Price To Book Ratio

My multi-month world trip with my wife (who is Austrian – nationality rather than economic school of thought) and 2 kids (who are 6 and 10) begins on Tuesday, starting with a week in Singapore, adopted home of Jim Rogers. He has said that a smart man would have moved to London at the start of the 1800s, to New York at the start of the 1900s and to Asia in the early 2000s, anticipating Asia to be the economic power of this century. He believes today’s Asian work ethic is the same as the USA used to have. I hope to get a feel for that myself. After Singapore we travel by land into Malaysia, and from there into Thailand. We intend to visit quite a few countries around the world, so if I am coming to your neck of the woods, and you have a few tips on what to do, what to see, where to eat or where to stay, let me know. John (at) solarcycles (dot) net. I will keep you updated of our route. My posting times will change, due to the time difference. Also I may not be able to achieve the same depth or frequency. But over this important time (when it is ever not?) I will absolutely still be sharing my thoughts and actions, and looking for your continued input.

OK, to the markets. This week’s data looks like this. US earnings are now overall slightly negative year on year but slightly above pre-season expectations (which was for worse). US economic was data overall mixed, but Economic Surprises are still strong (now standing at +51.7). Conference Board global leading indicator data has generally disappointed for this month. Australia -0.8 (last month zero), Eurozone -0.4 (last month +0.5), China +0.3 (last month +0.7). That data is a warning flag because the global improvement seen in September over August may be being reversed. Eurozone PMI came in lower than expectations and sets the scene for a negative GDP reading.

Source: SoberLook / Markit

Technically pro-risk has been pulling back en masse, but without obvious recipients, as treasury bonds, corporate bonds and gold have not advanced. I’m not quite sure what to make of that development, but we will find out soon. As per my last post, I believe that the next move will be a counter rally in pro-risk and there is some evidence that we may be reaching the kind of bearishness that may initiate a snapback:

Source: Sentimentrader

After this coming Monday’s full moon the pressure should change to positive, coinciding with positive seasonality into and around the US election. Again, as per my last post, I will be looking for an up move with negative divergences (in economic data and technicals) for evidence a cyclical equities topping has begun (and to sell into the up move), or for positive developments to accompany the up move and to suggest that the sell-off we have seen was rather a post QE announcement normal pullback based on unimpressive earnings. Tom Demark believes the Nasdaq has made its price peak already and the counter rally due will therefore fall short, whereas he believes the SP500 will make a marginal new high, before both then retreat 12-17%.

The Hang Seng has held up relatively well during this last 2 weeks and has maintained its long term triangle breakout. Treasury yields have also performed bullishly. Gold sentiment has pulled back sufficiently to enable a renewed move higher, and the 1700 level that it has currently reached represents a 38 fib retracement of the recent up move.

Source: Sentimentrader

Below is my recent prediction for stocks and commodities into 2013. Now if stocks top out lower than 1600 on the SP500 and have begun their topping process already then that is still consistent with historic mirrors (only the peak price level would change), as long as commodities now go on to outperform and make their blow off secular top. The rise in treasury yields despite the pull back in pro-risk is a positive for this scenario because by history yields need to rise as money flows out of safe havens into pro-risk, and if equities are stalling then commodities should be the recipient. The current threat to this scenario is the renewed weakness in global data (leading / concurrent). I maintain there needs to be sufficient health in the global economy into 2013 to enable a broad secular commodities blow-off top. Gold could potentially go its own way – operating as a hard currency and safety asset – but right now it isn’t showing any outperformance. And one last thought – if a renewed global turndown did gather pace right ahead, then might the Fed step in once again, this time with one of its as-yet-unused unorthodox policy tools, which could then inspire a mania into hard assets if desperation was perceived? It may not work again but could provide a tipping point into hard assets.

Well, that’s just speculation. We will see how things develop. Any cyclical stocks top should be a drawn out rounded affair so there is no rush to action. And the leading commodity in this secular commodities bull, gold, is in a bullish technical position, having broken upwards out of its 11 month consolidation. Collectively, when stocks and commodities make their next up trend move – whether that be counter or renewed trend – more evidence will come to light.

Regarding US stocks, if we cross reference the closest percentage correlated periods from history in terms of chart action to date together with presidential election seasonality (i.e. periods into the US  election like now) as well as previous secular stocks bears / secular commodities bulls periods then the closest mirrors from history are shown below:

Source: MRCI

Both have chart correlation percentages over 80%, both 1944 and 1972 were US election years and both fell within secular stocks bear / secular commodities bull periods, and the combined prediction would be for an up move next into and around the US elections, which is consistent with expectations further up the page. No guarantees of course – just a guide.

Lastly today, price to book ratio.

Price to book ratio (p/b) is an alternative valuation measure for stocks to price/earnings. A p/b ratio of 1 is the theoretical liquidation value of a company or stock index, i.e. assets minus liabilities. Buying a stock at a p/b sub 1 is either getting a bargain or there is something wrong with the company. Shown below is the p/b ratio for US and Europe indices since 1975 to current. The best time to buy a porfolio of the two would have been 1981/2 when they both dipped under p/b 1.

Source: Seeking Alpha / MSCI

The cheapest stock indices valuations globally that have ever been witnessed were in Thailand at the time of the Asian Financial crisis (late 1990s) and Greece in the Euro debt crisis of current times. Greece hit a price/earnings valuation of sub 2 at its lowest whilst the Thai SET reached a p/e of 3.

Here is the Thai SET long term p/e valuation chart, showing a double dip to around 3 in that crisis period. The Thai SET is currently 4 times higher now than then, so buying Thai stocks when the p/e was 3 would have been a good investment.

We can also see the p/b ratio hit its lowest around then also, to around 0.6, which again would have been a great entry point, with markets overly discounting bad scenarios.

A snapshot of global stock indices p/b valuations in 2011 looked like this. Greece was the cheapest on a p/b of 0.76. The great majority of other countries, ranging from G10 to developing nations ranged from a p/b of over 1 to sub 3, with a few rogue outsiders more expensive than p/b 3.

