I have no strong opinion on near term market direction. I was prepared for this little downward correction, as for the larger bounce off 666 on the S&P500, but am highly ambivalent about where we go from this juncture.
Has this been a four month flat correction?
A case can be made that the entirety of market action since November has been one giant zig-zag correction that terminated last week, in which case we are now about to plunge to 550 among the kind of panic conditions that were so lacking at the latest lows. In support of this scenario we have the death-defying performance of a great number of tech and consumer stocks that have failed to even re-approach their November lows, as well as some of the most extreme readings on retail bullishness since the start of the bear market (Rydex bull/bear fund assets, put/call ratio, NYSE Tick). Remember, the ’29-’32 market corrected from its initial crash with a 48% rally from November ’29 to April ’30. If this is the Greater Depression (and by the looks of the latest trade and manufacturing numbers, let alone the scale of the debt saturation that caused this situation, it is), perhaps a big zig-zag is all the enthusiasm society can muster this time.
Or was it actually a washout?
That said, more likely in my mind is a protracted rally extending to 900 or higher by summer, then rolling over to meet a date with 400 next winter. Look at last year’s rallies from March to May and July to August for an idea of what this might look like, though on a larger percentage and time scale because we are correcting a larger sell-off. The case for such a move is bolstered when you hear major investment banks’ strategists calling this a dead cat bounce. Too many people are still afraid to call a bottom, and they need to be suckered into long positions before this is over (along the same lines, too many traders are embracing the dead cat bounce and need to be shaken out before it can get back to leading the buy-and-holders to slaughter).
I am highly skeptical, though respectful, of calls for a the mother of all bear market rallies. Robert Prechter and some other Elliott Wavers, as well as Tim Knight (slopeofhope.com) seem to be anticipating a 6-month or longer rally to as high as 1050. I simply don’t see why that is necessary in this environment. This is a depression, and the last one was accompanied by bear market that, after the first 6 months, maintained the momentum of a cruising supertanker. Rallies of 20 percent and 2 months were about all you got from April 1930 to July 1932 as the Dow dropped from about 295 to 41. That deflation-driven event was a much more orderly bear market than the jagged trajectory of the dot-com crash, which occured while the credit bubble continued to expand. Interestingly, the 1966-1982 secular bear (a brutal 75% loss in real terms) also traced out such a series of steep plunges and rallies as the bubble kept inflating thanks to a compliant Fed and the abandonment of the last trace of the gold standard. Employment was down, but animal spirits were still running high with the computing boom, the advent of securitization, and new innovations in consumer credit.
Feel like a depression yet?
Though the current bear market is half over in terms of price (three weeks ago we hit -57% and you can’t lose more than 100%), we are still early in the game as far as the economy goes. Official (read: bullshit) unemployment is still just a tad over 8%, and while the old measure (U-6) is reading 14%, we are headed for 25% in a hurry. Baring a catalyzing event, Obama’s approval rating has nowhere to go but down — in terms of historical context his term is positioned like that of Hoover, not FDR, who took office after the market had bottomed and already doubled.
This all spells a continuing deterioration in mood, possibly even at an accelerated pace, but because the market is not efficient and couldn’t care less about the economic fundamentals, an aggressively bearish trading stance is still only warranted when the market is highly overbought in multiple time-frames. Right now, we are only mildly overbought on a week-by-week scale (on Friday we were very overbought on this scale), while of course oversold on a daily scale and still somewhat oversold to neutral on a monthly scale (picture a 1-year chart). It is the 3-10 year chart that makes me nervous about being too quick to load up on shorts again. All things being equal, does this look like a good spot to go short?
3-year view here from bigcharts.com:
To deal with this situation I have lately been slowly accumulating December 2011 OTM puts on the S&P, scaling up purchases as the market rises. These positions are for keeps. I do not intend to part with them until the market has fallen well below 600 if not 500 (32 months should be more than enough time for that to happen, no matter how things girate in the interim). For trading the twists and turns along the way, December 2010 and even 2009 puts do very nicely. They are highly liquid and responsive to the market’s daily moves.
I am still bearish on the precious metals from a trading standpoint, and exercise this opinion mainly through the silver futures market and various equity puts (that said, if you don’t already have a nice pile of physical gold, get some and you’ll sleep better). Here and there investors are still losing their minds over certain stocks (ahem, Best Buy), and I always stand ready to short such silliness.
Quick opinions:
S&P earnings: Analysts still have their heads in the clouds and the I-banks are still getting away with talking about “expected operating earnings.” NET NET NET trailing report earnings are all that matters, and those will fall under $20 and stay there for many months before they start to grow again. Put a PE of 8 on that Jackson for your stock market bottom.
