Nobel Prize Economist Warns of U.S. Stock Market Bubble

An American who won this year’s Nobel Prize for economics believes sharp rises in equity and property prices could lead to a dangerous financial bubble and may end badly, he told a German magazine.

Robert Shiller, who won the esteemed award with two other Americans for research into market prices and asset bubbles, pinpointed the U.S. stock market and Brazilian property market as areas of concern.

“I am not yet sounding the alarm. But in many countries stock exchanges are at a high level and prices have risen sharply in some property markets,” Shiller told Sunday’s Der Spiegel magazine. “That could end badly,” he said.

“I am most worried about the boom in the U.S. stock market. Also because our economy is still weak and vulnerable,” he said, describing the financial and technology sectors as overvalued.

He had also looked at “drastically” higher house prices in Rio de Janeiro and Sao Paulo in Brazil in the last five years.

“There, I felt a bit like in the United States of 2004,” he said, adding he was hearing arguments about investment opportunities and a growing middle class that he had heard in the United States around the year 2000.

The collapse of the U.S. housing market helped trigger the 2008-2009 global financial crisis.

“Bubbles look like this. And the world is still very vulnerable to a bubble,” he said.

Bubbles are created when investors do not recognize when rising asset prices get detached from underlying fundamentals.

Related Stories

Who Will Replace Bernanke At The Fed ?

  • Larry Summers, the man suspected to become the next Federal Reserve chairman, withdrew his name from the running last night. “I have reluctantly concluded that any possible confirmation process for me would be acrimonious and would not serve the interest of the Federal Reserve, the Administration or, ultimately, the interests of the nation’s ongoing economic recovery,” Summers wrote to the president.
  • The dollar immediately weakened on the news that Summers was out. Emerging markets, on the other hand, rallied. Market-watchers are pointing to the fact that Summers was perceived as more hawkish — meaning less likely to use monetary policy to juice the economy —than his main rival and current frontrunner Janet Yellen.
  • Many are now predicting (and for some, hoping) that Fed Vice Chair Janet Yellen will win the nomination. Writes our Josh Barro: “She’s a key architect and proponent of the Fed’s appropriately accommodative monetary policies. Her selection would reassure financial markets that easing would continue as appropriate. And she doesn’t have Summers’ track record of undermining his initiatives by unnecessarily alienating people.” Other names being floated are Jack A. Bass, former Fed Vice Chairmans Don Kohn and Roger Ferguson. Former Treasury Secretary Tim Geithner has held steady that he does not want the job.

Today In the Market

    • This morning at 9:15 A.M. we’ll get U.S. industrial production figures. Economists are expecting a 0.5% increase in August after July’s 0% print.
    • Later this week, the Federal Reserve will hold its two-day FOMC meeting. Economists are expecting the Fed to “taper” its $85 billion a month purchasing plan of Treasury notes and mortgage-backed bonds. On weaker economic news, many on Wall Street are predicting a “taper lite” – a reduction in bond purchases of $10 billion per month, bringing the total monthly purchase down to $75 billion (as opposed to the previous market consensus of $70 billion).
  • UPDATE
  • Stocks & bonds rally, dollar dips as Summers quits Fed race
    1 hour ago – Reuters
    Stocks & bonds rally, dollar dips as Summers quits Fed raceBy Ryan Vlastelica

    NEW YORK (Reuters) – U.S. stocks and Treasuries rallied on Monday as investors saw the withdrawal of Lawrence Summers from the running to head the Federal Reserve as making a more gradual approach to monetary tightening more likely.

    Further boosting risk assets around the world, and weighing on the U.S. dollar, were signs of progress in Syria following a Russian-brokered deal aimed at averting U.S. military action, all of which helped propel world shares <.MIWD00000PUS> to a five-year high.

    Summers’ surprise decision came just before the U.S. Federal Reserve meets on Tuesday and Wednesday to decide when, and by how much, to scale back its asset purchases from the current pace of $85 billion a month.

    Investors wagered that U.S. monetary policy would stay easier for longer should the other leading candidate for Fed chair, Janet Yellen, get the job.

