Wednesday, September 3, 2014

Message from Top Managers: “Prepare for Turmoil”

by Sprout Money

It is slow season in the media and things have significantly calmed down on the financial markets as well. It is so quiet you could hear a pin drop, which is tremendously frustrating, because a market without direction is the last thing an investor wants. Investors are being lulled to sleep and in practice that usually leads to unpleasant surprises once tension returns to the markets. We are, moreover, in a sort of transition phase for the large group of retail investors who are getting sick and tired of the fear of a market correction; year after year they waited for a correction worthy of mention which should have followed in the aftermath of 2008. Even more, the most important market indices are at their highest levels… ever!

Investors are suffering from ‘crash fatigue’. They no longer fear a new market correction, because ‘it is not going to happen anyway’. Although their timing and attitude might be questionable - the current bull market has been going strong for more than 5 years - they are happily participating in the stock market. The fact that investors would pick this moment for a large scale change in sentiment is worrisome in our opinion, however. You know as well as we do that everyone is positive at the top of the bull market and, although we would not say that every investor is all-in at the moment, we are getting dangerously close to a consensus.

That is also the opinion of former Fed Chairman, Alan Greenspan. This man is responsible for the expansive monetary policy of the ‘90s, which was at the base of the hefty market correction around the turn of the century. Greenspan knows what he is talking about. In a recent interview with Bloomberg he pointed out that the surge in the stock market will inevitably lead to a strong correction, even more so because the equity risk premium (versus bonds) is not attractive enough. He did going into specifics about the possible timing of this correction, however.

More and more of the world’s top (hedge) fund managers are joining in. It will probably not be a surprise to you that the most critical investors, like Marc Faber, have been underlining this for a while already. It is much more interesting, however, to look at investors who felt positive until recently, among which is Jeffrey Gundlach. The ‘Bond King’ has clearly changed his mind about the markets and he is also one of the best market timers in the financial world. Gundlach has become increasingly cautious about stocks in particular and he feels that the stock market is generously valued in this economic climate. He foresees profits declining in the near future, which does not bode well for share prices. Gundlach also noticed that the masses are increasingly invested in the stock market; never before have investors taken on so much debt in order to buy stocks on the NYSE.

NYSE margin debt

Source chart:

This is also an indicator that seems to have hit its ceiling. When ‘margin debt’ declines, you can expect a strong correction; another great point from Gundlach. However, talking the talk does not equate to walking the walk. That is something we do not see yet in his case. Especially not with regards to stocks. He is taking up a position indirectly by doubling down on a further increase in bond prices, however, which is obviously the area where the Bond King feels best.

A reknowned investor that did take action recently is George Soros. As a speculator, Soros became (in)famous for betting against the British Pound. The fall of the currency turned him into a billionaire and gave him premier status as a speculator. Over the last few years, George Soros was mostly enjoying the rise of the stock market and dabbled a little bit into commodities or commodity related segments (such as gold mining stocks). In his latest fund report it became clear, however, that Soros is increasingly protecting his capital from a future market correction (through put options on the S&P 500). He increased his short position on the S&P 500 index from 299 million USD to 2.2 billion USD, which is an increase of more than 600%. The size of the position within Soros’ total fund was raised from 2.96% to almost 17%! Of course, we have to add that the rest of the billionaire’s portfolio remains strongly invested in stocks. The purpose of this position is to hedge his current positions against a potential (and temporary) bad stretch on the market.

George Soros does have remarkable timing. Do not forget that the S&P 500 recently crossed the 2,000 points level, which was also our 2014 target for the index since the end of last year. From our point of view, there are 2 possible scenarios now. Either the rally pushes on and transforms into a true melt-up as a result of mass buying (from short covering) or the rally dies down and turns into a a swift correction. The former breakout level between 1,500 to 1,600 points would be the next station if that happens.

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