Vinny Catalano

On The Road

2012-01-25T18:18:00.002-05:00

Lots of traveling and events.

Posting will resume as the schedule winds down in the coming weeks.

Recent Media Appearances

2012-01-14T17:30:00.005-05:00

Two segments last week: foxbusiness.com and Taking Stock with Pimm Fox and Courtney Donohue.

To hear what was discussed, click here

2012 Market Forecast Series Begins Tomorrow

2012-01-04T10:50:00.002-05:00

Aptly titled, "Turbulence Times", my 2012 Market Forecast series begins tomorrow with The 15th Annual New York Society of Security Analysts' Market Forecast luncheon.

The panelists for this kickoff event are:

*Peter Boockvar, Equity Strategist, Miller Tabak + Co., LLC
*Daniel Clifton, Head of Strategas Research Partners' DC office
*Philip J. Orlando, CFA, Senior Vice President, Senior Portfolio Manager and Chief Equity Market Strategist, Federated Investors
*Mujtaba Rahman, Analyst, Eurasia Group
*Glenn Reynolds, CFA, CEO, CreditSights

A special introductory presentation will be provided by Sam Stovall, Chief Equity Strategist, Standard and Poor's.

To learn more and to register to attend, click here

The Fed's $7.77 Trillion Secret Funding Plan

2011-11-28T14:07:00.012-05:00

As the ECB considers stepping up to the plate and acting as the lender of last resort, yesterday's blockbuster Bloomberg article on the US Fed's secret funding program (forced out in the open via a Bloomberg lawsuit) could not be more timely.

Here are a few excerpts:

"The Federal Reserve and the big banks fought for more than two years to keep details of the largest bailout in U.S. history a secret. Now, the rest of the world can see what it was missing.

The Fed didn’t tell anyone which banks were in trouble so deep they required a combined $1.2 trillion on Dec. 5, 2008, their single neediest day..."

"The amount of money the central bank parceled out was surprising even to Gary H. Stern, president of the Federal Reserve Bank of Minneapolis from 1985 to 2009, who says he “wasn’t aware of the magnitude.” It dwarfed the Treasury Department’s better-known $700 billion Troubled Asset Relief Program, or TARP. Add up guarantees and lending limits, and the Fed had committed $7.77 trillion as of March 2009 to rescuing the financial system, more than half the value of everything produced in the U.S. that year..."

"The secrecy extended even to members of President George W. Bush’s administration who managed TARP. Top aides to Paulson weren’t privy to Fed lending details during the creation of the program that provided crisis funding to more than 700 banks, say two former senior Treasury officials who requested anonymity because they weren’t authorized to speak..."

"TARP and the Fed lending programs went “hand in hand,” says Sherrill Shaffer, a banking professor at the University of Wyoming in Laramie and a former chief economist at the New York Fed. While the TARP money helped insulate the central bank from losses, the Fed’s willingness to supply seemingly unlimited financing to the banks assured they wouldn’t collapse, protecting the Treasury’s TARP investments, he says..."

"On Jan. 14, 2009, six days before the company’s central bank loans peaked, the New York Fed gave CEO Vikram Pandit a report declaring Citigroup’s financial strength to be “superficial,” bolstered largely by its $45 billion of Treasury funds..."

To read the full story, click here

Quotable Quotes: "You Did Not Persuade Me!"

2011-11-25T13:18:00.007-05:00

To those who believe the current economic risks are all about the Eurozone and that the stock market decline is in nothing more than a bull market correction and to all of us who have been convinced otherwise, I offer the following quote from "The Last King of Scotland" with us as Nicolas and those as Idi Amin:

Idi Amin: I want you to tell me what to do.
Nicholas Garrigan: You want ME to tell YOU what to do?
Idi Amin: Yes, you are my advisor. You are the only one I can trust in here. You should have told me not to throw the Asians out, in the first place.
Nicholas Garrigan: I DID!
Idi Amin: But you did not persuade me, Nicholas. You did not persuade me!

Bloomberg: "China Credit Squeeze Prompts Suicides"

2011-11-11T08:36:00.001-05:00

Heard enough about China's "growth" miracle, with its Louis XIV-style corporate palaces and its ghost cities? No? Well, then I am sure you will enjoy this neat little story from Bloomberg about the unregulated loan-shark-rates lending that many (most?) non state controlled businesses are forced (choose?) to rely on and what happens when their ability to pay is impacted by difficult economic and credit conditions:

"Hours after a creditor and his gang of tattooed thugs hustled Zhong Maojin into a coffee shop in Wenzhou, he says he wouldn’t yield to their demands.

They wanted to take over one of the pharmacies in a chain he’d built by borrowing from private lenders. Instead, he made an offer of traditional retribution in this eastern Chinese city, known for loan sharks who have sometimes meted out violence to bad debtors.

“If you like, you can cut off one of my fingers instead,” Zhong, 42, says he told them.

Giving up the store would have made it impossible to pay back another 130 creditors, Zhong said.."

To read the finger licking good tale, click here

What China Is Doing With Its Money

2011-11-10T10:20:00.031-05:00

A few weeks back, I provided the video of an Australian investigative program on the ghost cities of China. If that wasn't enough to concern investors about China's "growth" miracle, perhaps this will. Here are a few (yes, there's more here and here*) photos of the corporate headquarters recently built for state owned Harbin Pharmaceutical.

And these are the guys whom investors are relying on to provide capital for the Eurozone and save the world economy with middle class demand. Ghost cities and corporate palaces. Good luck with that.

*Note: For some reason, this second link no longer works.

Motion Is Not Movement: Risk Appetite Still Unchecked

2011-11-09T10:54:00.014-05:00

Despite sporting an above large cap P/E (19.1 times versus 12.6, estimated for 2011) and despite having an exceptionally optimistic consensus earnings estimate for 2012 (27.3% versus 9.3%) and despite facing the heightened risk of an era of diminished US consumer demand (which is the primary business space small companies operate in), the emboldened bottom up crowd (see yesterday's comment re the bottom up idol, Warren Buffett) joined by the who-cares-what-direction-the-market-moves-just-as-long-as-the-market-moves momos remain fairly sanguine as they have yet to show any meaningful and sustained reduction in their risk appetite. To see this clearly, just look at the accompanying chart illustrating the performance of the small caps (IJR) versus the large (SPX) and mega caps (OEF) over the past 2 years.

While there have been relatively brief periods of reduced risk appetite (when small caps underperform their larger cap brethren (bottom portion of the accompanying chart), the cumulative result still remains fairly rosy.

Investment Strategy Implications

Today's big market move is yet another example of a point I have made on numerous previous occasions: large moves within trading ranges mean nothing. It is only when the current first wave of the bear (my view) or the bull market correction (bulls view) resolves itself with a clear downside or upside break AND is accompanied by confirming action from other indices that the true trend will be exposed.

One early sign would be if there is or is not a change in the risk appetite investors and their momo cohorts. And that would reveal itself in the relative performance of the small caps. Telescoping that performance into today's action: OEF -2.11%, IJR -2.62%. Applying the point made re the range bound market to todays' performance: motion is not movement. Unless and until this changes on a sustained basis, the risk appetite remains unchecked.

Motion is not movement. In fact, motion often resembles commotion.

Note: Accounts managed by Blue Marble Research presently hold a long/short position in the above mentioned issues and their inverse comparables.

The Italian Opera

2011-11-08T09:50:00.018-05:00

First, the Greek tragedy. Now, the Italian opera.

As the global deleveraging crisis continues to wreck havoc on the Eurozone and interest rates for one of its largest economies hits record levels (see chart), it is advisable to understand the multiple dimensions of this financial and economic opera.

In his blog posting yesterday, Nobel Laureate Paul Krugman notes, “…Italy is not a shadow bank; its debt has on average a roughly 7-year maturity, so high interest rates take time to filter into higher debt service. As a matter of arithmetic, this could go on for a while, maybe even a couple of years, without necessarily pushing the country into default.”

However, as Mr. K also notes, “...rates can go even higher; banks can come under pressure; and bank depositors can vote with their feet.” And therein lies the real trouble – a run on the bank, in this case, a sovereign. As the FT noted recently, “The biggest US money market funds cut their exposure to European banks to another record low last month, amid continuing uncertainty over the fate of the region’s debt crisis.”

As money flows away from risky areas and into safe havens like the US dollar denominated assets, stress fractures in the global financial and economic fabric continue to break apart thereby producing a cascading effect upon all and an obsessive focus on who’s next.

Bottom line: This opera won't end until the fat lady sings. Unfortunately, I don't hear her even warming up.

And don’t think the Chinese are so dumb nor so economically secure (you can’t built ghost cities forever) that they will send boatloads of bailout cash to sinking ships around the world. Turandot falls in love only once.

But, hey, none of this really matters to the bottom up boys and girls who are no doubt emboldened by the actions of their leader, Warren Buffet, who went on a spending spree in the third quarter.

Mangia!

2011-11-02T09:07:00.010-04:00

Here is The Economist cover image that I referenced in yesterday's foxbusiness.com interview: the Eurozone leaders being lowered into a sea of trouble (mostly of their own doing) with a pasta colander serving as their boat.

One of the points made in yesterday's interview was the near certainty that a recession is on its way (if it's not already there) for the Eurozone. Today's Eurozone manufacturing data only reinforces that view. What is more ominous, however, is the prospect that the best case scenario for the Eurozone appears to be recession. The worst case? Don't ask.

foxbusiness.com appearance

2011-11-01T15:43:00.000-04:00

To view the segment, click here.

Talking Head Alert: foxbusiness.com Today

2011-11-01T09:45:00.007-04:00

Okay, so I look prescient (at least for 3 days) after last Thursday's appearance on Bloomberg radio's "Talking Stock with Pimm Fox and Courtney Donohoe" some 60 S&P 500 points ago. Now what?

Today's talking head appearance affords me another opportunity to describe my emerging bear call and can be viewed at foxbusiness.com (not on cable) at 1 PM (eastern) today.

In addition to my submitted suggested talking points (below, sent yesterday), I hope to explain why
1 - Big market moves within defined trading ranges mean nothing.
2 - On its own, moves above and below the 200 day average also mean nothing.

Plus the emerging bull market in Komboloi (see accompanying image).

Suggested talking points:

Commentary: Blind Faith

* Bottom up type of investors - those that make investment decisions based primarily (many exclusively) on earnings - have helped drive stocks to current levels.
* Following their lead is a very dangerous practice for investors, as bottom up investors have an investment method that is fraught with danger.
* Last Thursday's stock market rally illustrated just how dangerous their approach to investing is: driving stocks higher on the news of the Eurozone deal without full knowledge of the deal's consequences.
* Their method - earnings matter above all else - is anchored in the belief that what's good for business is good for the economy. To believe this is to believe in laissez-faire economics, that unfettered markets work best, that government that governs least governs best.
* One would think that the recent experience (2007 - 2009) would have put this thinking to bed. But old ideas based on an ideology (dogma) die hard.

Market Assessment

* There is neither a fundamental nor a technical analysis reason to change my early bear call.
* My proprietary Mega Trend is still strongly in the bear category.
* Earnings are on the verge of a serious decline into 2012 (and beyond) as the Eurozone slips into recession.
* At best, stocks should sell at a low double digit P/E, not the current average (15 times) P/E.

Actionable Items

* Resist the siren call of the bottom up bulls. Keep a low equity exposure (50 to 60%).
* Put on mega cap, small cap hedges (long mega cap OEF, long the inverse small cap RWM).
* Be prepared to drop the equity exposure below 50% when the second wave of the bear emerges.

To view the segment live, click here.

Bloomberg Radio Today

2011-10-27T14:10:00.011-04:00

In addition to answering (explaining!?! defending!?!) why I believe this is a counter rally within an emerging bear market, I am hopeful that today's Bloomberg radio segment (4:30 PM easter, "Talking Stock with Pimm Fox and Courtney Donohoe") will touch on the risks inherent in the methodology that most traditionally trained bottom-up portfolio managers and strategists employ in their investment decision-making. And why it is risky to follow those who employ this approach with its faulty premises and embedded blind spots.

To listen to the segment live, click here.

Bottoms Up!

2011-10-25T12:19:00.009-04:00

Giving the devil his due, the bottom-up crowd has won this round, as earnings results are not disappointing as economists did for the third quarter. Therefore, in light of the recent market action, it seems more than productive to understand the nature of this important (but not dominant) segment of the market.

Most investors are bottom-up oriented. They buy and sell stocks with a passing reference to the sector and style tilt their portfolios produce. Like many sports teams, portfolios are populated with the best ideas. Sectors and styles are a by-product. Individual company earnings results, performance metrics (such as profit margins, growth rates, etc.), and valuation levels determine the buy/sell/hold decisions made. From that comes the action taken.

This situation is largely due to tradition and training: traditional among individual investors, training among the professional crowd (the CFA program, for example). It is what the financial media obsesses on while providing limited, yet sorely needed, education on what constitutes good portfolio management.

As one of the two essential elements that drive stock prices up or down (the other being financial market liquidity), earnings results can dominate the moment, as they appear to have done thus far this month. When good earnings results motivate investors to act positively, the momos (the real power in today’s market) join the party, as they are indifferent to the reasons that drive investors and are far more interested in an excuse to act. As long as money is abundant (financial market liquidity), the upside bias exists. Which brings us back to earnings results.

As long as companies deliver positive earnings results and financial market liquidity remains ample, the bottom-up crew can move markets (aided and abetted by the momos, of course) to a significant degree. Should earnings falter, however, then the dual impact of declining results and diminution of financial market liquidity (in the form of redemptions and withdrawals) can produce a negative feedback loop to the real economy (Soros’ “reflexivity”). Yet, more importantly, within this investing approach lie the seeds of its own destruction.

Bottom-up investing is aided and abetted by ivy tower fantasies about efficient markets, assisted with high-sounding phrases like “price discovery” and “capital asset pricing models”, and supported by economic methodologies that are anchored in traditional metric analyses. Such traditional economic methodologies do, however, come with two significant blind spots: the inability to forecast with any degree of accuracy and consistency (certainly commensurate with a practice that fancies itself as a “science”) and an inability to do global macro analysis particularly well.

The first point is self evident and saturated with historical fact. For example, one need only look at today’s consumer confidence miss to see just how off the mark these “social scientists” can be. The second point was made most evident in the debacle known as the Great Recession. Moreover, the inability to do global macro well also comes with an inability to incorporate contagion’s speed and source (real and/or financial economy).

This is a big part of how the world works in Wall Street. It is the dynamic reality that exists in the surreal world of finance. It is the state of denial that many who play the investing game occupy. And it is why it is so essential to step back and smell the global macro rose, which right now has a decidedly foul odor to it.

But, hey! “Who cares?”, say the bottom-up boys and girls. "Earnings are good and that’s all that matters to me."

Quotable Quotes: China's Ghost Cities

2011-10-14T12:41:00.003-04:00

This week's Quotable Quotes takes a look at China's ghost cities via a recent (March 2011) investigative report from SBS Dateline (Australian TV). If investors are looking for the other economic shoe to drop on the tenuous global economic environment, this very well could ultimately be the source.

To view the video, click here.

Reasons and Excuses:Taking The Financial Media To Task

2011-10-12T12:09:00.017-04:00

The financial media is at it again. "Stocks soar today because..."(you fill in the reason). "Stocks plunge tomorrow because"... (you fill in the reason).

What the financial media fails to recognize is that, over the past several decades, the structure of the market has changed. Today's short-term market moves are at the margin and being driven not by rational ivory-tower-pipe-puffing-erudite academics but by momentum chasing lemmings who have copycat methodologies that require they follow the mob.

High correlations and high volatility are market outcomes in this reign of the momos. Yet, from a real world economic perspective, the financial media insists on attributing their actions as rational. They are not. They are, however, rational from a personal perspective: they are animal-spirit driven creatures intent on maintaining a lifestyle they have become accustomed to. Who can blame them? They are simply exploiting the system as it functions today.

Investment Strategy Implications

Investors look for reasons to take action. The agnostic momos look for excuses.

Investors look for fundamental and/or technical analysis reasons to act. The agnostic momos could care less.

Keeping my house in Greenwich is how I first described this syndrome, in which the momos' relative performance vis-a-vis their "competitors" trumps all else. In order for them to keep their house in Greenwich, they must not underperform their "competitors". Hence, the mob rule of the momo lemmings' effect and its effect on the markets.