    The Dow Jones industrial average <.DJI> was up 142.01 points, or 0.92 percent, at 15,518.07. The Standard & Poor’s 500 Index <.SPX> was up 13.20 points, or 0.78 percent, at 1,701.19. The Nasdaq Composite Index <.IXIC> was up 16.20 points, or 0.44 percent, at 3,738.39. Gains in the Nasdaq were limited by a 1.7 percent decline in Apple Inc <AAPL.O> shares.

    European shares <.FTEU3> rose 0.5 percent while the MSCI all-country world equity index rose 1 percent. Markets had perceived Summers as less wedded to aggressive policies such as quantitative easing and more likely to scale stimulus back quickly than Yellen, who is second in command at the Fed.

    “His passing as a contender for the top role has left in its wake a significant risk-on rally,” said Andrew Wilkinson, chief economic strategist at Miller Tabak & Co in New York.

    It was even possible a first Fed interest rate rise could be pushed out to 2016, rather than 2015 as currently expected, added Chris Rupkey, chief financial economist at Bank of Tokyo-Mitsubishi UFJ. Going by Yellen’s past speeches, he said she would most

    probably prioritize reducing unemployment.

    “Yellen looks like the clear front-runner and seems to be the public’s popular choice,” he said. “The Fed will shoot to lower the unemployment rate to the full employment level, and this means the new target could be more 5.5 percent, not 6.5 percent.”

    DOLLAR DIVE

    The dollar <.DXY> slipped to a near four-week low against a basket of currencies, with the euro up more than half a U.S. cent at $1.3370 after hitting its highest in almost three weeks and sterling at an eight-month high. <GBP/>

    The greenback proved more resilient against the yen, which was hampered by its status as a safe haven and pared early losses to stand at 98.76. Liquidity was lacking, with Japanese markets closed for a holiday on Monday.

    In the latest U.S. data, industrial output rose 0.4 percent in August, as expected, while manufacturing output rose 0.7 percent, a slightly faster rate than had been forecast.

    MSCI’s broadest index of Asia-Pacific shares outside Japan <.MIAPJ0000PUS> had gained 1.8 percent overnight as South Korean shares <.KS11> added 1 percent, Australia’s <.AXJO> rose 0.5 percent and Indonesian stocks climbed 3.4 percent <.JKSE>.

    PUSHING OUT THE HIKE

    Sentiment was underpinned by Saturday’s deal between Russia and the United States to demand that Syrian President Bashar al-Assad account for his chemical arsenal within a week and let international inspectors eliminate all the weapons by the middle of next year.

AMP Portfolio Overview : Higher Stock Prices Are Set In Place

The Apprentice Millionaire Portfolio ( available from amazon.com) sets three criteria in selecting investments :

In order

1) forecast for the economy THEN

2) select the sectors to benefit from that forecast And Finally

3) in your own and the Jack A. Bass Managed Accounts, select the stocks that will do best in the selected sectors.

So, first ascertain :

Where are the most important economies ( U.S. and China ) headed in the next 12 to 36 months ?

China’s economy showed fresh signs of resilience in August, with key trade data pointing to a sustained strengthening in global demand for goods from the country.

Exports continued to gather steam, rising 7.2% in August from a year earlier, according to data released Sunday by the General Administration of Customs. This was up from a 5.1% rise in July and a contraction of 3.1% in June. Imports rose 7.0% from a year earlier in August, down from 10.9% in July.

The overall picture was of a Chinese economy benefiting from progressive strengthening of demand in the U.S. and other key export markets. China is also continuing to stock up on raw materials for its industrial sector. “China’s back,” said Stephen Green of Standard Chartered Bank. “It won’t be a strong recovery but it’s increasingly clear we’ve bottomed.”

AND the reason is U.S. growth leading to increased demand for products from China.

One sector that benefits is shipping because that increase will be moved by ships.


AFP/Getty ImagesEnlarge Image

China’s trade surplus strengthens in August on strong exports driven by U.S. demand.

August’s trade numbers are the latest in a series of positive data releases, after overseas sales and factory output in July showed signs of improvement.

There are still some questions surrounding the sustainability of the current upswing.

Rising wages and a stronger currency dent the competitiveness of China’s exports. Beijing’s recent moves to slow lending growth — after years of credit-fueled economic expansion — could curtail investment and imports.