There is no question in my mind that the Greek stock index will return handsomely in the long term for those brave enough to have ventured in at its lows this year and last (it has currently doubled off its lows). The risk is that it tanks again, once or more, before rallying in earnest, subject to developments in Europe and the wider world. Now that is has doubled, its valuation by p/e or p/b is no longer cheap but mid-range globally. But, like the Thai SET in the late 1990s, the point is to buy in at a p/b some way below 1 and be patient.

So, it is interesting to see Japanese stocks at a p/b ratio of just 0.77.

 Source: Vectorgrader

Whilst price/earnings valuations haven’t dropped so extreme low (13.7 Nikkei, 10.9 Topix currently), the price/book ratio reveals a much more compelling undervaluation, suggesting the liquidation of all Japanese companies in the Nikkei would actually return almost 25% more cash than it costs to buy them currently.

Since the 1989 Nikkei peak, the index has gradually been making what appears to be a rounded bottom. Recall the 19 year cycle showing up in the Dow Jones stock index spectrogram? Well, from the Nikkei peak to the nominal low to date was 19 years. Just speculation that it may have relevance here, but if the rounded bottom continues its trajectory then that nominal low of Oct 2008 should hold.

Underlying source: Ed Yardeni

In support of that price bottom holding, the price to book ratio of 0.77 is historically extreme. It is in the same zone as the Thai SET at the worst of the Asian financial crisis and as Greece in the Euro debt crisis accuteness. It is also little higher than that reached at the Nikkei’s nominal Oct 2008 bottom.

So are the Japanese stock indices a great buy and hold opportunity here?

To answer that we have to consider its debt and deflation problem that has plagued it throughout its decline since 1989. It has the highest debt to GDP ratio in the world. However, unlike other indebted countries most of this debt is held domestically, by the Japanese people. This makes Japan less likely to be a default candidate, particularly given the Japanese culture. However, it has to keep rates low to service the debt and pursues inflationary policies which would help shrink the debt. Until now though it has failed to re-ignite inflation despite its policies. It is heading for one of two outcomes: debt default – which I believe is unlikely (at least in this decade) – or inflation finally takes hold and yen-weakening becomes the trend. Given the yen has been in a 30 year bull market since the early 1980s making for extreme relative historic valuation to other currencies, and real estate prices have dropped to 36% below long term averages in terms of both versus rent and versus income, and equities have reached extreme historic p/b cheapness valuation, I believe there is a strong possibility that money now starts to pour into the inflationary assets or equities and real estate (over months and years).

So what about the p/e valuations not having reached sub 10? Well, that is a thorn in the side of the undervaluation story, however, Japanese p/es average higher historically than other countries. Nikkei and Topix p/es are actually lower now than they were at the bottom of the 1970s secular bear.  On p/e alone I would not be a buyer but it is the p/b valuation that really shows the current value on offer. If further casts doubt on a deep stocks bear ahead – at least in that part of the world, with also Chinese equities on a p/e of just 7.9 paying dividend yields of 3.8.

In terms of Japanese equities I believe it is more likely they can further their rounded bottom. The historic extreme undervaluation for real estate and historic extreme overvaluation for the Yen is also supportive of a wider risk/safety inflation/deflation asset reversal. I maintain we are in the transition years from global secular stocks bear to global secular stocks bull and K-winter to K-spring, and that this is also supportive.

My average Nikkei long position is 8481 (current price 8913). I have added to that this morning with a view to a longer term hold based on the above.

Edit: One more chart to add that I missed off: Japanese equities now yielding more than Japanese bonds, adding to their relative attractiveness.

Source: Daily Wealth

 

Cyclical Stocks Bull Topping Indicators

This is how some of the key stock indices currently stand. The FTSE 100 is trying to break out of a long term triangle.

On the nearer term view, however, it has been turned away at declining resistance. The question is whether this is a fifth failure since the cyclical bull began in 2009, or whether it is consolidating before it finally breaks through.

The Hang Seng, meanwhile, has now broken out of its similar long term triangle, and it is breaking out on a p/e of 11, which is historically relatively cheap. Unless it is pulled back in this week then that break would be validated.

On the nearer term view, it can be seen that it is now up against another resistance level: the March 2012 highs. So if it is to be pulled back into that long term triangle range, then here is a level to be repelled at. Two things to keep an eye on therefore.

The German Dax is also into a zone of importance. Below is the horizontal support of the March 2012 highs which it appears to have successfully backtested, whilst above is the cyclical bull high-to-date resistance (from 2011) around 7500. It additionally has the support of a rising channel to potentially take the index up to that resistance level. A break of either support would turn things more bearish.

Meanwhile, the Nasdaq in the US is in a different place. Unlike the indices above, the Nasdaq reached far above its 2011 highs already, early in 2012. It since then rose above those 2012 highs (in March) to higher highs (in September) but has failed to hold above. The chart below shows that this could be meaningful.

The near term action since September has produced a little series of lower highs and lower lows, which suggests a new bearish trend. On the flip side, the index is nearing oversold, approaching RSI 30.

Clearly the Nasdaq has some way to fall before dropping out of the bottom of its cyclical bull channel and officially into a new bear market, but we should not need to wait for that to be able to judge whether the cyclical bull has topped out. One topping signal would be a major distribution day near the top, and we saw that on Friday. Another would be that cyclical stocks such as Techs break down first and money roates into defensive stocks. Techs are the weakest sector currently. US earnings are now overall flat year-on-year, which actually beats expectations (which were for shrinkage), but tech stock reports particularly have disappointed.

So the question is, are we seeing the first part of a topping process, with techs leading us down first, or are we just seeing some current weakness particular to tech stocks and their poor earnings (overall US earnings are so far flat, which actually beats expectations), with some knock on effect from the Nasdaq index onto other indices? With different indices around the world in different positions, it’s not clear, but there are some other common characteristics to cyclical stocks bull tops, so let’s review:

1. A topping process, normally months, with reversals of reversals of reversals in a range

This chart shows the last two cyclical bull market tops highlighted. Both topping processes lasted around a year, and within the boxed ranges there are both double tops and double bottoms, reflecting the reversals of reversals in a range criteria. If we are seeing a top on the SP500 currently, then we should see this play out into next year, with some sideways volatility to make a topping process. That should allow the 200MA to catch up and then the market can slice through it to begin a new cyclical bear. Could the topping process have begun in March this year at the lower peak? If so, we should still see more up/down oscillation as the market gradually rolls over.

