Financial Armageddon

Podcast: Paradigm Shift

In my latest Panzner Insights podcast, "Paradigm Shift," I discuss one of the week's big developments:

Most people knew that Bernanke & Co.’s grand experiment would end one day, but that notion has largely been seen on Wall Street (and elsewhere) as a vaguely distant possibility. However, things have changed following this week’s publication of the minutes from the Federal Reserve’s December policy meeting. In fact, I believe we’ve witnessed a paradigm shift that has important implications for markets, economies, and society overall, as I discuss in today’s broadcast.

As a special treat, this 30-minute program is also available to non-subscribers. To listen now or download, please click here.

Risk of Downturn Is High

At last week's The Big Picture conference, respected strategist and newsletter writer Michael Belkin posted a comprehensive table with details about the recessions the U.S. has experienced over the past 110 years and what has happened to share prices during those times.

Given that the current business cycle is 40 months old (vs. the average expansion of 45-months -- or 37 months if you exclude the bubble-blowing era that began with the Greenspan Fed), the risk is high that another downturn will be starting soon (if it hasn't already done so).

Under the circumstances, it's worth keeping in mind, as Belkin noted, that the average recession-period decline for the Dow Jones Industrials average is 30.6 percent.

Uh-oh.

FYI, that was just one of the topics I discussed in yesterday's weekly podcast, "Looking Out Over the Investment Landscape," at my new members-only website, Panzner Insights.

If you are interested in reading and hearing more unique updates on markets, economics, and geopolitics, you might want to consider joining those who've already signed up.

Not the Beginning, But the End

The following is another example of the broader range of content you can expect to find at my soon-to-be-launched website, Panzner Insights (though it seemed to be a good fit for Financial Armageddon, too):

There has been a changing of the guard with respect to which style has performed best when investing in companies of a certain size since the overall market rally began on July 1st.

During the early stages of the move, small cap growth shares outperformed their value-category counterparts by a notable margin; since late-July, however, things have gone the other way. In contrast, large cap growth languished early on, but has outpaced its value category counterpart over the past six weeks.

While its hard to say for sure what accounts for the divergence, one theory is that:

• hedge funds and other institutions that had been on the sidelines during the early stages of the run-up were forced to jump in and try to play catch-up by buying the more volatile (but more liquid) large cap names (i.e., growth);
• small investors and others who tend to focus on small cap issues have become more defensive amid deteriorating economic and industry-specific conditions.

If true, this assumption would tend to support the notion that the recent strength in the market has been driven by towel-throwing and performance-chasing rather than a fundamentally-inspired change of heart.

In other words, it's the sort of activity you would expect to find near the end of a move, rather than at the beginning of another leg up.

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Coming soon: Panzner Insights,
an exclusive members-only website focused on
markets, economics, and geopolitics

If you are interested in learning more, please click here to open a form where you can fill in your name and email address (or alternatively, shoot me a quick email with the details), and I will be in touch...

(Note: your contact information will ONLY be used to let you know when my new site is up and running. I DO NOT sell, trade, exchange, or otherwise transfer any email addresses or other personal data that you provide to me. Privacy is precious. I respect yours.)

No Fear...Anywhere

Two recent posts, "No Fear," and "Reversal Time?" noted the fact that investor sentiment looks dangerously complacent. But that seeming lack of fear is actually a global phenomenon. Not only is the widely watched CBOE Volatility Index (VIX) trading near its multi-year lows, indicating that options traders are less-than-concerned about the prospect of a major market disruption, so, too, are implied volatility indexes in Europe, China, and Japan.

