End Of 2014

I’m back and refreshed. Thanks for all the messages, and for all the comments in my absence. Here is the big picture.

1. Primary shift to defensives and away from risk occurred as of January 2014, as measured by stocks to bonds, cyclical to defensive sectors, small caps to all caps and high yield to treasury bonds. Clock ticking from that point.

30dec2

 Source: Stockcharts

2. Solar maximum looks to have occurred around April 2014, marking peak speculation. Equities mania on borrowed time thereafter.

Screen Shot 2014-12-30 at 06.16.52

 Source: Solen

3. Game over effective start of July. World equities, crude oil, high yield bonds and the US dollar all turned at that point. Deflation in charge.

30dec44. US equities composite, breadth measures and volatility all show the same reversal at the same point: start of July.

30dec1

5. Those twin peaks in risk appetite at the start of the 2014 and mid-year fit the seasonal model which is from the influence of geomagnetism:

30dec12

6. Which sets us up for a final peak at the end of Dec 2014 / start of Jan 2015 for those remaining stock indices which have yet to top. I referred to this as my worst case scenario (latest peak) in 2014.

30dec15

7. Developments in December support this now happening: sharpening falls in crude and government bond yields, flattening of yield curves, blow-off top in equities allocations.

30dec530dec10

8. A new bear market in stocks will be a cyclical bear within an ongoing secular bear market. No new secular bull market as many believe.

30dec16

9. This secular position is dictated by demographics.

30dec20

10. The other play from this is that gold should enter a new cyclical bull within an ongoing secular bull, and this is supported by recent signals such as miners:gold ratio, gold/miners sentiment and price basing patterns.

12se1

 Source: Glenn Morton / My projections

11. A sampling of stock indices from around the world, below, shows 2014 has been clearly either a large topping process or a large consolidation range. If the latter, then we should have seen excesses in valuations, sentiment, allocations and leverage worked off with time rather than price, yet all those measures remain highly stretched, suggesting this is a topping process.

30dec3012. Plus, the two strongest sectors of 2014 are the two that are historical associated with outperformance after bull markets peak out:

30dec7

Source: Macromon

13. The peak-to-date in margin debt remains close to the solar maximum. This leverage, along with major extremes in sentiment, allocations, tail-risk, valuations and our post-solar-maximum status, is the set-up for a market crash. To repeat what I have said before, until/unless these measures are reset without a crash, then history dictates that is the most likely outcome. Crashes don’t occur often, but when they do, the set-up looks like the current.

30dec9

Source: DShort30dec8

14. Leading indicators and the longer term stocks:bonds ratio resemble 2000, 2007 or 2011, suggesting a minimum 19% drop in equities. This is the percentage figure I quoted as my general target for short positions because, stretching the view to the last 100 years, this is the minimum we should expect without being greedy by aggregating various angles on the market. To be clear though, the set-up is compelling for a bear market, not just a sharp correction, so I refer you to the secular bear chart above for the bigger projection.

30dec40

Source: DShort30dec41

15. Which brings us to the value of history as our guide, because 2014 taught us one key lesson: 100 years of reference points may not be enough, we need to allow for the unprecedented. An aggregation of angles shows how unprecedented 2014 became:

30dec50

 Source: Hussman

So what caused this? The most common view is that central banks brought this about with their policies of ZIRP and QE and unwavering verbal support. However, I maintain that ‘central bank policy trumps all’ was rather the mantra for this solar maximum mania than the driver. To prove this, we should now see equities collapse and gold rise despite central banks, and that is the final part of the real time test for the power of the solar maximum. If I am incorrect, then equities should continue their bull market in 2015 as central banks policies overrule. However, I refer you back to all the topping indicators and angles in equities that have amassed, together with the examples of 1930s US and 1990s Japan which revealed central banks’ true relative impotence. Ask yourself if typing numbers into a computer (ZIRP and QE) and saying a few soothing words can really work.

The crazy stretching of indicators delivered this year made for the most difficult year of trading since 2000, the last solar maximum. So if I can make one prediction for 2015, it is that it will be easier and more predictable. I am short equities and long gold and expect patience to be finally rewarded. I wish you all the best for the coming year.

Advertisements

Break

With my current illness, then Xmas and NY, and what looks like a bounce/pause in the declines off that breadth capitulation, I’m going to take a break from what’s been relentless toil this year for little reward.

I can NOT regret my analysis: by the 1st Jan there were around 30 topping indicators for equities, and they have remained in place all year. But 2014 turned out to be a once in a decade or generation style event, taking sentiment, allocations, valuations and leverage to unprecedented stretching.

As a real time test of the influence of a solar maximum on speculation it has been better than could have hoped, but the associated collapse remains elusive for now. Those super-stretched multi-angled indicators suggest it’s coming, however. Plus, a little more hindsight on the solar data front will allow us to tidy up both sides of the equation.

So, enjoy the festivities and thanks for all your contributions.

John

State Of The Markets

It’s been a while, so here’s how things now stand.

1. The topping process kicked off at the turn of the year with a gradual shift to defensives, as represented here by stocks:bonds, consumer discretionary:utilities, high yield:treasuries and small caps:all caps.

13dec10

Source: Stockcharts

2. The shift to defensives was a global phenomenon, shown here by German, Japanese and UK bond yields, as well as US.

13dec13

3. The smoothed solar maximum is likely to have been April 2014. Historically, peak speculation and appetite for risk assets has topped close to that:

Screen Shot 2014-12-13 at 11.05.52Source: Solen

4. In keeping with that, margin debt peaked in February, the commodities index peaked in April and certain breadth measures peaked around that time:

13dec16

5. Then either side of that, the move to defensives occurred as of January and the price topping formation in equities took place in the window from July to November, with US large cap stock prices rising in a megaphone formation whilst the remaining supports for equities were dismantled and many flags were raised. Here shown are breadth, volatility, bullishness, junk bonds and leveraged loans as examples.

