A Dumb Mechanism

Posted on August 15, 2015 Posted in Indicators, Macro, Solar Cycles, Stocks, Uncategorized110 Comments

Evidence reveals the financial markets to be ‘dumb’. Long term trends are dictated by demographics (swelling numbers of buyers or sellers) and solar cycles (influencing speculation levels amongst participants). Markets top out when there are no new buyers left and/or no room or appetite for existing buyers to increase debt, and bottom at the opposite. This contrasts with common wisdom that markets are instead dictated by central bank actions, economic indicators, or company fundamentals. They play a role, but the evidence shows that the stock market leads the economy, that central banks are typically behind the curve, and that stocks rise purely on multiple (valuation) expansion if there is either swelling leverage or swelling buyers (or fall vice versa).

Into 2014’s solar maximum we saw a speculative mania in equities akin to the last solar maximum of 2000. But unlike 2000, there was no demographic tailwind, instead a headwind. Without new buyer flows into the market, we have therefore seen equities bid up by (1) existing buyers leveraging up and (2) companies buying back their own shares.

This chart captures the flat money flows as predicted by demographics versus the declining share issuance due to buybacks.

Source: Business Insider

The effect of buybacks is to increase EPS and decrease P/E. The latest earnings show a blended 1% decline YOY, but without those buybacks the figure would have been closer to -4%. Revenues declined 3.3% YOY and reveal a truer picture of companies performance. Additionally, companies have largely borrowed to buy back their shares, making this market fuel particularly ‘unhealthy’.

Buybacks are likely heading for a new record this year, beating the 2007 record. This may partially account for stocks continuing to levitate despite all-round deterioration in other indicators.

Source: Bloomberg

The other fuel source has been increasing leverage. We can see that leveraged loans peaked out around last year’s solar maximum:

Source: LeveragedLoan

Whilst margin debt lurched upwards again in 2015 to a current April high.

Source: D Short

Meanwhile in China margin debt went crazy and can be seen to be wholly accountable for the rise in the Shanghai Composite. This too fits with demographics there: no new buyers, only existing buyers leveraging.

Source: FX Street

The subsequent collapse in China’s stock market shows what happens when there is no room or appetite for further leverage amongst participants, which brings us back to the top of this post. Then, when leverage starts to unwind, it brings about forced redemptions and thus more selling, as it is effectively a ponzi scheme.

So the question is when leverage in the US and elsewhere starts to unwind. Based on historical evidence, appetite for leverage should wane post solar maximum. We see that in leveraged loans above, but margin debt has rallied further. We know from 1929 that leverage extended a year post solar maximum before collapsing, whilst breadth deteriorated over the same 12+ months. We are again producing that kind of outlier extension, set against a similar ongoing breadth deterioration since the solar max of last year.

Either the sideways range in US stocks in 2015 is the pause that refreshes the bull or it is the topping process that turns into the leverage reversal inspired sharp declines. Solar-aside, there have been so many indicators that this is a market top, sharing characteristics with 2007, 2000 and other major historic peaks, that a bull pause is highly unlikely. But what’s different is that the interest rate, QE and inflation environment, together with commodities relative performance, hasn’t been seen in 50+ years, if this is to mark a top. However, rather than that negating a top, we simply need to look further back in time for reference points. Yet, if the stock market is a dumb mechanism, then we shouldn’t even need to do that.

The solar max produced the stock market mania. Demographic trends meant it has been fuelled by leverage and buybacks. The flat market of 2015 suggests saturation has been reached. Post-solar max, appetite for speculation unwittingly declines. China has broken and all markets are off their peaks. The last several weeks, indicators that have worked for the bulls over the last 2 years haven’t been working. I think the fuel is spent. Buybacks and margin debt are the key here, but both data sets come out with a lag.

Below we see several key indicators peaked out with last year’s solar max whilst a couple of others extended beyond. Now the latter should fall in line with the former. Note how the levels reached have been largely similar to 2000’s saturation levels.

Source: Stockcharts

We are now through the August new moon, heading into the seasonal (geomagnetic) lows of Sept/Oct. I’ve been back on the attack short stocks, with particular emphasis on Biotech.