Still, two months of stronger data has increased optimism that the government will be able to hit its full-year target for gross domestic product growth, which stands at 7.5%. It also reduces the chances that leaders will introduce a major new stimulus policy.

Economists have responded to the signs of strengthening by edging up their growth forecasts. J.P. Morgan now expects 7.6% year-on-year growth in the third quarter, up

their growth forecasts. J.P. Morgan now expects 7.6% year-on-year growth in the third quarter, up from a previous forecast of 7.4%, which points to an acceleration from 7.5% growth in the second quarter.

China’s trade surplus widened, with the difference between exports and imports growing to $28.5 billion in August, up from $17.8 billion in July, marking its highest level since January.

Syria: War and Equity Returns

English: Brasilia - The president of the Syria...

English: Brasilia – The president of the Syrian Arab Republic, Bashar Al-Assad during a visit to Congress Português do Brasil: Brasília – O presidente da República Árabe Síria, Bashar Al-Assad, em visita ao Congresso Nacional (Photo credit: Wikipedia)

The U.S. and its allies are under increasing pressure to take some action other than humanitarian aid ever since the chemical attack took place. However, overthrowing Syrian President Bashar al-Assad could create a vacuum that Al-Qaeda or some other hard line Islamist group would be happy to fill. Any military action could be a show of force to punish, rather than remove al-Assad. Nobody in the West wants the Syrian civil war to spill over into other countries, which could lead to a much larger conflict and cause oil prices to spike. This in turn would be a negative for the market and for corporate earnings.

Equity Returns Following Wars

I don’t mean to sound callous about any of this but my job is to look at it from an economic perspective. The historical performance of the market following the outbreak of both major and minor wars seems to indicate that, regardless of the actions taken by the U.S. or UN forces, there will likely not be a lasting effect on global equity markets.

For the moment, assume these recent developments drag the U.S. into the middle of another civil war in the region and ground forces are brought in to stop the killing of Syrian civilians. History teaches us that wars are not harbingers of bear markets. Certainly in the short run conflicts can cause the market to drop as people fear the worst and investors’ risk aversion tends to increase.

However, when you look at historical equity returns following the outbreak of a war, you’ll find the wars seem to have a slightly positive impact on the equity markets. There are many examples of this throughout history. One year after the start of WWI in 1914, the Dow Jones Industrial Average (the Dow) dropped 0.98%. Five years after the start of the war to end all wars, the Dow was up 25.54%. From the start of WWII on September 1, 1939, the Dow increased 11.95% after the first month and five years after the outbreak of WWII the Dow was up 8.81%.

These were the two biggest wars of the century and the market shrugged them off and continued higher, although at an annualized rate of appreciation that was lower than the historical average. If you look at some of the smaller wars, the return of the market following the start of fighting is more positive.

In a small conflict the increase in government spending likely helps push GDP growth and corporate earnings higher and is generally positive for the market.

After the start of the Korean War, which like the Vietnam War, was a proxy conflict between the United States and the U.S.S.R, the Dow was up 4.17% after 3 months, 7.36% after 6 months, 15.13% after one year and 110.30% after 5 years. The time period following the start of the Vietnam War in 1962 was not a particularly good time for stocks but not terrible either. Six months after it began, the Dow decreased by 17.56%, but after one year the market was down only 5.15%. Five years after the conflict began the Dow was up 20.11%.

Recent Conflicts

The results are similar for more recent wars. One year following the start of the first Gulf War on August 2, 1990, the Dow was up 4.95% and five years after the start it had increased 63.73%. One year after the start of the war in Afghanistan on October 8, 2001 the Dow had decreased 17.27%, but that had more to do with the tech-led bear market than the war. Five years after the start, it was up 30.77%. The start of the Iraq War in March, 2003 didn’t rattle the market at all as we were in the early stages of a five-year bull market. One year after the start, the Dow was up 23.24% and five years after the start it was up 43.46%.

