Total Capitulation of the Bears

by Pater Tenebrarum

One of Wall Street's “Biggest Bears” Throws the Towel

Recently we have come across one of those forecasts that are a dime a dozen these days, and usually escape out attention. The article at Marketwatch, entitled “Bull could run 5 more years, carry S&P 500 close to 3,000” only seemed interesting because the forecast sounded a bit extreme. We quickly scanned the headline, thinking that whoever was making this assertion surely hadn't breathed a word about this when the SPX traded at just below 670 points in March of 2009. Such wildly bullish forecasts are strictly a function of SPX 2000 in our opinion, on a par with the “Dow 36,000” forecast, which gained some notoriety in the late 90s. One of the reasons behind the SPX 3000 forecast mentioned in the article did amuse us greatly though, namely the following:

“They cite extensive deleveraging in the U.S. as well as the uneven global recovery among other reasons why “this could prove to be the longest U.S. expansion – ever.”

Extensive deleveraging! Right.

“Extensive US deleveraging” in one comprehensive chart – click to enlarge.

However, in the meantime we have found out via Barry Ritholtz that the man making the prediction was hitherto apparently “one of Wall Street's biggest bears”:

“Until not so long ago, Morgan Stanley’s Adam Parker was one of the most bearish analysts on the street. […]

Following last year’s 30% S&P 500 rally, he has had a change of heart. He now has a 3000 upside target for the S&P 500.”

This background information actually does make the forecast a bit more interesting. It is yet another indication that bears have really capitulated across the board.

Recent Data – Yet Another Record Falls

In this context, take a look at the most recent Investor's Intelligence survey. Not only has the bull-bear ratio been at a 27 year high for two weeks in a row (i.e., a reading last seen in 1987),  but the percentage of bearish advisors has actually declined to a record low (as far as we know it was never lower) – only 13.3% of all advisors surveyed by II still declare themselves to be bearish:

The II survey exhibits the lowest bear percentage ever – click to enlarge.

This is of course in line with the other sentiment and positioning data we have frequently discussed in recent weeks, such as the extremes in the Rydex ratio (currently the Rydex bull/bear asset ratio stands at 17.75, i.e., it has surged back to a level close to the recently recorded record high of 18.51). Volatility and trading volume are both exceptionally low as well.

Interestingly, although margin debt has expanded again after its initial dip from the all-time high recorded earlier this year, it only managed to rise to a slightly lower high. This is an especially interesting divergence, as a roughly similar sequence has occurred near every major peak: first, margin debt expansion “goes parabolic”, then the total amount outstanding begins to dip a few months ahead of the peak in prices, and subsequently doesn't manage to make it back to its cyclical high. Interestingly, in spite of margin debt rising to a lower high, negative investor net worth is at a new record -  a sign that the cap-weighted indexes are masking internal weakness. This is of course confirmed by other technical data which we have recently discussed (see “Internals Are Weakening”).

NYSE margin debt bounces to a lower high after peaking earlier this year. Note the similarities between the last three parabolic advances in margin debt (chart via Doug Short) – click to enlarge.

Negative investor credit balances reach a new record in spite of the SPX reaching a new high and overall margin debt only rising to a lower high – this means that the average portfolio held by investors must be weaker than the cap-weighted indexes suggest – click to enlarge.

Finally, here is a long term chart of the NAAIM net fund manager exposure survey. What makes this data point interesting is that the recent pattern – i.e., the divergence of net exposure to prices – has been following a path that is by now beginning to look eerily similar to that of 2006-2007:

NAAIM survey of net fund manager exposure (replies ranging from “200% short” to “200% long” are possible). The divergence with the SPX is by now very similar to that seen in 2006/7 – click to enlarge.

Conclusion:

The so-called “wall of worry” is certainly no longer in evidence. Stock market bears seem to have given up entirely. Of course this capitulation has been a process rather than an event, and has been going on for some time now. Still, new records are seemingly made every month.

