Global Stocks Secular Bear Market

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This is my pattern and projection for the global secular stocks bear market and its conclusion, based on solar/secular history:

That secular bear pentagon is present in the individual main country stock indices. Here is the current UK FTSE and my projection (click for larger):

Here is the German Dax:

Moving to Asia, here is the Japanese Nikkei:

Here is the Hong Kong Hang Seng:

Moving to the US, here is the SP500:

And lastly the Dow Jones:

So, my projection for all the indices is an approximation of that shown on the MSCI world stock index and the FTSE index charts at the top, namely a breakout upwards out of the pentagon into 2013, followed by a giving back of those gains and a retreat to the pentagon nose price level 2013-2014 (leading into and out of a mild recession), followed by a momentum take-off in a new secular bull market as of 2014/15. The US stock indices have led the way out of the pentagon, with the German and Hong Kong indices are now attempting to break out also.

I have added the price/earnings valuations of the indices at the key highs and lows. There is a theme of p/e valuations declining over the secular period, which is consistent with normal secular bear progress. It is inflation that makes secular bears track overall sideways rather than downwards, but progress in p/es reveals the true decline in stocks from expensive to cheap.

Secular bear history dating back into the last century reveals that stocks become a long term buy once they hit single digit p/es. In the secular bear to date, all the indices above have hit single digit p/es for a period, except the Nikkei. Despite falling the farthest in terms of valuation from its peak, the Japan index has only just lately come back to fair value when compared to the other country indices, and accordingly has the sorriest looking chart.

In the secular bear of the 1970s, the Dow Jones hit p/e 7 at its lowest valuation. In the secular bear of the 1940s, the Dow Jones hit p/e 9 at its lowest valuation. I suggest there is a reason why that stock index was bought up at a higher bottoming valuation in the 1940s than in the 1970s: the difference in secular yields/rates. Whilst the 1970s mirrors the 2000s in terms of a secular commodities bull and secular stocks bear, the 1940s is our closest match historically as it is both those but also a secular bonds bull. The 1970s was a secular bonds bear. It makes an important difference, in that equities are more attractive relative to other assets when bond yields and rates are ultra low. These next two charts show how stocks have now moved to relative extreme value versus treasury bonds and corporate bonds by dividend yields.

With both types of bonds paying negligible or negative real yields, the relative attractiveness of equities in that environment becomes that much greater. It is the pessimism that characterises the end phase of a secular stocks bear that is keeping money parked in bonds, but once confidence grows in economic outcomes, money should flow the other way. I am suggesting that stocks could bottom at a 1940s style p/e 9 rather than a 1970s style p/e 7 in this environment because of the additional value provided by dividend yields over and above treasury and corporate bonds and the relative attractiveness of true yielding assets in a negligible interest rates environment (rather than a high interest rates environment like the 1970s).

Solar and secular history predicts an inflationary finale in 2013, which if stocks went nowhere (nominally) would reduce p/e valuations further. I therefore expect that my projection of stocks breaking out and then returning to that kind of nominal level perhaps 18 months hence will see the indices largely breaking beneath 10 into single digit p/es at the ‘go’ point. The US indices, currently the most expensive, would be unlikely to make single digits unless they fell harder than the rest. However, not all indices made single digits at the end of the last secular bear – the Nikkei, for example, ended at p/e 20. The US stock indices have both hit p/e 9 in this secular bear already however, and that is comparable to the bottoming valuation of the 1940s secular bear. In support of this, it can be seen that the German Dax has been bought up each of the three times it hit p/e 9, in 2003, 2009 and 2011.

Key Assets In Charts

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The Hang Seng is at long term resistance, attempting to break out. By my secular/solar history analysis, the kind of path shown by the arrow would be appropriate, i.e. a breakout here, a rally away from the range, then a pullback in keeping with a final bear and mild recession before a new secular bull takes off with momentum.