The obvious question, of course, is whether such complacency is justified. History would say otherwise.

~~~~~

Coming soon: Panzner Insights,
an exclusive members-only website focused on
markets, economics, and geopolitics

If you are interested in learning more, please click here to open a form where you can fill in your name and email address (or alternatively, shoot me a quick email with the details), and I will be in touch...

(Note: your contact information will ONLY be used to let you know when my new site is up and running. I DO NOT sell, trade, exchange, or otherwise transfer any email addresses or other personal data that you provide to me. Privacy is precious. I respect yours.)

No Fear

In "Reversal Time?" I pointed to several sentiment indicators that suggest investors are way too complacent about the risks ahead. A post at Walter Kurtz's Sober Look (a site worth visiting, I might add), "Risk Aversion the Lowest in Over Two Years," highlights other measures that indicate investors have set themselves up for a nasty surprise, including the Fisher-Gartman Risk-On Index, which is trading at its highest level since the index was launched.

~~~~~

Coming soon: Panzner Insights,
an exclusive members-only website focused on
markets, economics, and geopolitics

If you are interested in learning more, please click here to open a form where you can fill in your name and email address (or alternatively, shoot me a quick email with the details), and I will be in touch...

(Note: your contact information will ONLY be used to let you know when my new site is up and running. I DO NOT sell, trade, exchange, or otherwise transfer any email addresses or other personal data that you provide to me. Privacy is precious. I respect yours.)

Equity vs. Credit Markets: The Divergence Grows Ever Larger

Given that each market is essentially a barometer of the economic well-being of corporate America, the yawning gap in performance that has opened up between the stock market and the credit market suggests that one or the other is out of synch.

While there are not enough data points to make a definitive statement about which is right and which is wrong, I would note that the last time we had the kind of disparity we have now was in late-2007.

Of course, things are different this time...right?

Reversal Time?

There's an old market saying that positions tend to match convictions. If investors are bullish, it's (naturally) assumed that they are betting on the upside, and vice versa.

However, if things reach a point where too many are positioned in the same way, especially where price trends have reinforced those views, it has often set the stage for a sudden and occasionally violent move in the other direction. That's one reason why many market-watchers try to keep tabs on sentiment.

While the relationship between what people say and what they do has been somewhat undermined by the unprecedented interventions of the Federal Reserve (and other authorities) in various markets, the wild market gyrations of the past decade, and a growing cacophony of commentary about where prices are headed next, that doesn't mean traditional sentiment gauges no longer matter.

Most likely, it means that the bands that have historically marked optimistic or pessimistic extremes have either widened out or, in the case of the "Bernanke Put"-type equity market environment we have now, shifted upwards.

Still, while caution is warranted when it comes to assessing the significance of any one indicator, when you reach a point where a growing number of them are telling a similar story -- even if some haven't quite hit their "new normal" extremes -- then it tends to confirm that too many in the trading crowd are leaning the same way -- and that a contrarian reversal is at hand.

With that in mind, it's hard not to read the following reports (and accompanying graphs) as anything other than a sign that the current rally is on very shaky ground -- especially when expectations are as high as they are that the Fed and/or the ECB and/or China and/or Apple will do or say something positive for stocks:

"This Is The Most Bullish Moment We Can Recall Since The Financial Crisis Ended" (Business Insider)

Markets are down a hair today, but the theme of the morning is clear: Uber-bullishness. Everywhere.

This is the most unanimously bullish moment we can recall since the crisis began.

Note that this comes as U.S. indices are all within a hair of multi-year highs, and the NASDAQ returns to levels not seen since late 2000.

"Late-Stage, High-Risk" (Hussman Funds Weekly Market Comment)

For investors who don’t rely much on historical research, evidence, or memory, the exuberance of the market here is undoubtedly enticing, while a strongly defensive position might seem unbearably at odds with prevailing conditions. For investors who do rely on historical research, evidence, and memory, prevailing conditions offer little choice but to maintain a strongly defensive position. Moreover, the evidence is so strong and familiar from a historical perspective that a defensive position should be fairly comfortable despite the near-term enthusiasm of investors.