Top Signals And Bottom Signals

Posted on August 6, 2015 Posted in Indicators, Stocks, Uncategorized372 Comments

The Dow and SP500 are combined flat for the year and the 7 month price range has resulted in bollinger bands that are the closest in 20 years. Behind the scenes we see evidence of a major peak in equities, making the range a likely topping process.

Source: Hussman

Source: Dana Lyons

Source: Yardeni

Yet we are also seeing signs of a significant bottom.

Data source: Rob Hannah

Source: Dana Lyons

Source: Fat-Pitch

These bottoming signals have formed less than 5% from the highs. So are they a springboard for a break upwards out of the price range before stocks top out? It’s one possibility.

Note that previous incidences of the topping indicators gave rise to at least a 15% sell off, whether it be more like 2011, 2010, 2007 or 2000 in nature. Meanwhile, the bottoming indicators often formed at bear market pauses, at selling exhaustion points. Has a bear market begun then? It’s another possibility, but the shallowness so far of the selling is odd.

What’s also confusing is that some indicators have washed out at this point whereas others remain at contrarian levels, such as Vix. Plus note that some indicators have produced a clustering of extremes for 12 months now, stuck at levels from which mean reversion would have historically fairly swiftly occurred. All told, it’s more history in the making and makes it difficult to call the outcome with high confidence.

Buybacks peaked out in Q1 2014, IPOs in Q3 2014. Data shows that money flows into equities have been flat in this cyclical bull, in line with demographic predictions. Without new buying sources, the bull has been fuelled by buybacks and existing participants leveraging up. With buybacks decreasing, the bull (if still in progress) is reliant on continued increases in leverage.

As things stand right now, stocks may need to move higher to neutralise those bottoming indicators. Therefore I can’t rule out the possibility of a final move higher, an overthrow, before a true rollover. However, stocks are also overdue a deep and sharp correction and the clustering of indicators, both top and bottom, within such a tight price range, could also produce a swift move lower, before a partial retrace upwards. It may be that fuel has been exhausted and certain indicators are therefore not as contrarian as they may be perceived. In short, right now I’m watching and waiting to see which we way we break before attacking again.

Update

Posted on July 31, 2015 Posted in Indicators, Macro, Stocks206 Comments

Capitulative breadth now down to 6 on the rally in stocks, but still suggestive of some more upside for equities to properly neutralise it.

Source: Rob Hannah

Today is the full moon, and lunar phasing for 2015 looks like this:

Not all have been compelling turns but nonetheless shorting each new moon and going long on each full moon would so far have made a profit every time this year. Historically, lunar phasing has worked better in periods of sideways chop like this. Based purely on the moon, we could expect stocks to peak out again in mid-August. But at some point this price range will break one way or the other.

As you know there have been many technical indicators for a bull market peak, suggesting that price range to be a topping process. Here are two more from Dana Lyons:

Source: Dana Lyons

Valuations are crazy high:

And US small caps are the most expensive they’ve ever been.

Source: Meb Faber

But whilst stocks continue to levitate the key question remains whether excesses in valuations, sentiment, allocations and leverage need to be reassessed in the context of ZIRP and QE, and don’t pose the same threat as typically historically. That analysis is further complicated by not having experienced this combination of negligible rates, low inflation, low growth and high debt for over half a century.

However, the reason for ZIRP and QE is that the world economy has been in serious trouble since 2008, with demographic trends in the major nations all having turned negative. Below we can see the break in the long term trends of US growth and employment and how they remain broken:

Source: Scott Grannis

So, either (1) the stock market is majorly divorced from reality and reverting to mean soon, or (2) the economy finally picks up from here and catches up with stocks having led, or (3) this is a new norm skewed by central banks whereby current indicators of a top that resemble 2007, 2000 and others no longer apply. You know where I stand on this question, but the sideways price range of 2015 has yet to validate or invalidate any of the options.

Leading indicators still largely point to a pick up now and towards the end of 2015.

Source: Variant Perception

Whereas China looks to be in trouble.

