Category Archives: social mood

Three months to go?

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I prefer to do the most basic charting imaginable. I just look at history and try to find times that resemble the present. In tonight’s browsing of the record of mankind’s opinion of its future, my eye zeroed in on September 2001 to March 2002. The dot marks the week of September 17, 2001:

This interim bear market bottom came 18 months after the all-time peak. Sound familiar? We had a dramatic sell-off into that bottom followed by a very sharp recovery, no doubt boosted by desperate short-covering. The bounce had covered most of its total ground within three months, but it was not until the VIX retreated to levels last seen at the top of the previous bounce that the indexes registered their final highs. This occurred after another three months of choppy trading, after which the VIX snapped right back to panic levels and stocks began to roll over into the final descent of the three-year bear market.

If this is our fate, perhaps the S&P chops its way to 1050 by September and the VIX touches 20. In that scenario, a lot of pain awaits holders of puts and inverse ETFs, and a lot of gain awaits patient buyers of the same.

I don’t feel like posting 10 charts here, but I couldn’t help but notice how many major market turns have come in September and March. These are the equinox months, and I believe we are primed to experience a collective shift at these times as a remnant of our past as farmers and hunter/gatherers whose livelihoods were very much tied to the seasons. If anyone has the time and know-how, it would be interesting to see if the numbers back up this hunch.

Of course confidence was up in May

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Since they both reflect prevailing social mood, the stock market and consumer confidence move together. Today’s CC figure (about as high as last summer), is another sign that the investing public’s opinion of our economic prospects is overly optimistic:

If this were a stock chart of a company with horrible fundamentals (a prospective short), I would wait a bit longer to see if it kissed the 2002-2003 bottom before going heavily short, though I might start to establish a position at these levels.

What is striking about this 9-year view is how closely CC tracks the stock market, and how much more lackluster the mood was in the dead-cat bounce from 2003-2007 than the true secular peak in the late 1990s to 2000.

Most of the way there.

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The bounce has been faster and more comprehensive than I expected. I was thinking that we would top around these levels, but by summer or fall, not early May. I have continued to scale into distant-expiry SPY and QQQQ puts, favoring ITM and ATM, and have now deployed about 1/3 of the money I am willing to allocate to shorts. I also have a smidgen of shorter-term positions in certain ridiculously high-flying restaurant and other consumer stocks.

The bond sell-off and commodities rally indicate that inflation fears now have the upper hand, as most people still believe deflation will be a short-lived phenomenon. The aforementioned movements are setting up nicely for long and short replays, respectively.

Notwithstanding a long-overdue correction, I suspect that stocks have further to run, and am no longer such a skeptic of certain Elliott wavers’ target of S&P 1050. Bullishness is now at 80%, up from 2% in March, but judging from attitudes on TV, there is still a great deal of skepticism to be overcome before we can call a top. That said, the speed and evenness of the advance leads me to expect much more choppiness for the remainder.

Shorting precious metals has been frustrating, and I suspect that we are repeating the pattern of last spring, when we had to work our way through several months of chop after receding from manic levels (1030 gold that time, vs 1007 in February).

It is important to keep in mind the real situation, not just the current market mood (though you can’t trade on fundamentals alone). We can’t work off the greatest credit bubble in history in 18 months and just a 57% loss in the stock market. The real (private, productive) economy is not going to stop shedding jobs, let alone add them, for years, and people are so indebted that they cannot be enticed to reflate the asset bubble or return to previous levels of wasteful spending. It will take a generation to work through our debt and lifestyle delusions.

It bears repeating that today’s official headline unemployment number (8.9%) cannot be compared to numbers from before the 1990s, when the Clinton administration changed the reporting methodology to exclude large segments of unemployed. A more useful measure for historical comparisons is U-6 unemployment, which now stands at 15.8% for April. Today on Bloomberg I heard Christina Romer say that things were nothing like the Great Depression, as she compared apples to oranges. In reality, we are at solidly depressionary levels already.

Also bear in mind that stock valuations remain at bubble levels. This is easy to see when you remember that stocks have no intrinsic value other than marked to market book value and heavily discounted future earnings. The major indexes’ trailing PE’s on net earnings will be under 10 by the time this is over. We still need to work off the bubble that was blown in the 1990s, which didn’t finish deflating in 2003 because of the easing of credit. Every kind of credit is tightening now, unless of course you are a bank holding company.

The Global Dow needs to crash some more.

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Last fall, Dow Jones launched the Global Dow index, composed of 150 stocks from around the world. A quick glance at its 10-year chart shows that stock prices have only so far blown off the froth from 2006 and 2007:

Source: wsj.com

Stocks are driven by mood, and mood today seems to be highly coordinated around the globe, so rather than scrutinize the twists and turns in the Dow, DAX or Nikkei, perhaps this new index is the best reference.

What is most striking about this picture, as opposed to that of the S&P500, Eurostoxx 50, or Nikkei, is that stock prices are only 2/3 of the way back to the 2002 lows, as opposed to right upon them.