13dec18 13dec19

6. Considering the final thrust to the peak to be the rally from October to the start of December, then its size and duration fits in well with similar topping thrusts from history:

2000: 17% in 23 days

2007: 15% in 39 days

2010: 16% in 55 days

2014: 14.5% in 37 days

So is this finally it? Dare we dream that equities have topped out and are now in a bear market? Yes we do.

7. A key change in the last two weeks has been that the remaining leaders appear to have finally reversed, such as the Sensex, Nasdaq 100, Apple, USD/JPY and the Nikkei. These are tentative reversals but the point is they have aligned in the declines.

8. Looking at the bigger picture, households are about as exposed to equities are they likely to be (given no demographic tailwind):

13dec30

Source: Fat-Pitch

9. Dittto, valuations are as high as they likely to reach:

13dec40

Source: DShort

10. Sentiment is as lop-sided as it could be:

Screen Shot 2014-12-13 at 13.58.23

Source: Yardeni

11. Leading indicators for the US are negative:

13dec50

Source: DShort

12. Corporate earnings for Q4 have been sharply revised downwards due to both the high dollar and falling oil price.

13. Put/Call ratio is signalling further price declines:

Screen Shot 2014-12-13 at 07.01.14

Source: Barrons

14. Stocks are nowhere near oversold yet:

13dec60Source: Charlie Bilello

15. However, Rob Hannah’s capitulative breadth hit 5 at the close of the week, suggesting more selling Monday/Tuesday could take this to exhaustion levels.

16. Which brings us to the phenomenon I have covered before: selling right into the close on Friday can trigger steeper selling on Monday due to weekend reflection. Is this finally going to happen? Allocations, sentiment and Skew are all set for it to occur.

17. But what about the favourable seasonality of year end, the ‘Santa rally’ in the second half of December?:

13dec70Source: Sentimentrader/UKarlewitz

There is upward pressure into the Dec 22 new moon and a limited history of bull market peaks occurring near the last trading day of the year. Offsetting that, we have downward real geomagnetism pressure at this time of year, and that megaphone price topping formation which ought to now have a destiny with the lower boundary given the overthrow turned out to be just that. Meanwhile gold has built out a compelling bottom and is ready for a rally at the expense of stocks.

The whole topping process is already on borrowed time versus the solar maximum, and indices such as RUT and DAX stretched about as far as they could again in November without jeopardising the topping process. Therefore, I see reasonable odds that the Santa rally won’t happen. In mirror topping years 2000 and 2007, December was a down month both times.

Let’s see if Monday opens the selling floodgates. The key should be a gap down open, with weakness starting from early in Asia/Europe. Should stocks alternatively garner support again then maybe they can hold up into the end of Dec before finally rolling over. But it’s high time we saw weakness into Friday’s close follow through, against that sentiment/allocation/skew backdrop.

Happenings

Oil plunging. High yield dropping. New all-time lows for bond yields in many European counties and Japan. Gold and silver major reversal. Apple large down day. Crazy spike in Rydex allocations.

ECRI leading indicators for the US negative. A combination of oil price drops and US dollar gains adding to sharp earnings projections revisions. On Sept 30th, earnings growth for Q4 was projected to be 8.3% and revenue growth 3.8%, but now these are more than halved to 3.8% and 1.5% respectively.

SPY looks like this:

2dec2Source: Stockcharts

Currently an island/overthrow top. But now we need follow through.

The Russell 2000 looks like this:

2dec20

Repelled at a critical point. Same for the FTSE shown underneath. If these indices were to maintain their 2014 topping processes then they couldn’t stretch much further upwards.

Indicators largely rolling over again, also suggesting equities turn here.

2dec6 2dec8 2dec1

So it seems like indicators and cross-asset developments are turning the tide on equities just at the critical point.

I believe it comes down to how the price process now plays out. As previously noted, we might see a price range play out from here on divergent momentum which could hold equities up into late December, or we might see a more straight forward reversal from that island top / megaphone overthrow and print a significant down month for December.

We don’t yet see a significant reversal in the US Dollar, and the Indian, Japanese, Chinese and German stock markets are still motoring. Plus, Apple and the Nasdaq 100 reversal candles yesterday need follow through. So these are the threats, but it may be the point at which US equities start to lead to the downside.

Commodities started plunging in May 1929 and forewarned of the stock market woes (hat tip Edward Dowd). They began to tumble in May of this year too. Some are quoting oil’s fall as a stimulus, but it should be clear from associated developments in government bonds and the USD that this is a deflationary wave more in tune with 1929. But this doesn’t pin down when equities might tumble, only that they should be on borrowed time. The latest sunspot update suggests the same:

2dec7

With the story of the topping process in stocks (which I have laid out in detail on the site) revealing a kick off Jan 1st 2014 and an intensification from the start of July, I maintain the probability that stocks are completing their topping out now, and keep a lesser likelihood as the end of December. Given the recent cross-asset developments in gold, high yield, government bonds and oil, I don’t see a stocks bull market extending into 2015. The Rydex allocations spike looks fairly terminal too.

2dec30

The situation is fairly delicate at the moment, as a little more craziness can’t be ruled out. So we need to see a follow-though day to the downside. But I believe we are into the final price manoeuvrings before the heavy falls finally come to pass.