It, therefore, behooves the financial media to get up to speed and start educating the investing public about how the changed structure of the market has changed how the game is played. Which brings us to this question: Is the financial media's job to educate or to entertain? (I guess the answer to this question can be found every weekday at 6 PM eastern.)

Another Day, Another Opportunity… to Fade the Rally

2011-10-10T10:52:00.013-04:00

Memo to the momo lemmings: It’s more than the Eurozone that’s the problem.

Applying simplistic analysis, the momo crowd has unleashed yet another round of risk-on trades this morning. Jacking stock prices back near their 200 day (exponential) moving average – at least when it comes to developed markets. Emerging markets (remember them, the global economic sector where all the growth is supposed to come from?), however, are lagging the party thus far.

Yet, beyond the short-term wiggles and squiggles that the momo crowd tends to heavily influence, the longer-term picture paints a rather different story. As the accompanying chart** shows rather clearly, the Mega Trend* is decidedly in bearish mode. Moreover, both MACD and RSI are hardly exhibiting robust support for the rally, with MACD yet to crossover to the positive side (when the blue line crosses the red).

As the chart shows, the past is fairly clear what happens when the Mega Trend turns negative. Moreover, only when MACD and RSI register an internal non confirmation (as it did so significantly in the winter of 2008 into the spring of 2009) is there cause to believe the establishment of a negative Mega Trend is at the point of reversal.

To be sure, RSI did register a modest divergence last week but MACD did not. And while one indicator is fine, two is always better.

Investment Strategy Implications

The momo crowd is enthused that another round of inadequate political action will save the Euro day. And perhaps the movement they have fostered these past few days has some lasting power to it resulting in the aforementioned reversal conditions. However, with earnings season starting this week, there is every reason to expect the optimistic bottom-up projections will follow the macro economic forecasts for the third quarter, which were well below economists’ expectations. And that reality may trump the momos rationale du jour. Yet, when it comes to the momos, here's something useful to remember:

Being agnostic when it comes to the longer term and the real world of earnings and economics, they will follow whatever short-term trend they manufacture. That's what lemmings do.

*use search function on the top left to read about the Mega Trend.
**click image to enlarge.
Note: the above chart is a weekly chart in which the 50 and 200 day daily moving averages are converted to the equivalent 10 and 40 week moving averages.

Quotable Quotes: Steve Jobs

2011-10-07T11:50:00.006-04:00

Appropriately, this week's Quotable Quotes is the 2005 Stanford commencement address delivered by Steve Jobs.

"I am honored to be with you today at your commencement from one of the finest universities in the world. I never graduated from college. Truth be told, this is the closest I've ever gotten to a college graduation. Today I want to tell you three stories from my life. That's it. No big deal. Just three stories.

The first story is about connecting the dots.

I dropped out of Reed College after the first 6 months, but then stayed around as a drop-in for another 18 months or so before I really quit. So why did I drop out?

It started before I was born. My biological mother was a young, unwed college graduate student, and she decided to put me up for adoption. She felt very strongly that I should be adopted by college graduates, so everything was all set for me to be adopted at birth by a lawyer and his wife. Except that when I popped out they decided at the last minute that they really wanted a girl. So my parents, who were on a waiting list, got a call in the middle of the night asking: "We have an unexpected baby boy; do you want him?" They said: "Of course." My biological mother later found out that my mother had never graduated from college and that my father had never graduated from high school. She refused to sign the final adoption papers. She only relented a few months later when my parents promised that I would someday go to college.

And 17 years later I did go to college. But I naively chose a college that was almost as expensive as Stanford, and all of my working-class parents' savings were being spent on my college tuition. After six months, I couldn't see the value in it. I had no idea what I wanted to do with my life and no idea how college was going to help me figure it out. And here I was spending all of the money my parents had saved their entire life. So I decided to drop out and trust that it would all work out OK. It was pretty scary at the time, but looking back it was one of the best decisions I ever made. The minute I dropped out I could stop taking the required classes that didn't interest me, and begin dropping in on the ones that looked interesting.

It wasn't all romantic. I didn't have a dorm room, so I slept on the floor in friends' rooms, I returned coke bottles for the 5¢ deposits to buy food with, and I would walk the 7 miles across town every Sunday night to get one good meal a week at the Hare Krishna temple. I loved it. And much of what I stumbled into by following my curiosity and intuition turned out to be priceless later on. Let me give you one example:
Reed College at that time offered perhaps the best calligraphy instruction in the country. Throughout the campus every poster, every label on every drawer, was beautifully hand calligraphed. Because I had dropped out and didn't have to take the normal classes, I decided to take a calligraphy class to learn how to do this. I learned about serif and san serif typefaces, about varying the amount of space between different letter combinations, about what makes great typography great. It was beautiful, historical, artistically subtle in a way that science can't capture, and I found it fascinating.

None of this had even a hope of any practical application in my life. But ten years later, when we were designing the first Macintosh computer, it all came back to me. And we designed it all into the Mac. It was the first computer with beautiful typography. If I had never dropped in on that single course in college, the Mac would have never had multiple typefaces or proportionally spaced fonts. And since Windows just copied the Mac, it's likely that no personal computer would have them. If I had never dropped out, I would have never dropped in on this calligraphy class, and personal computers might not have the wonderful typography that they do. Of course it was impossible to connect the dots looking forward when I was in college. But it was very, very clear looking backwards ten years later.

Again, you can't connect the dots looking forward; you can only connect them looking backwards. So you have to trust that the dots will somehow connect in your future. You have to trust in something — your gut, destiny, life, karma, whatever. This approach has never let me down, and it has made all the difference in my life.

My second story is about love and loss.

I was lucky — I found what I loved to do early in life. Woz and I started Apple in my parents garage when I was 20. We worked hard, and in 10 years Apple had grown from just the two of us in a garage into a $2 billion company with over 4000 employees. We had just released our finest creation — the Macintosh — a year earlier, and I had just turned 30. And then I got fired. How can you get fired from a company you started? Well, as Apple grew we hired someone who I thought was very talented to run the company with me, and for the first year or so things went well. But then our visions of the future began to diverge and eventually we had a falling out. When we did, our Board of Directors sided with him. So at 30 I was out. And very publicly out. What had been the focus of my entire adult life was gone, and it was devastating.

I really didn't know what to do for a few months. I felt that I had let the previous generation of entrepreneurs down - that I had dropped the baton as it was being passed to me. I met with David Packard and Bob Noyce and tried to apologize for screwing up so badly. I was a very public failure, and I even thought about running away from the valley. But something slowly began to dawn on me — I still loved what I did. The turn of events at Apple had not changed that one bit. I had been rejected, but I was still in love. And so I decided to start over.

I didn't see it then, but it turned out that getting fired from Apple was the best thing that could have ever happened to me. The heaviness of being successful was replaced by the lightness of being a beginner again, less sure about everything. It freed me to enter one of the most creative periods of my life.

During the next five years, I started a company named NeXT, another company named Pixar, and fell in love with an amazing woman who would become my wife. Pixar went on to create the worlds first computer animated feature film, Toy Story, and is now the most successful animation studio in the world. In a remarkable turn of events, Apple bought NeXT, I returned to Apple, and the technology we developed at NeXT is at the heart of Apple's current renaissance. And Laurene and I have a wonderful family together.

I'm pretty sure none of this would have happened if I hadn't been fired from Apple. It was awful tasting medicine, but I guess the patient needed it. Sometimes life hits you in the head with a brick. Don't lose faith. I'm convinced that the only thing that kept me going was that I loved what I did. You've got to find what you love. And that is as true for your work as it is for your lovers. Your work is going to fill a large part of your life, and the only way to be truly satisfied is to do what you believe is great work. And the only way to do great work is to love what you do. If you haven't found it yet, keep looking. Don't settle. As with all matters of the heart, you'll know when you find it. And, like any great relationship, it just gets better and better as the years roll on. So keep looking until you find it. Don't settle.

My third story is about death.

When I was 17, I read a quote that went something like: "If you live each day as if it was your last, someday you'll most certainly be right." It made an impression on me, and since then, for the past 33 years, I have looked in the mirror every morning and asked myself: "If today were the last day of my life, would I want to do what I am about to do today?" And whenever the answer has been "No" for too many days in a row, I know I need to change something.

Remembering that I'll be dead soon is the most important tool I've ever encountered to help me make the big choices in life. Because almost everything — all external expectations, all pride, all fear of embarrassment or failure - these things just fall away in the face of death, leaving only what is truly important. Remembering that you are going to die is the best way I know to avoid the trap of thinking you have something to lose. You are already naked. There is no reason not to follow your heart.
About a year ago I was diagnosed with cancer. I had a scan at 7:30 in the morning, and it clearly showed a tumor on my pancreas. I didn't even know what a pancreas was. The doctors told me this was almost certainly a type of cancer that is incurable, and that I should expect to live no longer than three to six months. My doctor advised me to go home and get my affairs in order, which is doctor's code for prepare to die. It means to try to tell your kids everything you thought you'd have the next 10 years to tell them in just a few months. It means to make sure everything is buttoned up so that it will be as easy as possible for your family. It means to say your goodbyes.

I lived with that diagnosis all day. Later that evening I had a biopsy, where they stuck an endoscope down my throat, through my stomach and into my intestines, put a needle into my pancreas and got a few cells from the tumor. I was sedated, but my wife, who was there, told me that when they viewed the cells under a microscope the doctors started crying because it turned out to be a very rare form of pancreatic cancer that is curable with surgery. I had the surgery and I'm fine now.

This was the closest I've been to facing death, and I hope it's the closest I get for a few more decades. Having lived through it, I can now say this to you with a bit more certainty than when death was a useful but purely intellectual concept:

No one wants to die. Even people who want to go to heaven don't want to die to get there. And yet death is the destination we all share. No one has ever escaped it. And that is as it should be, because Death is very likely the single best invention of Life. It is Life's change agent. It clears out the old to make way for the new. Right now the new is you, but someday not too long from now, you will gradually become the old and be cleared away. Sorry to be so dramatic, but it is quite true.
Your time is limited, so don't waste it living someone else's life. Don't be trapped by dogma — which is living with the results of other people's thinking. Don't let the noise of others' opinions drown out your own inner voice. And most important, have the courage to follow your heart and intuition. They somehow already know what you truly want to become. Everything else is secondary.

When I was young, there was an amazing publication called The Whole Earth Catalog, which was one of the bibles of my generation. It was created by a fellow named Stewart Brand not far from here in Menlo Park, and he brought it to life with his poetic touch. This was in the late 1960's, before personal computers and desktop publishing, so it was all made with typewriters, scissors, and polaroid cameras. It was sort of like Google in paperback form, 35 years before Google came along: it was idealistic, and overflowing with neat tools and great notions.

Stewart and his team put out several issues of The Whole Earth Catalog, and then when it had run its course, they put out a final issue. It was the mid-1970s, and I was your age. On the back cover of their final issue was a photograph of an early morning country road, the kind you might find yourself hitchhiking on if you were so adventurous. Beneath it were the words: "Stay Hungry. Stay Foolish." It was their farewell message as they signed off. Stay Hungry. Stay Foolish. And I have always wished that for myself. And now, as you graduate to begin anew, I wish that for you.

Stay Hungry. Stay Foolish.

Thank you all very much."

The video version of this speech can be found on my media blog, Beyond the Sound Bite.

What Is A Bear Market?

2011-10-04T10:29:00.020-04:00

To many, especially those in the financial media, a bear market is a statistic. For example, during Monday's swoon, the words "The market, down 20%, is now in bear market territory" could be heard early and often. However, to investment strategists and seasoned portfolio managers, a bear market is not a statistic but a trend established or in the process of being established in which lower prices are the dominant trend. How one comes to this conclusion is a process of the methodology employed. And only time will tell if the forecast is correct.

At present, the view here is that the bear is the operative major trend. This is so for reasons described on many previous occasions, most notably the Mega Trend*. If I (and others) are correct and we are in the throes of the bear, then there are three portfolio decisions that need to be made.

First, what is the appropriate asset allocation mix? The answer depends on one's risk tolerance, goals, objectives, constraints, etc.

Second, what is the appropriate sector mix? The answer here depends partly on the answer to first question but also includes a standard reduced volatility exposure (lower beta) via "defensive" sectors. Thus far, in this bear that has produced some good alpha.

Third, what is the most productive tactical approach to take? Here, the answer resides in what phase of the bear we are in. If in the first wave (which is what I believe we are still in), fade (sell) the rallies is the appropriate course of action. Rallies are a feature of the first phase, as the bulls still have considerable residual strength and the supporting argument that we are only in a correction. This is not the case in the second and third phase, when rallies are few and far between.**

There is a related topic to discuss re the bear: "Because."

Like all market factors, the reasons for the bear (or the bull, for that matter) are many and complex. The simple "Because" reasons given so blithely so often in the financial media are the construct of the business dynamics of the financial media industry and human nature. For many, it is hard to believe that cause and effect (the real world reasons for why markets move) is not always the case. The problem with this is simple: the cause is rarely one thing. It is predominantly many issues with many complex dynamics at work.

One last point: the magnitude of a move is very difficult to forecast. Assumptions can (and should) be made. However, given the highly dynamic nature of the markets (see Soros' "Reflexivity" on this*), it is hard enough getting the direction correct let alone how large the move will be and when it will end.

Bottom Line: A bear market is not just a statistic. It is the view (followed by the reality) that a downward trend is in effect that results in significant loss in value or time. It's a bear until it ain't. Or, to quote the famed philosopher, Yogi Berra, "It ain't over 'til it's over."

*Use search function to find prior posts on this and other topics.
**When entering the 2nd and 3rd phase, the asset allocation should be at the desired level.

DO Fight The Fed

2011-09-21T09:17:00.016-04:00

Today, Wall Street's Professional Investor Class (PIC) waits with bated breath for the Fed to provide words of comfort so that one of Wall Street's revered axioms, "don't fight the Fed", will deliver much needed relief to the beleaguered warriors of finance.

One of characteristic of the PICs that is useful to remember is that they are highly reliant on heuristics - rules of thumb that help frame the world into bite-sized analytical pieces. One of the heuristics that has worked from time immemorial is 'don't fight the Fed". For example, last year, around this time, a well-known hedge fund manager advised investors and traders of this well-worn axiom to great effect and result (stocks rose from the fall of 2010 into the summer of 2011). Unfortunately, while the monetary elixir did work its magic on the PICs (they bought stocks), it had little effect on the real economy.

Never sated, the ever-thirsty PICs are back at the don't-fight-the-Fed troff for another hearty slurp of monetary ease = higher risk asset values. From the PICs and Fed's perspectives, the economic rationale for this view is rather simple: Easy money = an increase in the value of risky assets = a positive wealth effect = increase demand = higher GDP (which then = higher wages, increased hiring, etc, etc). Hence, don't fight the Fed ALWAYS delivers. Or does it? And when it does, is the effect always the same under all conditions? Or are the results a product of the economic and financial times?

It may be a risky thing to go against such a dogma. After all, the four most dangerous words in the investment language is "this time is different". And to assume that more easy money will not produce the above listed outcomes is the speak those very dangerous words. Yet, if one believes we are in times that are truly different, particularly in the post WW II era, then perhaps it's time from some fresh perspectives.

Going against such a well-established dogma of day is also especially dangerous given the changed structure of the market. For, when the momo lemmings (who could care less what the drivers are or what direction the markets are headed, just along as stock prices move) jump on the market trend du jour bandwagon, the wheels get turning rather quickly.

Investment Strategy Implications

If you are going to go against a revered heuristic it is useful to have your own heuristic to counter the revered one. My heuristic is this: in a liquidity trap, the effectiveness of monetary policy is limited, at best. Moreover, monetary ease becomes even more limited when fiscal policy is contradtionary (i.e., expansionary austerity). These global macro forces are strong, pervasive, and global in scope.

So, the PICs may rejoice in what they hear today. And risk assets may rise - for a while. But the global macro forces at work can, and I believe will, overwhelm the monetary elixir the Fed will provide. And the PICs don't do global macro very well. (More on this point in a future blog posting.)