This says to me that even this first stage of the crash has further to run. Fundamentals are deteriorating with blazing speed, but market participants remain in secular bull market mode. Too many are still buying the dips, or at least ignoring their losses and hoping for a rebound. The stock market is still viewed by most Americans as the best way to save for retirement, and the myth persists that if only your time horizon is longer than a decade or so, stocks will always beat cash.

This wave off of the November lows is looking weaker and weaker. We had our chance for a strong bounce like the one after the crash of ’29 (the Dow was up about 45% from November ’29 to April ’30), and all we could muster was about 20%.

Today’s action is a pretty strong indication that panic has been lurking just below the surface. With the sell-off in bonds possibly having run its course, precious metals stalling out at resistance, and a very low put/call ratio indicating extreme trader optimism, the news of the Great Pork Package and latest bankers’ bailout may be just the catalyst we need for a sell-off. Hope is fading fast.

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Oh, and it is worth mentioning that John Mauldin reports that a contact at S&P told him that the latest quarter’s earnings are apparently coming in at a NEGATIVE $7 for the index. I have been saying all along, that if this is a depression (it is), PE’s should bottom out at well under 10 and even dividend yields should be in the double digits. Whatever figure you come up with as a final bottom target for the S&P, it should be a very low multiple of very low earnings.

Fear recedes, so how will it return?

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The markets are experiencing a bit of a thaw today, with the memory of panic several weeks behind us now. The VIX has just broken decisively below 40 for the first time since September. Treasury yields have broken out just a tad from their extreme lows. Oil has jumped back to the mid-40s, copper has relieved its oversold condition, the GDX gold stock ETF has more than doubled, and the Dow has crept back to near 9000 again.

The question now remains, how will fear return? In several more weeks or months after the mood turns from relief to greed (and fear of missing out), or in the very near future?

My mind is not made up, but any breakaway rally is way overdue. With every week since the November 21 lows, we have been relieving the oversold condition as a function of time rather than price. That is not to say that the Dow couldn’t creep all the way to 10,000 by March, but the longer we hover here, the less necessary such a rally becomes.

What would be interesting in a January plunge is for the bond market to sell off with the stock market for the first time in recent events. But if the inverse correlation still holds, the overbought condition in Treasuries could find relief in a “happy days are not quite here again but will be soon” rally in stocks. Today’s action is what such an environment would look like, but with a great deal more animal spirits — $65 oil might even materialize (before new lows of course).

At any event, with the VIX below 38 I picked up a few more cheap puts on GDX today. Gold stocks have had a great run, and the same people are buying them today as were holding them in the crash, and for the same reasons. That is a bad sign.

My favorite short though is still the death-defying Home Depot. Also keep an eye on WalMart. People need cheap stuff, but they don’t need as much of it as they have been buying in recent years. At 16.5, the PE on that behemoth is still out of line, as is Costco’s at 18.5.

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PS — Note that in this kind of analysis, I don’t pay much attention to news pieces or economic releases. That is not the way to trade. For instance, we have horrible manufacturing data out today, and all data is worse than 6 weeks ago, but the mood is hopeful and stocks are up, so how can you make money trading on the news?

I look at the mood of the market itself and try to figure out what it is feeling and what themes it is trading on: greed, panic, relief, inflation, deflation, dollar bad, dollar good, etc. I try to figure out the mood by what different asset prices are doing, and wait for entry and exit points when trends look exhaused. To know the larger trend is key, in this case deflation and depression, but the market’s take on the situation is always changing. You wait for Mr. Market to be very wrong about a situation or just too enthusiastic, as in the case of the overextended bond rally this month — in deflation, bonds are good, but overbought is overbought.

The next bubble: cash.

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This is deflation, a contraction of money and credit. Hardy anybody argues about that anymore. So what happens next? Will Obama and the bailout maniacs inflate a new bubble in green energy in their new, green deal? Maybe, but it would only be a limited bubble, not the worldwide craze in any and all non-dollar assets that we saw the last time around.

Don’t assume that any new bubbles at all will form for a long, long time. The mood has shifted from risk to hoarding. Now that people have been burned by everything from dot-coms to gold miners and are scared to death of losing their jobs, they are going to hang onto the one thing that still works: Washington Wallpaper, the little notes that promise, “I owe you nothing but more of these IOUs.

Deflation will rage, until it doesn’t. We are still early in this phase, since among the public there is still a healthy fear of the dollar and paper money in general. But over the next year, as commodities and foreign currencies slide still lower and consumer prices stay solidly and noticeably negative, people will forget about the deficit and the $100 trillion in debt at just the wrong time.

This is the rule of maximum pain for the maximum number. The dollar is not yet ready to fail because it is too feared and despised. But when people let their guard down and sell for $450 the Krugerrands that they are paying $900 for today, take all that they have, because then the real fun will begin.

Just as the public will get too complacent about holding I-owe-you-nothings (Doug Casey’s phrase), Congress and Obama will get too complacent about printing them up, and the whole debt-based money system will come crashing down. I don’t pretend to know how it will play out (hyperinflation or just plain-old, “sorry, we can’t pay” default), but it will be visibly ugly, and I am glad I’ll only be watching it on TV. This won’t be pretty anywhere, but the US is not a civilized country anymore, and it has a most uncivil government.