Fairly brisk money supply growth and extremely low rates have so far helped the market to recover from every correction attempt, with volatility contracting ever further in the process. Keep in mind though that even when both valuations and sentiment data are at or near extremes, it is still possible to get a blow-off move as a kind of last hurrah – this happened e.g. in late 1999/early 2000.

As to valuations, while the cap-weighted indexes appear still well below the peak valuations of the late 90s bubble, the same is not true of the average stock. While in the late 90s a handful of big cap tech stocks greatly distorted the total market P/E, a great many genuinely cheap stocks were available at the time (the entire “value” universe was quite subdued valuation-wise). This is definitely not the case this time around. It seems that both sentiment and valuations are at or near historical extremes. Investors may well be sitting on a powder keg.

See the original article >>

Queen - Who Wants To Live Forever

"Who Wants To Live Forever" There's no time for us, There's no place for us, What is this thing that builds our dreams, yet slips away from us. Who wants to live forever, Who wants to live forever.....? There's no chance for us, It's all decided for us, This world has only one sweet moment set aside for us. Who wants to live forever, Who dares to love forever, When love must die. But touch my tears with your lips, Touch my world with your fingertips, And we can have forever, And we can love forever, Forever is our today, Who wants to live forever, Who wants to live forever, Forever is our today, Who waits forever anyway?

Obviously Not A Bubble

by Tyler Durden

See the original article >>

End-to-end game

by The economist

Commodity-trading houses are growing—and running more risks

BANKS, harried by regulators and short of capital, are fleeing the commodities business. Deutsche Bank, Morgan Stanley and UBS either shuttered or shrank their commodities operations last year; this year Barclays, Credit Suisse and JPMorgan Chase have scaled back. But even as they retreat, commodity-trading houses, most of which began life as simple middlemen, are getting ever more deeply involved in the extraction, shipping and refining of raw materials. The buyer of JPMorgan Chase’s physical commodities unit, for instance, was Mercuria, a ten-year-old firm based in Switzerland that started out trading oil but now owns (or has joint ventures with) oil-exploration companies, oil-terminal and pipeline operators, coal and iron-ore mines and biofuel refineries. Vertical integration of this sort gives trading operations more flexibility and brings valuable commercial intelligence, but it also pushes the firms into capital-intensive businesses and compounds their exposure to the commodities cycle. America has some big commodity firms, including Archer Daniels Midland, Cargill and Koch Industries. But the real behemoths are based in Switzerland. Vitol, which started out in 1966 trading oil products along the Rhine, had $307 billion in sales in 2013. In addition to its trading business, it also owns or charters ships to transport crude oil, petrol, gas, coal, chemicals and sugar (200 are at sea at any time); refines 350,000 barrels of oil a day and owns a power plant in Britain. Glencore had $233 billion in sales last year. It both mines and markets coal; its oil businesses span exploration and distribution and its agricultural assets include farms, processing plants, storage and distribution. Trafigura, another commodities giant based in Switzerland, had sales of $133 billion in 2013. It too takes a cradle-to-grave approach: the firm’s oil business, for instance, includes everything from exploration to petrol stations.

Such integration may improve trading margins, but only by getting the commodities firms into lots of low-margin, capital-intensive businesses like shipping and mining. It may work well when commodity prices are stable or rising, but it leaves them woefully exposed to the next recession. In spite of their size, the trading houses have only limited pricing power in markets that are highly cyclical and far more prone to unanticipated events (such as war, nationalisation, financial crises and other black swans) than, say, the market for detergent. As traders, they could ride out and often profit from such crises. But the assets they are snapping up will become far less valuable if the global economy sours. Big oil firms are pursuing the opposite strategy: selling infrastructure in an effort to improve returns. Carlyle International Energy Partners, an investment firm, estimates that they have $300 billion of assets on the block.