Quotable Quotes

2011-09-16T10:54:00.005-04:00

"You know Charlie Walser? Has the place east of Sanderson? Well you know how they used to slaughter beeves, hit 'em with a maul right here to stun 'em... and then up and slit their throats? Well here Charlie has one trussed up and all set to drain him and the beef comes to. It starts thrashing around, six hundred pounds of very pissed-off livestock if you'll pardon me... Charlie grabs his gun there to shoot the damn thing in the head but what with the swingin' and twistin' it's a glance-shot and ricochets around and comes back hits Charlie in the shoulder. You go see Charlie, he still can't reach up with his right hand for his hat...Point bein', even in the contest between man and steer the issue is not certain."
Ed Tom Bell
"No Country For Old Men"

"The Planning Fallacy"
David Brooks
NY Times, September 15, 2011

When the Nobel Prize-winning psychologist Daniel Kahneman was a young man, he led a committee to write a new part of the curriculum for Israeli high schools. The committee worked for a year, and Kahneman asked his colleagues how long they thought the rest of the project would take. Their estimates were around two years.

Kahneman then asked the most experienced among them how long such work took other curriculum committees. The gentleman pointed out that roughly 40 percent of the committees never finished their work at all.

But what about those that did finish? The gentleman reported that he had never seen a committee finish in less than seven years and never in more than 10.

This was bad news. They might fail to finish a task that they thought would be done in three years. At best, the project might consume eight or nine years. Yet this information didn’t affect those on the team at all. They carried on, assuming that though others might fail or dally, surely they wouldn’t.

As it turned out, their project took eight years to finish. By the time it was done, the Ministry of Education had lost interest, and the curriculum was never used.

In his forthcoming book, “Thinking, Fast and Slow” (I’ll write more about it in a couple of weeks), Kahneman calls this the planning fallacy. Most people overrate their own abilities and exaggerate their capacity to shape the future. That’s fine. Optimistic people rise in this world. The problem comes when these optimists don’t look at themselves objectively from the outside.

The planning fallacy is failing to think realistically about where you fit in the distribution of people like you. As Kahneman puts it, “People who have information about an individual case rarely feel the need to know the statistics of the class to which the case belongs.”

Over the past three years, the United States has been committing the planning fallacy on stilts. The world economy has been slammed by a financial crisis. Countries that are afflicted with these crises typically experience several years of high unemployment. They go deep into debt to end the stagnation, but the turnaround takes a while.

This historical pattern has been universally acknowledged and universally ignored. Instead, leaders in both parties have clung to the analogy that the economy is like a sick patient who can be healed by the right treatment.

The Democrats, besotted by the myth that the New Deal ended the Great Depression, have consistently overestimated their ability to turn the economy around. They regard the Greek crackup as a freakish, unlucky break, even though this sort of thing is a typical feature of a financial crisis.

Republicans, who should know better, also have an inflated sense of the power of government. In the presidential debates, Rick Perry, Mitt Romney and Jon Huntsman argue about which one oversaw the most job creation during his term as governor, as if governors have an immediate and definable impact on employers’ hiring decisions.

The reality, of course, is that the economy is not a patient. It is a zillion, zillion interactions. Government is not a doctor. Most of the time, it is a clashing collective enterprise that is occasionally able to produce marginal change, for good and for ill.

Democrats should be learning about the limits of social policy. As in the war on poverty, as in the effort to transform American schools, as in the effort to create prosperity in the developing world, it is really hard to turn around complex systems.

Republicans should be reflecting on the fact that if a Republican president were in office right now, and even if he or she did sensible things, the economy would still be in the dumps. It would be Republicans losing “safe” Congressional seats in special elections.

The key to wisdom in these circumstances is to make the distinction between discrete good and systemic good. When you are in the grip of a big, complex mess, you have the power to do discrete good but probably not systemic good.

When you are the president in a financial crisis, you have the power to pave roads and hire teachers. That will reduce the suffering of real people who would otherwise be jobless. You have the power to streamline regulations and reduce tax burdens. That will induce a bit more hiring and activity. These are real contributions.

But you don’t have the power to transform the whole situation. Your discrete goods might contribute to an overall turnaround, but that turnaround will be beyond your comprehension and control.

Over the past decades, Americans have developed an absurd view of the power of government. Many voters seem to think that government has the power to protect them from the consequences of their sins. Then they get angry and cynical when it turns out that it can’t."

Note: emphasis added

Nothing To Hang Your Bullish Hat On

2011-09-15T10:12:00.012-04:00

Following on yesterday's market intelligence (what I believe quality technical analysis actually is) posting, a longer term view of the market reveals the erosion in strength that took place this past spring when the market made new highs. The accompanying chart illustrates this quite clearly: non confirmation from all three price momentum related indicators. This helped set the stage for the subsequent and current decline.

To be clear, as noted on numerous prior occasions the absence of external divergences (use search function for prior blog postings) + the modest (not over) valuation levels for stocks + the manner in which the bear got started (from bull to bear rapidly and not in rollover fashion) = a delayed recognition by yours truly to the current bear market conclusion. As Lord Keynes once said, "when circumstances change, I change my views. What do you do Sir?”

Going forward, a look back at the chart shows no signs of strength from MACD. This is perhaps the most reliable of the three indicators in confirming market direction. As is plainly shown, the crossover to the downside is solidly in place with no positive (bullish) crossover in the offing. Until that occurs (and it will, eventually), investors are advised to assume that the current rally is highly suspect.

Somebody Is Going To Be Real Right...

2011-09-14T15:33:00.020-04:00

...and somebody is going to be real wrong.

If you have not heard from your friendly technical analyst, maybe it's time to find someone else in that field.

In what can only be described as coming straight out of the Edwards and Magee technical analysis bible (“Technical Analysis of Stock Trends”), the accompanying chart is a classic example of not one but two technical analysis chart pattern icons: Head and shoulders top and a bearish pole and flag.

This plus the fact that nearly 90% of the global indices I track are flashing bearish Mega Trends (use the search function on the top left for prior blog postings explaining this tool) is about as bearish as one can get.*

The first wave of a bear market almost always looks like a correction. Bulls will argue convincingly that key metrics like earnings and interest rates support this view. However, the anchor for this argument - solid earnings - can be easily undermined should the global macro story develop into something far worse than the bulls currently envision. For a recent example of this, just look at what happened from 2006 (S&P 500 operating earnings at a record $87) to 2007 ($82) to 2008 ($49). In this regard, the MERI (use search function again) is practically screaming earnings disappointments beginning next month. That could start the chain reaction of doubt, which is a strong characteristic of the second wave of the bear (as price crashes below the previous lows).

For a market priced for an economic muddle through, the worse case scenario is yet to be realized. Moreover, with limited flexibility to provide meaningful counter cycle actions, governments will be in no position to act effectively. Then there is the self fulfilling aspect of the negative wealth effect on the global macro environment that declining equity values tend to produce, which will almost certainly accelerate the downward pressure on the global economy (and earnings). Lastly, there is the unknown. Can anyone say with absolute certainty that all is good in China?

There's more. But suffice to say, an uncertain environment is hardly the prudent time to be fully invested.

Investment Strategy Implications

The advisable strategy appears to be to move as close to the exit door as possible. In portfolio strategy terms that means

1 - Reduce the equity exposure to a safe level, which for accounts managed and advised by Blue Marble Research is 60%. This means fade (sell) the rallies to, at least, maintain a constant percent equity exposure, but to preferably reduce down to the close-to-the-exit door level.
2 - Shift assets holdings to high quality dividend paying stocks.
3 - Be prepared to reduce the equity exposure to below 50% once the second wave gets underway. This means sell into the declines. The first wave of the bear gives you ample opportunity to sell the rallies. ("Looks like a correction to me.") The second and third waves do not.

Like I said, somebody is going to be real right and somebody is going to be real wrong. Of all things so uncertain in these times, one thing I am certain of: we will find out soon enough.

*Previous blog postings describe the unusual nature as to how we entered the bear (use search function). But the past several weeks have made it all the more traditional.

At Least The View Is Lovely

2011-09-07T09:54:00.010-04:00

Stocks on the move today. Here's a picture that captures the moment.

Stocks Are Cheap

2011-09-06T11:33:00.021-04:00

...and that's exactly the point.

More and more I hear the phrase "stocks are cheap".

In a market dominated by institutional investors, why isn't the "smart money" (as they are fancifully called) buying the obviously cheap goods up for sale? Is it because cheap is about to get even cheaper once earnings season rolls around? Or is it just another case of the momo lemmings (a/k/a momentum driven fast money hedge funds and HFTs) following the price trend du jour?

The accompanying table* is the Capital IQ consensus numbers for each quarter for this and next year. Applying the forecasts to the current price of the S&P 500, the P/E ratio for year end 2012 (just 16 months away) sits at 10.27 times projected earnings and at 11.40 times next year's projected price (increased by 11%, the long term average return for large cap stocks). To put this in perspective, these are numbers that are well below the recent historical average P/E of 15.

With the 10 year US Treasury rate below 2% and corporate profits projected to grow at a fairly nice clip, what's stopping the "smart money" from stepping up to the plate?

*click image to enlarge

Quotable Quotes: Richard Koo and Martin Wolf

2011-09-02T09:24:00.023-04:00

Today, I am reinstating a popular blog service that I provided several years ago: Quotable Quotes.

In the past, I would seek out interesting and often humorous quotes from the very well known to those of lesser fame. In this updated version, I will include comments and other relevant data that are appropriate to the current economic, political, and market times.

The first installment (below) begins with a letter sent to and published in The Economist from noted economist Richard Koo. The emphasis (bold and italics) is added by me to accentuate key points that struck me as especially useful in understanding key elements in the investment decision-making process.

The second is an excerpt from Martin Wolf's most recent economic commentary. I encourage all to read his complete commentary (link provided, FT subscription required).

I trust you will find this reading well worth your time.

August 20, 2011

A different kind of crisis

SIR – The title of your leader on the debt crisis was well chosen (“Turning Japanese”, July 30th), but you missed the point. The Japanese problem of the past 20 years, together with the American and European problems of today, boils down to one fact: the economics profession has never considered a recession that could be caused by the private sector minimizing debt in order to repair balance sheets after a debt-financed bubble in asset prices. As a result, the profession has no clue as to what is the right thing to do.

In this rare type of recession, monetary policy is useless because people with negative equity will not borrow, no matter what the interest rate. Nor will there be many lenders when banks have such huge problems with their balance sheets.

In this environment, therefore, government must borrow and spend the savings generated by the deleveraging in the private sector in order to keep the economy from entering a deflationary spiral. But as John Maynard Keynes noted, it is almost impossible to maintain fiscal stimulus in a democracy during peacetime. It is this difficulty that prolongs this type of recession; it took Japan ten years to climb out of the policy mistake of premature fiscal consolidation in 1997.

The drama in Washington and other capitals is almost the exact replay of that confused policy debate in Japan. And the drama will continue until the public realizes that this is a different disease requiring different treatment.

Richard Koo 
Chief economist 
Nomura Research Institute 
Tokyo

August 30, 2011

Struggling with a great contraction

Mr Obama wishes to be president of a country that does not exist. In his fantasy US, politicians bury differences in bipartisan harmony. In fact, he faces an opposition that would prefer their country to fail than their president to succeed. Ms Merkel, similarly, seeks a non-existent middle way between the German desire for its partners to abide by its disciplines and their inability to do any such thing.

Martin Wolf
Chief economics commentator
Financial Times

Media Appearances today

2011-09-01T10:12:00.001-04:00

The time and segments are as follows:

Foxbusiness.com at 1 PM (eastern)

http://www.bloomberg.com/radio/ around 3 PM (eastern)

Prospective talking points:

1 - Overly optimistic earnings expectations by bottom-up analysts. A rude awakening awaits when 3Q11 earnings season gets underway. My proprietary MERI sits at -11.

2 - How the current bear market got started in an extremely rare fashion and why, for most investors, the current market rally will be so hard to sell into.

3 - My recent 10 day trip to Brazil. Impressions on the country and questions as why the US does not have a stronger presence there.

How The Markets Really Work

2011-08-12T10:19:00.010-04:00

Despite all the high-minded statements about market efficiencies and the alleged clairvoyant talents of the fast money crowd, here's a cartoon* that illustrates how the markets really work.
*Source: The Economist. click image to enlarge.

Talking Head Alert

2011-08-12T09:11:00.003-04:00

A segment of my most recent appearance on foxbusiness.com with Tracy Byrnes is posted.

To view the interview, click here.

Beyond the Sound Bite: An Interview with Robert Steven Kaplan

2011-08-10T11:15:00.004-04:00

It isn't everyday that we get to hear the former vice chairman of the Goldman Sachs Group share his thoughts and insights into the current economic and market environment.

Currently, Rob is professor of management practice at Harvard Business School and co-chairman of Draper Richard kaplan, a global venture philanthropy firm. Rob is also the author of the just published "What To Ask The Person In The Mirror": Critical Questions for Becoming a More Effective Leader and Reaching Your Potential.

In addition to discussing key aspects of his book, my podcast interview with Rob produced several very insightful thoughts on these most turbulent times, including the "series of sagas" investors are coping with, the implication of the changing structure of the market (e.g. capital impact on commercial banks during market swings, initiators and accelerators, pro-cyclicality), and President Obama and the question of vision and leadership.

To listen to the interview, click here.

Talking Head Alert

2011-08-09T11:45:00.014-04:00

I am headed to Stiletto City (a/k/a foxbusiness.com) where you can watch me attempt to describe how the policy response to the Global Stock Market Panic of 2011 will determine if the experience will be like 1987 or 1929. Segment begins around 1 PM (eastern) and can be viewed at foxbusiness.com.

The Global Stock Market Panic of 2011

2011-08-05T12:18:00.020-04:00

Here are two data points* that suggest that the drop in stocks is the 2011 version of an old fashioned stock market panic.

The valuation table lets the market tell you what P/E and S&P 500 operating earnings fit the current level. From this one can decide which combination makes the most sense. Unless earnings are about to fall off the cliff and/or their risk factors have risen dramatically, the P/E combination of a below average P/E of 14 times $95 is the most central point. Other combinations imply plunging earnings with rising P/Es (not logical) or plunging P/Es and rising earnings (also, not logical).

The chart shows the one month performance of selected global markets as of 12 noon (eastern) today. The point here is simple: unless one believes that a global recession is just around the corner and that emerging markets and high quality European companies are going to impacted in such a way that global growth and corporate profits are about to fall off the cliff, then the synchronized plunge makes no sense. Yes, one could argue that developed economies and the higher risk components within are at risk. But does that mean everything at every level is about to come to screeching halt, including those areas where growth is good and profits are both of a high quality and strong?

Investment Strategy Implications

The most logical culprit for this global stock market panic is a momentum-driven-hedge-fund-induced-high-frequency-trading-exacerbated panic than a justification for a global economic catastrophe lurking just around the bend. If true, this is a powerful indictment against the failure to appreciate the changing structure of the market. Also, if true, then investors should recognize this for what it is: a panic within a bull market correction.

*click images to enlarge

Vintage Farrell

2011-08-05T10:37:00.009-04:00

Yesterday, legendary technical analyst, Bob Farrell, published a one pager describing the extremes the market has come to in a very short time frame. The title says it all: "Capitulation".

The advice Bob renders is to avoid trying to catch the falling knife but the extremes reached yesterday are a reference point from which a test will likely ensue in the coming days. Should that test succeed, then the odds are favorable that a multi week rally will follow. Or as Bob puts it: "An initial rally will likely be a one or two day affair because all those who were buying the dips will now be selling the rallies. If the benchmark lows hold on a retest, then the market could set up for 2-3 weeks of recovery."

To be clear, Bob does note that a lower low may occur and that may set the reference point at a lower price point (his avoid catching the falling knife). However, my take of his advice is: if the 1 to 2 day rally is followed by a probing of yesterday's closing of 1200 and that does not produce another wave down, then the retest would be considered successful.

Talking Head Alert!

2011-08-04T08:29:00.007-04:00

Bloomberg radio today around 4:15 PM (eastern). Taking Stock with Pimm Fox. A little chat time with Pimm and Courtney.

Discussion will likely include my newly created reverse engineered valuation model: the Best Fit P/E Model. Also on tap - why the demise of the bull may be greatly exaggerated and some thoughts on Tuesday's NYSSA Market Forecast event.

Tune in, if you're so inclined.

Note: The updated MGP data is posted. Left side of this page.

Fanfare For The Start of the Bear Market

2011-08-03T12:50:00.008-04:00

According to many market and media pundits, the bear, with much fanfare, has arrived. I am, therefore, pleased to provide some exceptional fanfare music befitting the occasion. Let the misery begin!