There are few times in history when the S&P 500 has been within 1% or less of its upper Bollinger band (two standard deviations above the 20-period moving average) on daily, weekly and monthly resolutions; coupled with a Shiller P/E in excess of 18 – the present multiple is actually 22.3; coupled with advisory bullishness above 47% and bearishness below 27% - the actual figures are 51% and 24.5% respectively; with the S&P 500 at a 4-year high and more than 8% above its 52-week moving average; and coupled, for good measure, with decelerating market internals, so that the advance-decline line at least deteriorated relative to its 13-week moving average compared with 6-months prior, or actually broke that average during the preceding month. This set of conditions is observationally equivalent to a variety of other extreme syndromes of overvalued, overbought, overbullish conditions that we've reported over time. Once that syndrome becomes extreme - as it has here - and you get any sort of meaningful "divergence" (rising interest rates, deteriorating internals, etc), the result is a virtual Who's Who of awful times to invest.

"Investor Sentiment: Don’t Become Roadkill" (The Technical Take)

The “Dumb Money” indicator (see figure 1) looks for extremes in the data from 4 different groups of investors who historically have been wrong on the market: 1) Investors Intelligence; 2) Market Vane; 3) American Association of Individual Investors; and 4) the put-call ratio. This indicator is bearish, and just above the extremely bullish level.

Figure 1. “Dumb Money”/ weekly

Figure 2 is a weekly chart of the SP500 with the InsiderScore “entire market” value in the lower panel. From the InsiderScore weekly report: “We continue to see moderately high levels of selling across the market but as we noted last week, from a historic perspective the volume of activity is not particularly egregious. Nonetheless, there is obviously far greater conviction amongst sellers as compared to buyers as the quality of buying events has been generally poor over the past several weeks. “

Figure 2. InsiderScore “Entire Market” value/ weekly

Figure 3 is a weekly chart of the SP500. The indicator in the lower panel measures all the assets in the Rydex bullish oriented equity funds divided by the sum of assets in the bullish oriented equity funds plus the assets in the bearish oriented equity funds. When the indicator is green, the value is low and there is fear in the market; this is where market bottoms are forged. When the indicator is red, there is complacency in the market. There are too many bulls and this is when market advances stall. Currently, the value of the indicator is 71.55%. Values less than 50% are associated with market bottoms. Values greater than 58% are associated with market tops. It should be noted that the market topped out in 2011 with this indicator between 70% and 72%.

Figure 3. Rydex Total Bull v. Total Bear/ weekly

"Cash No Longer King? Investors Buying Stocks Again" (CNBC)

Cash levels in portfolios have fallen to a 15-month low, according to one survey that suggests a thawing in investor sentiment even as the market enters its historically worst month.

As the Standard & Poor's 500 added another 2 percentage points in August to its 12 percent year-to-date gains, investors dropped cash levels to 18.1 percent of their portfolios, the lowest since May 2011, a poll from the American Association of Individual Investors showed.

The shuffling coincided with a 0.7 percentage point increase to stocks to 60.5 percent of total portfolios, and a 2 percentage point increase to bonds to 21.4 percent.

The moves represent respective four- and six-month highs and come as September, with its traditionally negative returns, looms.

"How Hated Is This Rally?" (The Big Picture)

The objective measures shown below like the Investor Intelligence survey (first chart below), the VIX (second chart below) and the Commitment of Traders report (third chart) show nothing even close to what the article contends. If anything, this rally is getting overbought because of too much optimism.

Beep-Beep

A picture speaks a thousand words (or maybe only two)...?

(Images: http://www.businessinsider.com/corporate-profits-finally-top-out-2012-8, http://moneymattersblog.com/lpl-financial-research/weekly-market-commentary-may-9-2011/, http://www.businessinsider.com/henry-blodget-hows-our-bear-market-doing-2009-6, and http://evstudio.info/a-bicycle-city-requires-bicycle-infrastructure/)

The Big Bet That Nothing Will Happen in the Weeks Ahead

Many commentators have noted that the so-called "fear gauge," or CBOE Volatility Index (VIX), a measure of market expectations about near-term volatility, has been trading at multi-year lows, suggesting that traders are complacent about the risks ahead.