Source: Cam Hui

Source: CNN

Biotech is also wobbling currently, testing the bottom of the parabolic. So are these the last gasps of a topping process? Or is the price range of 2015 in broad equities the pause that refreshes the bull? We saw some evidence of reset by the end of last week: AAII sentiment, bullish percent, capitulative breadth, put-call all suggestive of a significant low. However, in the bigger picture historically, these look like a low in a bear market, i.e. from which a counter rally erupts before lower lows ahead. What’s confusing is their occurrence just 5% from the highs in nominal terms.

Right now I expect stocks can move higher before they move lower again. So I am waiting and watching for evidence they are rolling over again. The key is whether they do so before they reach the July highs and then the May highs. At the same time I am looking for a lower low in gold and miners on positive divergence.

We still have a host of indicators pointing to an underlying peak around the solar maximum of last year:

That June/July 2014 peak remains in play unless we see those indicators reverse and reset. 12 months later they still haven’t. So I remain of the opinion that equities will ultimately break downwards. It’s just a matter of gauging the shorter term waves. On which note I have to prudently add that I can’t rule out a final move up to new highs before a collapse. It happened in 1987 and 1929. A range trade over the first half of the year and then a final rally to a peak in Aug or Sept:

Source: Financial-Spread-Betting

That extreme reading in capitulative breadth may support this occurring, so have to stay open minded. Hence the importance of watching indicators and price for evidence of a roll over before the July highs, then the May highs.

Bounce

Posted on July 28, 2015 Posted in Indicators, Stocks134 Comments

A bounce looks likely here, and a significant one at that.

Capitulative breadth (Rob Hannah) hit 20 yesterday, which is extreme. See other extreme readings here:

In the past, they typically occurred after major falls, but October last year and now have been more shallow. The Dow fell yesterday to just 3% off its July peak or 5% off its May peak. Capitulative breadth is made up of a count of large cap stocks in the index showing capitulative selling. Quite why this has occurred after only shallow nominal price falls is unclear.

Also, bullish percent (SPX) reached a level suggestive of a low.

Source: Urban Camel

Plus, CPC on Friday hit an extreme also only seen at previous lows, and the recent little cluster of such readings further points to a significant bounce.

Source: Stockcharts

Draw it all together and it looks like the Dow (and other indices) is going to get a decent bounce here at long term rising support.

On the flip side of the equation, gold miners bullish percent hit zero again, like the boxes in the past shown:

But note the norm in the past was for a lower low on positive divergence before a true bounce.

Therefore, it appears likely we will see a rally back upwards in broad stocks imminently whilst gold miners go on to form a lower low on positive divergence. The bigger picture of a major top in equities and a major bottom in gold remains unchanged.

No Change

Posted on July 19, 2015 Posted in Gold, Indicators, Stocks356 Comments

The underlying picture still looks the same. Stocks have rallied back up but there are so many persistent divergences that aren’t supportive. Here breadth, strength and bullish percent all look like the last gasps in 2011.

The Nasdaq has outperformed the other indices to make new highs with the rally back up, but breadth is flagging a clear warning.

Really, there are so many divergent indicators on US stocks it’s take your pick.

Meanwhile, gold dropped again but the picture is the reverse, with sentiment and positioning at contrarian levels suggestive of a bottom.

Source: Sentimentrader / King World

Therefore, not much expansion needed. We are through the new moon and moving beyond the seasonal geomagnetic peak, and all the indicators are calling time (namely, major reversals in both classes). So just watching for the turn again to resume the attack and that should be the final move.

Topping Process

Posted on July 9, 2015 Posted in Indicators, Stocks413 Comments

Some big moves in commodities, China stocks, Japan, and a change in character in US equities whereby nothing is currently working for the bulls. It begs the question where we are in the topping process, specifically is the market going to fall apart from here, or do we yet get another rally back up to a lower high.

Dow Jones World looks like this:

Source: Stockcharts

Like other recent major peaks, it shows a topping price pattern with negative divergences on the second higher high. We can pinpoint the first peak in the topping process as June/July last year:

Junk bonds, oil and financial conditions all peaked out then too. The second peak in nominal equities was May 2015, making for a 10 month topping process. That’s not dissimilar in duration to 2000 and 2007.