The commodities firms’ growing integration is also attracting the attention of regulators, particularly in America and the European Union. They fear that the traders’ ownership of infrastructure allows them to manipulate local prices, even if they do not have the heft to rig global markets (an American regulator accused the unit JPMorgan Chase sold to Mercuria of such behaviour last year, and extracted a $410m penalty). Earlier this year Mukhisa Kituyi, secretary-general of the United Nations Conference on Trade and Development, accused the industry of “corruption and illicit financial flows” and “large-scale trade mispricing” in developing countries. The Swiss government, for its part, says the industry must be more transparent, while the Swiss parliament is examining its record on human rights and the environment. It is not just the commodities cycle that can turn.

See the original article >>

The big freeze

by The Economist

Throughout the rich world, wages are stuck

CENTRAL bankers once used to inveigh against wage inflation. Guarding against a return to the ruinous price-wage spirals of the 1970s was a constant preoccupation. Since the financial crisis, however, they have started to fret about the opposite concern: stagnant wages and the growing risk of deflation.

There has been a squeeze on pay in the rich world for several years now. Between 2010 and 2013 real (inflation-adjusted) wages were flat across the OECD, according to its annual “Employment Outlook”, published on September 3rd. Real wages have barely grown at all in America over that period and have fallen in the euro area and Japan (see chart). Declines have been particularly sharp in the troubled peripheral economies of the euro zone, such as Portugal and Spain, but real wages have also tumbled in Britain. In most advanced countries—though not in Britain or Italy—labour productivity is picking up again. Moreover, the downward pressure on wages from high unemployment is easing in some countries, including America and Britain (in the euro area, alas, the jobless rate is still 11.5%). Yet even though unemployment in America has dropped from a peak of 10% in late 2009 to 6.2%, growth in even nominal wages (ie, not adjusted for inflation) is tame. In the private sector, they had been rising by around 3.5% a year before the crisis, but are currently increasing by less than 2% a year. In Britain, where unemployment has fallen from a peak of 8.4% to 6.4%, nominal pay is growing by 0.6% a year, far below the pre-crisis average of 4%.

Divergent trends in the supply of labour help to explain why the pay squeeze has been more intense in Britain than in America. The British labour participation rate—the proportion of adults who are either in work or looking for jobs—has returned to its previous peak of almost 64% and looks set to rise further. By contrast, America’s participation rate has declined by three percentage points since the financial crisis and is now bumping along at around 63%.

Working out to what extent the low participation rate is structural, meaning that it will persist, rather than cyclical, caused by a weaker-than-usual recovery, will be crucial in determining when the Federal Reserve raises interest rates. The Fed has seen quiescent nominal wages as evidence the labour market has more slack than falling unemployment suggests. But Janet Yellen, its chairman, recently said that the weakness in wages might be deceptive. New research by the San Francisco Fed suggests that many employers froze pay during the recession because workers resist cuts in nominal pay more fiercely than the erosion of their purchasing power by inflation. Employers, unable to reduce wages when times were bad, have not been raising them now that times are better. But once this “pent-up wage deflation” has run its course, pay growth might take off.

Such a rebound may occur outside America, too, since there has been a widespread—although by no means universal—reluctance to cut nominal wages across the OECD, according to this week’s report. Between 2007 and 2010 there was a big jump in the share of workers whose wages remained flat in nominal terms. In Spain, for instance, the proportion of full-time workers having to accept pay freezes rose from 3% in 2008 to 22% in 2012.

Weak Japanese wages are worrying Haruhiko Kuroda, who as governor of the Bank of Japan is in charge of his country’s latest attempt to vanquish deflation. A new programme of quantitative easing—creating money to buy bonds—has been more successful than previous, half-hearted attempts to get prices rising again, but wages have remained sluggish. Although cash earnings jumped by 2.6% in the year to July this largely reflected bigger bonuses; regular pay rose by only 0.7%, well below the newly revived level of inflation. Mr Kuroda recently said that a “visible hand” was needed to co-ordinate higher wages.