The German stock index and US SP500 stock index share a similar look to each other: battling to hold the breakouts made above the March 2012 highs. My leaning is that they are making bull flags above the breakout, successfully backtesting before advancing. This consolidation of several weeks post QE announcement fits the action post QE2 announcement before advancing, and it also fits with Presidential seasonality, namely a consolidation mid-October before a rally around the US elections.

Crude oil appears to be making a rounded bottom:

Gold has paused at horizontal 1800 resistance, and has made a 23 fib retrace. It could potentially drop further to make a 38 fib retrace, but either way I believe gold will shortly resume its uptrend and break through 1800, targetting the next resistance at 1900. Supporting that, seasonality is most positive for gold Sept-Feb, gold has been building energy in an 11 month consolidation, and if pro-risk breaks out as I predict above, I expect precious metals to also.

The Euro-USD pair is at an important juncture. Either it is completing a bull flag in an ongoing uptrend and is about to break out above horizontal and down-sloping resistance, or its rally is going to end here at those key resistances and it will eventually break down beneath rising support. I favour the former, in line with pro-risk.

A broad agricultural commodities ETF is shown below. After the fierce rally of mid-2012, brought about by extreme global weather conditions, softs have pulled back to between a 38 and 50 fib retrace currently. This is in line with Gann predictions for a partial retrace before a renewed rally to new highs emerges as of now, so perhaps once at the 50 fib, I expect softs to renew their upward trend.

Supporting a rewewed advance in softs, the latest NOAA climate data for September came in as the hottest globally land/ocean for that month on record, and the latest US Department of Agriculture report revealed even tighter grains supply than previously understood.

Supporting a wider rally in pro-risk from here we have (i) US economic surprises still trending up, (ii) US ECRI leading indicators still trending up, (iii) US retail sales and consumer sentiment surprising to the upside, (iv) money supply and export data from China surprising to the upside, (v) money market spreads in Europe and the US back to benign levels, (vi) German investor sentiment rising more than expected. In short there is growing evidence of global reflation, and there is a useful chunk of data coming out this week that will either add to or subtract from that, namely, Conference Board LI data for several key countries, some key China data including GDP, and some big US earnings reports.

I believe pro-risk assets are primed to resume advancing technically, subject to supportive reflation evidence, and that recent data is supportive for reflation. I therefore maintain my pro-risk portfolio as it is.

I have updated all models this morning.

Friday Roundup

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This is how the Sp500 stands. The consolidation is comparable after both QE announcements, if the market now proceeds to rally, and it has twin technical support for an uptrend resumption, as shown:

Its a useful triple confluence (channel support, holding above March highs and behaviour similar to the last QE announcement), because a decisive breakdown would swiftly provide 3 reasons to be bearish (i.e. triple confluence failure). I say decisive breakdown, because the market can sometimes make a fakeout to flush out the weak hands, so I’d want to see a couple of consecutive closes beneath the marked zones, to give more weight to the bearish alternative. The positive pressure around Monday’s new moon is still in play if the market can rally today and early next week, which gives us another reason for a renewed rally without delay, if it is going to happen.

The correction so far has largely neutralised indicators, such as II investor sentiment (now more bears than bulls), stocks above the 50MA (now back beneath the mean), and bullish percent / call put (neutral zone). If the correction is going to be a full flush out (or a new bear), then we’d expect these indicators to go all the way to extreme oversold/bearishness, but if this is just a consolidation in an uptrend then they have reset enough to push on again. I am still in the continued uptrend camp, and still expect the SP500 can reach around 1600 before keeling over. I maintain that because we don’t yet see the typical evironment for a cyclical bull market top (yields rising, inflation rising, leading indicators in a renewed downtrend, economic surprises in a downtrend, negative breadth divergence, etc) and that there is growing evidence of reflation.