Since a ground assault at this point seems unlikely, the most similar situation we can compare it to is the Yugoslavian Civil War. When I say similar, I am referring to the military action taken by the U.S., not the reason for the initial conflict. The Civil War started in 1991 but didn’t end until NATO forces ended the war with an air campaign designed to destroy the Yugoslav military infrastructure in 1999. If you’ll recall, 1999 was a great year to be invested in stocks with the Dow rising 25.22%. As I stated earlier, any military action taken against Syria will most likely be a targeted bombing campaign, and based on the historical data it appears that even when the conflict has the potential to drive oil prices higher as was the case in the Gulf Wars, the market does not necessarily perform poorly in the five years following the start of the conflict.

Putting it All Together

It is still unknown how world governments will respond to the tragedy happening in Syria. There is always the possibility that the conflict could lead to a large scale confrontation, with Russia and China intervening on behalf of their commercial ally Syria. Such an event would be a worst-case scenario and would cause the market to sell-off. I feel though that such a scenario is highly unlikely to occur as it is in no country’s best interest for the conflict to escalate. In the current globally interconnected world, no country benefits from the higher oil prices that result from instability in the Mid-East.

I do believe some form of military action will almost assuredly be taken against al-Assad’s regime. If the goal of such action is to punish Assad or just take out his chemical weapons facilities, it will most likely be a non-event as far as the stock market is concerned. I remain far more concerned about the lack of robust corporate earnings growth than the fallout from increased military actions in Syria.

Build Your Portfolio On A Solid Foundation : All You Need To Succeed – in 500 pages of Investing Strategy and Selections


Stock Market Magic: Building Your Apprentice Millionaire Portfolio 2012: All you need to succeed in today's stock market

Available at http://www.amazon.com

Stock Market Magic:

Building Your Apprentice

Millionaire Portfolio

 All you need to succeed in today’s stock market [Paperback]

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All You Need To Succeed – in 500 pages of Investing Strategy and Selections


Stock Market Magic: Building Your Apprentice Millionaire Portfolio 2012: All you need to succeed in today's stock market

Available at http://www.amazon.com

Stock Market Magic:

Building Your Apprentice

Millionaire Portfolio

 

 All you need to succeed in today’s stock market [Paperback]

Jack A. Bass (Author)

5.0 out of 5 stars  See all reviews (2 customer reviews) | Like 1678

Price: $28.95 & this item ships for FREE with Super Saver Shipping

All You Need To Succeed – in 500 pages of Investing Strategy and Selections


Stock Market Magic: Building Your Apprentice Millionaire Portfolio 2012: All you need to succeed in today's stock market

Available at http://www.amazon.com

Stock Market Magic: Building Your Apprentice Millionaire Portfolio 2012: All you need to succeed in today’s stock market [Paperback]

Jack A. Bass (Author)

5.0 out of 5 stars  See all reviews (2 customer reviews) | Like 1678

Price: $28.95 & this item ships for FREE with Super Saver Shipping

Number of S&P 500 Companies Reporting Negative Guidance a Red Flag

By Michael Lombardi, MBA for Profit Confidential

Standard & Poor’s, the credit rating agency, believes the likelihood of the U.S. credit rating being downgraded in the near term is less than 33% (one in three) and it has decided to keep its credit rating on the U.S. economy at AA+, slightly lower than the best investment grade. (Source: Standards & Poor’s, June 10, 2013.)

This may be good news to the politicians who continue to believe there is an economic recovery in the U.S. economy, but it’s not enough to convince me.

In March, 47.7 million Americans, or 23.1 million households, were on some form of food stamps in the U.S. economy. (Source: United States Department of Agriculture, June 7, 2013.) This is more than 15% of the U.S. population.

And instead of people moving away from the government’s help, as would be the case during economic growth and a recovery, dependence on the government is actually increasing. Food stamp use in the U.S. economy was lower at 44.5 million in March of 2011.

Economic growth in the U.S. economy means job creation and consumers increasing spending—we have the exact opposite today.

After 2009, we had a sense of economic growth in the U.S. economy as demand in the global economy meant many multinational American companies were able to sell their goods for a profit outside the U.S. But as the global economy struggles now, it’s a different story.

For the second quarter of 2013, 116 companies in the S&P 500 have provided corporate earningsguidance; 93 of them have provided negative guidance. The ratio of companies providing negative guidance compared to companies providing positive guidance has hit the highest level since the first quarter of 2001! (Source: Thomson Reuters Alpha Now, June 10, 2013.)