A Father/Son Conversation About Bear Markets

2011-08-03T11:03:00.007-04:00

Son: Hey, dad. How do bear markets get started?

Father: Well, son, after stocks have been going up for a few years they then go sideways for a while. While they go sideways, the price and its moving averages begin to converge. At the same time, markets begin to diverge from one another.

Son: What happens then?

Father: Well, stocks begin to rollover, going down in a rather gentle manner.

Son: Why is that?

Father: You see, son, investors are still big believers in the bull market. So, when the price starts to go down they don’t believe it will go much lower. In other words, they are complacent at the start of a bear market.

Son: Is that what is happening now?

Father: No, not exactly. Yes, stocks did go sideways for a while. So that part of the story is true to form. But the moving averages have not crossed, nor has the longer term moving average, its 200 day, which has yet to roll over and point downward. Also, when the sideways action was occurring, very few divergences emerged between markets, and those that did were very minor.

But that’s not the big thing.

Son: No? What is?

Father: Bear markets are sneaky. They start out with disbelief as they gently rollover. Kind of like a sleepy bear waking up from his long winter nap.

Son: Well, dad, that doesn’t sound like what I see on TV today.

Father: No, son, it isn’t. What you see and hear today is fear. And fear is not how bear markets start out. Fear is a characteristic of bull market corrections and end of bear markets, not at their sneaky, sleepy starts.

Of course, this is way bear markets have happened for more than 50 years. So, maybe this time is different. But you know what they say about that?

Son: No, dad, what?

Father: The four most dangerous words in the investing vocabulary is “this time is different.”

Son: Thanks, dad. You’re the best!

NYSSA Market Forecast

2011-08-01T17:31:00.003-04:00

Tomorrow I will moderate the summer edition of NYSSA's signature event series:

The 14th Annual NYSSA "Summer Market Forecast"

Panelists include:

* Robert Steven Kaplan, former vice chairman, Goldman Sachs
* Phil Orlando, CFA, Chief Equity Market Strategist, Federated Investors
* Phil Roth, CMT, Chief Market Technician, Miller Tabak + Co.
* Don Rissmiller, Chief Economist, Strategas Research Partners
* Sean West, US Policy Analyst, Eurasia Group

We will cover the key issues impacting the economy and markets. Needless to say, there will be no shortage of areas to explore.

To learn more about the event and to register, click here.

Pulling the Social Security Plug on Grandma: The BGOV Interactive Tool

2011-07-29T10:46:00.020-04:00

How would you like the chance to play US Treasury Secretary and President of the United States and decide who gets paid and who doesn't? Well, thanks to BGOV's interactive tool you can.

Next Tuesday is D (default) day. On the assumption that Obama will not invoke the 14th amendment (he won't) and that the tea partyers in the House won't relent (anarchists of the world unite!), the US Treasury will have to start the process of prioritizing its payments for the month of August.

According to BGOV, the US government bills due for August are $306.7B. The revenues projected are $143.9B. To avoid a technical default, the interest payments are $29B. That doesn't leave a lot of bread for everything else (pulling the social security plug on grandma?).

Speaking of bread: According to the Bible, Jesus had to turn a few fish and loafs of bread into enough food to feed the multitudes who had gathered. The task set before the US Treasury and Obama are the modern day version. (After all, he is The One!)

To access the BGOV interactive tool, click here.

Great Britain: The Expansionary Austerity Canary in the Economic Coal Mine

2011-07-28T15:22:00.016-04:00

When it comes to Expansionary Austerity, the UK has had a full year head start over the US, having implemented a series of cuts advertised to produce fiscal order, which will then produce a robust economy and jobs growth. So, it seems quite logical to look at how that's going in the real economy and, more importantly for investors, how the market perceive the situation.

From a real economy perspective, the most recent data from the St. Louis Fed shows quite clearly that the "cut to grow" philosophy at the heart of Expansionary Austerity has yet to deliver as promised. Half of the indicators tracked (industrial production, real retail sales, real compensation, real private final consumption expenditures, and real gross fixed capital formation) are all headed in the wrong direction (down), with the other half not exactly exuding the robust economy and jobs growth advocated for.

From a markets perspective, as the accompanying chart shows, the picture is fine - for now. If, however, price crosses to the downside and the two key moving averages (50 and 200) head in the same southerly direction, it will be hard for the bulls to draw any conclusion other than a bear market has begun.

Investment Strategy Implications

The conservative government in the UK adopted its version of Expansionary Austerity a year ago. Therefore, investors would be well served to consider it a test case (both economically and in the markets) for what the US may experience. Based on the record thus far and considering the global macro implications that the much larger US economy is likely to have the global economy, the prospects do not look encouraging.

Is It A Bear Market Yet?

2011-07-28T12:41:00.018-04:00

To rephrase Orson Welles from the accompanying 1970s commercial, "We will sell no stocks before it is time."

As noted in my Timing the Bear Market blog posting last month, bull market tops are different from bull market bottoms. Tops tend to have a rounding pattern to them in which sideways action leads to a rolling over phase during which price breaks below its 50 and 200 day moving averages and both moving averages cross and head downward. This action signals the end of the bull market, which is eventually followed by a cascading down of price in an accelerated fashion. Market tops also tend to produce divergences, both internal (intra market) and external (inter market).*

Do any of these conditions presently exist? In a word, no.

There is some evidence of this process underway but not to the extent needed to ring the bear market bell. But what of the big price swings these past months, investors might ask? It is fruitful to remember that big moves within trading ranges rarely have market trend changing qualities. Yes, there are the rotational aspects that can be exploited (sector to sector). However, when it comes to a market directional change, big price movements at key inflection points (including the aforementioned moving averages) have greater significance than intra trading range swings - regardless of the magnitude.

Investment Strategy Implications

Is a bear market headed our way? Most definitely. When? When the above related conditions are met.

The macro picture looks pretty dismal. Yet, it is vital to remember that stocks are primarily driven by two factors: valuation and financial market liquidity*. Only when the macro picture begins to impact these two factors will stocks be poised for a trend change: at the nexus of fundamental and technical analysis.

What might be the catalyst that provides the impact? Expansionary Austerity is the leading candidate.

*To learn more about the Mega Trend and Divergence Principle as well as the two factors, use the search feature at the top left of this blog.

Cold Turkey: Expansionary Austerity's Aftermath

2011-07-27T15:19:00.006-04:00

Get a good look at how the global economy will likely look after Expansionary Austerity works its magic.

President Hillary Clinton

2011-07-27T09:58:00.007-04:00

Given the near certainty that in the short run the new economic philosophy being adopted by most western economies, Expansionary Austerity, will result in a major economic contraction, there very likely will come a time in the not too distant future when enough US voters in 2012 will turn to someone else to help rescue the US (and, therefore, global) economy. In this regard, two names come to mind: Michael Bloomberg and Hillary Clinton.

Both have the business credentials to help the troubled economic climate ahead. Mayor Mike, for all the obvious reasons (turning $10 million into $10 billion speaks for itself). And Hillary because of the economic success of the Clinton years. Of the two, the edge has got to go to Mrs. Clinton.

Hillary Clinton has the tenacity and, now, the individual track record to mount a formidable attack on the President Gandhi. And when Bill Clinton injected himself into the recent debt ceiling fiasco by stating that he would invoke the 14th amendment and make the courts stop him (as opposed to President Gandhi, who relies on lawyers and experts to guide him virtually every step of the way), he showed what leadership looks like (a quality sorely lacking in the White House these days).

Consider it: Hillary in the White House and Bill at Treasury. One with the diplomatic and legislative bona fides, the other with strong economic credentials. A real two-fer, if there ever was one.

Obviously, there are many obstacles that stand in the way of a second Clinton presidency, most notably getting the nomination. But there may come a point over the next 6 months when fear rises to such a level that the unthinkable today becomes the best course of action. And at such a point, a draft movement would be all the impetus needed to start the process.

Expansionary Austerity: A New Economic Philosophy

2011-07-24T16:57:00.003-04:00

foxbusiness has posted my Friday appearance, in which I describe the new economic philosophy that is being adopted in western economies: Expansionary Austerity.

To view the interview, click here.

Why It's So Hard To Beat The Market

2011-07-21T10:53:00.025-04:00

Here's a rather sobering view for those investors seeking to beat the best asset class (equities) over time.

The accompanying table* illustrates the asset allocation decision only. It assumes that an investor does not outperform during the up or down markets but is able to make consistently excellent asset allocation calls (being largely in up markets and even more largely out of down markets).

Numerous studies show that for well diversified portfolios the asset allocation decision overwhelmingly determines investment performance (85% of investment performance). Therefore, getting this call right matters most. Getting this call wrong, however, destroys investment performance to a considerable degree and makes outperforming the market (alpha) that much more difficult.

Understanding this fact helps explains the momentum lemming, risk on/risk off nature of the market (especially the current environment). Falling too far behind is, for some, running the risk of losing their house in Greenwich.

*click image to enlarge

Better Late Than Never

2011-07-18T12:01:00.023-04:00

The Wall Street Journal online just posted a lead story titled "Dearth of Demand Seen Behind Weak Hiring". The opening paragraph states the following: "The main reason U.S. companies are reluctant to step up hiring is scant demand, rather than uncertainty over government policies, according to a majority of economists in a new Wall Street Journal survey."

Well, guess what? Over a year ago I conducted a Beyond The Sound Bite podcast interview with Bill Dunkelberg, Chief Economist with the National Federation of Independent Business. In the interview, Bill stated that sales, which are derived from demand, is the key metric the jobs creation engine in America - small business - uses when making their hiring decisions.

Therefore, contrary to those politicians who seek to gain political advantage by spinning the story to the uncertainty factor dealing with regulation and taxes as to why jobs are not being created, as my podcast interview from June 2010 and now the WSJ and those economists surveyed makes clear: the primary reason why businesses not hiring is "weak sales".

In these highly politicized times and when a premium is paid to complicating just about everything, the correct answer is often the most obvious. Just like deciding who should head the jobs creation effort in the US. Should it be a small business leader or someone from a large company who fires US workers and hires foreign ones?

Bernanke to Wall Street: More Cowbell

2011-07-13T11:47:00.006-04:00

“I got a FEVER! And the only prescription...is MORE COWBELL!”
-Bruce Dickinson (Christopher Walken)

There are two reasons why the stock market is trading where it is. One deals with valuation levels. The other is liquidity. These factors are the most direct to stock market levels. From a stock market point of view, the larger macro economic, political, and societal (including cultural and demographic) issues matter only to the extent that they ultimately impact the inputs to the valuation levels – cash flows, growth of the cash flows, and the uncertainty (the risk) of receiving those cash flows – and liquidity, specifically liquidity to the financial system.

It is on this second factor, financial system liquidity, that many fast money professional investors (hedge funds, high frequency traders, prop desk traders) are paying the most attention to in today’s testimony by Fed Chairman Ben Bernanke. As the primary market forces that move markets at the margin, fast money types want to know that the Bernanke Put (rising prices of risky assets help produce the wealth effect, which helps the broad economic environment) is still operative.

Based on what they heard thus far, all is good. Or as the Saturday Night Live quote above suggests, the fast money crowd has a fever (they always have a fever) and generous Ben assures them that there will be more cowbell.

Investment Strategy Implications

Hang in there. A resolution to the sideways market is not far off. As noted on several recent blog postings, the clock is ticking and appears to be set to strike midnight very soon.

Will it ring a new day for the bulls or will investing Cinderellas themselves with pumpkins and not stagecoaches for transportation? Right now, it's anybody's guess.

Destination Resolution

2011-07-08T08:53:00.013-04:00

From a technical analysis perspective, the initial stock market reaction to today's dismal jobs data (on all levels, most notably the 0% wage growth) does little more than move equity markets away from the top end of their multi month trading range. In the process, it moves stocks closer to the more important issue: a resolution of the sideways action.

As the accompanying chart implies (click to enlarge) and the historical information provided by S&P's Sam Stovall suggest*, price and moving averages are likely to converge in the not too distant future (did someone say August 2nd?).

At present, the Mega Trend (use search function on top left for information re the Mega Trend) is bullish. The interplay between price and its moving averages are positive. However, as noted several times previously, market tops tend to be quite different than market bottoms. The sideways affair is almost always the precursor to the rollover phase (which is when the Mega Trend reverses and the bear market is confirmed) followed by the tumble and the OMG moment for far too many investors.

An accompanying set of market action circumstances almost always occurs when the resolution takes place: divergences.

Inter-market divergences** signal broad market weakness. Confirming action signals broad market strength. At present, most markets are moving in sync with the US large cap group and are or are close to confirming a prospective new high. That said, further sideways action or a premature upside breakout could produce a deteriorating condition between and among markets.

Destination Resolution

The resolution of the sideways action should signal the next major stage for equities: a resumption of the bull or the return of the bear. The fact that the timing of the current resolution will likely occur in August is eerie. For August is the month that precedes the historically poorest performing time of the year: the fall.

Funny how these things seem to work out.

*see blog posting below, "If Sam Is Right".
**Intra-market divergences also signal market weakness, just to a lesser extent.

Talking Head Alert

2011-07-07T16:48:00.005-04:00

Recent media appearances for myself ("Taking Stock with Pimm Fox") and my good friend, Vahan Janjigian (foxbusiness.com with Tracy Byrnes), are posted.
To view and listen to the interviews, click here.

Jobs: Methinks I See A Pattern

2011-07-07T15:49:00.012-04:00

As investors contemplate tomorrow's jobs data, the accompanying chart (click image to enlarge) from McKinsey & Co. showing the state of jobs creation in the US over the last 3 economic recoveries stands out for all the wrong reasons.

Hmm, let's see. Globalization plus free trade agreements plus technological innovation plus stock oriented executive compensation schemes plus high growth in emerging markets plus control of the political and financial process = labor arbitrage, zero real wage growth (in developed economies), and what you see in the chart to your left.

I guess this is why Mr. Obama chose Mr. Immelt to help create jobs in the US.

Not My Job: The Economic Consequences of Advocacy

2011-07-06T10:14:00.022-04:00

"Never underestimate the power of a few committed people to change the world. Indeed, it is the only thing that ever has."
Margaret Meade

Today's NY Times' article "Big Business Leaves Deficit to Politicians" affords me this opportunity to comment on something I have been wanting to touch on for some time: the economic consequences of advocacy.

In regards to the main topic of the Times article - the US federal deficit, the article references that big business is "part of the problem", that big business "...consistently lobbies for a higher deficit. The roundtable defends corporate tax loopholes and even argues for new ones." This is true. But the article fails to go to the reason behind the actions taken by business - it's not their job.

Business (big and small) do not act for the collective good because it is not their job. A company may be headquartered in a country and even do most of their business in that country. Moreover, the senior management of the company may be lifelong citizens of that country, served in the military of the country, and be as patriotic as the next guy. However, when it comes to business, where one's heart is not where one's pocketbook is.

Their job, specifically senior management, is to advocate for their business. They are compensated according to how well their business does regardless of the consequences in a larger context. And this means pursuing any and all means necessary (and, one assumes legal and even moral) to achieve their financially driven goals: earnings and growing at a rate of return in excess of their cost of capital.

This advocacy approach is rooted in two areas:

1 - The big shareholders rule. A CEO will not keep his/her job very long if they are not advocating for their enterprise as aggressively as possible. Activist shareholders see to it that the CEO feet is kept firmly to this fire.

2 - The ideology of acting in one's best interest results in the collective being best served. According to this thinking, this is the way the world works and works best. All other approaches are fraught with conflicting efforts and outcomes (think laissez-faire versus socialism).

Acting in one's best interest also includes advocating in all related corporate realms - which includes the political and regulatory environments.

In sum, it is unfair to criticize senior management for doing their job, as there is no motivation for senior management to do anything other than act in their own (business and personal) selfish best interest. To do otherwise is, at a minimum, career suicide*.

As for the consequences to the larger economic environment that such an approach might have, the answer is not clear cut one way or the other and is, frankly, an area where the economics profession would be well served to provide some opinions and guidance. What does seem clear, however, is that without counterbalancing forces at work (representing other socioeconomic interests), the focused power of the advocacy of one constituency in a position of competitive advantage acting in their own selfish interests can easily distort and possibly ruin the greater good.

*And, in the minds of some, business and economic suicide.