If we look at near term clues, the triple confluence of spikes in CPCE, Trin and Vix:Vxv to current levels (specifically all three together) hasn’t been seen since the breakdown in 2011.

Their spiking could represent a near term low for equities, from which they get a decent bounce now. Or, they could represent the first stage of a large fear move, like in 2011. Right now the SP500 is just 4% off its high, whilst in 2011 it made a 19% correction.

If we look at the bigger picture, all major indices around the world are now off their highs, most topping out in May or June. Is this about news out of Greece and China? They are providing a narrative for short term buffeting, but we can see equities have been in a typical topping process for a year. The under the hood peak was around last year’s solar max, as it was in 2000. Then as now stocks continued to levitate for several months following, whilst internals deteriorated, and the writing was on the wall. We know that allocations, sentiment, valuations and leverage have all been at saturation levels for some time. I suggest that the worries about Greece and China have initiated a trickle of bulls over to the bear camp. At some point this will become a rush and that’s when panic selling will make for swift, harsh falls. If you don’t believe that, then this will be the first time from such levels of leverage, valuations, sentiment and allocations that we don’t see a crash period averaging around 6 weeks taking around 35% off stock prices.

A fairly common topping pattern at major peaks in the past was primary distribution – peak (shake out) – second chance peak – crash, normally lasting around 6-8 months, like this:

Source: Financial-Spread-Betting

If we think of it as less of a roadmap and more of similar waves of crowd psychology playing out, it’s the ‘second chance’ which is my focus, namely are we though that or is it still to come?

If we are through it, then the market ought to quickly fall apart here, with any up days quickly engulfed. That’s kind of what we have been seeing the last 2 weeks. Plus, the heavy falls in China and commodities could be the initation of wider heavy falls. On the flip side, those spikes in near term indicators could provide a bottom here for stocks from which to rally back up into mid or late July, making a second chance peak ahead.

So what am I doing? Attacking but with stops (short Dow, RUT, IBB, long gold). If we are post second chance then there is no time to lose. The stock market should rapidly fall apart with increasingly big lurches downwards. On the other hand, if we have a second chance rally back up, I don’t want to be too exposed and save my big positioning for a little longer.

Lastly, might all this be way off and we are still safely in a bull market? Well, financial conditions just turned negative. The Ted spread is now higher than it was when stocks tanked in 2011. US economic surprises are still negative and ECRI leading indicators are flirting with zero. Earnings season starts this week with predicted 4.5% yoy falls in both earnings and revenues. With sentiment, allocations, valuations and leverage so extreme for such a prolonged period now, even a safe bull market is more likely to see a sharp correction here, something like 1987 or 2011. But I don’t believe that: the case is much stronger for a fully fledged bear market, within which Biotech retraces its whole move of the last 2.5 years.

Gold And Gold Miners

Posted on July 3, 2015 Posted in Demographics, Gold, Indicators, Solar Cycles185 Comments

Gold as an investment: not straight forward. It was the original money, valued for its rare, precious and indestructible qualities. Fiat money then took over, but convertible to gold. Now, fiat money is purely a game of confidence, and gold floats freely. Gold is a non-yielding, non-productive asset so comes into favour (jewellery demand aside) only under specific conditions, namely when real interest rates are negative (which can be under inflation or deflation), when fiat money is being diluted (such as by policies of inflation or money-printing), when debt is growing significantly (as this is money borrowed from the future) or when other assets are in decline (which chiefly occurs due to demographic trends).

Right now, real interest rates are borderline negative, public debt is at record levels, QE has been rolled out across the developed world and demographics are united negative (i.e. pro gold) in the major nations. So why isn’t gold going up?

By demographics and solar cycles, gold should be in a secular bull from 2000 through to circa 2025, the next solar max.

Therefore, gold’s bear market from 2011 to 2015 would be a cyclical bear within an ongoing secular bull, similar to as occurred in the mid-70s. Gold has been making a long basing, as evidenced in the TSI below, over the same period that stocks have been making a topping mania. When stocks start to fall in earnest, then I expect gold to take off, in a new cyclical bull within an ongoing secular bull.