Going back to Standard & Poor’s keeping the U.S. economy’s credit rating unchanged…it doesn’t mean much. We are far away from economic growth, and the troubles in the global economy continue to be a major hurdle.

American companies have plenty of cash on hand; but because they hold a very gloomy view of the U.S. economy, they are shying away from spending their money. So instead of our economy recovering on its own, we have money printing and government spending trying to help our situation—both of which failed miserably for the Japanese economy.

Michaels’s Personal Notes:

I can’t stress this enough: troubles in the eurozone are far from over.

First and most important, the strongest nations in the eurozone are experiencing an economic slowdown now too. As I have written before, France and Germany are seeing diminishing demand.

Finland, one of the financially strongest nations in the eurozone, fell into a recession in the first quarter of this year. Why? Exports from Finland are declining due to economic slowdown in the eurozone area, unemployment is increasing, and the government has introduced spending cuts. (Source: Wall Street Journal, June 5, 2013.)

The European Central Bank (ECB) expects the eurozone economy to shrink by 0.6% this year, lower than its previous estimate of 0.5%. In the first quarter of 2013, the eurozone experienced its sixth consecutive economic slowdown. (Source: Associated Press, June 6, 2013.)

Regardless of what you hear or don’t hear in the popular media, don’t believe for a second that the economic slowdown in the eurozone is going away anytime soon. The region is struggling with extreme levels of unemployment—the highest ever just recorded in April.

Some countries in the eurozone such as Ireland, Greece, and Portugal have now reached debt-to-income ratios (what the government spends compared to what the government brings in) above 300%. (Source: The Guardian, June 9, 2013.)

We have heard the head of the ECB say that the central bank will do “whatever it takes” to save the eurozone. But Germany is challenging this notion. The President of Germany’s central bank is expected to testify in front of the court and say it is illegal to bailout bankrupt eurozone countries; it puts no limit on the country’s spending and it’s essentially a way to give loans to governments of other countries. (Source: BBC News, June 11, 2013.)

You need to keep in mind that Germany was at the forefront when it was trying to help the eurozone after the debt crisis hit, sending the eurozone into a downward spiral; if Germany backs away from this “whatever it takes” stance, the outcome will not be good.

The eurozone’s economic slowdown is very important to observe, because it affects us here at home—in the profits of American companies and their stock prices.

What He Said:

“A Stock Market’s Obituary: It is with great sadness that we announce the passing of the Dow Jones Industrial Average. After a strong and courageous battle, the Dow Jones fell victim to a credit crisis and finally succumbed on Friday, October 3, 2008, when it fell decisively below the mid-point between its 2002 low and its 2007 high.” Michael Lombardi in Profit Confidential, October 6, 2008. From October 6, 2008 to November 27, 2008, the Dow Jones Industrial Average experienced one of its biggest two-month losses in history.

 

The Japan Economic Disease

English: Portrait of Milton Friedman

English: Portrait of Milton Friedman (Photo credit: Wikipedia)

The Japanese are rapidly coming to their own Endgame, the end of their ability to borrow money at interest rates that are economically rational. If interest rates on Japanese bonds rise to a mere 2.2%, 80% of tax revenues will go just to pay the interest on their debt. At a 245% debt-to-GDP ratio, they are in desperate straits, and they know it. And desperate times call for desperate measures.

To get to where they want to go, to grow their way out of their deflationary problem, the Japanese need both inflation and real growth. Real growth can come from massively increased exports, and inflation can even come from an increase in export prices. Both results can be obtained by weakening the yen. As I have shown, they need to devalue the yen by 15-20% a year for many years in order to break through to the other side.

That should be easy, at least in theory. Inflation, Milton Friedman famously said, is “always and everywhere a monetary phenomenon.” If you want to create inflation and devalue your currency, just print more money. A second shift in the print shop is in order, and if that doesn’t produce the desired results a third shift can be arranged, and then you can run full tilt on weekends. And soon maybe it will be time to build another print shop.

But that is the theory. In practice it may be harder for Japan to grow and generate inflation than it might be for other major nations. Today we’ll focus on Japanese demographics. . The forces of deflation will not go gently into that good night.

