Weekend Updates

1. US stocks to bonds and to dollar ratios continue to show a clear top mid-2014:

21febu9 21febu11Source: Stockcharts

2. Dow Jones World stock index shows a peak the same as the above, but that peak may be under threat:

21febu43. The SP500 has broken upwards to new highs but breadth, volatility and junk bonds continue to show divergences. The resistance levels in all four are now being tested.

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4. Various risk measures remain in downtrends since the turn of 2014, though the cyclical to defensive sector ratio has repaired the most in recent weeks.

21febu55. Sentiment and allocations remain at extremes like previous major peaks. Here fund managers and Rydex:

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Source: Fat-Pitch

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6. Buybacks and mergers have pulled back from their peaks:

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 Source: Elliott Wave

7. Bloomberg financial conditions remain in a downtrend since mid-2014:

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Source: Bloomberg

8. Earnings growth forecasts have turned down, mirroring the 2007 peak, but price has yet to conform:

Screen Shot 2015-02-21 at 16.13.53Source: Factset

9. The rise in share prices contrasts sharply with current trends in earnings and economic surprises, captured here:

Screen Shot 2015-02-21 at 15.41.10

10. The economy is showing signs of recession as evidenced here in wholesale inventories versus sales:

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Source: TheEconomicCollapseBlog

11. And leading indicators remain in negative growth and in the big picture continue to show a secular bear market:

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Source: Dshort / Ecri

12. Money has been pouring steadily into bonds, with the stocks:bonds ratio in decline since mid-2014.

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In summary, we see a hallmark, typical, run-of-the-mill major topping process, that fits with the smoothed solar maximum of April 2014. Firstly, the mania and excess is evident in valuations, sentiment and allocations. Secondly, between the start of 2014 and mid-2014 various indices, ratios and indicators made their telltale breakdowns and divergences. Thirdly, leading indicators, economic surprises and earnings have all turned down. Fourthly, buybacks, mergers, margin debt and leveraged loans have all stalled or declined. YET, despite all this, price has not conformed, so there is something missing from the analysis.

I don’t subscribe to the view that the solar maximum is producing an extended mania like in 1929. We see in the charts above that a typical underlying topping process has occurred centred around last April’s smoothed solar maximum. It all fits as expected. But something is keeping nominal prices rising. So what’s different this time? By a process of elimination we do get to the influence of dark pools and primary dealers against the backdrop of QE and ZIRP.

The dominance of the dark pools over the main exchanges the last couple of years is shown here:

21febu28Plus the leakage from the primary dealers (from who the central banks buy bonds with their QE money) into the stock market. 80% of QE money may be parked as excess reserves but correlations and reports suggest some of the rest finds its way into the stock market.

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It’s not easy to quantify either influence accurately. However, all historic manias saw leverage rising right into the peak. ZIRP enables the leverage here, but it’s not increasing through margin debt or leveraged loans. Speculation, as measured traditionally, peaked out with the solar maximum mid-2014. All things considered, it would make a lot of sense if, as BC said, several of these major players are driving price and using increasing leverage to do so, as that then explains the anomaly. It would mean the stock market has gone from being fair game governed by natural forces, to one in which – temporarily at least – a few large hands are controlling price to some degree.

If so, it doesn’t change the situation with earnings or economy which are moving the opposite way. It doesn’t stop the bulk of market players behaving as normally post solar/speculation peak, as shown in the charts. I don’t believe it changes the outcome, only delays, the crash. If the bull market has become highly concentrated in a few major hands using dark pools and leverage, playing a game of chicken in the face of valuations, earnings, concurrent and leading indicators, then it would take a broad improvement in all those to sustain it, otherwise the risk is the market collapses at any time as one or more players reverse, in self-interest.

We ended the week cementing the breakout in stocks, and I keep my options the same. Either stocks reverse down from the current marginal new highs, heading for seasonal March/April lows and maintaining the real stock market peak as July 2014 – or – stocks move higher in a final mania that extends to the summer. If the latter looks to be transpiring I won’t be playing the long side. I consider it far too dangerous as a collapse could occur any moment. Rather I would bide my time and short again when the pop looks to be occurring. I continue to watch gold for evidence of a renewed (and associated) move to safety, plus the extremes in sentiment and positioning pro-dollar and anti-euro look set for reversal at any time, which would likely fit with reversals in stocks and gold.

For the time being I will only be posting at the weekend. I have engaged in new projects during the week whilst the irrationality of the markets persist. But I remain poised to attack once they finally break, continuing to monitor each day and read your contributions on the board.

