Roundup into the ECB

1. Copper has popped above resistance, in a similar manner that gold did:

Underlying Source: Trading Charts

2. The Chinese stock market has reached a Demark buy set up:

Source: Market Studies (hat tip Gary)

3. The Dow Transports broke down yesterday. Ed Yardeni rationalises the relative weakness of the Transports to the Dow (Industrials) as it has two main components, Railroads and Air Freight. The railroads index broke to a new high, reflecting the stronger US economy, whereas the Air Freight is what’s dragging down the Transports due to the weakness elsewhere in the world.

Source: TSP Talk

4. Meanwhile, the small caps index has caught up and is displaying a bullish cup and handle formation:

Source: TSP Talk

5. The latest global country P/Es reveal that much of Europe is at secular bottom valuations, whilst USA remains one of the most expensive markets in the world:

Source: Megane Faber (valuations as at end of August)

6. The US dollar is at support. Today’s ECB meeting outputs and next week’s FOMC outputs could either generate a dollar bounce or a breakdown.

Source: Stockcharts

7. The bigger picture for the US dollar shows a currency still very much languishing near the lows.

Source: Stockcharts

8. The easing of European debt concerns continues and is supportive for the Euro.

Source: Scott Grannis

9. Treasury yields still show potential for a H&S bullish break up, having pulled up the last couple of sessions:

Underlying Source: Stockcharts

10. The bigger picture for treasuries reveals that the recent run up echoes previous important peaks that led to sharp falls over the next 12 months for treasuries back to the lower support.

Underlying Source: Stockcharts / James Craig

In summary, a bottom for Chinese stocks and a breakup in copper would perhaps foretell improvement in that part of the world, which in turn could resolve the Tran issue. Euro debt has settled down, making the number 1 issue the weakness in the non-Western economies and particularly China. Despite that, US and European stocks have consolidated just beneath new 2012 highs, and technically look ripe for a breakout. Treasuries could potentially fall over the next 12 months, providing the backdrop for the secular commodities finale that I project. Gold and silver have broken out and are into the positive period of seasonality for the year. The dollar is at a cross roads. If the Fed announces QE3, or some other currency diluting initiative, which appears increasingly likely, then I expect it to breakdown and also help fulfil the commodities finale. There remains the potential for disappointment, both by the ECB and Fed, and in turn for these assets at important junctions to resolve the other way, but I maintain the weight of evidence is pro-risk currently. Lastly, various European country stock indices are at secular low valuations. For the long term investor, buy and hold of these indices should return handsomely with a 10 year view.

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13 thoughts on “Roundup into the ECB

  1. What causes a P/E ratio to decline over time? If the FTSE 100 has been range bound for the last 13 years, what caused its P/E ratio to drop from 30 all the way to 12?

  2. It is not inflation, rather the combination of two components: rising earnings (E) and sideways prices (P). Here is a basic chart, which shows that while prices have remained range bound for over a decade, earnings have overtime moved higher with each business expansion. Therefore, the P/E ratio has moved lower and lower, making the overall stock market cheaper.

    There is a warning that comes with measuring P/Es on any given day. The chart I posted shows that earnings are cyclical in nature, as the ebb and flow from a recession to an expansion and back to a recession again. Keep that in mind, because it is never wise to use P/E during the peak of the business cycle, like we are witnessing today, when earnings are at record highs. Even if it is CAPE 10, it is still much wiser to see how much earnings fall during recessions, before relaying on valuations.

    In the post above, John is measuring the P/E as of right now, but let us see what happens when earnings globally fall, as they have started already into the next recession of 2013. It will be very interesting to see how low the P/Es really are and “how cheap” markets truly are when a potentially bad case scenario occurs.

    As an example, I believe European GDP is nowhere the bottom, as I expect a full blown crisis similar to 2008 when the GDP fell about 5%. I see the same again. If I am right, earnings will become a lot more disappointing relative to today, despite everyone on CNBC trying to convince me that the worst is over.

    In that scenario, the current P/Es will not be a cheap as today, unless the price of stocks falls enough more than today (I’m talking majors like Italy, Spain, Germany, Holland and France). Either way that is just an example, as I know majority of people here disagree with that as they see very bullish outcomes into next year. Everywhere I look everyone is bullish. Where have all the bears gone?

  3. Apologies – I misread. What I meant was stocks go sideways in a secular bear because inflation holds them up in nominal terms. In inflation-adjusted terms the chart would show the index falling over time as we drop from excessive overvaluations at the peak down to excessive undervaluation at the bottom. Extremes in p/es reflect excessive greed and fear. See here:

    It’s possible that those European country p/es drop further from their current low levels, but my point was that history shows if you buy under p/e 10 and hold for 10 years you’ll make great returns.

    If we are talking stocks, we see currently a lofty level of bullishness in Rydex, but not yet at the bullish extreme in Investors Intelligence (bulls minus bears at 26, versus over 35 historic extreme) and very neutral AAII sentiment (33 bears, 33 bulls, 33% neutral). So I don’t see that everyone is bullish.