 

The Demographics of Doom

Creating inflation is the goal, but Prime Minister Abe and Bank of Japan Governor Kuroda face a very difficult task. Unlike in Zimbabwe, Argentina, and a host of other countries with defunct fiat currencies, in Japan it is not simply a matter of racking up untenable amounts of debt and then printing tons of money. If it were that simple, inflation would be rampant in Japan, for the Japanese have borrowed more than any country in modern history (relative to their size). And while their efforts to create inflation have been futile, it is not for lack of trying: the Japanese have been actively pursuing quantitative easing for many years. Carl Weinberg of High Frequency Economicswriting in the Globe and Mail, gives us a very succinct summary of the Japanese dilemma:

The National Institute of Population and Social Security Research projects that Japan’s working-age population will decline over the next 17 years, to 67.7 million people by 2030 from 81.7 million in 2010. We select 2030 as the endpoint of today’s discussion because almost all the people who will be in the working-age population by 2030, 17 years from now, have been born already. Immigration and emigration are trivial. The 17-per-cent decline in the working-age population is a certainty, not a forecast. It averages out to a decline of 0.9 per cent a year. In addition, these official projections show a rise in the population aged over 64 to 36.9 million in 2030 from 29.5 million in 2010. If the labour-force participation rate stays constant, we estimate the number of people seeking work in the economy will fall to 56.5 million by 2030 from 65.5 million today and 66 million in 2010.

What happens when a nation’s population declines and the proportion of working-age people decreases? In the first, simplest, level of analysis, the production potential of the economy declines: Fewer workers can produce fewer goods. This does not mean GDP must decline; productivity gains could offset a decline in the labour force. Also, an increase in the labour-force participation rate could mute the effect of a declining working-age population. However, even if the labour force participation rate were to rise to 100 per cent by 2030 from 81 per cent today (which it cannot, because some people have to care for the old and the young, and some are disabled or lack adequate skills or education), there would be fewer workers available in 2030 than there are today.

With fewer people working, the burden of servicing the public-sector debt will be higher for each individual worker. We project that the debt-to-GDP ratio and the debt-per-worker ratio will grow unabated over the next 17 years and beyond. Also, the rise of the ratio of retired workers to 32 per cent of the population from 23 per cent means that people who are still working in 2030 will have to give up a rising share of their income to support retirees. The disposable income of the declining number of workers will fall faster than the decline of production and employment. Overall demand of workers will decrease – with their disposable income – faster than output for the next 17 years at least. Demand will also fall as new retirees spend less than in their earning years.

Based on demographic factors alone, the decline of aggregate demand between now and 2030 will exceed the decline of output, creating persistent and widening excess capacity in the economy. Prices must fall in an economy where slack is steadily increasing. In addition, advancing technology will likely increase output per worker in the future. With overall demand and output falling, productivity gains will lower labour costs and add to downward pressure on prices. Disinflation and deflation are the companions of demographic decline.

Andrew Cates, an economist for UBS, based in Singapore, published a penetrating study on the relationship between inflation and demographics this week. He notes that countries with older populations tend to have lower inflation. That is not what the textbooks suggest, but it’s what the data reveals:

Since ageing demographics will now start to feature more prominently in the outlook for many major developed and developing countries this is clearly of some significance for how inflation might evolve from here. By extension it could be of greater significance for monetary policy settings and the broader outlook for global growth and financial markets as well.

Let’s first look at the evidence. In the chart below we show average inflation levels over the last 5 years plotted against the 5-year change in the dependency ratio. The latter is the ratio of the very old and the very young to the population of working age. A shift down in that ratio implies that the population in a given country is getting younger (and vice versa). The chart therefore shows that those countries that have been getting older in recent years have typically faced very low inflation rates and, in the case of Japan, deflation. In the meantime those countries that have been getting younger in recent years, such as India, Turkey, Indonesia and Brazil, have faced relatively high inflation rates.

Abe has proposed an economic reform package comprising “three arrows”: aggressive monetary easing, labor and other structural reforms (which will be politically very difficult to achieve) intended to induce private-sector growth-promoting investment, and a flexible fiscal policy (whatever that means – I guess, since it’s “flexible,” it means whatever he decides it means).  He gave a speech this week on those reforms, and the market promptly threw up. The “reforms” he touted were more of the same old same old. At dinner on Wednesday night, Art Cashin modified the opening line from the old Longfellow poem: “I shot an arrow into the air… and it landed in my foot.”