Source: Ed Yardeni

2. Evidence of overbought and overbullish extremes (such as RSI and sentiment surveys)

I’ve done some checks on this and the evidence isn’t very compelling that this actually correlates with a cyclical bull top, namely because of the sideways ranging. These indicators can flash at the start of a topping process, as an up move rolls over into ranging, but thereafter don’t hold persistently.

3. Breadth divergence (such as new highs / new lows and advance-declines)

Cobra’s chart here shows how at the 2007 cyclical bull top for the SP500 price made a higher high whilst advance-declines made a negative divergence. This shows narrower participation compared to a healthy rally which is based on broad participation.

Source: Cobra / Stockcharts

Chris Puplava’s chart here shows that in the run up to the previous cyclical bull top of 2000 shares hitting new lows in the NYSE (SP500 and Dow) exceeded those hitting new highs, which again is a signal of a narrowing rally.

Source: Chris Puplava

This is how things stand today. NYSE (SP500 and Dow) advance-declines are still in an uptrend. For topping evidence, we would want to see a pullback in stocks and this ratio, followed by a new high or double top in stocks where the ratio negatively diverges.

Source: Stockcharts

And this chart is a cominbation of Nasdaq new highs – new lows and NYSE new highs – new lows. Again, we don’t see divergence yet, so would want the same as above – pullback then push up with negative divergence.

 

Source: Humble Student / Stockcharts

4. Cyclical sectors topping out before the index top and money flow into defensives

Leading into a cyclical bull top, money normally rotates out of cyclical sectors such as technology, consumer discretionary and materials into defensives such as healthcare, utilities and consumer staples. This is because the economy is turning down or forecast to turn down and these sensitive sectors therefore become less attractive. Below we can see that into the 2007 top, two cyclical sectors topped out several months before, whilst one remained strong, but the two were sufficient a clue for a top.

Source: Chris Puplava

Fast forward to today and this is how things stand. SP500 cyclicals have overall been in an uptrend since August and do not show that negative divergence.

Source: Stockcharts

Comparing three defensive sectors to three cyclical sectors below, we don’t yet see defensives outperforming and cyclicals falling away.

XLV Healthcare, XLU Utilities, XLP Consumer Staples

XLY Consumer Discretionary, XLF Financials, XLB Materials

Source: Stockcharts

However, the biggest faller has been tech, and that is a cyclical sector. So, as things stand, I would want to see a couple of other cyclical sectors join tech in underperformance relative to the wider indices, to add weight to a top.

5. Major distribution days near the highs

We got one on Friday so that’s a warning flag.

And in the wider environment:

4. Yield curve flat or negative

5. Tightening of rates through rising yields

6. Excessive inflation

7.  Rolling over of leading indicators and recession model alerts

The below chart captures 4. and 5.

Source: Scott Grannis

Cyclical stocks bulls have historically ended with inflationary and speculative froth, money pouring out of safety and pushing up yields, inflationary pressure and natural tightening tipping us over into recession, and indicators of forthcoming recesssion in evidence before the speculation tops. Is this time different due to Fed intervention in the bond market? I don’t believe it affects the overall mechanism, but perhaps means yields will peak lower than otherwise. I still foresee this excessive speculation and inflation playing out, as per my previous Forecast 2013 posts. Thus far we see a little inflationary froth through grain prices, but little else excessive.

Regarding leading indicators rolling over, a glance at the US ECRI WLI shows an indicator performing quite differently to the last two cyclical bull tops (leading into the grey banded recessions). What we would need to see is this indicator start to roll over and break into the negative. This coming Friday’s WLI reading is forecast to slip to 5.82, so there is a potential seedling for a trend change. But we would need to see a few weeks of increasingly lower readings to be consistent with previous tops.

Source: Dshort

The Citigroup economic surprises index for the US is also in a strong uptrend, and its correlation with the SP500 is shown. Again, it would need to reverse trend for a few weeks and break into the negative to be consistent with previous tops. More often than not, this indicator leads a trend chane ahead of stocks topping or bottoming.

Source: Ed Yardeni

 Turning to the global picture, Conference Board leading indicator latest readings for Germany and Australia this week both came in negative and worse than last month. This is in contrast to the recent general improvement since August in global leading indicators. Once again, we should see a trend change in global indicators back to the negative over several weeks, to be consistent with previous equities tops, i.e. leading indicators should roll over before the definitive top in stocks.

So let me sum up. There are several potential cyclical stocks bull topping signs: techs underperforming, the Nasdaq breaking technically and a major distribution day near the highs. However, this could as yet be a ‘theme’ to US earnings season, namely disappointing tech stocks sell off, infecting other indices, in seasonally weak mid-October, before the cyclical bull continues. To differentiate between the two we should see more bull topping indicators aligning, if this is to be a top, and the whole process should last a while yet. Following the current down move we should see another up move, and perhaps repeat that down-up oscillation one or more times again lasting into the end of this year. In support of this, Tom Demark’s latest forecast is for the SP500 to make a move up again to peak out at 1478-1485 in the next 10-12 trading days and for that to be the high for this year. That would fit with Presidential seasonality being strong into and around the US election.

Should we get that move up, then we should expect to see some negative divergences if this is indeed a topping process, such as narrower participation or economic indicators weakening or underperformance of cyclicals. Should that occur then I will use that strength to sell out of some or all of my stock indices positions.

It is curious to see the Hang Seng breaking out and the Shanghai attempting to bottom whilst the Nasdaq is potentially peaking. How might that resolve? Well, my overall message is that a market top should take some months yet to fully form, so there is no rush for everything to align. Solar and secular history suggests equities should top first and then commodities should make their blow off top. It is therefore appropriate that we see some strength or at least stabilisation in China, as a key demand source for commodities. US indices are also amongst the most expensive by p/e whilst China is in single digits. It would therefore fit if the US indices were to roll over first.