Talking Head Time: foxbusiness.com

2011-06-23T22:15:00.003-04:00

In this interview with Tracy Byrnes, I bring back a point I made on a number of occasions in the past - the conflicted position of the US worker, who also happens to be the US consumer. In a globalized world, one wins (consumer) while the other loses (worker).

To view the interview, click here.

The Stock Market, King Lear, and the Meaning of Nothing!

2011-06-23T12:31:00.005-04:00

Apparently in saying nothing yesterday the Fed Chairman did say something. By denying more financial morphine for risky assets, the markets reacted as King Lear did when his beloved daughter, Cordelia, said the same to him. The moral of this story: When the truth produces the tantrum, sanity is surely in question.

Badda-beep, badda-bap, badda-boop, badda-Ben

2011-06-22T16:35:00.003-04:00

So, Chairman Bernanke spoke today. And what did he say? Well, it kind of reminds me of this scene from "The Godfather":

Sonny: Hey listen to this…the Turk wants to talk. Eh gosh…imagine the nerve of the sonofabitch, eh? Craps out last night, and wants a meetin’ today.
Tom: What did he say?
Sonny: What did he say…Badda-beep, badda-bap, badda-boop, badda-beep…

The Fine Art of Valuing the Stock Market

2011-06-22T09:23:00.016-04:00

When I appear on foxbusiness.com* today with Tracy Byrnes, one of the items I hope we discuss is the accompanying valuation table (click image to enlarge).

Then are several ways to employ this table but perhaps the most useful way is to:

1 - Start with today's price level for the S&P 500.
2 - Then find those P/E and projected operating earnings in present value section (right side) of the table that roughly match today's price.
3 - Now look at the future value (left side) of the table. That is where the market projects it will be 12 months hence.
4 - Decide if you agree or disagree with the market's conclusion.
5 - Let the debating begin.

Valuation is a subjective process that attempts to bring into the equation what investors forecast earnings will be AND what they (and this is key) believe the appropriate P/E that should be applied to the forecasted earnings. There are many factors to be taken into consideration. For example, an above average P/E (say 17) can mean:

1 - It is appropriate in terms interest rates, growth rate of earnings beyond the next 12 months, quality of earnings, and degree of risk (global macro), Therefore, the current level of the market is far too pessimistic at 17 times $85.
2 - It is appropriate as earnings will tumble but, for a variety of additional reasons, the P/E will anticipate that the earnings decline will be short lived.
3 - It is inappropriate as rates will rise, risk is and will be far greater in the not too distant future, and the growth rate in earnings will disappoint. Therefore, a lower P/E is more appropriate.

And that's only a start. Other P/E and earnings mixes lead to other combination of factors.

What the accompanying table provides is a way to reverse engineer that process by starting with the current level of the market and then identifying what the current level suggests.

Therefore, taking yesterday's close, the following P/E and operating earnings closest are:

14 x $102 (average of $100 and $105)
15 x $95
16 x $90
17 x $85

As step #5 says, "let the debating begin".

*To view the 12 noon eastern time appearance, click here.

If Sam Is Right…

2011-06-21T11:43:00.007-04:00

“From April 29, 2011 through June 10, the S&P 500 recorded six straight weekly declines and fell a total of 7.2% in price, spooked, in our opinion, by a potential debt default by Greece and the projected downshifting of global economic growth. Since 1950, the S&P 500 experienced 14 other times in which it declined six weeks in a row. In the seventh week, the “500” gained an average ½ of 1%, and advanced in 11 of 14 observations. Last week’s performance made it 12 of 15 times, as the market rose 0.04%. History now says, but does not guarantee, that in the coming six weeks the S&P 500 will rise slightly more times than it falls, but that the market will end up slipping around 1% from where it concluded its six week selloff.”

Sam Stovall
Chief Investment Strategist, Standard and Poors
“SECTOR WATCH: Does Volatility Offer a Clue to Market Declines?”
June 21, 2011

On Friday, I wrote "Timing The End of the Bull Market", which put a Mega Trend* timeframe on the end of the sideways market and prospective end of the bull market. Now, along comes the above information from that fountain of historical analysis, Sam Stovall.

As the above excerpted quote describes, we now have the historical context from which the current market can be framed. Now, let’s tie what Sam has provided with my Friday posting:

If Sam is right, the timing will be uncanny. A convergence will take place in which the historical will meet the technical at the junction of time and space (price and moving averages - the Mega Trend*). If this unfolds in anything close to this manner, the resolution of the sideways market (consolidation or distribution) will be all the more clear.

*Use search function above left to read more about the Mega Trend.

Timing The End of the Bull Market

2011-06-17T10:03:00.018-04:00

''Let me tell you about the very rich. They are different from you and me.''
F. Scott Fitzgerald, "The Rich Boy"

Like the very rich, bull market tops are different than bear market bottoms.

Whereas bear market bottoms tend to be panicky affairs (probably has something to do with real losses versus opportunity costs), bull market tops tend to be drawn out affairs. In the process of forming its top, the dying bull experiences 3 distinct phases – sideways, rollover, and breakdown. The time period between each phase varies but a look at the last 2 traditional market tops during the first two phases - sideways and rollover - should help time the next market top.

The first 2 charts illustrate that the time period of sideways to rollover was 11 months (1999 – 2000) and 8 months (2007), respectively. The third chart shows that the current sideways US stock market action (S&P 500) is six months in the potential top making. If sideways evolves into the rollover phase (when price crosses the moving averages, the shorter term moving average crosses the longer term one, and both moving average point downward – a/k/a my Mega Trend*), one could assume it would take place sometime in the not too distant future (did someone say September?).

Until we get a definitive rollover of the sideways action, only the amazingly clairvoyant know for certain that the current sideways market is a distribution (meaning top) and not a consolidation phase**.

*Use the search function on the top left to find prior commentaries describing the Mega Trend.
**A consolidation phase is the pause that refreshes as the resumption of the bull market gets underway.

Super Bulls - Welcome Back to Earth!

2011-06-16T09:56:00.010-04:00

Lately, life has not been kind to the super bulls who, just a few months ago, were all aglow with expectations of record busting highs for stocks. Triple digit S&P 500 operating earnings times above average (>15) P/E ratios = Big bucks!! Who said, “Greed, for lack of a better word, is good”, was dead?

Never mind the fact that the root causes of the damage wrought by the Great Recession were never fully and properly addressed. Who cares if, metaphorically speaking, treating the cancer in the global economic patient with antibiotics and morphine will most likely not work? Corporate profits, courtesy the global technological and labor arbitrage plus robust, if somewhat suspect, emerging economies growth, are off to the races. And, when combined with the Bernanke put, lofty P/Es (>15) times robust earnings = great returns.

So, what has really happened these past several months?

The valuation levels you see in Table 1 provide the parameters for fair value for the S&P 500. At yesterday’s closing price, Earth at its historical P/E (15 times) rate times a more realistic (yet, still record busting) operating earnings (for the next 12 months) = fair value.

It may not be Heaven, and it hopefully won't devolve into Hell, but Earth is where the markets have settled in - for now.

It’s The Demand, Stupid

2011-06-15T11:18:00.004-04:00

“One thing you’ve got to understand is that we do not hire workers for the sake of hiring workers. We hire them to do jobs,” Mr. Goodnight said. “If we don’t have the work coming in, nothing will make me hire another person.”
Frank W. Goodnight, President, Diversified Graphics, a publishing company in Salisbury, N.C., quoted in today’s NY Times article, “A Slowdown for Small Businesses”

This morning, two reports (see links below) were published that illustrate the economic dilemma the US (and, therefore, the global) economy finds itself in – there just ain’t enough demand out there.

This is nothing new. But with the government stimuli clock running out, the viability of an organically driven, private sector led sustainable economic expansion hangs in the balance. The recent US economic data has put a sharp spotlight on the decelerating US economy. The crisis in Europe is stuck in its own feedback loop, with the outcome quite uncertain. Then, there’s the hot, hot, hot emerging markets with inflation topping the economic list of worries (to be sure, there are lots of other risks that many bullish investors choose to ignore).

With US growth decelerating, the chosen phrase is soft patch. The economic soft patch, however, could quickly turn to quicksand. And, given both the limited remaining resources in the governmental fiscal and monetary bag (not to mention the toxic political atmosphere and the consequences of austerity in a time of weak demand), the quicksand the global economy would find itself entrapped in could be far worse than most investors currently anticipate.

So, what do the two reports tell us about the state of the US economy? For one, it says that in the business world it’s a tale of two economies – one that benefits from the global growth story, the other primarily on US domestic demand. However, herein lies the dilemma for all: In the end, global growth is dependent on end user demand, which is centered on developed economies like the US as developing markets' end user demand is both too small and years away from making a significant impact on global end user demand. This is fairly clear cut to developed economies but is far less appreciated when it comes to developing economies.

Developing economies, like China, depend on two engines of growth – fixed domestic investment and exports. Fixed domestic investments eventually require end user demand. You can build only so many new ghost towns before the money runs out. Excess inventory is the chicken that eventually comes home to roost. (Tech bubble, anyone?)

As for the other engine of emerging markets growth, exports, well that depends primarily on…you guessed it, end user demand in developed economies. And the problem there lies in the fact that end user demand in developed economies (like the US and Euroland) relies on wage growth and higher employment. And that is mainly resides in the small business arena.

I’ll give you one guess as to which report published today painted a less than rosy picture? (Hint: it isn’t the big boy’s report.)

Investment Strategy Implications

As for the stock market - it may all work out. Then again, it might not. Stocks locked in the first of a potential 3 stage march to a bear market (stage 1 – sideways; stage 2 – rollover; stage 3 – breakdown) may actually resolve itself to the upside, which would make the current market action the prelude to higher highs (thereby showing that sideways was little more than a consolidation phase, which all bull markets go through from time to time).

No one knows for sure how the current sideways market action will resolve itself. I would suspect, however, that based on how the past two bear markets came about (topping process in time and manner), we should have a very good idea before this summer is over (when price and its two key moving averages – 50 and 200 day might converge) whether consolidation or distribution was the real story of our multi month sideways markets.

In regards to the economy, one thing is certain: if end user demand turns negative, the environment will become very bad very quickly. And then all that will be needed is some event somewhere (in the economic, financial, or political realm) to turn bad to ugly.

The task for President-elect Romney will not be an easy one.

Here are links for the two reports:

Good

Business Roundtable

Not so good

NFIB

One relies primarily on global growth, the other primarily on domestic demand.

Bottoms Up?

2011-06-10T08:55:00.010-04:00

I received an email this morning re some analyst's view advising investors on the prospects of a market bottom. I may have it ass backwards, but talk of a "bottom" needs to be clarified.

A 4.9% drop (closing price to closing price) from the May 31 close within a sideways market (since the spring for US and the fall of last year for most emerging markets) is hardly the stuff of market corrections (5 to 10% or more).

With Momentum, MACD, and RSI in full retreat, more time is needed for a "bottom" to be formed (first chart).

What would be ideal (for a "bottom") is a non confirmation of Momentum, MACD, and RSI versus price. That could then lead to a good rally but not necessarily a "bottom" (as in something more than one that leads to a tradable rally) as the sideways market we have been experiencing may turn out to be a distributional range and not a consolidation phase. Technical analysis support for this possibility (distribution leads to market top) rests in the deterioration (and non confirmation) in Momentum, MACD, and RSI on a longer term (weekly) basis (second chart).

It must be noted, however, that these momentum indicators (which is what Momentum, MACD, and RSI are) are warning signs only.

The key inflection point is IF the Mega Trend reverses (price, moving averages, and their relationship to each other). That could occur late summer or early fall if the sideways markets resolve to the downside (by price breaking below its moving averages, shorter term moving average crosses longer term one to the downside, and the slope of both moving averages is downward).

These are the signs investors and traders might consider as markets debate if the real economy is experiencing an economic soft patch or something else. In other words, soft patch = consolidation, something else = distribution (followed by bear market).

Beyond the Sound Bite: The Mr. Miyagi Market

2011-05-25T09:22:00.004-04:00

Yesterday, my latest appearance on foxbusiness.com with Tracy Byrnes afforded me the opportunity to describe the Mr. Miyagi market (wax on, wax off).

To view and listen to the interview, click here.

Ben Opens The Kimono

2011-04-29T10:20:00.022-04:00

If one took the time to sit and listen carefully, the Bernanke press conference was an excellent opportunity to understand not only the decisions made but the economic philosophy underlying them. For that, Bernanke should be applauded. Transparency is almost always a good thing.

You don’t have to agree with the decisions made. However, knowing the thought process that leads to the decisions will help much more than whether his voice sounded shaky (which, if you listen to his testimony to Congress, it always does) or if he appeared to be sitting behind a piano (I actually love that comment. The imagery of Ben crooning a tune is priceless. Thanks, to Matt Phillips at WSJ).

In a manner similar to what St. Louis Fed President James Bullard discussed at the NYSSA luncheon I moderated last fall, Bernanke lays out the thinking behind the decisions. Therefore, here are a few observations:

• First quarter slowdown is transitory. Economic pace will pick up over time. Accordingly, the US economy should achieve a sustainable expansion. Continued improvement is expected. (Key words "over time". Lots of wiggle room.)

• Concern re inflation and its impact on jobs. Inflation (and any deviation away from stable, low inflation, which, of course includes deflation, for that matter) will inhibit job growth and must be guarded against.

• Related to this is the issue of long-term unemployment, which the Fed can virtually nothing about beyond seeking to help the current conditions and, thereby, help facilitate a virtuous circle of jobs creation. The long-term unemployment problem is one for the political process and other areas of the US economy.

• The Fed holds a “stock view”, which is actually Soros' "Reflexivity" – the feedback loop from the financial markets to the real economy and back and forth over and over. In this regard, QE (1 and 2) worked because “easing financial conditions leads to better economic conditions.” This is exactly the same philosophy and view expressed by St. Louis Fed President James Bullard at the New York Society of Security Analysts luncheon I moderated last fall.

• As for the potential of more QE, Mr. Bernanke took that off the table when he noted that in the Fed’s view the tradeoffs of more easing versus the risks of inflation and inflationary expectations are not favorable. (Perhaps for the reasons John Hussman has been fretting about.)

• Fiscal cuts (austerity) at the state and local level are not a major concern and, therefore, no plans to respond monetarily. The Fed is ready to react but no worries right now. (Not sure how this squares with the previous point.)

• The first step that signaled the end of monetary easing is occurring at the end of June, when QE2 ends. The second step that will signal the end of Fed easing is when the Fed stops reinvesting the US Treasuries and the mortgage back securities it has on its bloated balance sheet. This will, in effect, lower the size of its balance sheet.

• Rogoff and Reinhardt have shown that recoveries following financial crises tend to be slower and less robust. Bernanke believes this is true, as the problems tend to be in the credit markets and housing. He also, believes, however, that the reason for the post credit crises below average recoveries is that policy responses were not adequate. In his and the Fed’s board view, the aggressive and extraordinary actions undertaken by the Fed should help lead to a better economic outcome for the US. That said, he did acknowledge that the US economy growth (and employment, for that matter) thus far has been sub par but, as noted above, the Fed expects “recovery continues to be moderate but the pace will pick up over time.”

So what can we take away from this press conference that is of meaningful investment value? Two main items come to mind:

1 – The Fed is driven to maintain stability at the price level. They are very concerned about inflation (for the employment related reasons noted above). They are, however, deathly afraid of deflation. A Goldilocks approach to inflation is the only porridge that will do. And that is a very difficult thing to accomplish indefinitely.

2 – In the current environment and now that, in the Fed's view, the deflationary dragon has been slain, inflation and job creation are joined at the hip. Rising inflation will impact job creation and must be avoided at all costs.

Everything described above assumes an private sector led sustainable economic expansion lies ahead, which takes us to my third and most important point:

3 - No one asked the one question that I would have asked (and the one I have been asking for months now), What if the US economy does not achieve the escape velocity of a private sector led sustainable economic expansion?

What will the Fed do? What can the Fed do?

How will the markets, the economy (US and global), the geo and socio political environment react to another round of monetary easing? Why would QE 3, 4, or 5 work when 1 and 2 produced such transitory (and some would argue negative) effects?

If the Fed is right and a private sector led sustainable economic expansion does emerge, then the outlook will improve but to what extent remains to be seen. If not, then what?

Is there a plan B? A plan C?

Bottom line: What Bernanke did is a terrific thing. Transparency is almost always an excellent thing. Moreover, I truly believe he is sincere, knowledgeable, hard working, and has little in the way of political agenda (unlike Geithner). That said, being a good guy is not enough if the actions taken lead to a bad outcome.