US bonds: bearish but not shorting
US dollar: bullish
Euro and Swiss Franc: bearish
Yen: neutral
Oil: neutral but prepared to start shorting at 60
Base metals: neutral to bearish (will short again if higher)
Grains: still waiting to buy
US real estate: wait until 2012 and figure on a cash market, but maybe buy in late 2010 if you can still get a low fixed rate loan.
NYC real estate: wait a year longer than the rest of the US — amazingly, denial still runs deeper there.
Guns ‘n ammo: good to own, but worthless if you don’t learn how to use them intelligently.
Obama: To appease and distract the masses, will he be crucified like Nixon?
Mike,
Nice to see your post after a long time.Been waiting for your thoughts on the markets
I do not have an excellent political antenna:
But how will the Democrats and Obama fail? Of course, it is easy to imagine scenarios where they would fail, but my question is what would be the ideology to replace it.
Initially, I thought it would be right-wing populism that appeals to Pat Buchanan. Buchanan, of course, does not support a welfare state, but he does opposes free trade and immigration which opens up domestic markets to foreign overcapacity. Foreign overcapacity does not benefit labor. I thought supporting protectionism and opposing immigration would be the low hanging political fruit, but as far as I am concerned, people such as Rush Limbaugh haven’t exploited this (yet.)
Also, I thought there would be even more support for the welfare state, and I am surprised that the Republicans’ planned budget would have more taxes. Since people are afraid to be losing their jobs, I thought this would not have as much political appeal when compared to increased social spending.
Furthermore, since most people would be drowned out of the market in a Darwinian flush, they would not be holders of stock or capital. Thus the overlap between the interests of capital and the general population would be less.
Deflation should increase populist sentiment such as increased demand for social welfare programs (left) and anti-immigration policies, (right) and protectionism (neutral), but I do not see it. Perhaps, the US is a plutocracy and such views are not expressed by most politicians because they are not in the interest of the ruling class. Maybe fascism, not social democracy is in the cards for the US. And I do not want Obama to fail if it means fascism.
Anyone want to argue against this?
“Obama: To appease and distract the masses, will he be crucified like Nixon?”
Even though have left-wing political views… there is no compelling empirical argument I could make to support Obama, but I do not regret support him (but not voting for him) over McCain. It would have been much better if people just let the deflation take over (it does have some good effects by causing major suffering for the bankers) and alleivate the suffering with some welfare programs instead of trying to return to the “status quo ante bellum” of the inflated credit bubble with all of its malinvestments.
And regarding your bearish position in US bonds, would you take an outright short position on it, that is not using ETFs? And I do love your short oil and base metal view. Everyone seems to be bullish on them (go to Seeking Alpha), and of course, consensus investing is a disaster.
Regarding the Dec 11 puts, how expensive are they? I thought they would be expensive because of the high vega.
I am curious about your bullish stance on the dollar. I guess it is meant as a long term bullish view, because if you chart the dollar index against the SPX, you will see that rallies are fuelled by a declining dollar. Therefore, although the “price” of equities are rising, the “value” of equities is falling.
In fact, the entire “bull” market of 2003 – 2007 can be attributed to currency debasement.
How far OTM, Mike?
Your political antenna look pretty good to me, Kynikos.
Bridget, I trade all different strikes. So far, I am staying close to the money for the 2011s and ITM for 2010s. I go deeper OTM when I am more bearish. Remember that I am prepared to and expect to lose money on my 2011 puts for many months — they could easily drop by 1/2 to 2/3 in a big rally. That is where I want to buy the bulk of them.
Vic, yes panic has been good for the dollar so far, but all correlations break down eventually. It is not impossible for the dollar to rise with equities.
Kynikos, yes, I will probably short bonds with futures if I decide to act, but I do not have enough conviction.
I meant to say “Republicans’ planned budget would have more tax cuts.”
Protectionism might not happen in the US because China has so much leverage on US policy because they own US debt securities and are large buyers. I do not think US savings could finance the deficit in a deflationary environment.
Also, I do not see socialism in the US largely because of its ethnic diversity. People are willing to accept a large welfare state if they do share kinship. Again, this is kind of like the “selfish gene” and “kin selection” in evolutionary biology.
Mike,
In your mind, what is the best way to short T-Bonds for a long-term play?
Tom
On bonds, I am leaning near-term (days to weeks) bearish, intermediate term (months to a couple of years) bullish and long term (2+ years) bearish.
To just go long term short, you could buy 2011 puts on TLT, but the time decay might kill you.
Hey Mike, After spending a good bit of time mulling over your idea that I spread my 401K around, since I can’t get out, several weeks ago I got entirely out of the fixed income I was in and spread it around numerous equity funds. Just in time to catch the rally. I have since been easing back into the fixed funds and have started testing the waters on long term S&P puts in my IRA to cover me if (when) trouble in the fixed market forces me back into equities.