A gradual topping process over a few months (rather than a swift decline) should also enable sufficient speculative froth to produce the inflationary finale whereby commodities make a secular final parabolic and bond yields escalate.

So, I sit on my positions for now. I await a renewed up move in pro-risk after this coming weekend’s full moon and into the US elections, targetting Tom Demark’s range. There I will look for further evidence of a topping process to judge whether to sell out of equities.

Friday Roundup

This is the main story of my year: aggressive buying in stocks and commodities in mid-May, and then largely sitting on the portfolio since then.

It looks straight forward with hindsight, but of course the hardest part has been staying put and resisting selling. Now the key question is whether we are going see further upside into year end, or whether the ‘sitting’ should be brought to an end before then.

Based on solar/secular history, the next top in equities should be a cyclical bull top. Based on cyclical bull history, we might expect an overthrow move as the ending move, and given we have just broken out technically in various indices around the globe we are in a good position for that to now occur. Equities should top out (cyclical top) before commodities (secular top), so timing the exit of stock index longs is the most pressing, I believe.

Cyclical stocks bulls have historically ended with a tightening of rates (yields). Too much money pours into pro-risk and out of safety, there is too much buying, speculation and inflation, until a tightening of yields, or central bank rate tightening chokes it off and tips the economy into recession. See here:

Source: Scott Grannis

We last saw this phenomenon when the last cyclical bull ended in 2007. So the question is, has QE and central bank interference broken this mechanism, or are we headed for the same this time round, namely an overbubbling of growthflation and speculation, before we top out? By solar/secular history, we should indeed be heading for an inflationary and speculative finale in 2013 (analysis and evidence here), so I believe this is going to occur. As yet, we don’t see a particularly strong uplift in inflation around the world, but as per that analysis I believe it is coming, and nor do we see excessive froth in pro-risk or a hasty exit out of bonds. We just see tentative evidence of reflation and so I believe the process has some way to go yet before we enter the likely zone of a cyclical equities top. To support this, we do not see the usual cyclical topping indicators yet such as breath divergence, evidence of distribution and a rolling over of leading indicators.

Those who I read who are largely in tune with my view would include the Puplava brothers and Scott Grannis, whilst those on the other side include Marc Faber and Tiho. Marc Faber has been gradually selling out of long positions and moving to cash since May/June time. Because he has been on the wrong side of it for some months now, I believe he has got it wrong for once and was wrong-footed by developments. I believe the same of ECRI and Tiho who also diverged around the same time. I am going to address some of the points that Tiho makes in this post, so I’ll start with evidence that there is historically low levels of money in cash, as a contrarian indicator to get out of pro-risk.

Reducing interest rates to negligble or zero discourages money from being held on deposit. QE then brings down bond yield rates to negative real levels, including the longer end of the spectrum. This discourages money out of bonds and also is currency-devaluing, which further decreases the attractiveness of holding cash. In this environment it is therefore normal to see historically low cash levels and money market fund flows. Because currencies and bonds have international markets, central bank actions in rates and QE have global affects, producing bubbles in assets and pockets of inflation as we have seen over the last few years. Rare earth minerals are a recent example:

Source: Scott Barber

What rate cuts and QE cannot do is directly bring about economic growth or hiring or lending or consumption. However, they reduce the systematic risk and provide an environment that as far as possible encourages money to be put to work rather than held on deposit. In fact, much of the new money through QE has become banking reserves and is not being lent out. The increase in money supply is balanced by the decrease in money velocity. The US Fed and others are continuing with these measures until they see money circulation pick and growth take off in an enduring way. The risk is that they are pressing on this accelerator for too long and could see a sharp inflationary episode ahead as too much of the new money gets lent out or too much money is chased into hard assets in a low-yield environment.

I do not share the view that central bank actions are impotent, and that once this is recognised the markets will tank. If I am correct in that, then the recent succession of rate cuts, the renewed QE and other 2012 stimulus measures (such as China infrastructure programmes) should produce a global reflation, and I believe we now see evidence that this is occurring.

1. Both the Shanghai Composite stock index (green line) and the Baltic Dry Index have broken up out of falling wedges. Still tentative at this stage, but promising.

Source: Bloomberg

2. The Dow Transports has been catching up the Dow Industrials and shrinking the divergence.

Source: Bloomberg

3. Inflation expectations have picked up.

Source: Scott Grannis

4. Stock market breadth is strong – there is no negative divergence.

Source: SeeItMarket

5. Economic Surprises for the G10 nations have trended up into the positive. Emerging markets are trending down but there is some evidence in leading indicators for improvement ahead.

Source: Citigroup

6. Credit markets have normalised.

Source: Chris Puplava

7. US fundamentals have turned up to follow stocks upwards and resolve the divergence, and they echo improvement in ECRI leading indicators (ECRI WLI growth is forecast to rise again today).

Source both: Ed Yardeni

8. US SP500 earnings so far this season have come in at a 64% beat rate, and show marginal earnings growth year on year. Whilst earnings are not very impressive, the expectation was for negative growth, which so far has not been the case. Google’s report was bad yesterday and dragged down the Nasdaq, but the overall earnings picture has not been so troubling so far. One chart that regularly pops up (in Tiho’s analysis and many others) is this one below, that suggests US corporate profits should come down a long way and mean revert to the historic average importance to GDP.

However, the chart is a red herring because globalisation and the world dominance of multiple US behemoths mean the relation to US GDP is now different. Comparing these global US giants to global GDP is a fairer reflection.

Source: Scott Grannis

9. Global trade may be about to turn up based on global PMIs. This is again tentative but promising.

10. Below top is how the latest Conference Board global leading indicators stand, and beneath that is the table as it was at the end of August. There is a notable improvement across the board, and whilst Japan and Korea are still negative, even they have improved.

Source: Conference Board

11. The combined picture of output, real money and leading indicators in Euroland and China also suggests an upturn.

Source both: Thomson Reuters

I therefore refute assertions that the global economy is deteriorating and that China is heading for hard landing. Whilst both those things could occur at some point in the future, the current picture and near term future show a global economy tentatively reflating and a stabilisation in China rather than an accelerating decline.