Source: Stockcharts

A bear market in equities would, through the wealth effect, tip the fragile economy into a deflationary recession, which should then result in negative real rates, additional fiat dilution by central banks, rising nominal debt levels and cash-flow looking for a safe haven. All favourable for gold.

However, contrast that with the common perception currently, which is that we are in a young secular bull in equities, with the economy early in the cycle and about to start growing strongly, and a trend of increasingly positive real rates ahead. Once this perception is revealed to be a misunderstanding, then the narrow interest in gold will become much broader.

A near term look at gold technicals suggests one more washout to the downside may be needed, as evidenced here in the gold put/call. The short interest is already at contrarian levels.

Source: The Daily Gold / CFTC

I would see this as fitting with a last rally back up in equities into the mid-July new moon (to a lower high), which was predicted by CPCE and Vix/Vxv as highlighted two posts back. I therefore lightened up my equities shorts and gold longs after this week’s full moon. Earnings season starts next week and properly gets going the week after. With a predicted 4.5% yoy drop in both earnings and sales for Q2, this provides a backdrop for stocks to topple over from that second week in July, and in turn gold to finally wake up. I believe that point will mark the definitive trend change in both and currently see that as the point of max attack.

Gold miners sit between the two asset classes: as both equities and tied to gold. In the last 4 years they have very much sided with the latter, declining in the face of a rising stock market. But notably they have performed much worse than gold, as shown in GDX:GLD below.

In fact, on the long term view, the miners to gold ratio is the lowest its ever been.

Source: Incrementum

However, the major miners have been diluting their shares, making them not the bargain they initially seem.

Source: Seeking Alpha

Additionally, there is a question mark over how they might perform under sharp stock market falls. With few historic reference points, we can at best draw on the 1929 experience whereby the gold miners didn’t escape the initial falls but broke away later once the stocks bear was more clearly cemented. For these reasons, I stick with gold itself as the pure play and will pass on the miners.

Charts Update

Posted on July 1, 2015 Posted in Indicators, Solar Cycles, Stocks96 Comments

It’s a picture of a major market top. The ‘real’ peak was mid-2014 at the solar max, as it was at the last solar max of Spring 2000. The supports for price since mid-2014 have been dismantled and evidence suggests the nominal price peak in equities occurred May 2015. Annotated, so no further comments.

Selling Exhaustion Signs

Posted on June 30, 2015 Posted in Indicators, Stocks58 Comments

The first day of decent selling…. but exhaustion signals appear.

Yesterday was the highest downside volume day since March 2012. It ended the longest streak of no >2% up or down day on the SP500 since May 2012. It was the 8th largest daily percentage move in the Vix of all time, at >30%.

Equity put/call hit an extreme in fear. Here is the indicator’s history:

Source: Stockcharts

Now here is a zoom on those previous instances of prints >0.90:

Typically they marked lows or were a precursor to a low within a few sessions.

Next is bullish percent as a ratio to total put/call. I’ve previously highlighted the divergence in this indicator with the market since January 2014. However, because it has been in decline, yesterday’s selling took it to the kind of deep level associated with previous bottoms.

I also previously highlighted the divergent breadth in stocks above the 50MA. Again, because it has been in decline, yesterday’s selling has now put it in a zone that could spell a bottom, particularly if we combine it with the reading on Tick. The most similar such pairing from recent times would have been last August’s low.

The picture from stocks above the 200MA isn’t dissimilar.

Source: Charlie Bilello

Lastly, here is Vix to Vxv. It too has spiked to the kind of level associated with previous lows, with the exception of the 2011 falls.

Here is a zoom on recent incidences of this indicator spiking over 1:

We can see that a bottom occurred within several sessions of Vix:Vxv coming off its spike high.

Drawing all these indicators together, odds are that we see a rally from a low within a few sessions. Thursday’s full moon would fit with this too. As per my note yesterday I entered short RUT and IBB early and took a chance. They and the Dow positions are all in profit but in light of the above indicator readings I will be looking to cut back again later this week, anticipating a lower low from here within the next several of days but then a rally back up in July, perhaps to the mid-July new moon.