Anyway, it’s still pretty scary, but some of the ideas I’ve gotten from reading your thoughts have really, really been helpful.
Just wanted to say I really enjoy reading your musings on the markets, I only wish you had more time to post more often. Thanks jaime
Mike,
Thanks for your comments on the bond market.
Tom
What happens if there are only must-buyers, no must-sellers and everyone and especially buy-and-holders waddling around in oceans of money and…. Bernanke keeps hitting his keyboard?
“securitized assets” cannot be reverse veg-o-matic’d so they MUST inflate everything under the sun. the car guy from Hyde Park had it easy. WE have Obama and Geithner and Bernanke. they rock.
SovSpec-
How about the 1907 Panic as a bear market fractal for what comes next?
http://goldversuspaper.blogspot.com/2009/04/new-fractal-consideration-for-general.html
Nice. Thanks.
what worries me the most is that I think this guy is more like Woodrow Wilson than FDR, which is a really horrifying thought…..
Mike, where are you??
Hey mike where are you? Its been a long time no see!!!!
I got some good news Mike.
“The Fed has tripled the size of its balance sheet, and the Obama administration is comfortable with running deficits that are close to 15% of GDP. The magnitude of that type of stimulus, monetary and fiscal, makes it virtually impossible to stick the landing on inflation.
But I expect it to be somewhat different than the inflation rate you saw in the 1970s, when there was broad-based inflation. So it is very possible that out of this policy, which is essentially focused on creating jobs and creating nominal GDP growth — as opposed to real GDP growth — that you get commodity-price inflation. That would be in the energy and basic-materials sectors — and gold. So those types of companies should do well over the longer term.”
“I actually believe the market saw its lows in March, but I also believe that we are moving into a period where returns are going to be a little bit like a ground war; that is, the easy part of the rally is over. We are using roughly $60 for Standard & Poor’s 500 operating earnings next year. Even if you assume a conservative multiple of 15, that gives you an S&P 500 of 900, versus around 845 last week.”
http://online.barrons.com/article/SB124061340301354557.html
Mike, don’t you love it when people disagree you? I hope this makes you happy.
I am sticking with the deflationary speculative thesis, and my hyperbolic discounting model and Darwinian shakeout view.
I do not think a commodities rally will be sustainable though. Mike’s the next bubble being cash is largely correct, and I do think the contango will kill any commodity rally (although copper is backwardated).
I am also stating to become bullish on treasuries. Does anyone share the same sentiment?
More information in the metagame Mike:
http://seekingalpha.com/article/134904-sentiment-overview-bears-take-the-lead?source=article_lb_articles
Conditions are looking bullish for treasuries, but I do not think we are in the “oversold” area for that yet.
“Last weekend brought out Barron’s quarterly Big Money poll. The small group of strategists surveyed were decidedly optimistic with 59% stating they were either bullish or very bullish. While a surprising 58% stated that they didn’t believe the market had bottomed yet, almost the same percentage (59%) identified the stock market as the best asset class for the next 6 to 12 months going forward. I’ll leave you to ponder the riddle of their logic.
The problem with the Big Money poll is that in its history, as a group, it has never been truly bearish. So while we would like to use it as a contrarian measure, we really can’t because for the most part it has no edge.
Drilling down into the sectors, the most unloved were Transportation and Utilities. In contrast, the Big Money poll liked corporate bonds, emerging markets (Latin America & Asia) and oil. But the one thing they almost all agreed on (84%) was to be bearish on US treasuries. This is puzzling since they’ve been persistently bearish on bonds for the past 8 years in the face of a powerful bull market in that asset class – especially in 2008.
Wall St. Strategists
The insistent bearish stance of the Big Money poll participants is in contrast to the current recommended allocation by the average Wall St. strategist. Right now they’ve peaked at a suggestion of 38.9% of client portfolios to (US long term) bonds, which is the highest in 12+ years. The last time they were even close to this level was in 1998 (34% allocation) when bonds topped and didn’t regain their previous high for another 3 years.
The asset class garnering the highest allocation is equities with a 52% weighing. Similar to the Big Money poll, Wall St. strategists are never outright bearish. Their bullishness is either raging or reluctant. So put in that proper context, the current allocation is very timid. It is the lowest allocation to equities since 1997. And during the bear market bottom of 2002-2003, their equity allocation was 68%.”
I just found this… sorry for the extra post. I think you imagine most of those scenarios:
http://seekingalpha.com/article/134820-the-worst-case-scenario-someone-has-to-say-it
There is still a lot of bearishness (on stocks). I wonder how many hedge funds have been wrong-footed by this rally.
Max: Heard from a friend today (that works for a hedgefund) that as many funds got wiped out by the rally as did by the initial plunge. No data to back that up, but his observation is at least a bit revealing of what the truth/mood may be.
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