Turning to equities, Tiho suggested that  the risk-on correlation between corporate bonds and stocks means that an imminent burst in corporate bonds (which reveal excessive inflows and historical pricing) could spell trouble for equities.

Excessive inflows into corporate bonds reflect excessive pessimism in relation to equities. That excessive pessimism can be seen in equity yields recently diverging. I expect that yield gap to be corrected by flows out of corporate bonds and into equities. I don’t subscribe to the view that flows out of corporate bonds would have negative implications for equities – I rather believe they would be a recipient. Corporate bonds are at the end of a 30 year bull market like treasury bonds, rather than in a decade long secular bear like equities. The yields chart below shows this (inverted).

Source: Scott Grannis

Treasury bonds are potentially making a rounded top (yields a rounded bottom), which by Gann is predicted to be the secular top, and based on internal secular history should be the start of a multi-month decline (or advance for yields). If so, that would again be supportive of the normal unfolding into the cyclical stocks bull top as outlined above.

Source: Stockcharts

Neither of the two most widely-followed US stocks sentiment surveys are indicating excessive bullishness currently. Both these should reach bullish extremes to end the cyclical bull.

Source: Schaeffer Research

Source: Bespoke

And here is Credit Suisse’s global risk appetite updated. Currently around zero it is very neutral, and I would also expect this to reach into the upper extreme in a pro-risk inflationary finale next year.

Underlying Source: Credit Suisse

All things considered, I believe there is sufficient evidence of global reflation to support pro-risk markets, together with a lack of cyclical topping indicators in equities or broader risk excessive frothiness. As always, it’s a probability calculation and I will keep reviewing the technicals and fundamentals as they develop. Things can of course change quickly, but right here right now, I believe the evidence supports maintaining my pro-risk portfolio as it is and further ‘sitting’.

To finish today, a re-sharing of cycles evidence, prompted by Rick’s link. There are many financial markets cycles banded about, but we can verify which are real by spectrograms (for markets with a long enough history). These reveal the greatest concentrations of actual real cycles, shown by the blue lines in the charts below. The first chart is for the Dow Jones and reveals the most important cycles to be 3.5 years (Presidential cycle 4 years plus cyclical bull average 3 years), 9-14 years (solar cycles range from 9 to 14 years averaging 11), 19 years (your causal explanations welcome, readers), 33 years (3 solar cycles or 1 lunisolar cycle) and 44 years (4 solar cycles).

Source: Sergey Tarassov

I suggest this provides good evidence for solar cycles operating in the stock market. It also refutes certain other supposed cycles.

Turning to commodities, here is a spectrogram for wheat. The main cycles are 9-11 years (one solar cycle), 33 years (3 solar cycles or one lunisolar cycle), and something ultra long over 100 years.

Source: Sergey Tarassov

Again, that provides good evidence for solar cycles in the wheat market not only being present but being more dominant than any other cycles.

We can cross reference this with other commodities by looking at long term charts of cattle prices and corn prices with solar cycles and we can see that pattern of price spikes in both every third solar cycle, or one lunisolar cycle, as per my work on my site.

Source: Sergey Tarassov

I did not choose solar cycles to be dominant in my work, but rather, the evidence led me there. If there are cycles in the market, I want to see statistical/data evidence for them, and scientific or logical reasoning. I do not agree with the approach of those who suggest there are cycles in the market but don’t provide a reasoning as to why. With solar cycles, there is both the evidence for their presence and dominance in stocks and commodities, and the scientific reasoning as to why: the biological impacts on humans and their subsequent behaviour in relation to risk-taking, speculation and sentiment.

Global Stocks Secular Bear Market

This is my pattern and projection for the global secular stocks bear market and its conclusion, based on solar/secular history:

That secular bear pentagon is present in the individual main country stock indices. Here is the current UK FTSE and my projection (click for larger):

Here is the German Dax:

Moving to Asia, here is the Japanese Nikkei:

Here is the Hong Kong Hang Seng:

Moving to the US, here is the SP500:

And lastly the Dow Jones:

So, my projection for all the indices is an approximation of that shown on the MSCI world stock index and the FTSE index charts at the top, namely a breakout upwards out of the pentagon into 2013, followed by a giving back of those gains and a retreat to the pentagon nose price level 2013-2014 (leading into and out of a mild recession), followed by a momentum take-off in a new secular bull market as of 2014/15. The US stock indices have led the way out of the pentagon, with the German and Hong Kong indices are now attempting to break out also.

I have added the price/earnings valuations of the indices at the key highs and lows. There is a theme of p/e valuations declining over the secular period, which is consistent with normal secular bear progress. It is inflation that makes secular bears track overall sideways rather than downwards, but progress in p/es reveals the true decline in stocks from expensive to cheap.

Secular bear history dating back into the last century reveals that stocks become a long term buy once they hit single digit p/es. In the secular bear to date, all the indices above have hit single digit p/es for a period, except the Nikkei. Despite falling the farthest in terms of valuation from its peak, the Japan index has only just lately come back to fair value when compared to the other country indices, and accordingly has the sorriest looking chart.

In the secular bear of the 1970s, the Dow Jones hit p/e 7 at its lowest valuation. In the secular bear of the 1940s, the Dow Jones hit p/e 9 at its lowest valuation. I suggest there is a reason why that stock index was bought up at a higher bottoming valuation in the 1940s than in the 1970s: the difference in secular yields/rates. Whilst the 1970s mirrors the 2000s in terms of a secular commodities bull and secular stocks bear, the 1940s is our closest match historically as it is both those but also a secular bonds bull. The 1970s was a secular bonds bear. It makes an important difference, in that equities are more attractive relative to other assets when bond yields and rates are ultra low. These next two charts show how stocks have now moved to relative extreme value versus treasury bonds and corporate bonds by dividend yields.

With both types of bonds paying negligible or negative real yields, the relative attractiveness of equities in that environment becomes that much greater. It is the pessimism that characterises the end phase of a secular stocks bear that is keeping money parked in bonds, but once confidence grows in economic outcomes, money should flow the other way. I am suggesting that stocks could bottom at a 1940s style p/e 9 rather than a 1970s style p/e 7 in this environment because of the additional value provided by dividend yields over and above treasury and corporate bonds and the relative attractiveness of true yielding assets in a negligible interest rates environment (rather than a high interest rates environment like the 1970s).

