, Fat-fingered Freddie didn't cause the market to plunge. What did do it was steady, heavy selling from nervous money managers who are beginning to see the writing on the wall. Tops take time to form and we may have started doing just that over the last few months. Sure the S&P 500 exceeded it's January high in April, but it has already retraced that gain and is currently trading below the January high and just above a flattening 200-day moving average. Furthermore, the 20-day has recently dropped below the 50-day moving average, portending continued market weakness, at least for a few more weeks. The 200-day lies in the vicinity of 1100, a big round number in its own right, making that level very important to traders (and that's most everyone these days). Finally, we've had ten days of well above average down volume since the middle of April, a sign that smart money is exiting. All in all the weight of the evidence suggests a very cautious stance is warranted from a technical point of view.
Fundamentally, the picture is even more worrisome. Europe is in trouble and contractionary forces there are likely to intensify in the coming quarters. The effects of the EU's self described Bazooka (the pledge of a 750 billion Euro backstop to Europe's banks) are already fading as the Euro is weakening again and approaching four-year lows, even as sovereign risk spreads have started to widen, despite intervention from the European Central Bank (ECB). The massive rescue package is as ill-conceived as the U.S. TARP effort (which led to a short term bounce in the stock market but saw an eventual 50% additional decline in the S&P 500 after the short-covering rally faded).
The ECB's proposed 750 billion Euro bomb is a declaration that they stand ready to buy almost $1 trillion dollars worth of distressed Euro-area debt in order to preserve the Euro. Of course, they are also on record as stating that they will sterilize the transactions to prevent the Euro from debasement (750 billion Euros let loose in the EU could create inflation on a massive scale if the transactions were left unsterilized). But that means the ECB is planning to, "debase the quality of its balance sheet by exchanging higher quality Euro-area debt with lower-quality debt of countries that are ultimately likely to default," according to Dr. John Hussman.
Now if that M.O. sounds familiar, well it should, since that is exactly what the Federal Reserve has done over the last couple years in the U.S. The Fed has exchanged U.S. Treasuries for the toxic assets residing on U.S. bank balance sheets, prostituting its own balance sheet in the process and setting the U.S. dollar up for a massive decline in value going forward.
But the worldwide debasement of paper currencies and the ultimate high inflation rates that will follow is for later. For now, it is likely that the EU economy will slow and eventually fall back into recession. Likewise, China is showing early warning signs of an impending slowdown. Finally, the U.S. economy is very likely to return to recession within the next quarter or two, based on the ongoing contraction in real money supply that began last December. Which gets us back to a much more reasonable explaination of what caused the Dow's thousand point drop. Rather than pointing to Fat-Fingered Freddie, we should instead be acknowledging that the professional money managers, who have composed the bulk of the historic rally off of the March 2009 lows, are beginning to edge toward the exit, and that their selling temporarily overwhelmed buying from the public. It's well known among traders that when an overcrowded trade reverses it often does so violently and to excess. Prudent investors would do well to heed the warning shot that was fired on 6 May 2010, it quite likely presages more trouble to come....
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