Herbert Hoover was a good guy and look at how that turned out.

Joe Battipaglia

2011-04-15T08:50:00.031-04:00

As most of you are well aware, yesterday the world of investing lost an exceptional investment professional, Joe Battipaglia. For me, I lost a friend.

It was in the late 1990s when I began producing and conducting market forecast events for NYSSA that I had the pleasure of first interacting with Joe. As a participant at my market forecast events and later as a guest on my podcast service ("Beyond the Sound BIte"), Joe was never dull nor without a forceful point of view. Matching his impressive physical presence, Joe's intellect always came with a provocative point of view, none more on display than the time he launched into his Libertarian perspective on the economy, the markets, and the financial services industry at my CFA Society of Orlando's Market Forecast dinner in early 2009. Unfiltered Joe was a sight to behold.

What I remember most about Joe, however, was his kindness and generosity. As David Gaffen at Thomson Reuters quoted me yesterday, "Besides the obvious physical attributes of looking like a linebacker, the best way to say it was that he was a very generous guy," said Vinny Catalano, chief investment strategist at Blue Marble Research.

"He truly was a gentle giant. He was a lot of fun to interact with both professionally and personally, and it's truly a large loss."

Perhaps my fondest memories of Joe was on the Forbes yacht a few years back (see the accompanying photos). As guests courtesy Wally Forbes and Vahan Janjigian and with Joe sporting a tan John Boehner would be proud of, we shared that warm early summer evening with drink and talk and friends.

He will be missed.

Talking Head Alert

2011-04-13T11:55:00.003-04:00

It's talking head time with yours truly in the media this past week: Bloomberg radio, BNN TV, and New Delhi TV.

To view and listen to the segments, click here.

Krugman Agrees with Vinny - again

2011-04-13T09:43:00.008-04:00

Over the past several days, an awakening of sorts has occurred in Princeton, New Jersey, home of Nobel Laureate Paul Krugman. It is the reality that Barack Obama is no leader. This is a point that Mr. Krugman has begun to make several times of late, most recently in his blog today. This is point that I first made nearly one year ago.

So, as we await yet another speech from the man in the White House, here is what the Nobel Laureate had to say today (link to full commentary provided) and what little old me said one year ago. The rest is history in the making.

from Paul Krugman's blog today today:

"Various reports suggest that in today’s speech Obama will try to position himself as a pragmatist, as opposed to the ideologues of right and (probably) left. We’ll see how that works; as I recall, the last president we had who viewed himself primarily as a manager was … Jimmy Carter."

from this blog, June 9, 2010 (note the year):

The Real Problem with Obama

"Let me cut to the chase: It’s not about Mr. Obama’s capacity to show emotion beyond a clenched jaw that is missing. It’s about his capacity to lead. Just because someone has the title of leader doesn’t mean he/she is a leader.

In his media book tour for “The Promise”, author Jonathan Alter notes how impressed he was with Obama’s ability to manage the job – to synthesize the information and make an informed decision. This is no doubt due to his God given abilities. But it is also no doubt due to his educational training.

Mr. Obama is an excellently trained Harvard business manager. One of the attributes of a good manager is the ability to work for incremental improvements. Another is to be quite pragmatic. Mr. Obama has both qualities, so eloquently combined in Frank Rich’s commentary this past Sunday – incremental pragmatism. And therein lies the rub.

Being an excellent manager means espousing phrases like “don’t let the perfect be the enemy of the good”. Stop and think about that phrase for a moment, then ask yourself if that is something that a leader would ever articulate as the centerpiece of his philosophy?

Perhaps a Chicago trained politician might hold such a core view. Certainly a well trained manager would. But a leader?"

Will Mr. Obama surprise us today with a demonstration of spine and vision? Does a leopard change his spots?

A Head and Shoulders Bottom?

2011-04-12T10:10:00.010-04:00

If you have read any of my technical analysis work over the past years, you know that I am not a pattern recognition guy. However, there are times when one can't help but notice the emerging pattern involving long term interest rates. Specifically, the head and shoulders bottom that appears to be forming in the 10 year US Treasury (see accompanying charts).

When you add into the equation the following recent comment in an Economist article - "Since mid-November America’s Treasury has issued some $589 billion in extra long-term debt, of which the Fed has bought $514 billion." - it is hard not to conclude that once QE2 ends and the Fed stops buying long term Treasuries that a major demand factor will be removed from the mix.

The obvious equity market impact of rising rates is in valuation models, which will note that the cost of capital has just gone up thereby making equities less attractive. Could this explain why stocks have recently traded sideways?

Is Technical Analysis Dead?

2011-04-07T12:13:00.004-04:00

Something very peculiar is happening with equities.

For more than a year, stocks have not performed according to technical analysis Hoyle. Stock markets have risen on far below average volume. Correlations for virtually all economic sectors and many asset classes hover just below 1.00. And many technical analysis tools have been rendered impotent. Why is this so? Perhaps the answer lies in the nature of the beast: the structure of the market.

Over the past several decades, the structure of the market has changed. In the 1960s and 70s, traditional institutional investors (mutual funds, pensions, insurance companies, and large asset managers) replaced individual investors as the dominant traders of the day. Recently, hedge funds and now high frequency traders (with algorithmic traders in tow) have supplanted traditional institutional investors as the dominant volume drivers in equities. At the same time, products and services such as dark pools, derivatives, and structured products operate outside the traditional norms of equity investing.

Yet, most investors and many in the financial media operate as though there are virtually no effects, no consequences – intended and otherwise – that have occurred in this new environment. All is as it was. Or is it?

As for technical analysis, of all the tools that have worked with a reasonable degree of accuracy, perhaps none have been impacted more by the brave new financial innovation world than sentiment indicators.

Once the bastion of sound investment strategy, the human emotions of greed and fear afforded astute investors and traders with the opportunity to exploit the polar ends of investment human behavior. Ride the greed and fear train for as long as possible then, when things go too far, shift to other side (the contrarian side) of the equation. Not easy to do but highly rewarding if done correctly. However, given the changed world equities operate in today, the question has to be asked, Do such tools work in a world dominated by black box methodologies? A financial world without humans?

When it comes human emotions such as greed and fear, does a hedge fund manager, an algorithmic trader, or a high frequency trader base their decisions on judgment? Do they feel anything? Do they get swept up in the emotional tide of the times? Or is virtually every action taken done based on a set of rules and parameters that do not rely on such human qualities?

And that brings us back to the issue of technical analysis and, specifically, sentiment indicators. Do they still work? Has technical analysis lost a key tool in its toolbox?

Based on the evidence at hand, in the case of sentiment indicators, the answer has to be yes. In the case of volume indicators, the answer is also yes. In the case of momentum indicators, the answer is no.

The one market variable that is least impacted by our financial innovation brave new world is price. And price changes over time, which is what momentum indicators are all about, are tied to the real world of valuation, which is, in turn, tied to the real economy.

Is technical analysis dead? No. But I find it hard to argue for the status quo when so much has changed. Or Keynes once said, “When the facts change, I change my mind. What do you do, sir?”

Life After QE2

2011-04-05T09:55:00.009-04:00

“…it’s far from clear that the recovery will prove self-sustaining.”
Paul Krugman
NY Times, April 4, 2011

In his “The Transmission Mechanism for Quantitative Easing” commentary, Dr. Krugman delves into the how, why, and to what extent QE2 has worked thus far. He points to the sources of growth in US GDP (see accompanying chart) and highlights the fact that consumption and exports account for nearly 90% of the increase. Going a step further, Mr. Krugman then explores how a weaker US dollar and a higher stock market are likely significant factors to the results noting, “…casual observation suggests that a lot of the growth in consumer spending has been at the high end, which suggests in turn that a higher stock market might be driving it. And the lower dollar has clearly helped US exporters and import-competing firms.”

One conclusion from his analysis has to be the Fed’s intention of lifting the value of risky assets (stocks, specifically) and, thereby, triggering the “wealth effect” which then produces greater consumption which in turn helps the overall economy. However, as Mr. Krugman also notes, “…a lot of the growth in consumer spending has been at the high end…”, which helps bring him to a conclusion that is the crux of yesterday’s blog commentary: will the end of QE2 usher in an era of private sector led sustainable economic expansion?

If yes, then the US economy will (at best) continue to improve and maybe create the virtuous circle that enables the Fed and the government avoid, but more likely forestall, the day of economic reckoning.

If not, then what? Just a few points investors should contemplate as the stock market continues its Alfred E. Neuman (oh, excuse me, its climbing a wall of worry) rally.

Ho Hum

2011-04-04T14:42:00.003-04:00

I don’t know about you but I’m bored.

Stocks are locked into their upward drift waiting for what will almost certainly be an earnings season right around expectations (MERI data). And since we have 2 more months of monetary alcohol (that’s supposed to find its way into the real economy but is actually is stuck swirling around risk assets) to finally see if it has worked its magic and produce a private sector led sustainable economic expansion, the predictive dynamics of equity investing has been reduced to the investment equivalent of waiting for Godot. And therein lies the real rub for stocks.

The central issue for stocks is not whether earnings and guidance will exceed or (more likely) meet expectations. Nor is it a 15 multiple on a $90 S&P 500 operating number (which results in a 1400 target) that is at the top of the investment decision-making to do list. Rather, it is what happens after the monetary steroids have stopped being pumped into the sub par US economy? Which brings us to when things will start to get more lively – the third quarter of this year. For it is in 3Q11, when Chairman and head drink mixer Bernanke is set to stop (but not withdraw) the flow of monetary alcohol that we will see just what $4 to 6 trillion dollars has gotten us: a private sector led sustainable economic expansion or the early stages of the next economic crisis?

Until then, a plentiful supply of No-Doz is in order.

U.A.E. To The Rescue

2011-03-22T13:07:00.011-04:00

How is the US going to square the circle of involvement in Libya but not in the far more strategically important Bahrain? While the thrust of the following WSJ article is in one direction (why the United Arab Emirates (U.A.E.) is not engaged militarily in Libya), the real value lies in the fact that the U.A.E. has provided a way for the US to avoid the hypocrisy of involvement in Libya but not Bahrain: blame it on Iran.

From today's WSJ:

Former U.A.E. Official Blames U.S., EU for Libyan Pullout
By NOUR MALAS

"ABU DHABI—The United Arab Emirates was prepared to deploy 24 aircraft to help enforce a no-fly zone over Libya but decided not to participate in the allied effort because of U.S. and European policies towards Bahrain, the former commander-in-chief of the U.A.E. Air Force said Tuesday.

"The U.A.E. was willing, and there were preparations, to deploy a significant number of aircraft for the no-fly zone, but a re-prioritization—specifically the European and U.S. positions on Bahrain—did not satisfy the Gulf states to this end," said Maj. General Khalid Al Buainnain.

The U.A.E. had been prepared to deploy two squadrons of 12 aircraft each to Libya, Mr. Buainnain, said on the sidelines of a conference in Abu Dhabi.

Mr. Buainnain said the U.S. and Europe had failed to appreciate the extent of Iran's interference in the Gulf countries, and had misread the protests in Bahrain as a spill over of calls for democratic change sweeping through the region.

"What's going on in Bahrain is much beyond our Western allies [ability] to understand," he said. "It is a complete conspiracy of the Iranians in the region...The European and U.S. positions are unable to imagine the extent of Iranian intervention in Bahrain."

"It's a matter of political disagreement—not a matter of resources—between the Gulf states and the Europe and U.S.," Mr. Buainnain said. "The position of the Europeans, especially the United States, towards Bahrain—really, this is something that is very scary, and it's not encouraging," he said.

Mr. Buannain didn't specify which policies the U.A.E. objected to. But the U.S. warned against the use of violence during the recent crackdown on protesters in Bahrain, and urged both sides to reach a negotiated solution.

On Sunday, Qatar became the first Arab nation to join international action against Libya's Col. Moammar Gadhafi, saying it was sending fighter jets to Libya to help enforce the U.N. resolution calling for an international military intervention to impose a no-fly zone over the country.

There has been speculation that the U.A.E. would send military assistance as well, though late Monday the country said it is playing a purely humanitarian role in Libya by delivering aid supplies. The U.A.E.'s role is "strictly confined to the delivery of humanitarian assistance," according to a statement carried on the state news agency.

The U.A.E had taken a leading role in the calls for action in Libya, hosting a meeting of the Gulf Cooperation Council in Abu Dhabi on March 7 at which the six-member bloc of Gulf Arab nations urged the international community to enforce a no-fly zone.

The U.A.E. Ministry of Foreign Affairs didn't immediately return requests for comment Tuesday.

Bahrain's Sunni ruling family has for more than a month battled protests led by its largely-Shiite opposition, leading King Hamad bin Isa Al Khalifa to declare a three-months state of emergency amid rising sectarian tensions on the Gulf island kingdom.

Last week, Saudi Arabia and other GCC states including the U.A.E., sent security forces to Bahrain to help quell the ongoing protests. Soon after the Gulf troops arrived, Bahrain launched a violent crackdown on the antigovernment protesters, clearing them from the capital's financial district and the Pearl roundabout, imposing a curfew and banning all public gatherings.

On Monday, Bahrain's King Hamad said a foreign plot against his state had been foiled—presumed to be a reference to Iran—and thanked troops brought in from neighboring Saudi Arabia and the U.A.E. to help keep security. Iran has condemned the arrival of foreign troops in Bahrain.

Mr. Buainnain said the U.A.E considered Bahrain's security "an extension" of its own security, and sees it as a top priority. He also said Bahrain risked turning into a third center of Shiite extremism in the Arab world, in addition to the presence of Hezbollah in Lebanon and the Houthi group in Yemen.

His comments follow warnings by GCC Secretary General Abdel Rahman bin Hamad Al Attiyah Monday, at the same conference, that the Gulf states reject any foreign intervention in their affairs, including by Iran.

Mr. Buainnain, a former U.A.E. fighter pilot who rose to head the air force, retired in 2006. He is now president of the Dubai-based security think-tank, the Institute for Near East and Gulf Military Analysis."

*Note: bold and italics emphasis added above

Nero Would Be Proud

2011-03-17T10:00:00.002-04:00

From Today's FT:

Inside Obama’s not-at-war room
By Robert Shrimsley
Published: March 16 2011 21:49 | Last updated: March 16 2011 21:49
The leader of the free world is debating Libyan intervention with his closest advisers.

Obama: So what are we going to do to support the Arab democrats?

Which ones.

The ones in Libya. They are taking a shellacking.

Actually, Mr President, our intelligence has classified it as a hammering; Secretary Gates is not ready to upgrade it to a shellacking.

When will he be ready to do that?

After they’ve been crushed, sir.

Shouldn’t we be helping democrats against a brutal dictatorship?

Are we sure they are democrats, Mr President?

Second aide: Didn’t we do this meeting last month?

That was Egypt. . . or Tunisia.

Obama: Well, that seemed to work out; what did we do then?

We positioned ourself carefully behind the curve and immediately backed whatever had happened the day before. It was cost-effective and it worked, sir. Your strategy of protracted hesitation has paid dividends in a number of theatres.

David Plouffe prefers to call it the evaluate-and-decide strategy.

I apologise Mr President, I thought that was our Afghan strategy. I understood we’d moved on to an “evaluate and then evaluate some more” strategy here.

The forces in Benghazi may only have a few days left.

Yes Sir, the Secretary hopes this problem will be off your desk by Friday.

So don’t we need to act now? What about a no-fly zone.

Secretary Gates is strongly in favour of a no-fly zone, Mr President. He says all talk of intervention must be shot down immediately. He advises we do all we can to assist the rebels short of actually helping them.

I have spoken out many times on the need for Gaddafi to go.

Yes Mr President, Secretary Gates has long felt that your words can speak louder than our actions. He added that should you wish to make an inspiring speech on the matter, he’d very much like to be there.

Obama: What are the risks of intervening in Libya?

The risk is that we face another Iraq where we are dragged into a foreign war from which we cannot extricate ourselves. What’s more, there’s also strong evidence that democrats would not support it.

Really, which democrats?

The ones in New Hampshire, Sir. There is also the issue of double standards Mr President. Can we be seen to support rebels in one place while acquiescing in their suppression somewhere else.

We must back hope against fear; fright against might; the oppressed against the oppressors.

Is that everywhere, Sir, or on a case by case basis?