What few US earnings report there have been so far have on average beaten expectations, but next week will produce a better sample.  ECRI leading indicators rose again last week and this week the shadow index is predicting the WLI growth will rise to 5.53 from 4.67. Conference Board leading indicators for the UK came in positive again today and higher than last month, but we have to wait until the end of next week for other country updates. OECD leading indicators came in unimpressive again this month:

 Source: OECD

The horizontal lines represent historic average growth, not a growth/recession divide, but nevertheless they don’t paint a picture yet of a global economy in resurgence. The particular bright spots in their report were Brazil and UK. There is a potential trend change in China occurring as shown, and the Shanghai stock index continues to look like it may be breaking out of its long term downward trend, plus the Baltic Dry index has risen 40% over the last couple of weeks, so I continue to watch these.

Yesterday grains had a bumper day as the latest US Department of Agriculture report suggested stockpiles will drop more than expected due to the adverse weather conditions and continued robust demand. And the US dollar index made an inverse hammer candle at both horizontal and diagonal resistance.

Source: Stockcharts

That’s only significant if there is now follow through, so again my focus is on how pro-risk and safety behave the next couple of sessions.

Gold And Apple

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The exponential or parabolic or Hubbert phenomenon typically looks like this:

Source: Wikimedia Commons

It occurs in nature and it occurs in the markets. Occasionally the exponential run up is followed by a flattening out at the top, to make an S-curve:

Source: Wikimedia Commons

But most of the time there is a collapse down the other side, fairly equal to the run up, and here are some examples of that:

Source: Chris Kimble

Apple is the world’s biggest stock by market capitalisation and now dominates the fortunes of the Nasdaq. Apple’s chart has gone parabolic over the last few years:

Source: Stockcharts / Yahoo

So is it due to collapse? Well, here’s the thing about exponentials: they can get steeper and steeper, putting on faster and faster gains.  Recognising the pattern therefore isn’t enough, plus there is the possibility that a chart that has gone exponential flattens out into an S-curve rather than collapses. Typically, a parabolic that reflects a speculative mania to valuation excess will result in a collapse, whereas a parabolic that reflects genuine growth or fair value may flatten out.

In this next chart we can see that Microsoft was bid up to a forward p/e of 67 in 2000, compared to a historical average around 15. The new internet companies of the time reached 8% of the total US stock market capitalisation, the SP500 reached a p/e of over 40, and the Dow-gold ratio reached an all time high of just under 50. By various measures, it was clear the tech parabolic became a speculative mania, and a collapse followed. Of course, timing the exit from the parabolic was difficult – it only looks easy with hindsight.

Source: Reuters

As can be seen, Apple is currently valued at just a 13.8 forward p/e, which is cheaper than the historical average, and it is cheaper than the majority of SP500 companies currently. So whilst it has exceeded Microsoft’s capitalisation of 2000, it isn’t the same kind of speculative bubble.

The near term view of Apple looks like this. A correction is occurring, following a higher high on negative volume divergence.

 Source: AfraidToTrade

That suggests it may correct further yet, and in so doing it is dragging down the Nasdaq. As the Nasdaq is usually the leading index, other indices are usually affected. So Apple’s fortunes are important. But Apple’s parabolic does not suggest a collapse as its rise is based on genuine growth and its valuation is still relatively cheap. Barring an economic downturn whereby all stocks are affected, I expect Apple to resume its uptrend post-correction, or to flatten in an s-curve if Apple’s growth starts to slow.

Turning to gold, we see the same exponential pattern over the last few years. At any point up the curve a trader could have called a top based on an unsustainable trajectory, but the curve just got steeper. The 9 month consolidation from 2011-2012 brought about bigger calls for a top, but again it appears to be resolving upwards into what should be an even steeper parabolic.

Source: Valcambigold

Assessing the parabolic for gold is more complex than for equities, because there are multiple valuation measures for gold as it fulfils various purposes from inflation hedge to hard currency to commodity. The publisher of that chart compares the percentage of assets in the gold sector as one measure. Certainly the 1% current position is not excessive compared to 26% in 1980 or dot com companies reaching 8% of the US market in 2000.

Valued as a reserve currency in the face of large monetary base expansion, its parabolic appears to reflect genuine fundamentals.

Source: Economicsfanatic

As a non-yielding asset that fares well when real interest rates are negative and declining, it has also been rising at ‘fair’ value.

