History Vs Kool Aid
, On Friday May 7, 2010, 3:12 pm EDT
It now appears the 14-month old bull market that so many analysts, mutual fund managers, investors and Wall Street types said would perpetually continue, has changed its mind. In fact it appears, all along it was never really a new bull market, but a bear market rally cloaked in sheep’s clothing.
A 1,000 point fall within a half-and-hour’s time has a direct and nasty way of communicating its ultimate message. And now a host of new old problems are on the table. Let’s analyze just a few reasons why the odds of an extended bear market significantly jumped.
European Blues
It wasn’t that long ago the euro dollar (NYSEArca: FXE - News) was touted as the world’s very next reserve currency and the heir apparent to the US dollar. Now it appears, Europe’s (NYSEArca: VGK - News) conquest will have to wait.
Greece is expected to receive a $145 billion lifeline from other European countries (NYSEArca: EZU - News) and the International Monetary Fund (IMF). Has anybody wondered who funds the IMF? With about 20%, the U.S. is the largest contributor to the IMF. Greece is another U.S. bailout in disguise.
What about France, Switzerland and Germany who own nearly $300 billion worth of
At the beginning of the year, the ETF Profit Strategy Newsletter predicted sovereign defaults, such as Greece, to be one of the mega themes for 2010 and recommended to stay away from European equities and the euro. In January, $1.30 was given as target for the euro. Already, the euro has fallen below that level.
The concerns about the global ripple effect of sovereign debt defaults, is seen by the decline in the broad international MSCI EAFE Index (NYSEArca: EFA - News). If you think China (NYSEArca: FXI - News) can fix it, consider this: The
Spending Our Way to Prosperity
Has any nation anywhere ever printed or spent its way to economic prosperity? No doubt, low interest rates and easy money has been a significant contributor to the 70% rally in the Dow (DJI: ^DJI), S&P (SNP: ^GSPC),
An honest evaluation of the U.S. economy reveals not a true economic recovery, built upon sustainable earnings growth and a healthy job market, but rather, a false economy manipulated by massive infusions of government stimulus money.
Never before has the Fed or the government spent such enormous amounts of money so recklessly. There is no telling what such spending will do. To some degree, the government’s spending spree is a Black Swan event. By extension, the effects of government spending - such as rallying equities - are a Black Swan event. Do you want to bet on a Black Swan event?
More certain than betting on a Black Swan turning into profits, are historic patterns.
Historic patterns show that the government has a spotty track record when it comes to intervention.
Consider the Glass-Steagall Act - a law designed to control speculation - which was established in 1933, one year after the Great Depression in stocks ended and repealed in 1999, just before the 2000 bear market started.
Can the U.S. spend its way out of a recession? Easy money has certainly delayed the inevitable, but can it eliminate the inevitable?
History vs. Kool-Aid
The past few months have been an epic fight between sentiment readings and momentum. Thus far, momentum has carried prices higher and defied the validity of sentiment readings. For the market to move higher, it would have to invalidate many decades worth of generally accurate sell signals.
Here are a few of the extremes recorded over the past few months that unequivocally add weight to the sell side of the ledger:
- April 12, 2010: VIX (Chicago Options: ^VIX) drops to 15.58, the lowest level since July 2007.
- April 14, 2010: The CBOE Equity Put/Call Ratio drops to 0.32, the lowest reading in nearly ten years.
- April 21, 2010: Investors Intelligence (II) bullish advisors clock in at 53.3%; the highest reading since 1-12-2010 (53.4%) and December 2007.
- December 30, 2009: Investors Intelligence bearish advisors drop to 15.6%, the lowest level since 1987.
- February 2010: Mutual fund cash levels drop to 3.5%. This matches the July 2007 all-time low. Fund cash levels are a valuable contrarian indicator as they reflected the herding behavior of fund managers.
- March 2010: Investors’ cash allocation (polled by the American Association for Individual Investors - AAII) drops to 18%, the lowest level since March 2000.
- April 19, 2010: Buying climaxes spike to 467, one of the ten highest readings in 20+ years. Buying climaxes take place when a stock makes a 12-month high, but closes the week with a loss. They are a sign of distribution and indicate that stocks are moving from strong hands to weak ones.
- April 22, 2010: Insiders are selling nearly eight stocks for every one they buy. The eight-week insider sell/buy ratio is well above 4:1. Sell/buy ratios above 2.5 are considered negative.
- April 27, 2010:
- April 2, 2009: The Financial Accounting Standards Board (FASB) is forced to change rule #157. This change allows banks (NYSEArca: KBE - News) and financial institutions (NYSEArca: XLF - News) to overstate toxic assets and sweep ‘unrealized losses’ under the carpet. Earnings from the financial sector are thus exaggerated.
- April 2010: Earnings increases are based on cost cutting and lagging revenue growth. David Rosenberg reports that the surprise factor (the gap between expected numbers and actual numbers) for earnings is 21%. Excluding financials, the surprise factor would be around 10%. The surprise factor for revenue, however, is a disappointing 3% (including financials) and zip if you exclude financials. In other words, companies in general beat their earnings forecast but revenue is flat.
This lack of revenue growth suggests that consumers aren’t spending and that profits are still driven by cost cutting. Lack of consumer spending is easily explained by a look at consumer confidence and employment numbers.
After a fierce 13-month, 75% rally in stocks (NYSEArca: VTI - News), led by financials (NYSEArca: IYF - News) and technology (
Seeing the Warning Signs
Contrarian investors know and appreciate the value of sentiment indicators. Sentiment indicators flashed a sell sign in 2000 and 2007 and a buy sign early in 2009. A few weeks ago, the ETF Profit Strategy Newsletter identified the most pronounced, composite sell signal in recent history.
- April 12, 2010: VIX (Chicago Options: ^VIX) drops to 15.58, the lowest level since July 2007.
- April 14, 2010: The CBOE Equity Put/Call Ratio drops to 0.32, the lowest reading in nearly ten years.
- May 5, 2010: Investors Intelligence bullish advisors spike to 56%, the highest reading since late 2007.
- May, 2010: Mutual fund cash levels for March drop to 3.4%, the lowest level in history.
- May 3, 2010: Buying climaxes spiked to 1,079. An all-time record
Getting Ready for the Next Big Move
The list goes on, but its core is this simple fact: When so many indicators are so unanimously aligned, something big is about to happen!
If you step back and look at the bigger picture, this makes sense. The 2007-09 decline was the biggest decline since the Great Depression. The 2009-10 rally was the biggest since the Great Depression.
The next leg of the decline will likely have Great Depression like features and is likely to be proportionate to the 2007-09 and 2009-10 moves. In other words, it will be massive.
The ETF Profit Strategy Newsletter consistently keeps track of the above-mentioned indicators and many more purely technical gauges (like a master dashboard) to formulate a short, mid and long-term forecast.
A balanced, common-sense, out-of-the-box analysis is the only way to survive the financial carnage just ahead. Are you ready?
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