In fact, a low VIX has often been the precursor to market corrections and sell-offs over the past several decades.

But a more granular reading of the term structure of implied volatility, which shows how expectations vary at different points in time, offers, perhaps, a more interesting perspective.

As the following chart shows, expectations about implied volatility -- essentially, the relative price of options -- on two widely-followed (and heavily-traded) ETFs have over the past month fallen much more on a relative basis for short-term options than for their longer-term brethren, suggesting that investors have been making an aggressive bet that nothing untoward will happen in the immediate period ahead.

Arguably, this low level of concern reflects the fact that traders believe: 1) the Fed will launch another round of easing (most likely announced around the time of Kansas City Fed's Jackson Hole symposium at the end of the month); 2) the ECB and other authorities will do whatever it takes to prevent any sort of calamity from unfolding in Europe ahead of critical meetings and other developments set to take place starting in September; 3)  growing turmoil in the Middle East won't reach a boiling point until well into the fall; 4) or, nothing of any consequence will happen in the remaining dog days of August because so many people are on vacation or otherwise sitting on their hands.

For their sake, let's hope they are right.

A Slightly Different Take on the Recent "Good News"

Companies in the S&P 500 had been beating earnings estimates at a higher rate than in a typical quarter, providing ammunition for those who believe that bottom-line growth is what has been driving share prices higher. But a post at Thomson Reuters' Alpha Now blog gives us a slightly different take on the recent "good news":.

These second-quarter reports may not be as rosy as these figures make them seem, however. That’s because underneath the headline-grabbing growth in profitability, it’s clear that companies aren’t doing nearly as good a job when it comes to beating analysts’ expectations on the revenue front. Last week’s crop of second-quarter earnings reports from industrial companies – one of the strongest sectors in the market, of late – reinforced that trend, with ten of the 12 S&P 500 Industrials companies that announced results last week posting better-than-expected earnings but only three saying that their revenue came in ahead of expectations.

At the beginning of earnings season, analysts were predicting that industrials companies – as a group – would generate 6.4% growth in revenues, putting them third among the ten sectors in the index. So far, however, only 26% of industrials companies have announced revenues that were higher than analysts’ forecasts, and that revenue growth rate was only 5.5% as of the end of last week. To produce higher earnings on lower-than-anticipated revenues requires companies to boost their margins, and indeed, industrials in the S&P 500 have seen their net margin climb from 8.6% to 9%.

That may have been OK up until now,. but amid clear evidence that the global economy is slowing down, notes blogger Greg Harrison, the top line that may soon matter more.

To the extent that companies aren’t able to support earnings growth via higher revenues, companies will have to rely increasingly on boosting efficiency or cutting costs – or run the risk of disappointing investors on the earnings front as well as on revenues in the future. The trend taking shape in corporate revenues serves as a reminder of a growing source of risk to corporate earnings as 2012 moves forward.

Of course, if all you care about is which rabbit Uncle Ben is going to pull out of his hat at the next Fed meeting (or whenever he feels like it), then please ignore the foregoing and carry on as before.

Buy, baby, buy!!!

(Image: source)

Financial Dissonance

Amid the euphoria in the equity market, the credit market continues to sing a rather more pessimistic tune.

At the Forefront Once Again?

I (and others) have noted that the stock market seems increasingly divorced from economic reality. But that is not entirely true. As the chart shows, one sector, comprised of economically-sensitive issues, has been lagging the broader market for several months. In fact, the Morgan Stanley cyclical index has just hit its lowest level relative to the S&P 500 index in three years. Given that cyclical stocks led the way up when the bull market began more than three years ago, the obvious question is: Are they at the forefront once again?

A Big Joke...

...in honor of yet another hopium-fueled stock market rally (via Capitalists@Work):

Once upon a time, in a place overrun with monkeys, a man appeared and announced to the villagers that he would buy monkeys for $10 each.