Solar and secular history predicts an inflationary finale in 2013, which if stocks went nowhere (nominally) would reduce p/e valuations further. I therefore expect that my projection of stocks breaking out and then returning to that kind of nominal level perhaps 18 months hence will see the indices largely breaking beneath 10 into single digit p/es at the ‘go’ point. The US indices, currently the most expensive, would be unlikely to make single digits unless they fell harder than the rest. However, not all indices made single digits at the end of the last secular bear – the Nikkei, for example, ended at p/e 20. The US stock indices have both hit p/e 9 in this secular bear already however, and that is comparable to the bottoming valuation of the 1940s secular bear. In support of this, it can be seen that the German Dax has been bought up each of the three times it hit p/e 9, in 2003, 2009 and 2011.

Key Assets In Charts

The Hang Seng is at long term resistance, attempting to break out. By my secular/solar history analysis, the kind of path shown by the arrow would be appropriate, i.e. a breakout here, a rally away from the range, then a pullback in keeping with a final bear and mild recession before a new secular bull takes off with momentum.

The German stock index and US SP500 stock index share a similar look to each other: battling to hold the breakouts made above the March 2012 highs. My leaning is that they are making bull flags above the breakout, successfully backtesting before advancing. This consolidation of several weeks post QE announcement fits the action post QE2 announcement before advancing, and it also fits with Presidential seasonality, namely a consolidation mid-October before a rally around the US elections.

Crude oil appears to be making a rounded bottom:

Gold has paused at horizontal 1800 resistance, and has made a 23 fib retrace. It could potentially drop further to make a 38 fib retrace, but either way I believe gold will shortly resume its uptrend and break through 1800, targetting the next resistance at 1900. Supporting that, seasonality is most positive for gold Sept-Feb, gold has been building energy in an 11 month consolidation, and if pro-risk breaks out as I predict above, I expect precious metals to also.

The Euro-USD pair is at an important juncture. Either it is completing a bull flag in an ongoing uptrend and is about to break out above horizontal and down-sloping resistance, or its rally is going to end here at those key resistances and it will eventually break down beneath rising support. I favour the former, in line with pro-risk.

A broad agricultural commodities ETF is shown below. After the fierce rally of mid-2012, brought about by extreme global weather conditions, softs have pulled back to between a 38 and 50 fib retrace currently. This is in line with Gann predictions for a partial retrace before a renewed rally to new highs emerges as of now, so perhaps once at the 50 fib, I expect softs to renew their upward trend.

Supporting a rewewed advance in softs, the latest NOAA climate data for September came in as the hottest globally land/ocean for that month on record, and the latest US Department of Agriculture report revealed even tighter grains supply than previously understood.

Supporting a wider rally in pro-risk from here we have (i) US economic surprises still trending up, (ii) US ECRI leading indicators still trending up, (iii) US retail sales and consumer sentiment surprising to the upside, (iv) money supply and export data from China surprising to the upside, (v) money market spreads in Europe and the US back to benign levels, (vi) German investor sentiment rising more than expected. In short there is growing evidence of global reflation, and there is a useful chunk of data coming out this week that will either add to or subtract from that, namely, Conference Board LI data for several key countries, some key China data including GDP, and some big US earnings reports.

I believe pro-risk assets are primed to resume advancing technically, subject to supportive reflation evidence, and that recent data is supportive for reflation. I therefore maintain my pro-risk portfolio as it is.

I have updated all models this morning.

Friday Roundup

This is how the Sp500 stands. The consolidation is comparable after both QE announcements, if the market now proceeds to rally, and it has twin technical support for an uptrend resumption, as shown:

Its a useful triple confluence (channel support, holding above March highs and behaviour similar to the last QE announcement), because a decisive breakdown would swiftly provide 3 reasons to be bearish (i.e. triple confluence failure). I say decisive breakdown, because the market can sometimes make a fakeout to flush out the weak hands, so I’d want to see a couple of consecutive closes beneath the marked zones, to give more weight to the bearish alternative. The positive pressure around Monday’s new moon is still in play if the market can rally today and early next week, which gives us another reason for a renewed rally without delay, if it is going to happen.

The correction so far has largely neutralised indicators, such as II investor sentiment (now more bears than bulls), stocks above the 50MA (now back beneath the mean), and bullish percent / call put (neutral zone). If the correction is going to be a full flush out (or a new bear), then we’d expect these indicators to go all the way to extreme oversold/bearishness, but if this is just a consolidation in an uptrend then they have reset enough to push on again. I am still in the continued uptrend camp, and still expect the SP500 can reach around 1600 before keeling over. I maintain that because we don’t yet see the typical evironment for a cyclical bull market top (yields rising, inflation rising, leading indicators in a renewed downtrend, economic surprises in a downtrend, negative breadth divergence, etc) and that there is growing evidence of reflation.

What few US earnings report there have been so far have on average beaten expectations, but next week will produce a better sample.  ECRI leading indicators rose again last week and this week the shadow index is predicting the WLI growth will rise to 5.53 from 4.67. Conference Board leading indicators for the UK came in positive again today and higher than last month, but we have to wait until the end of next week for other country updates. OECD leading indicators came in unimpressive again this month:

 Source: OECD

The horizontal lines represent historic average growth, not a growth/recession divide, but nevertheless they don’t paint a picture yet of a global economy in resurgence. The particular bright spots in their report were Brazil and UK. There is a potential trend change in China occurring as shown, and the Shanghai stock index continues to look like it may be breaking out of its long term downward trend, plus the Baltic Dry index has risen 40% over the last couple of weeks, so I continue to watch these.

Yesterday grains had a bumper day as the latest US Department of Agriculture report suggested stockpiles will drop more than expected due to the adverse weather conditions and continued robust demand. And the US dollar index made an inverse hammer candle at both horizontal and diagonal resistance.

Source: Stockcharts

That’s only significant if there is now follow through, so again my focus is on how pro-risk and safety behave the next couple of sessions.