  4. Tiho: You’re forgetting one massive detail: the willingness for governments worldwide to relentlessly ease with no thoughts or regret for future ramifications. Draghi today announced his bond buys have “no quantitative limit.” I think this is horrifying considering the US and EURO are (currently) the world’s currencies. After the Feb and ECB are done pumping the system, other currencies will have to take over, possibly the Yuan finally allowed to float free. I can’t quite figure out if the Chinese government will let go of that power though. If they did, they would be signalling that they wish to become a net importer and mot likely become the wealthiest nation over night once everyone realizes their dollar and euros have almost no value. Commodities would be buys, as a broad basket. John, I agree with a lot of your view, but I think the commodity flurry rise could shoot out towards 2014. I see interest rates coming to a “climatic” bottom in the middle of 2014. After most likely another round of dollar destroying QE3, the government will be devastated to find rates rising and the Fed’s balance sheet becoming insolvent. So, the Fed will have to continue to act, most likely forcing the ridiculous amounts of excess reserves to begin purchasing long-term treasuries to “stabilize the system.” Otherwise the Fed will have to start dumping bonds, causing rates to rush up even higher. Could be a scary process if not managed properly. However, I think the “fear” of everything will cripple the system and make for good buying opportunities to those who see that the dust will settle.

    Here’s a good article that outlines the events I’ve discussed in plain detail with good history and facts. Check out how our Fed’s leverage is 51:1! Worse than Lehman brothers before their collapse.

    http://www.guggenheimfunds.com/resources/intelligence/article/12-08-22/The_Faustian_Bargain.aspx

    John, great blog. I love visiting and seeing the information you post. Always fresh to get a new perspective. Keep up the great work! I hope to start a blog of my own someday.

    1. Thanks, and appreciate your thoughts. NASA have just pushed their solar peak forecast out to Fall/Autumn 2013, which I’m going to cover tomorrow as it affects my timeline, and means commodities could rally into early 2014.

  5. I am not forgetting anything. The difference is that you must believe everything central banks promise you. According to that theory, all we had to do over the last century, since the Fed was introduced in 1913, was to print money and we would have NEVER had even one recession or crisis. I don’t believe in fairy tale stories, but I did when I was a little kid.

  6. $SPX:IEF broke out from the bull flag and thus (its up-trend) just made a higher low.

    Any traders who are in the pursuit of profits rather than being right eventually must be on the long side for the near term. Is this a valid stance??

    1. I favor energy and I am betting it will be the straw to break the back of the middle class once again in the future as money will find a home. My holding of XOM breaking out from the IHS with a target of $108.. Hmmm, oil will be $160/bbl by then.?

  7. Tiho, I agree with a correction coming, however I think it is possible to come in the form of a flat market over the next 5 years, allowing Earnings to continue growing while price stalls. It could also come in a “collapse,” but I do not think it would begin until January 2013. I think the adjusted PE could easily fall below 10 again. I am not “pro S&P 500.” The only belief I have is that we could see new markets highs before we have our next 25%+ decline. This would give us another rally over 10%, which I believe can be more safely played in commodities for the next year and a half, rather than stocks. This is not from growth but from growth in the money supplies, worldwide. So I agree with no fairy tales, but sometimes the market does, which could give us a push to 1600 in the S&P 500.

  8. Real earnings growth and inflation. I think they both work, and might even be somewhat symbiotic. 😉

    New closing basis breakouts (above declining resistance or to new ST highs) today: AEX, BKX, COMP, GLD, NDX, NYA, OEX, SPX, XAU, XLF, WLSH, the PM’s (copper will come along for the ride) to name the most important. I don’t include the Dow since it didn’t close at a new high, although it did make a new short term closing high, nor the RUT since it is right at downtrend resistance, although it did make a substantial gain to a new ST high as well.

    Confirmations of previous breakouts (consisting in a break, backtest and new thrust higher): DAX, CAC and TSX to name what I quickly see.

    Not bad, and, as I’ve already said in the Disqus world, my hat’s off to those who didn’t lighten up coming into important resistance. Now it’s time to see if these breaks hold and are followed by still more. Fridays have been very bullish recently. A gap and go tomorrow wouldn’t surprise me.

  9. John, and Tiho, you guys always have great commentary!! And Sam, I am with you that we have not seen the lowest of the low on interest rates….3Q 2014 possibly..??

    We could get a pullback next week into the 14/17th. We could possibly be nearing an intermediate term crest coming up around Sept 18-21st, possibly lasting until the elections… therefore following John’s geomagnetic model more closely….

    Don’t worry Tiho, I am still bearish and there are many other bears out there, I don’t think there is much upside left. 1450 will most likely act as major resistance for the intermediate term.

    I still believe in Dow 8,500 in 2014….

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