Source: Moneyweek

However, when we look at its relative expensiveness to real estate or equities, it is into the historic extreme zone. Versus equities, it could yet become more relatively expensive to reach down to the 1980 level, but on this measure alone the gold parabolic does reflect some speculative froth.

Source: Sharelynx

Other ways to value gold include its relative price to food or broad commodities (due to close relations) and the proportion of its demand from investment (central banks and investors) versus supply growth. Drawing all together, I would suggest the picture for gold is one of a parabolic so far based largely on fundamentals, i.e. a genuine ‘growth’ based exponential rather than a speculative mania. However, I also suggest that this is likely to change ahead. I have argued elsewhere that yields should begin to rise now, that ‘investment’ demand for gold is due to top out in the next 18 months whilst supply is already growing, and that a whiff of policy change in relation to rates was enough in the 1940s to kill the gold bull (rather than requiring real rates to go positive). I believe we will get that whiff once we reach an inflationary spike next year.

I predict a speculative mania in gold will occur, based on historical mirrors, and we will then see the divergence from fundamentals that will bring about a huge run up followed by a collapse. But thus far, gold’s parabolic is not particularly speculative, and that does suggest that the Dow-gold ratio could reach 1980s levels before reversing. There is no easy way to time an exit from a speculative parabolic that has diverged from fundamentals, only to recognise it and then choose your weapon. That weapon could be trailing stops, or solar cycle timing, or technical indicators such as overbought/overbullish extremes together with negative internal divergences. But first, let’s look for evidence of transition from value parabolic to speculative parabolic.

Near Term Timeline

Posted on Posted in Indicators, Macro, Solar Cycles, Stocks11 Comments

Here is a timeline of events into the end of 2012. I place more weight and validity on some of these than others, but it helps to lay it all out. If I’ve missed something you consider important, let me know.

1) US Earnings start tomorrow with Alcoa and continue until Mid-November

2) 12-15 October Carolan crash window

3) US Elections are 6 November

4) Lame Duck Congress session 13 November for decision on fiscal cliff

5) Correction in commodities, and potentially equities too, into around 21 November, based on Gann, before mega commodities rally erupts lasting all 2013

5) Late November market top predicted by Eurodollar COT futures

6) 28 Nov – 7 Dec Puetz crash window

7) 22 Dec last major Bradley Turn of 2012

8) 31 Dec / 1 Jan fiscal cliff comes into effect, if no postponement or change, i.e. tax rises and spending cuts which will hamper the economy

9) Presidential election seasonality suggests equities should consolidate a little here in October and then make a push higher around the election, and potentially even higher by year end:

Source: Bespoke (plus my update in thicker blue of 2012’s SP500)

Source: SeasonalCharts

10) Geomagnetism is seasonally at its tamest in December and January, which coincides with (or belies) the ‘Santa Rally’

Drawing it all together, if we don’t see a crash into this coming weekend (Carolan’s work as highlighted by readers), a little consolidation here in mid-October would be normal seasonally, and is perhaps fitting as we await the ‘theme’ of US earnings (which will not become clear until next week), and for the US election polls to make their telling late swings. Based on the latest odds, President Obama will be re-elected, and this fits with the stock market having made its largest historical gains under his Presidential term. Furthermore, in this scenario historically, a re-elected Democrat President has led to bigger subsequent gains in equities than a switch to Republican. So, as things stand, the rally around the election that has been historically normal, may indeed come to pass again – assuming the polls suggest Obama to win, followed by his actual victory. Perhaps an associated US Dollar rally around the elections could fit with a consolidation in commodities, before they embark on a major rally, as per Gann.

The fiscal cliff will then come back into focus, and we will see whether the fiscal tightening is allowed to come to pass (which will be negative for the  economy) or whether it is postponed or amended. Whilst no President will want to risk sinking a precarious economy, the first year of a Presidency is often used to implement unpopular policies.