The villagers, seeing that there were many monkeys around, went out to the forest, and started catching them.

The man bought thousands at $10 and as supply started to diminish, they became harder to catch, so the villagers stopped their effort.

The man then announced that he would now pay $20 for each one. This renewed the efforts of the villagers and they started catching monkeys again. But soon the supply diminished even further and they were ever harder to catch, so people started going back to their farms and forgot about monkey catching.

The man increased his price to $25 each and the supply of monkeys became so sparse that it was an effort to even see a monkey, much less catch one.

The man now announced that he would buy monkeys for $50! However, since he had to go to the city on some business, his assistant would now buy on his behalf.

While the man was away the assistant told the villagers, “Look at all these monkeys in the big cage that the man has bought. I will sell them to you at $35 each and when the man returns from the city, you can sell them to him for $50 each.”

The villagers rounded up all their savings and bought all the monkeys.

They never saw the man nor his assistant again, and once again there were monkeys everywhere.

Now you have a better understanding of how the stock market works.

(Image: source)

Still Not There

After this week's jump in share prices, I reckon it won't be long before some highly-paid "experts" are again heralding the arrival of another secular bull market. Unfortunately, along with all the other measures I highlighted in "Almost Laughable," which together make it clear that valuations are nowhere near the ultra-cheap levels that prevailed three decades ago, we have another well-regarded indicator telling us a similar story, as Also Sprach Analyst reports in "Chart: Tobin’s Q Ratio for US Equities":

Q ratio is a measure of whether equities’ valuations are, as a whole, attractive or not, invented by James Tobin.  Conceptually it is measured by dividing the market value of equities by the replacement costs of equities.

The variables used to calculate this ratio is in the Z1 Flow of Fund Accounts, with the latest just published by the Federal Reserve.  Here’s how Q ratio looks like, computed by using line 35 of table B.102 divided by line 32 of table B.102.  As you can see, stock market reached an extreme during the tech bubble, and has gone through a long period where the ratio contracted to around unity.  However, if the previous great market bottoms could be of any guide, the Q ratio at the current level remains both above the long-term average and the lowest point in the history [gray annotations mine].

Almost Laughable

In "‘The Death of Equities’… Again?" FT Alphaville ponders whether sentiment has reached the kinds of extremes that have historically marked major -- secular -- turning points:

Thursday’s FT declares “the end of a six-decade passion for equities”. Quite a claim.

Institutional investors, from pension funds to mutual funds sold directly to the public, have slashed holdings in the past decade. Stocks have not been so far out of favour for half a century. Many declare the “cult of the equity” dead.

The story may evoke a feeling of déjà vu for some. Especially those who read the August 13, 1979 edition of BusinessWeek, which famously also announced ‘the death of equities’.

Admittedly, it took another couple of years for the bear market to end, but what followed was one of the biggest bull markets in history.

As a long-time market-watcher, I am acutely aware of the fact that "the crowd" tends to get overly pessimistic at market bottoms (in fact, for those who accuse me of being a permabear, I would have them note my well-publicized calls for a trading rally in March 2009).

Still, the notion that share prices are at a turning point akin to what we saw in the early-1980s is almost  laughable given that:

1. Interest rates back then were at record highs, while they are near all-time lows now;
2. Price-earnings ratios three decades ago were testing all-time lows and were half of what they are currently;
3. Dividend yields were nearly three times as high thirty-odd years ago as they are today;
4. Mutual fund cash levels in recent years are a fraction of what they were in the early-1980s;
5. Share prices had essentially tread water for a decade-and-a-half prior to the stock market's early-1980s lift-off, while the current malaise has not lasted nearly as long;
6. Hardly anybody was calling for a major bull market just over three decades ago, while these days generational bottom-callers seem to be a dime a dozen.

As always, I could be wrong, but I really don't think, to paraphrase a market cliche, this time is different.