Gold And Apple

The exponential or parabolic or Hubbert phenomenon typically looks like this:

Source: Wikimedia Commons

It occurs in nature and it occurs in the markets. Occasionally the exponential run up is followed by a flattening out at the top, to make an S-curve:

Source: Wikimedia Commons

But most of the time there is a collapse down the other side, fairly equal to the run up, and here are some examples of that:

Source: Chris Kimble

Apple is the world’s biggest stock by market capitalisation and now dominates the fortunes of the Nasdaq. Apple’s chart has gone parabolic over the last few years:

Source: Stockcharts / Yahoo

So is it due to collapse? Well, here’s the thing about exponentials: they can get steeper and steeper, putting on faster and faster gains.  Recognising the pattern therefore isn’t enough, plus there is the possibility that a chart that has gone exponential flattens out into an S-curve rather than collapses. Typically, a parabolic that reflects a speculative mania to valuation excess will result in a collapse, whereas a parabolic that reflects genuine growth or fair value may flatten out.

In this next chart we can see that Microsoft was bid up to a forward p/e of 67 in 2000, compared to a historical average around 15. The new internet companies of the time reached 8% of the total US stock market capitalisation, the SP500 reached a p/e of over 40, and the Dow-gold ratio reached an all time high of just under 50. By various measures, it was clear the tech parabolic became a speculative mania, and a collapse followed. Of course, timing the exit from the parabolic was difficult – it only looks easy with hindsight.

Source: Reuters

As can be seen, Apple is currently valued at just a 13.8 forward p/e, which is cheaper than the historical average, and it is cheaper than the majority of SP500 companies currently. So whilst it has exceeded Microsoft’s capitalisation of 2000, it isn’t the same kind of speculative bubble.

The near term view of Apple looks like this. A correction is occurring, following a higher high on negative volume divergence.

 Source: AfraidToTrade

That suggests it may correct further yet, and in so doing it is dragging down the Nasdaq. As the Nasdaq is usually the leading index, other indices are usually affected. So Apple’s fortunes are important. But Apple’s parabolic does not suggest a collapse as its rise is based on genuine growth and its valuation is still relatively cheap. Barring an economic downturn whereby all stocks are affected, I expect Apple to resume its uptrend post-correction, or to flatten in an s-curve if Apple’s growth starts to slow.

Turning to gold, we see the same exponential pattern over the last few years. At any point up the curve a trader could have called a top based on an unsustainable trajectory, but the curve just got steeper. The 9 month consolidation from 2011-2012 brought about bigger calls for a top, but again it appears to be resolving upwards into what should be an even steeper parabolic.

Source: Valcambigold

Assessing the parabolic for gold is more complex than for equities, because there are multiple valuation measures for gold as it fulfils various purposes from inflation hedge to hard currency to commodity. The publisher of that chart compares the percentage of assets in the gold sector as one measure. Certainly the 1% current position is not excessive compared to 26% in 1980 or dot com companies reaching 8% of the US market in 2000.

Valued as a reserve currency in the face of large monetary base expansion, its parabolic appears to reflect genuine fundamentals.

Source: Economicsfanatic

As a non-yielding asset that fares well when real interest rates are negative and declining, it has also been rising at ‘fair’ value.

Source: Moneyweek

However, when we look at its relative expensiveness to real estate or equities, it is into the historic extreme zone. Versus equities, it could yet become more relatively expensive to reach down to the 1980 level, but on this measure alone the gold parabolic does reflect some speculative froth.

Source: Sharelynx

Other ways to value gold include its relative price to food or broad commodities (due to close relations) and the proportion of its demand from investment (central banks and investors) versus supply growth. Drawing all together, I would suggest the picture for gold is one of a parabolic so far based largely on fundamentals, i.e. a genuine ‘growth’ based exponential rather than a speculative mania. However, I also suggest that this is likely to change ahead. I have argued elsewhere that yields should begin to rise now, that ‘investment’ demand for gold is due to top out in the next 18 months whilst supply is already growing, and that a whiff of policy change in relation to rates was enough in the 1940s to kill the gold bull (rather than requiring real rates to go positive). I believe we will get that whiff once we reach an inflationary spike next year.

I predict a speculative mania in gold will occur, based on historical mirrors, and we will then see the divergence from fundamentals that will bring about a huge run up followed by a collapse. But thus far, gold’s parabolic is not particularly speculative, and that does suggest that the Dow-gold ratio could reach 1980s levels before reversing. There is no easy way to time an exit from a speculative parabolic that has diverged from fundamentals, only to recognise it and then choose your weapon. That weapon could be trailing stops, or solar cycle timing, or technical indicators such as overbought/overbullish extremes together with negative internal divergences. But first, let’s look for evidence of transition from value parabolic to speculative parabolic.

Near Term Timeline

Here is a timeline of events into the end of 2012. I place more weight and validity on some of these than others, but it helps to lay it all out. If I’ve missed something you consider important, let me know.

1) US Earnings start tomorrow with Alcoa and continue until Mid-November

2) 12-15 October Carolan crash window

3) US Elections are 6 November

4) Lame Duck Congress session 13 November for decision on fiscal cliff

5) Correction in commodities, and potentially equities too, into around 21 November, based on Gann, before mega commodities rally erupts lasting all 2013

5) Late November market top predicted by Eurodollar COT futures

6) 28 Nov – 7 Dec Puetz crash window

7) 22 Dec last major Bradley Turn of 2012

8) 31 Dec / 1 Jan fiscal cliff comes into effect, if no postponement or change, i.e. tax rises and spending cuts which will hamper the economy

9) Presidential election seasonality suggests equities should consolidate a little here in October and then make a push higher around the election, and potentially even higher by year end:

Source: Bespoke (plus my update in thicker blue of 2012’s SP500)

Source: SeasonalCharts

10) Geomagnetism is seasonally at its tamest in December and January, which coincides with (or belies) the ‘Santa Rally’

Drawing it all together, if we don’t see a crash into this coming weekend (Carolan’s work as highlighted by readers), a little consolidation here in mid-October would be normal seasonally, and is perhaps fitting as we await the ‘theme’ of US earnings (which will not become clear until next week), and for the US election polls to make their telling late swings. Based on the latest odds, President Obama will be re-elected, and this fits with the stock market having made its largest historical gains under his Presidential term. Furthermore, in this scenario historically, a re-elected Democrat President has led to bigger subsequent gains in equities than a switch to Republican. So, as things stand, the rally around the election that has been historically normal, may indeed come to pass again – assuming the polls suggest Obama to win, followed by his actual victory. Perhaps an associated US Dollar rally around the elections could fit with a consolidation in commodities, before they embark on a major rally, as per Gann.