We have a market top forecast by Eurodollar COT futures at the end of November, together with a Puetz crash window. Whilst Puetz windows have been very hit and miss, the two combined adds more weight. I am expecting a cyclical bull top in equities ‘soon’ (based on secular and solar anytime as of now through to Q2 2013), but want to see the usual topping indicators present, e.g. a topping range with negative divergence in breadth, overbought and overbullish readings, yields and inflation up, leading indicators and economic surprises trending down. So if enough of these are flagging by late November, which would fit with Eurodollar COT plus Puetz, then I’d be getting out of equities. However, if reflation is just getting going currently, then that may be too soon, and we might look to beyond the Santa (benign geomagnetism) rally of December/January for a top (unless geomagnetism is unseasonally bad).

Bradley Turns I also find very hit and miss, but if 22 Dec is to be valid, then by the theory it can be a top or a bottom. If equities top out late Nov and make a Puetz crash then 22 Dec could mark a bottom, and this would roughly coincide with a bottom predicted by Eurodollar COT. If technical and macro topping indicators are absent in late Nov, then maybe stocks could make a top 22 Dec. Well, with all these potential markers and triggers, we will get more clues as we move through the checkpoints in October and November.

To return to where we stand this week, US earnings will begin, as will the Carolan crash window. I find it hard to produce a case for a crash at the end of this week. In the US, economic surprises have moved up to a new high for H2 2012, as have ECRI WLI leading indicators – both are decisively in the positive and trending upwards. Global leading indicators have improved, and it would take a quick and major reversal to bring about a market panic. Rather, reflation is likely due to 6 months of central bank rate cuts and renewed stimulus, and with leading indicators tentatively reflecting this, I rather expect the markets to await more data. Euro debt remains subdued, and US earnings (by relation with ISM PMI) are most likely to be unimpressive but above expectations. Lastly, we don’t see topping indicators aligned in equities – there are a couple of flags but not enough to mark a top. We see excessive frothiness in gold speculation but given its 9 month coiling prior to this current rally, I expect a consolidation only.

The reflation I expect (assisted by the collective central banks effort), and see tentative evidence for (in leading indicators and assets), fits with solar cycles: an inflationary finale in 2013. To be more precise, we should see pro-risk rise strongly before commodity rises become excessive, killing off equities and tipping us into recession. Treasury yields should rise into the cyclical bull top for equities, and the longer term treasury channel action that I have previously shown suggests that should indeed occur over the next 12 months (supported by Gann projections too). Because of this cross-referenced picture, I don’t side with an imminent top and crash in equities, but remain open to one if the usual topping signals and indicators align. So as always, one day and one data item at a time, but I rather believe we are heading for an inflationary speculative froth before anything bearish and deflationary occurs.

If solar cycles do fulfil, then there are other associated expectations leading into 2013’s solar maximum. One, solar maximums are correlated with increased earthquakes. Should a major earthquake occur, then the implications for the markets would depend on location, but earthquake occurence could help tip the global economy into recession. Two, solar maximums are correlated with protest and war. Should conflict increase in the world then it could both assist in tipping the global economy into recession and also in fulfilling the secular commodities bull conclusion, if energy and food are affected.

Iran has remained in the spotlight due to its potential for energy supply disruption and conflict in that region of the world. Now, hyperinflation has taken hold, with monthly inflation up to 70%, in part due to the sanctions imposed on the country. Internal social unrest has begun, and is likely to escalate. Historic examples of hyperinflation correlate with subsequent war and social/political upheaval. Refuge is also sought in gold, and Iranian gold purchases have been escalating in line with the currency debasement. I believe these circumstances could play a key role in fulfilling solar cycle predictions of a secular commodities and inflation finale next year, anticipating regional conflict around Iran, oil supply disruption and oil price escalation, and the knock-on effects for other commodities. This could be viewed as either solar maximum conflict and war fulfiilling a solar maximum inflation/commodities blow-off top, or the other way round. Certainly, now inflation has escalated out of control in Iran, there isn’t going to be a way back, so it’s a question of how the social and political impacts unfold from here.