Which case did you have in mind?

Libya.

Yes.

Bahrain?

I see your point.

As you know Mr President, the Saudis have already gone in to quell the protests in Bahrain. They will not let the Crown Prince fall.

That doesn’t sound good. What influence can we bring to bear?

We’ve told the Saudis to use restraint, Sir.

What does that mean?

They’ll try not to kill anyone on camera and restrict brutal crackdowns to the hours of darkness.

That seems a measured approach. We must be careful about the signal we send to our ruling friends and allies in the region. They need to know we will not desert them in their hours of need; that America is a true and loyal friend. They need to know that we will not cut and run at the first whiff of trouble.

No Sir.

We want them to know that we only cut and run when trouble hits at least its second or third whiff.

Yes Mr President.

OK, now what am I going to do about the Europeans. David Cameron is leaving lots of messages with my secretary. I’ll have to get back to him sooner or later.

The Brits are pressing for a no-fly zone over Libya.

That’s pretty easy to do when you’ve abolished the Royal Air Force What’s he planning to police it with, a British Airways 737? Thank you for joining us on this routine patrol; we will be circling Benghazi for a few hours. Insurgents are invited to help themselves to snacks and drinks from our trolleys.

The French are also demanding actual intervention, Mr President.

We’re being out-hawked by the French?

We think it’s empty rhetoric, Sir.

I’m being outgunned on rhetoric?

The (Fed) King's Speech

2011-03-09T09:17:00.018-05:00

Lionel Logue: [as George "Berty" is lighting up a cigarette] Please don't do that.
King George VI: I'm sorry?
Lionel Logue: I believe sucking smoke into your lungs will kill you.
King George VI: My physicians say it relaxes the throat.
Lionel Logue: They're idiots.
King George VI: They've all been knighted.
Lionel Logue: Makes it official then.

“We have seen increasing evidence that a self sustaining recovery in consumer and business spending may be taking hold.”
Fed Chairman Ben Bernanke
Congressional testimony, March 2011

There are two major issues equity investors are currently struggling with. The first is the obvious one: the price of oil. The second is one that I raised months ago at each and every Market Forecast event (10 of them) that I conducted throughout the US: will the US economy reach what economists call “escape velocity” and achieve a sustainable, private sector-led economic expansion WITHOUT the aid of government stimuli? Apparently, our esteemed Fed chairman has answered that question. Let’s hope he’s right.

Let’s hope that:

• The US consumer is capable of spending beyond his/her means, a fact that becomes that has been made all the more difficult as middle income wages have stagnated for decades, that the ability to borrow is now limited to non revolving (as in autos) credit versus other sources, such as revolving (credit card) and home equity withdrawals (see Monday’s Consumer Credit report for the latest installment of this reality), and that the need to continue to repair their balance sheet (deleverage, a/k/a save more, spend less) is combined with the need to prepare for a world of reduced government support (cuts to Social Security and Medicare, for example) looms on the horizon.
• US based corporations decide it’s time to unleash their nearly $2 trillion cash horde on capex projects in the low growth/high cost US and not in the high growth/low cost emerging markets.
• High growth/low cost emerging market governments allow US based companies in to the detriment of their domestic companies, not to mention their emergent, large, multinational competitors.
• Cut backs at the state and local level don't more than offset a prospective hiring and wage increase binge by US companies.
• The US dollar doesn’t crater to new all-time lows thereby driving up longer-term interest rates.
• The unrest and turmoil in North Africa doesn’t leap frog over the Suez Canal into the oil rich, Western friendly despotic kingdoms of the Middle East thereby driving oil prices to record levels.
• The structure of the markets doesn’t produce a financial crisis courtesy some financially engineered Frankenstein ("It's alive!") product, service, or process that few truly understand.

This partial list of concerns is the tip of the iceberg. The full list is a long one. But that’s what bull markets driven by tons of liquidity and constructive earnings results* are supposed to look past. Or, so it's said.

Investment Strategy Implications

Stock market dogma states that a bull market climbs a wall of worry. However, when that wall has lots of grease on it and given the interconnected, interdependent, rapid transmission nature of our globalized world, any slip can turn into a self-reinforcing downward tumble in a very short period of time.

Hope is not a strategy but in the end it may be what this bull market largely rests on.

* The one truly bright spot, that may have run its course with its cutting, management and technology efficiency benefits. Is there more blood that can be wrung from the cost cutting efficiency stone?

Note: Many of the above points were expressed yesterday when I appeared on foxbusiness.com. To view the interview on my media blog click here.

Talking Head Time

2011-03-07T08:38:00.003-05:00

This morning I had the opportunity to participate in a week ahead market discussion for BNN TV.

To view the segments, click here.

Say What?

2011-02-24T10:35:00.005-05:00

Yesterday, I had the opportunity to be a guest on Bloomberg radio's "Taking Stock" program and NDTV (New Delhi Television) Profit's program discussing the current market and economic environment. A key focus explored was one of the two major themes of my recently concluded Market Forecast series (10 events, 10 cities, 34 expert panelists, 920 attendees, in 6 weeks): once the the US economy is taken off stimulus steroids, will it achieve a private sector led sustainable expansion (what economists lovingly refer to as "escape velocity")? The answer will almost certainly disappoint you.

To listen and view the interviews, click here.

Beyond the Sound Bite: An Interview with Philip J. Orlando, CFA

2011-02-23T10:59:00.001-05:00

My annual interview (this being the fourth) with Federated Investors' Senior Vice President, Chief Equity Market Strategist, Senior Portfolio Manager includes the good news/bad news aspects of the current US economic and corporate profits outlook, the direction of interest rates, an appropriate multiple for stocks, the importance of education as a long term solution to stagnant US middle income wages, and how a traditional institutional investor manages the changed structure of the markets.

Beyond the Sound Bite podcast interviews can be found at the Blue Marble Research media blog. To listen to this interview, click here.

Note: Phil is actively involved with FECA, the Foundation for Educating Children with Autism

Beyond the Sound Bite: An Interview with James J. Valentine, CFA

2011-02-09T10:19:00.001-05:00

Ivory tower meets real world.

Once in a great while, a book comes along that blends the theoretical with the practical in such a way that readers are treated to insights of great value. Such is the case with Best Practices for Equity Research Analysts: Essentials for Buy-Side and Sell-Side Analysts, the topic of this week's interview.

The former multi year II ranked analyst and former director of global training and development with Morgan Stanley describes in five parts how to excel as an equity analyst. Anyone interested in, involved in, or considering a career as an equity analyst (buy or sell side) will have their knowledge and almost certainly their career enhanced. I cannot overstate the usefulness provided.

Beyond the Sound Bite podcast interviews can be found at the Blue Marble Research media blog. To listen to this interview, click here.

Beyond the Sound Bite: An Interview with Phil Roth, CMT

2011-02-02T09:50:00.000-05:00

In his last appearance back in April 2010, I asked the highly respected market strategist, "Is the bull done?" His reply now is the same as then, "Not yet". This despite the continuing absence of any meaningful participation by traditional investors (professional and non) and the risk that having an equity market dominated by the fast money crowd (hedgies and others).

In such a non traditional bull market, what are the market related signs one should be on the lookout for? What are seasoned Wall Street veteran's likes and dislikes in the market? And is the market climbing a wall of worry?

Beyond the Sound Bite podcast interviews can be found at the Blue Marble Research media blog. To listen to this interview, click here.

Beyond the Sound Bite: An Interview with George Milling-Stanley

2011-01-26T13:44:00.001-05:00

The Bard once wrote, "All that glitters is not gold". The precious metal may glitter uniquely among assets, but how does one measure the value of gold? Can one measure the value of gold?

In my interview with the Managing Director, Government Affairs for the World Gold Council, key factors in assessing the precious metal are explored. Additionally, understanding the role of gold and central bank's reserves ("The Importance of Gold in Reserve Asset Management") is discussed*.

Beyond the Sound Bite podcast interviews can be found at the Blue Marble Research media blog. To listen to this interview, click here.

Beyond the Sound Bite: An Interview with William Hartung

2011-01-19T09:55:00.000-05:00

Too big to fail. Think it pertains only to the banking industry? Think again.

With the defense budget representing a very large chunk of the US federal pie, it behooves all investors to better understand this vital area of US government, not to mention the US economy. From his most recent book, "Prophets of War: Lockheed Martin and the Making of the Military-Industrial Complex", key aspects of President Eisenhower's final speech warning is fleshed out by the defense expert with the "New America Foundation". The consequences of actions - economic and geo political - go far beyond the industry itself and cannot be overstated.

Beyond the Sound Bite podcast interviews can be found at the Blue Marble Research media blog. To listen to this interview, click here.

Beyond the Sound Bite: An Interview with Robert Arnott

2011-01-12T09:33:00.004-05:00

To most investors, including many investment professionals, indexes are constructs designed to track a defined area of the economy, usually via financial assets. Yet, "indexing as an investment concept" is far more prevalent than most realize.

In my interview with the co-author of " The Fundamental Index" and Chairman, Founder of Research Affiliates, we explore such areas as efficient indexing, the market inefficiencies that result from cap weighted indexes, and RAFI, the Research Affiliates Fundamental Index approach to investing. For those interested in understanding an investing methodology that large institutional investors such as PIMCO utilize, this interview will open the door to a fascinating and largely under-appreciated segment of the financial markets.

Beyond the Sound Bite podcast interviews can be found at the Blue Marble Research media blog. To listen to this interview, click here.

Upcoming Media Appearances

2010-12-29T15:36:00.001-05:00

Bloomberg radio, "Taking Stock with Pimm Fox", today, Wednesday, December 29, @ 4:05 pm (eastern)

BNN TV, "Business Day", tomorrow, Thursday, December 30, @ 3:05 pm (eastern)

Beyond the Sound Bite: An Interview with Meir Statman

2010-12-22T10:11:00.003-05:00

Do investors really know what they want?

Well known among those in the CFA Institute and CFA society circles, the highly regarded behavioral scientist shares his thoughts and insights from his most recent book, "What Investors Really Want". Benefits (utilitarian, expressive, and emotional), cognitive errors, human nature, and rational investing are touched on in this most interesting and informative interview. Who knows, by exploring the mind of the market you may find yourself looking in the mirror.

Beyond the Sound Bite podcast interviews can be found at the Blue Marble Research media blog. To listen to this interview, click here.

Beyond the Sound Bite: An Interview with Bethany McLean

2010-12-15T12:14:00.000-05:00

In The Tempest the Bard wrote, "Hell is empty, and all the devils are here." He could have easily been describing the financial crisis, its causes, and its aftermath.

My interview with the coauthor of "All The Devils Are Here: The Hidden History of the Financial Crisis" takes us deep into the details of what went wrong and why. The depth of the investigative work is truly remarkable and, when understood in conjunction with my September 16th podcast interview with Simon Johnson, helps complete the picture of what happened, why it happened, and how to anticipate future such crisis.

Beyond the Sound Bite podcast interviews can be found at the Blue Marble Research media blog. To listen to this interview, click here.

Beyond the Sound Bite: An Interview with Michael Phillips

2010-12-09T12:35:00.002-05:00

My interview with the former CEO and Chairman of Russell Investments, current Chairman of the Russell 20-20 Association, and Chairman of Altaira Wealth Management, enabled me to tap into his decades of investment experience and insights to explore important economic and market issues including: a global macro economic overview, the recently adopted financial regulations, and the structure of today's financial markets with its prospective impact of producing a lost generation of investors.

Beyond the Sound Bite podcast interviews can be found at the Blue Marble Research media blog. To listen to this interview, click here.

Six Degrees of Kevin Bacon

2010-12-03T09:14:00.005-05:00

With Mitch McConnell wielding the paddle and John Boehner looking on, who knew Kevin Bacon would serve as the model for Barack Obama's management style.

Beyond the Sound Bite: An Interview with Ralph Acampora, CMT

2010-12-01T10:44:00.002-05:00

Now affiliated with the investment and wealth management firm, Altaira Wealth Management, the legendary market strategist shares his optimistic market views, the tools he uses to analyze the markets, and the importance and impact that a changed market structure has on the investing.

Beyond the Sound Bite podcast interviews can be found at the Blue Marble Research media blog. To listen to this interview, click here.

Time To Digest

2010-11-23T12:36:00.013-05:00

Those who heeded my Thursday last blog posting warning not to take the bait have been rewarded with +167 basis points thus far and are likely to benefit further in the coming days and weeks as the near term indicators tracked – momentum and MACD – are now even more solidly entrenched in pullback mode as the accompanying chart clearly illustrates.

Poised to close below last Tuesday’s closing price of 1175, the S&P 500 would join its major global markets brethren (EAFE (EFA) and emerging markets (EEM)) with downside price confirmation of the negative momentum and MACD trends warned of last Thursday. With the short term indicator (slow stochastics) well above its oversold territory (below 20), a pullback target to the average of 5 to 10% is more than achievable and would drop the S&P 500 to the most interesting price of 1133, or just above its head and shoulders neckline and 200 day simple moving average right around the 1125 price level before then signaling an end to the pullback.

Why Not More (Or Less) Of A Decline?

Since the market action that preceded this pullback lacked any external divergences and considering the fact that 100% of the 30 indices tracked are in bullish Mega Trends, the market only had the less serious internal divergences to work off. Accordingly, the magnitude of the current decline should be muted.

As for the decline stopping right here, that is not likely as the internal divergences are so solidly tilted to the downside plus the fact that the other major indices are also performing in like fashion. Such action rarely stops dead in its tracks and reverses itself without first producing signs of trend change.

Why Do Divergences Work?

It is important to remember that this divergence stuff I keep emphasizing works because of the nature/structure of the market. With so many market players operating in the short term space dominated by the need to match performance and with a philosophy of momentum investing, trends that get established tend to stay that way until they are exhausted thereby producing divergences. It is for we investors and traders who can correctly exploit this momentum lemming-like behavior by either joining or going against (contrarian) the crowd that can reap the absolute and relative performance rewards.

When Will It Stop?

The key bullish signs to watch for are the same ones that warned of the market decline we are now experiencing: divergences both internal and external. Specifically, the point at which momentum and MACD do not confirm lower lows will be time to consider increasing the equity exposure. Whether external divergences develop will factor into the decision process at that time.

Like a Thanksgiving meal, it is always good to digest some of what you ate before gorging yourself again on the simplistic “don’t fight the Fed” tune.

Note: My appearance yesterday on foxbusiness.com with Tracy Byrnes is available on my media blog Beyond The Sound Bite.

click image to enlarge

Don't Take The Bait

2010-11-18T08:59:00.011-05:00

US Stocks are poised to produce a nice upside opening today. Investors might therefore be tempted to conclude that the staple of this bull rally - buy the dips - is back in action and short term profits are in the offing. However, as the accompanying chart shows, when certain market conditions exist any upside move tends to be little more than a bounce followed by a resumption of the pullback. Here are the facts:

Thus far this year, the chart shows that whenever the two primary near term indicators tracked - momentum and MACD - both turn negative - mid January, mid April, mid August, and now - the stock market experiences a bounce that turns out to be a failing rally with a lower low in stocks shortly thereafter. This is made all the more likely this time as an internal divergence (between price and momentum) has occurred twice this year - mid April and now. It is only when MACD then turns negative that price then declines in a sustained manner.

In the April to early July pullback, US large cap stocks dropped more than 10%. The current pullback, however, is unlikely to repeat that magnitude decline (due to the absence of any external divergences). More likely in the 5 to 10% range, with a mid point of 1133, which interestingly sits right above the reverse head and shoulders neckline and 200 day simple moving average of 1125.

Of course, nothing is flawless and works perfectly all the time. But the odds of a healthy market pullback are highest when the above conditions exist.

click image to enlarge

The Fed, Sir Isaac Newton, and QE

2010-11-12T09:17:00.017-05:00

In today's FT, Mohammed El-Erian discusses the PIGS’ (Portugal, Ireland, Greece, and Spain) resurgent credit spread problems*. Toward the end of his commentary, he references a phrase that all non economists should know as it helps in understanding the mind of the dismal scientists and the comments posted the other day re the US Fed’s thinking on the risks of a Japan style deflation taking hold in the US**. The phrase is "path dependency".

"The history of emerging economy crises also tells us that these worrisome dynamics are self-reinforcing, resulting in what economists call “path dependency”. Rather than snapping back to a better outcome, bad developments increase the probability that the next set will be even worse."