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Behold

New highs in US equities despite…

1. Valuations on a par with the 1929 peak

2. Sentiment extreme lopsided (II 3.5x bulls vs bears, NAAIM 84% bulls)

3. Allocations to equities on a par with 2000 peak (household, fund manager, Rydex)

4. The solar maximum speculation peak being behind us in April 2014

5. Leverage having peaked out around then (margin debt Feb 2014, leveraged loans July 2014)

6. Multiple negative divergences in place 6-12 months (shift to defensives, breadth, financial conditions)

7. Economic surprises negative

8. Leading indicators negative

9. Earnings growth forecasts for H1 2015 negative

10. Buybacks peaked in Q1 2014

This is already so anomalous that I can’t offer much more by way of analysis. If there is a blow-off top about to unfold, then what is the fuel, given the extremes in allocations and sentiment and the stall in leverage and buybacks, plus the demographic headwind making for a shrinking investor pool? I believe it would have to come from leverage breaking its 12m ceiling and going to all-new extremes. But why would that occur, given the state of economic and earnings indicators versus valuations? And given we are approaching 12 months post solar maximum? It makes no sense.

I can still only side with logic, which says the real peak was mid-2014 and that this still represents last gasps of a topping process. That would mean nominal stock indices make marginal new highs here but then break down.

Screen Shot 2015-02-05 at 07.09.06

On the bullish side, there have been a couple of supportive developments. Cumulative advance-declines have broken upwards decisively, as they did in February 2014. Plus, cyclical sectors have taken over outperformance from defensive sectors now in 2015. These two developments alone certainly don’t overcome the list above, but, if stocks can now hold up whilst we go through the seasonal lows of March and April then we could perhaps again see economic surprises and earnings start to turn up again. In short, we could continue to see the market advancing in positive economic and earnings periods but not falling in negative periods despite the record lopsidedness, negative divergences and so on. Go figure.

That would in turn likely postpone the bear kick-off until the Autumn/Fall. I can’t compute that, but we have to consider the majorly anomalous here. Of course this can’t continue indefinitely. If stocks do somehow take off again here, then valuations, leverage, allocations and divergences will become yet more extreme, perhaps all-time extreme, making the subsequent crash even bigger and even more pressing.

But survival is key. So I have stepped aside and taken off my positions whilst we see how price action now unfolds. If we see a blow-off mania now somehow take hold, then I don’t want to hold short through that. If, instead, logic reigns, then stocks should only make marginal highs here on negative divergences and then be dragged down to new 2015 lows. We have the new moon on the 18th Feb into which I expect stocks to rise. Then we have the seasonally weak window into March and April. So either stocks make marginal new highs and then fall post 18 Feb into Mar/Apr to new 2015 lows, or they hold up and lift off through those seasonal lows heading for even higher highs in the summer. I will be looking to add back positions on evidence of the former unfolding.

Cross-market, gold’s behaviour will be another tell. If the bottom is in then gold should start to take off again here, making for a compelling higher low. Continued weakness and even a new low would postpone the whole process.

I still can’t regret my analysis, because it is as comprehensive and multi-angled as I could make it, and I still think the only logical outcome is that we do indeed look back on a topping process that kicked off at the start of 2014 but took a long time to play out. I can’t compute anything else, because I bring together such a wide range of angles and draw heavily on ‘fact’. However, it’s been a humbling 12 months and there is not yet sufficient clarity or hindsight to really diagnose it.

I host the website but you guys have created an excellent board, which is always a great read. Different opinions and approaches but there is a good balance and a lot of quality input. So thank you to all who comment.

So, let’s see now whether stocks break out decisively or fail at marginal new highs, whilst watching how gold performs.

Not So Different After All?

Comparing the 2000, 2007 and 2011 peaks to 2014-15.

Taking 2000 first, as that was the last solar maximum pre-2014 and therefore the most relevant, I’m using several measures that stretch back that far and show divergences pre-peak, namely Nasdaq breadth, 10 year treasury yields, cyclical to defensive sector performance and all set against the Dow Jones World stock index. Clear topping process progression and timings are labelled on the chart:

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Source: Stockcharts

Now here is 2014-2015. Amazingly it is almost identical in progression and timings in both the stock index and the indicators.

6febr21The only difference is that the July/Sept peaks in 2014 exceeded the solar maximum peak in nominal terms whilst in 2000 they were lower peaks.

Here are the 2007 and 2011 peaks to complete the comparison. No solar maximum in these two years, but otherwise a similar topping process with leading divergences in the indicators and a notable peak in July every time.

6febr23 6febr25With margin debt for December finally released here is the picture for net investor credit:

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 Source: Doug Short

We see another leading indicator for the 2000, 2007 and 2011 peaks, varying from 2 to 6 months on the monthly SP500. Currently we have a 4 month divergence versus the December 2014 existing SP500 monthly high, fitting in the historic range.