Friday Roundup

Posted on Posted in Currencies, Indicators, Stocks5 Comments

Yesterday’s action was bullish for pro-risk. The Nasdaq completed its successful backtest of key support by launching away from it. Oil completely reversed its heavy losses of the previous day. The Dow Transports pulled further back up into the range, making the recent drop out of the bottom look like a fakeout.

Source: TSP Talk

The Hang Seng has broken out of its long term triangle, to the upside.

That breakout is still tentative, but other Asian indices echo this, such as the Kospi:

Source: Bloomberg

Now let’s see if the Shanghai index can follow through on its tentative trend reversal next week, that it began before this week’s holidays.

The Baltic Dry index yesterday pulled another 6% away from its lows, and copper has recently broken out of a triangle to the upside.

Source: TradingCharts

And the US dollar broke down from a bear flag.

Source: TSP Talk

All in all, the picture is currently supportive for pro-risk and for reflation. Both AAII and II investor sentiment turned less bullish this week, putting both further neutral, and not indicating a top. So whilst there are a couple of topping flags for US equities, as noted in the last post, I don’t believe that’s enough at the moment to bring about a reversal here. Rather, if reflation is just getting going, and if Asian equities are just breaking out, then it seems more probable that the rally endures for some time yet.

Lastly, Yardeni’s fundametals versus stock market divergence in the US has now been partially resolved with the fundamentals turning up to point the same way as equities.

Source: Ed Yardeni

Current Markets And Macro

Posted on Posted in Currencies, Macro, Stocks14 Comments

Yesterday during the US session I was watching the support/resistance line on the Nasdaq shown:

It marks the March/April 2012 highs, and the battle below and above that level in August and September is clear to see. Having broken out above it in September, the market is now retesting the breakout and yesterday, marked by the arrow, saw the index briefly break down beneath it only to rally strongly into the close and hold above it. I believe that may be significant, and today’s out of hours action (Europe morning) is so far bullish. But, there remains the possibility that we are making a bear flag in a protracted correction, and the SP500 (below) and Dow are higher above the March/April peaks with more room to consolidate downwards.

We have a 2 week period of low forecast geomagnetism and upward pressure into the new moon now, and given last week was the seasonally worst week of the year together with a full moon, damage to pro-risk was contained. Supportive of pro-risk pressing upwards here is a particularly bullish correction formation in gold and a bear flag on the US dollar:

Source: TSP Talk

However, there are some warning flags for equities. This chart shows that when the Fear and Skew indices spiked together with a low Vix, equities were approaching a top.

Source: Sentimentrader

And this composite of Put/Call, Market Vane and Sentiment Surveys also suggests equities should be approaching a top.

Source: Technical Take

Note that with both charts, there is the scope for equities to top out now, or to keep rallying for another couple of months and then top out. So with that in mind, we can return to the top two charts of the SP500 and Nasdaq and watch to see whether they break back down below the March/April highs – which would make the breakout a fakeout and give more weight to a market top – or whether they can push on now this week and next and make the breakout backtest successful, which should mean a period of longer gains ahead as they move into clear air. My leaning is towards the latter because we don’t yet see the usual cyclical bear market topping signals or process.

We can look wider for more to gauge the environment for pro-risk. The key question is whether we are reflating or tumbling into recession. I previously noted the improvement in Conference Board global leading indicators but we have to wait until mid-month for new updates both in these and in OECD leading indicators. We have other data to keep an eye on though, starting with ECRI US leading indicators which rose again last week. It should be clear from the chart below that the action in the indicator does not resemble that in previous recessions:

Source: Dshort

RecesssionAlert caculate the probability that the US is in recession currently as 6.4%:

Source: RecessionAlert

Nowandfutures measure, which requires yield curve and CPI adjusted monetary base both to go negative, only has one in the territory:

Source: NowandFutures

Here are the latest global PMIs combined:

Source: World Bank

There is clearly some recent improvement, particularly in Europe. The key question is whether they are in a recovery trend, or just an oscillation in a continuing downtrend.