Such a solution smacks of desperation but it might work in Japan, which retains its currency. It would not make sense for the euro area, the other big economy where deflation remains a risk. Prices rose by just 0.3% in the year to August, but in a currency club it is vital to allow wages to rise and fall freely to provide the internal equivalent of fluctuating exchange rates.

If wages in Germany rise, the downward adjustment in less competitive economies in the euro zone need not be so severe. That is why Jens Weidmann, the head of Germany’s central bank, has been calling for higher pay—a daring step in a country of inflation hawks. The European Central Bank, which cut interest rates this week, could also act more boldly to raise inflation towards its target of almost 2%. That would allow the euro zone’s invalids to regain competitiveness through wage freezes rather than outright cuts.

Wages, of course, are not just important to central bankers. Weak pay saps revenue from income tax and social-security contributions, making it harder for governments to mend public finances. The lack of growth in real wages hurts household finances, too, keeping consumers tight-fisted. A healthy and sustained recovery in the rich world will remain elusive until the pay squeeze ends.

See the original article >>

3 Things Worth Thinking About

by Lance Roberts

["3 Things Worth Thinking About" is a weekly publication of ideas, usually contrarian to the consensus, to provoke thoughtful discussions and decision-making processes. As a portfolio manager and strategist, I am sharing things that I am considering with respect to current investment models and portfolio allocations. Please feel free to email or tweet me with your comments and ideas.]

Surge In Sentiment Surveys

There is an interesting divergence going on between sentiment based surveys, specifically the ISM Manufacturing and Non-Manufacturing surveys, and actual underlying economic data.  This week saw both surveys rise sharply to cyclically high levels despite weakness in actual new orders and consumer consumption.

It is also somewhat intriguing that two groups measuring the same data are getting vastly different results.  While the Institute of Supply Management survey saw sharp increases in optimism, Markit's surveys of the same manufacturing and services related data saw declines. This is one of those cases where only one can be right.

The chart below shows the composite index of the ISM surveys (simple average of manufacturing and services data).

There is a running pattern in the surveys which the initial decline mid-economic cycle reverses back up to cycle peaks. The next decline in sentiment is during the latter stage of the economic cycle prior to the onset of the ultimate recession. The recent surge in survey activity, ex-underlying strength in the actual data, suggests that sentiment is anticipating a recovery that may or may not occur.

The chart below shows just the ISM Manufacturing survey compared to core-durable goods orders.  Core-durable goods are ex-defense and aircraft orders which is a better metric of what the average consumer is doing.  The data, however, is very volatile, so I have smoothed with the monthly changes with a simple 12-month average.

Because I have smoothed the data with a 12-month average there is a slight lag to the data.  However, what is clear is that there is a very high correlation between core-durable goods and manufacturing sentiment.  Currently, sentiment is well ahead of actual activity which suggests that either the economy is about to come roaring back to life, which is what has been priced into the financial markets currently, or there will be disappointment.

There are a couple of important considerations with respect to your outlook with how this will ultimately be resolved. As I will discuss in just a moment, despite the ECB's attempt to stimulate the Euro-economy the deflationary pressures are picking up steam and the majority of economies are slowing. With 40% of domestic corporate profits coming from the global community, the Eurozone is the largest consumer, it is very likely the economic drag will be felt in the U.S. soon.  Secondly, the U.S. is about to enter back into a period of the year where unseasonably cold weather will resurface once again.  It is currently estimated that this winter will be as cold, or colder, than last which resulted in a 2% decline in economic activity in the first quarter of this year.

ECB Buys Bonds - Expects A Different Result

The European Central Bank announced this morning, much to the delight of stock market investors, that they are lowering interest rates from 0.15% to just 0.05%, which results in a negative real interest rate for depositors, and will begin buying asset backed bonds from its members.  Via CNBC:

"Draghi announced the ECB would purchase asset-backed securities (ABS) and covered bonds to boost the economy and boost inflation."