Lastly if we compare stocks:treasuries and stocks:dollar, we see additional leading indicators in a relative defensive shift with 0 to 3 month lead time for the 2000, 2007 and 2011 peaks.

Screen Shot 2015-02-05 at 07.09.06

Both measures show a 5 month divergence on our current December 2014 Wilshire 5K high. Yet both measures tie in exactly with when the Dow Jones World made its peak-to-date, July 2014.

All this strongly suggests the ‘real’ peak in stocks occurred back in July 2014. So how can we square fresh nominal highs in European indices and several US stock indices challenging for new all-time highs again? We can square it if European indices are making a final blow-off top and if US indices fail to make new highs here. Back in 2001 the DJW index turned down again at the start of February, heading for Mar/Apr lows, and that fits with the geomagnetic seasonal roadmap that I have presented before. It really means stocks must be repelled back down here, whilst gold ought to break upwards from its consolidation of the last 2 weeks. Drawing together time and price factors I suggest we have just a few trading days for this to transpire. As per my last post, if price and indicators start instead to break upwards then the picture changes and breaks with the logical case.

The Old Rules

Extremely stretched valuations, highly lop-sided sentiment and allocations, excessive leverage, long-standing negative divergences, persistent shift to defensives, negative leading indicators, disappointing earnings, declining financial conditions: these are some of the ‘old’ rules that dictated stock market peaks. Yet, many months in their presence, equities still haven’t dropped in any meaningful way.

Looking at the SP500, there has been no fall of even 10% in the last 2 years.

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Source: Rachael Shasha

Yet those indicators/rules would historically dictate a fully-fledged bear market. Add in the smoothed solar maximum timer, which now looks fairly definitively April 2014, and the continued levitation is even more surprising.

Screen Shot 2015-02-04 at 07.57.39

Source: Solen

Do the old rules still work? I still believe they have to. There are too many different angles amongst them for them to now all be redundant, even with central bank intervention distortion. But this really feels like the last chance for them to hold.

A selection of global stock indices shows what may turn out to be a long distributive topping process, if this isn’t to be a consolidation by time.

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Source: Stockcharts

A selection of risk-off negative divergences in play for a year would echo this:

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If we argue the correction or ‘bear’ has been by time not price then such indicators would now be poised to break upwards again. The problem with that angle is that there has been no resetting of allocations, leverage, valuations, sentiment and various negative divergences. Corrections by time gradually neutralise such indicators to refuel the bull, yet this has not happened.

4febr5A look at breadth shows what appears to be an initial attempt at a stock market peak at the start of 2014, followed by a breakout to the upside. We have then had a second attempt at a peak in the last 6 months, but potentially NYAD is showing another breakout which would reset the topping attempt again.

4febr7This would fit with developments in European stocks indices which are breaking out and look positively bullish. Potentially, the Eurozone’s QE and improving leading indicators could keep US stocks from falling significantly here in early 2015, as we could argue the US did for European stocks in 2014.

The big picture still looks like this: a definitive trend change in major asset classes in mid-year 2014. But we need to watch to see if the up-ticking of the last week could potentially spell a break from, or pause in, the downtrend.

4febr2US economic surprises versus valuations looks like this. See how stocks largely ignored a breakdown in economic strength in the first half of 2014. Will they ignore the current trip into the negative? Also note how valuations have risen at their steepest rate since the October 2014 low: the move up in prices has been very much counter-earnings.

Screen Shot 2015-02-04 at 07.57.05Source: Yardeni

Draw it all together and I still have to favour the ‘last gasps of the topping process’ angle. I refer to my 3 key dates of the turn of Jan 2014, the end of June 2014 and the end of Dec 2014 as they three key milestones in this, all anchored to the 2014 smoothed solar maximum.

However, if equities (meaning US equities joining European) and indicators break upwards again, then it would raise the prospect of a final blow-off top, a parabolic termination that could perhaps take us to mid-2015. I base this on the 1929 experience post-1928-solar-max, the failed topping attempt in breadth in 2014 perhaps failing a second time here, and the geomagnetic seasonality of the markets. Something like being here (circles):

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I just still find that very difficult to make a case for, given how super-stretched sentiment, allocations, valuations and leverage already are. From where is the fuel for another significant leg up?

The next few days are key. Did yesterday’s full moon mark an inversion top from which we now decline, keeping US indices from making new highs, whilst European indices in hindsight will show a blow-off top? Or do we now have a clear 2 week period of typical strength ahead into the new moon making for a comprehensive global breakout in equities? If the latter I would expect gold would be repelled downwards again.