The fiscal cliff will then come back into focus, and we will see whether the fiscal tightening is allowed to come to pass (which will be negative for the  economy) or whether it is postponed or amended. Whilst no President will want to risk sinking a precarious economy, the first year of a Presidency is often used to implement unpopular policies.

We have a market top forecast by Eurodollar COT futures at the end of November, together with a Puetz crash window. Whilst Puetz windows have been very hit and miss, the two combined adds more weight. I am expecting a cyclical bull top in equities ‘soon’ (based on secular and solar anytime as of now through to Q2 2013), but want to see the usual topping indicators present, e.g. a topping range with negative divergence in breadth, overbought and overbullish readings, yields and inflation up, leading indicators and economic surprises trending down. So if enough of these are flagging by late November, which would fit with Eurodollar COT plus Puetz, then I’d be getting out of equities. However, if reflation is just getting going currently, then that may be too soon, and we might look to beyond the Santa (benign geomagnetism) rally of December/January for a top (unless geomagnetism is unseasonally bad).

Bradley Turns I also find very hit and miss, but if 22 Dec is to be valid, then by the theory it can be a top or a bottom. If equities top out late Nov and make a Puetz crash then 22 Dec could mark a bottom, and this would roughly coincide with a bottom predicted by Eurodollar COT. If technical and macro topping indicators are absent in late Nov, then maybe stocks could make a top 22 Dec. Well, with all these potential markers and triggers, we will get more clues as we move through the checkpoints in October and November.

To return to where we stand this week, US earnings will begin, as will the Carolan crash window. I find it hard to produce a case for a crash at the end of this week. In the US, economic surprises have moved up to a new high for H2 2012, as have ECRI WLI leading indicators – both are decisively in the positive and trending upwards. Global leading indicators have improved, and it would take a quick and major reversal to bring about a market panic. Rather, reflation is likely due to 6 months of central bank rate cuts and renewed stimulus, and with leading indicators tentatively reflecting this, I rather expect the markets to await more data. Euro debt remains subdued, and US earnings (by relation with ISM PMI) are most likely to be unimpressive but above expectations. Lastly, we don’t see topping indicators aligned in equities – there are a couple of flags but not enough to mark a top. We see excessive frothiness in gold speculation but given its 9 month coiling prior to this current rally, I expect a consolidation only.

The reflation I expect (assisted by the collective central banks effort), and see tentative evidence for (in leading indicators and assets), fits with solar cycles: an inflationary finale in 2013. To be more precise, we should see pro-risk rise strongly before commodity rises become excessive, killing off equities and tipping us into recession. Treasury yields should rise into the cyclical bull top for equities, and the longer term treasury channel action that I have previously shown suggests that should indeed occur over the next 12 months (supported by Gann projections too). Because of this cross-referenced picture, I don’t side with an imminent top and crash in equities, but remain open to one if the usual topping signals and indicators align. So as always, one day and one data item at a time, but I rather believe we are heading for an inflationary speculative froth before anything bearish and deflationary occurs.

If solar cycles do fulfil, then there are other associated expectations leading into 2013’s solar maximum. One, solar maximums are correlated with increased earthquakes. Should a major earthquake occur, then the implications for the markets would depend on location, but earthquake occurence could help tip the global economy into recession. Two, solar maximums are correlated with protest and war. Should conflict increase in the world then it could both assist in tipping the global economy into recession and also in fulfilling the secular commodities bull conclusion, if energy and food are affected.

Iran has remained in the spotlight due to its potential for energy supply disruption and conflict in that region of the world. Now, hyperinflation has taken hold, with monthly inflation up to 70%, in part due to the sanctions imposed on the country. Internal social unrest has begun, and is likely to escalate. Historic examples of hyperinflation correlate with subsequent war and social/political upheaval. Refuge is also sought in gold, and Iranian gold purchases have been escalating in line with the currency debasement. I believe these circumstances could play a key role in fulfilling solar cycle predictions of a secular commodities and inflation finale next year, anticipating regional conflict around Iran, oil supply disruption and oil price escalation, and the knock-on effects for other commodities. This could be viewed as either solar maximum conflict and war fulfiilling a solar maximum inflation/commodities blow-off top, or the other way round. Certainly, now inflation has escalated out of control in Iran, there isn’t going to be a way back, so it’s a question of how the social and political impacts unfold from here.

Friday Roundup

Yesterday’s action was bullish for pro-risk. The Nasdaq completed its successful backtest of key support by launching away from it. Oil completely reversed its heavy losses of the previous day. The Dow Transports pulled further back up into the range, making the recent drop out of the bottom look like a fakeout.

Source: TSP Talk

The Hang Seng has broken out of its long term triangle, to the upside.

That breakout is still tentative, but other Asian indices echo this, such as the Kospi:

Source: Bloomberg

Now let’s see if the Shanghai index can follow through on its tentative trend reversal next week, that it began before this week’s holidays.

The Baltic Dry index yesterday pulled another 6% away from its lows, and copper has recently broken out of a triangle to the upside.

Source: TradingCharts

And the US dollar broke down from a bear flag.

Source: TSP Talk

All in all, the picture is currently supportive for pro-risk and for reflation. Both AAII and II investor sentiment turned less bullish this week, putting both further neutral, and not indicating a top. So whilst there are a couple of topping flags for US equities, as noted in the last post, I don’t believe that’s enough at the moment to bring about a reversal here. Rather, if reflation is just getting going, and if Asian equities are just breaking out, then it seems more probable that the rally endures for some time yet.

Lastly, Yardeni’s fundametals versus stock market divergence in the US has now been partially resolved with the fundamentals turning up to point the same way as equities.

Source: Ed Yardeni