If the goal of boosting inflation and the economy through buying bonds sounds oddly familiar, it is because it is exactly what the Federal Reserve and Bank of Japan set out to do.  In both cases, it was a significant miss.  The U.S. economy has muddled along with economic growth and inflation running below 2% with Japan just printing a near 7% drop in GDP despite a program three-times the size of the U.S. on a relative basis.

The issue of the inability to translate monetary policy into actual economic prosperity is something I discussed at length yesterday wherein I quoted Brad Delong:

"Instead, despite the absence of a significant increase in employment or a substantial increase in inflation, the Fed already is cutting its asset purchases and considering when, not whether, to raise interest rates."

In other words, what the Federal Reserve has figured out is that they are creating another asset bubble that must be unwound to some degree before it bursts. With interest rates at the zero-bound, an important tool of the Federal Reserve to support economic growth in the future has been exhausted. This leaves them few options for the future.

The interesting aspect to this is that despite expressed concerns by the Federal Reserve of inflated areas of the asset markets, the momentum chase has continued pushing asset prices to all-time highs.  Likewise, the influx of liquidity by the ECB will likely push assets even further creating the anticipated "melt-up" in asset prices in the months ahead.

However, what is becoming abundantly clear, is that these monetary programs and interventions have little effect on the middle class which is where the most help is really needed.

What is that old saying about repeating an action and expecting a different result?

Interest Rates And Sentiment

While the ECB's actions certainly aren't likely to cure the real problems that plague the Eurozone, primarily financially insolvency, what is clear is that investors love the idea of "more" liquidity.  David Tepper of Appaloosa Management tweeted out this morning following the ECB's decision to buy bonds that this is "the beginning of the end" for bonds.

As Zerohedge aptly noted:

"Empirically, Tepper may be right: in the past every time a central bank has launched a massive easing program (think QE1, QE2, Twist, QE3, etc.) it resulted in aggressive stock buying offset by bond selling. The issue is when said programs came to an end, and led to major selloffs in equities, pushing bonds to newer and lower record low yields. So perhaps for the time being, we may have seen the lows in the 10Year and in the periphery.

More importantly, it also explains why central banks now have to work in a constant, staggered basis when easing, as the global capital markets simply can not exist in a world in which every single central bank stops cold turkey with...liquidity injections."

I seriously doubt this is the end of the "bond bull" due to many reasons I will discuss next week.  However, with respect to the ECB's decision the size and scope of the purchases fall well short of the broad, large-scale asset purchases advocated by many economists (similar to the measures used by the Federal Reserve). While the announcement was "bullish" for investors wanting liquidity, it will likely have little effect on the broad deflationary pressures that are keeping rates under pressure.

However, as I stated, bullish sentiment was bolstered by the news. The chart below shows the composite index of both individual and professional investor "bullish vs. bearish" sentiment. Currently, the index is at levels reached only once before in the history of the data.  At 3.02, the index signals extreme bullish sentiment in the short term and is at levels that exceed all previous minor and major market peaks.

While there is currently no "technical" reason to become overly cautious on the markets (bullish trends are still firmly in place), there are many reasons to be "aware" of the rising risks.

Market reversions, when the occur, are extremely rapid and tend to leave a rather brutal "scar" on investment portfolios. There is clear evidence that economic growth is being impacted by deflationary pressures on a global scale. This suggests that the sustainability of current and projected growth rates of profits is questionable given the magnitude to which leverage has been used to boost margins through share repurchases. Manufacturing profits through artificial means, ie. cost cutting and share repurchases, are finite in nature, and most of the benefit of such activities have already been fully harvested. If the current rise in sentiment surveys is not met with actual activity in the near future this could pose a problem for over zealous investors.

See the original article >>