Not that I think Abe had much choice. He has a critical election next month. Touting a policy that allows employers a freer hand in firing workers is not likely to win over many voters, but he must get serious about reform if he is to have any hope of limiting the disaster he faces.

Banzai! Banzai! Banzai!

The Japanese are charging the deflationary battle lines, crying “Banzai!” This attack is all or nothing. I think the Japanese are offering us investors their flank. This week’s action in the markets showed us that this battle will not be one-sided. It will often get ugly. But I want to keep reiterating what I have been saying for a long time: shorting the Japanese government is the trade of the decade. That is the largest position in my personal portfolio, and it is going to get larger, as I intend to fully swap the mortgage I just took out this week into yen. As I said to Tom Keene this morning, it is my intention (more accurately styled as hope) to let Abe-san and Kuroda-san pay for a large chunk of my new apartment through their policy of destroying the yen. I have to admit to feeling good when the yen backs up like it has this week, since that gives me a chance to get my trade on at a better entry.

Best Stock Market Indicator Ever

AMP welcomes guest contributions. The views presented here do not necessarily represent those of AMP

See Is This the Best Stock Market Indicator Ever? for a discussion of this technical tool.

The charts below are current through the week’s close.

 

Monthly OEXA200R Over the Past Few Years

 

Click to View

 

Interpretation:

The OEXA200R ended the week unchanged at 88%.

Of the three secondary indicators:

  • RSI is POSITIVE (above 50).
  • MACD is POSITIVE (black line above red).
  • Slow STO is POSITIVE (black line above red).

Commentary

According to this system the market is tradable.

The “Printing Press Bull Market” continues. It could be seriously argued that since 2009, Fed intervention in its various forms has for all practical purposes simply camouflaged a second full blown Great Depression. Realistically however, Fed Chair Bernanke can only feed the economy so many cans of QE Red Bull before it eventually crashes. Consider the following realities:

  • After five years GDP remains feeble. 
  • U6 (actual) unemployment is over 14%. Many of the long term unemployed will never gainfully work again because they have either gone on disability or their skills are so rusty that employers will never hire them for the equivalent of their former positions. For many of those lucky enough to find work it doesn’t provide as much income as their old job did.
  • The gusher of money coming out of the Fed hasn’t yet caused overall inflation to increase, true – just inflation of the stock and now housing markets. But how can a country print an ocean of new money out of thin air attached to a stagnant GDP without eventually causing inflation? It’s never happened before in history and it won’t happen this time.
  • Southern Europe is in a full blown modern Great Depression, unemployment and other indicators make that clear. The relatively healthier economies of northern Europe continue to drag that ball and chain behind them with no end in sight.
  • The events in Cypress have been nothing short of eye-popping. The global banking system is built on solid faith that depositors can park their savings in an account and have it protected from robbery, as opposed to hiding their cash in a mattress. Cypress, however it turns out, has severely undermined that faith. The idea that a bank can engage in the financial equivalent of internet gambling, reap enormous profits if the gamble succeeds (not to be shared with depositors, of course) but can without warning raid depositors’ accounts if the gamble fails, ignoring deposit insurance and myriad law is mind boggling. And this idea had the quiet approval of the I.M.F. (meaning, the U.S. government). As hair brained as the Cypress precedent is, similar “bail-in” noises are even coming out of Canada.
  • But really, how fragile is the economic picture? Here’s one indication: Atty. General Eric Holder (for Pres. Obama) recently stated that he would not criminally pursue the mega-thieves at Bank of America, HSBC and other too-big-to-jail banks because it would just be too “unsettling” for the economy. The Attorney General is afraid to enforce the law against the largest, most dangerous financial criminals in world history, that’s how fragile it is.