Newton To The Rescue

A path dependency that leads to a steady state equilibrium for inflation and interest rates (which is the central point of the chart posted on Wednesday**) is the great fear of the Fed. And in the mind of the Fed the only way out of that condition is to exert an external force on it, with that external force being QE. Or as Sir Isaac Newton advised: "Every object in a state of uniform motion tends to remain in that state of motion unless an external force is applied to it."

Push, Ben, push.

*"Irish crisis demands new EU response"
**scroll down to Wednesday's posting, "Why The Fed Believes QE2 Is Necessary"

QE2 Sets Sail

2010-11-11T15:47:00.008-05:00

Here is the calendar for the first round of the Fed's $600B in purchases as QE2 sets sail. Anchors aweigh!

Here’s Why The Fed Believes QE2 Is Necessary

2010-11-10T12:39:00.009-05:00

Monday’s NYSSA luncheon with St. Louis Fed President (and voting member of the FOMC) James Bullard was most illuminating (wish you were there). In addition to the somewhat heated give and take with attendees, Mr. Bullard provided a chart that captures the principal fear the Fed has re deflation. It is what is known as the steady state (equilibrium) of inflation and interest rates.

The accompanying chart is the one he presented (which was also provided in his recent commentary and presentation “Seven Faces of “The Peril’”). In it I have pointed (larger arrows) to the steady state for the US (boxes to the right), steady state for Japan (circles to the left), and in the middle the May 2010 current level for the US. You will note that the May 2010 point is the closest to the Japan outcomes.

The concern at the Fed is that the slide toward the steady state for inflation and interest rates (in a zero bound interest rate environment) renders interest rate driven monetary policy impotent (as it has in the case of Japan). Moreover, a steady state tends to become entrenched (that’s why it’s called a steady state). And economists will tell you that when it comes to deflation/inflation it is the entrenched, longer term levels (and not the shorter term, more volatile factors such as commodities) that matter most.

As the May 2010 point illustrates quite clearly, the US trend is not where the Fed wants it to be.

Here’s Why The Fed Believes QE2 Will Work

In a nutshell – because it worked the first time.

Time and again in the aforementioned heated discussions, Mr. Bullard consistently pointed to the financial markets rebound during QE1 and in anticipation of QE2 as evidence of the positive effects of QE. Moreover, since the economy has recovered and avoided further economic deterioration (Great Recession not Great Depression 2), QE was and will be (in his opinion) effective.

Conclusion

No doubt the debate over the Fed's QE policy will continue. But at least now you know some of thinking behind the actions.

Caveat: Mr. Bullard was speaking for himself and his opinions do not necessarily reflect those of the Fed.
Click image to enlarge

The Gambler

2010-11-04T12:51:00.017-04:00

Who knew Ben Bernanke was actually Bret Maverick?

Using its dual mandate – price stability and full employment – as a rationale (excuse!?) for unilateral action, the Bernanke Fed has embarked on a grand experiment hoping that the wealth effect on financial assets will somehow stimulate the deleveraging US consumer to suddenly reverse course, revert to form, and shop ‘til he/she drops. The Bernanke Fed also hopes that the US consumers’ primary asset –his/her home – will somehow overcome the foreclosure fiasco and miraculously increase in value thereby adding spending fuel to the wealth effect fire.

Finally, the Fed is hoping that its actions will encourage the banks and corporations to disgorge themselves from the mountain of cash they have been hording and start lending and hiring again.

The cumulative effect of this grand adventure is to hopefully enable the US economy to reach an economic escape velocity and enter into the self-reinforcing, sustainable virtuous circle thereby enabling the Fed to enter into its exit strategy.

In today’s Washington Post, Mr. Bernanke provided his audacity of hope with arguments that had so many holes in them as to resemble Swiss cheese. Here’s a few morsels with his comments in italics and mine beneath:

Easier financial conditions will promote economic growth.
By how much? And when?

For example, lower mortgage rates will make housing more affordable and allow more homeowners to refinance.
What about the large supply of unsold homes? What about the impact of the foreclosure fiasco?

Lower corporate bond rates will encourage investment.
Possibly, but where will that investment occur – in high cost/low growth markets like the US or in low cost/high growth markets like emerging markets?

And higher stock prices will boost consumer wealth and help increase confidence, which can also spur spending.
Unlikely without the support of the US consumers’ most important asset – the home. (see above noted point) Moreover, deleveraging to save for an uncertain future is a strong force for soon-to-retire baby boomers, who know that entitlement reform is in the offing.

Increased spending will lead to higher incomes and profits that, in a virtuous circle, will further support economic expansion.
Not if companies decide to invest elsewhere, as noted above. Also, small businesses, the driver of jobs growth, will wait to see demand before committing to new hires and higher wages.

The Federal Reserve cannot solve all the economy's problems on its own. That will take time and the combined efforts of many parties, including the central bank, Congress, the administration, regulators and the private sector.
Correct, but unlikely given the looming political gridlock environment ahead.

But the Federal Reserve has a particular obligation to help promote increased employment and sustain price stability.
And this provides the justification to act unilaterally – without the aforementioned other parties involved as well as the cooperation and coordination of other central banks and countries around the world?

Steps taken this week should help us fulfill that obligation.
How's that hopey, changey stuff goin' for ya?

Investment Strategy Implications

The music is playing and the actors are dancing, driven in large part by the underperforming and desperate momentum lemmings from hedge fund land. Valuation levels are now moving well above average (>15 times) anchored in solid corporate profits, low interest rates, very ample liquidity, and belief that the cyclical forces at work will overwhelm the unresolved secular structural issues.

It is imperative that investors remember this one point – just because a company was founded in the US, is domiciled in the US, and derives some of its profits and growth from the US doesn’t mean it has to rely on the US for its future growth and profitability. And therein lies the rub with Bernanke’s argument: will QE2 (then QE3, then QE4) provide strong economic growth and prosperity for the US? Or will it produce yet another bubble in assets and other markets (notably emerging economies) leaving the US economy in worse shape than when it started?

Ultimately, the all important asset allocation question is: To what extent should an investor participate in this monetary Mephisto Waltz? The answer I've come to is listed to your left.

Bloomberg radio appearance

2010-10-21T23:28:00.003-04:00

In case you missed the Tuesday, October 19 appearance on "Taking Stock with Pimm Fox", click here

Seeing Is Not Believing

2010-10-08T10:10:00.013-04:00

Confused over this morning’s initial US stock market reaction to the poor employment data? Don’t be. Here’s why:

In the eyes of the cyclical bulls (who currently rule today’s market thinking, with the underperforming momentum lemming hedge funds in tow), the poor employment numbers are a twin win for the following two reasons:

1 – The Fed’s dual mandate includes the goal of full employment. Accordingly, QE2 is headed the economy’s way. This ensures another flood of money thrown at the problem, much (most?) of which will bleed its way into the financial assets.

2 – Today's employment data is the last report before next month's mid term election. Anything that damages the reviled party in power, the Democrats, enhances the chances of a Republican win next month. Gridlock will ensue, something the cyclical bulls believe is good for the economy and markets.

From a corporate profits perspective, third quarter results will be just fine – at to slightly above consensus expectations. This will provide the expectational foundation for future earnings results at consensus expectations at a minimum, which puts the 12 month forward operating earnings outlook for the S&P 500 at or above $84.

With an above average P/E of 17, the future fair value of the S&P 500 is 1428, or 1286 in today’s market.

Seeing Is Not Believing

Other than 3Q10 earnings results, I do not subscribe to any of the above views as presented but offer them as the rationale for this morning’s initial stock market action. That said, the technical analysis deterioration noted over the past weeks (see blog postings below) is unchanged. Unless reversed, a 3 to 5% stock market pullback is likely.

Dreams of a Cyclical White Knight

2010-10-06T11:54:00.017-04:00

And now for some more first order thinking.

At the heart of yesterday’s commentary is the issue of cyclical recoveries morphing into sustainable economic expansions. The argument by the bulls subscribing to this view is that this is precisely what will occur this time as it has every other time before. The virtuous cycle saves the day. This is about as straightforward as it gets. The argument against this thinking is equally straightforward.

When the global macro economic system is hit by an extraordinary event, the post crisis environment is anything but normal and the odds of a cyclical recovery resolving a structural crisis are very long. What is then needed is a structural solution to a structural problem. Examples of this thinking abound (not that the cyclical bulls are listening), with today’s commentary in the FT by Martin Wolf among the most cogent.

The topic of Martin’s commentary may be the emerging currency war with a particular focus on China. The essence of Martin’s commentary is, however, the more important point – structural problems require structural solutions, which in a global economy can only be solved via cooperation between the major global players. Yet, cooperation between the major global players requires leadership. Since the logical country in a position to exhibit that leadership, the US, has as its head a political manager and not a leader, the odds of someone taking the lead toward the necessary cooperative environment for structural change are very long indeed.

The Post Crisis Environment

Crises occur mainly due to structural (systemic) problems. The post crisis environment that ensues is one that rarely resolves itself via the cyclical solution. Yes, cyclical rebounds do improve things for a while but they do not get to the heart of the matter. The structural problems remain and will overwhelm the relatively meager energy of a cyclical bounce. It’s like trying to treat a patient with a life threatening disease with antibiotics. It just doesn’t work.

To use the stock market analogy in the current environment: cyclical bull markets within secular bear markets do not change the reality that the equities are in a secular bear market. Accordingly, cyclical recoveries within a structural (secular) change environment will not resolve the systemic issues at hand.

The bullish rejoinder to this is the muddle-through solution: Things are never so neat and tidy. Stuff happens, things are messy. But, fear not, we will find a way out of this mess. We always have and will do so again. This time is not different.

However, as I argued yesterday, such thinking concludes that this time IS different, for the norm in a post crisis environment is for extraordinary measures to be exerted, which includes fundamental changes in the rules of the game. Therefore, this time is not different as crises do occur and the subsequent environment requiring fundamental change is the norm.

Who will be right? The cyclical-recovery-saves-the-day crowd or the we-need-to-address-the-structural-problems club? Time will tell, which I suspect will be sooner than most think. One thing is for sure, however, someone is going to be real right and the other will be real wrong.

Investment Strategy Implications

My money is with the structural problem club. However, the cyclical dreamers are in control right now. Therefore, as an investor and investment strategist, I cannot act aggressively until the technical analysis signs that the market is ready to embrace the more worrisome view of my club. (Think, the recent vintage tech and real estate bubbles.)

Accordingly, before shifting from the currently cautiously bullish (60 to 90% in equities) posture to neutral (40 to 60% in equities) to outright bearish (<40%) clear technical analysis signs, most notably external and internal divergences, must be evident. At present, as noted last week only the internal divergences are. Therefore, cautiously bullish (the equivalent of driving with one foot on the brake) remains the advisable strategy.

As history teaches us all too well: delusional thinking rooted in old school dogmas can maintain its grip for a very long time.

This Time IS Different

2010-10-05T14:04:00.010-04:00

The bulls (not the bears) would have you believe that this time is different.

The root of this view in anchored in the dogma that the cyclical recovery cures all ills as follows:

The cyclical recovery evolves as increased corporate spending on wages and new hires which, along with an increase in emerging economies’ consumer spending, result in a consumer led demand driven sustainable cyclical expansion. Corporate profits rise further enabling the virtuous circle to become engaged.

The sustainable cyclical expansion then helps to alleviate the structural risks to the global economy – e.g. current account imbalances – thereby enabling the financial sector to recover further and move the global economy off government life support.

The financial markets respond with a move more toward normality as rates rise, the dollar stabilizes, gold loses its luster, and equity valuation levels return to above average (>15 times). The combination of higher corporate profits and above average P/E levels drives stock prices back to record highs, which for the S&P 500 means 1548 (18 x $86).

An era of growth and prosperity returns thereby proving that this time is not different; that there will be no new normal (i.e. below average growth and profitability).

Sounds good, doesn’t it? Even plausible, provided one thing – conventional thinking in unconventional times requires a belief that this time IS different.

The Burden of Proof

The bulls would have everyone believe that the burden of proof that this time is different falls on those who say what was no longer works (the old normal) and that the future is a place of great uncertainty (the new normal) with the road ahead a most bumpy one. There’s one problem with this thinking – evolutionary processes to new normals are normal. A purging of the old always occurs and it always leads to a new normal, whatever that new normal may be.

Extrapolating the recent past into the future often becomes a substitute for first order thinking. Be it fighting the last war or blindly accepting corporate earnings guidance, embedded interests conspire to preserve the status quo, which facilitates a blindness to change. And it is change that is normal, not what-worked-before-will-work-again-indefinitely thinking, made all the more illogical given the highly dynamic complex global macro environment the world finds itself in.

In evolution, those that are about to become extinct are the last to notice. The same is true in the social sciences of economics and the markets, where old rules in changed times demand the view that this time is different.

MACD Crossover Imminent

2010-09-30T11:50:00.012-04:00

Thus far this year there have been three occasions when MACD crossed over and Momentum turned negative. In each case, the equity markets experienced a meaningful decline (see chart for examples*). We are presently poised for a fourth occasion. Interestingly, October will likely produce lots of conflicting data for both bulls and bears.

For the bulls, earnings season will be more than satisfactory. The aggregate macro economic data produced in the third quarter plus the fact that the confession season has passed with little bad news suggests that earnings will meet or slightly exceed consensus expectations buttressing the bulls' case. On the bear side of the ledger is the emerging traditionally-thinking investor angst that the Republicans won't win either house of Congress, thereby knocking out the gridlock-is-good beam from the bullish structure.

Investment Strategy Implications

Because there are no external divergences, any market pullback in October will likely be minimized with many country/sector/industry/company specific cross currents occurring. Internal divergences on their own are a sufficient reason to lower one's equity exposure somewhat but insufficient to ring the bearish bell too loudly. That time will likely come after the pullback followed by a failed rally followed by the OMG-the-Republicans-didn't-win-either-house introduction to the bear of 2011.

*click image to enlarge

TheStreet.com media appearance

2010-09-29T14:29:00.000-04:00

Last Friday's TheStreet.com interview has been published and posted today.

To view the interview, click here

Internal Divergences Emerge. Market Pullback Probable.

2010-09-28T14:56:00.011-04:00

As noted in yesterday’s Bloomberg radio segment (see below), internal divergences are beginning to emerge for the first time since early August. The accompanying 3 charts* representing 3 key indices (US, EAFE, and emerging markets) illustrate identical action seen in virtually all indices with price moving up while the key near term internal indicators Momentum declining (a clear divergence) and MACD poised to rollover. Moreover, today’s bounce has lifted the short-term indicator (Slow Stochastic) back into overbought territory.

The net effect of the early August internal divergence was a negative 8% for the S&P 500. With so much enthusiasm behind the current market rally (see yesterday’s blog posting illustrating the record low cash levels of mutual funds and the valuation math supporting the current market, as examples), stocks are now in a much higher risk zone than is generally appreciated.

The saving technical analysis grace is the absence of any external (index to index) divergences. That said, a pullback now followed by a further run to higher highs (courtesy earnings season) may produce the external divergence condition necessary to signal an end to this rally followed by a far more meaningful decline. If no external divergences occur in an ensuing rally, however, then the bulls will rule the roost for a while longer.

*click images to enlarge

Bloomberg radio appearance

2010-09-27T23:15:00.001-04:00

In case you missed the Monday appearance on "Taking Stock with Pimm Fox", click here

Media appearance on Bloomberg radio "Taking Stock with Pimm Fox"

2010-09-27T14:14:00.004-04:00

Media appearance today on Bloomberg radio program "Taking Stock with Pimm Fox" at 4 PM (eastern).

Prospective talking points:

* There may be an enthusiasm gap in politics but there is certainly not one in the equity markets.
* The September relief rally has morphed into a more confidently bullish mode lifting valuation models well into overvalued territory.
* At to above average P/Es are now embedded in the data.
* Is the current environment average, which therefore justifies an average P/E of 15?
* Do the valuation math:
o current S&P 500 price: 1147
o required return: 11%
o future price (12 months ahead): 1273
o optimistic expected earnings (next 12 months): $86
o future price (1273) divided by exp. earnings ($86) = 15 P/E

Also, re enthusiasm - Cash levels at stock mutual funds are now at their lowest levels in decades. (see accompanying chart - click image to enlarge)

Plus market technicals - internal divergences have begun, no external divergences thus far.
Last time internal divergences occurred (early August), stocks dropped 8%.