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.
2. The Dow Transports has been catching up the Dow Industrials and shrinking the divergence.
3. Inflation expectations have picked up.
Source: Scott Grannis
4. Stock market breadth is strong – there is no negative divergence.
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.
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.
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.
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.
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.