The force driving the S&P to new highs is not actual economic recovery but mass delusion. The idea that no matter what – hell, high water, incompetence or criminality – the U.S. Government will do whatever it takes to keep the systemic banks afloat. That, and the assurance that the Fed will also go to any economically irrational extreme to keep Wall Street and those banks happy (since those banks ARE the Fed, that’s no surprise). All in the slim hope that if the bogus appearance of recovery and prosperity can be maintained for long enough, actual recovery and prosperity will somehow materialize in time. But in the certainty that either way those who control Wall Street and the systemic banks will continue to make a fortune.

The recent bull market in the S&P is based on the same mass speculative self-delusion that has characterized every other financial bubble since the Tulip Mania of the 17th century. Will the market crash next week or next month? Probably not. But all the other bubbles eventually ended, and in the same way that this one eventually will.


Background on How I Use This Indicator

The OEXA200R is a valuable metric used to accurately assess the state of the market in order to make profitable trading decisions. That is, whether we are in a bull, a bear or transitioning from one to the other, as well as market volatility and risk within each of those situations. Historically, it has also given traders a clear early warning signal of impending serious market downturns and later safe re-entry points. While not intended as a day trading tool per se it can certainly be used as background information by day or highly speculative traders. Simply put, the OEXA200R gives traders the ability to identify the most opportune conditions within which to execute their various long, short or hold strategies.

Following a major market correction, the conditions for safe re-entry are when:

   a) Daily $OEXA200R rises above 65%

And two of the following three also occur:

   b) RSI rises over 50
c) MACD black line rises above red line
d) Slow STO black line rises over 50 and is also above red line

Without the solid foundational support of two out of three secondary indicators it is unsafe to trade even if OEXA200R edges above the 65% line. Once two turn positive, the market is considered safely tradable as long as OEXA200R remains above 65%. Volatility and risk for long traders are relatively low. The trend is on their side.

When Daily OEXA200R drops to 65% it is taken as the conservative signal to exit all long positions, sit on the sidelines with your cash and wait for some clarity before proceeding. Volatility and risk increase substantially. Since 2007, this has often been a “tipping point” condition presaging a major market drop.

If the OEXA200R does not rebound but remains below 65%, how to proceed depends on the overall trend of the market, the macro-picture. During the cyclical bull of 2003 to 2007, the market was still safely tradable with OEXA200R in the 50% to 65% zone because there was enough upwelling lift in the S&P at that time to minimize the chance of a sharp, significant market downturn.

The problem is that we can by no means confidently compare our present situation to that of 2003 – 2007. There is no strong, steady wind pointing the market weathervane in one direction, it is being buffeted by swirls and gusts in unpredictable ways. To better understand this, take a look at the charts below, in particular the overall trend of the OEXA200R during the 2003 – 2007 cyclical bull compared to the trend from 2007 to present.

 

Click to View

 

 

Click to View

 

The S&P chart indicates that for the past five years we have not had a steady upwelling trend in the market comparable to 2003 – 2007. Absent that underlying support, the OEXA200R has undergone significant gyrations since 2007. Notice also that even in spite of the Fed-fueled rally, the S&P volume has experienced a steady decline since 2009, a classic Bear indicator.

If the OEXA200R drops below the 50% line we regain clarity as to the market’s direction. That will be the strong signal to exit any remaining long positions immediately in expectation of a serious, imminent market decline. Conversely, it will also be the clear signal to go short to take advantage of that sharp decline.

In my opinion, the most significant indicator of where we stand today is the fact that the market is above both its 140 year historical trend line and the trend line for the secular bear that began in 2000. These are the marco-forces that will gravitationally pull the market back into equilibrium at some point in the near future.

How far will the market drop? QE3 might save the day once again, temporarily. But in light of the factors mentioned above, it should come as no surprise if by 2014 we end up experiencing a market event worse than that of 2008 – 2009. Luckily, OEXA200R should give us ample advance warning of the next major correction however we want to trade it. Buckle up!

 


NoteStockcharts.com offers free access to the $OEXA200R indicator on a daily and weekly basis. The monthly view requires a subscription. Stockcharts allows users the option to download the last two years of indicator data. Unfortunately, I have not found a source for longer-term $OEXA200R data for performance back testing. Meanwhile, here is a link to a chart that gives a better look at the correlation between the $OEXA200R and the S&P 500 over the past decade.

 

 

(c) John F. Carlucci

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