This is how I see it. There is some clear improvement in leading indicators globally. We have had 6 months of rate cuts and renewed stimulus. I expect the reflation. Solar and secular cycles support the reflation. But I’m not jumping the gun. I want to see more evidence of improvement. Clear upward trends. So it’s one day and one piece of data at a time. But I don’t see reasons to take profits on pro-risk longs at this point.

Dr.Copper is behaving bullishly of late, as is Dr.Kospi, and the Shanghai index was potentially breaking out of its wedging downtrend on a Demark buy signal and RSI positive divergence, prior to the Chinese holiday week – something to watch next week. Treasuries regained some ground as beneficiaries of last week’s correction in pro-risk, but by QE history should begin a more enduring downtrend – unless of course you believe this time is different.

In summary, there is tentative evidence of a global reflation that should provide the backdrop to a secular commodities finale, but I want more evidence. I see stocks at a crucial point technically, either backtesting their breakout succesfully, or failing, and my leaning is the former. There are some technical indicators for stocks flashing a top in terms of complacency and overbullishness, but as yet a lack of other supportive topping indicators. Because those flashing indicators could remain at those levels for a while longer, and given Presidential seasonality, I think we can push higher yet into November. In terms of my solar and secular timings, a topping out of equities as we turn into 2013 would be reasonable, so I believe we are approaching that stocks peak, but are not there yet.

Kondratieff And Solar Cycles

Posted on Posted in Commodities, Inflation, Solar Cycles, Stocks41 Comments

Kondratieff was a Russian economist who argued that there was a long sine wave cycle in the economy lasting around 60 years broken down into 4 seasons each lasting around 15 years. There proposed reason for the cycle is…. other cycles. In other words, cycles of demographics, credit cycles, capital investment cycles and more, generate these long repetitions over time. Clearly that’s slightly unsatisfactory, unless we can explain the cycles of the source phenomena. Today, I am going to argue that Kondratieff cycling actually reflects solar cycling.

Here is the Kondratieff cycle and its subseasons:

Source: The Long Wave Analyst

We should be in a K-winter since around 2000, with gold and treasuries king. With both gold and treasuries having performed handsomely over the last decade and recently reached all time nominal highs, evidence is supportive.

The general theme of the K-winter should be deflation and cleansing. When Kondratieff wrote his theory, central banks did not have the freedom they have now to counter-attack with intervention and monetary inflation. Using Shadowstats data, we can see that the results of their actions in the US: high price inflation rather than deflation.

Source: Dshort

However, when US GDP is netted of this inflation, we can see that the K-winter appears to have fulfilled: a period of shrinkage, or cleansing.

Source: Dshort

We can measure this another way: stocks have tracked overall sideways since 2000 but when adjusted for inflation have significantly dropped. This is reflected in price/earnings ratios gradually falling since 2000 by more than half.

There has been a lot of debate about which of the two ‘flations is and has been occurring over this last decade, and it’s understandable. There has been major monetary inflation, and this has resulted in significant price inflation particularly in hard assets such as commodities. Yet, there have been characteristics of deflation: real economy shrinkage, a decline in money velocity (cash hoarding), debt deflation (in households and companies), and liquidity traps.

I suggest that some kind of K-winter has indeed been playing out since 2000 as per the theory, and that governments have been unable to prevent that, but they have been able to prevent a social-conflict-inducing depression by tinkering in the economy with what they can (rate cuts, bailouts, money supply increase, balance sheet expansion). The result is two-fold: (i) in nominal terms the economy and asset prices have held up because inflation has offset real declines (a popular illusion) and (ii) a lighter rather than deeper cleansing has been possible in the economy and assets because public balance sheets have been expanded to simply transfer some of the previous excesses rather than purging them. There is no magic to the public balance sheet expansion: this is simply prosperity taken from the future.

So, central bank large-scale intervention in a ‘natural’ period of cleansing (following the excesses of the 1980s and 1990s) has changed the parameters understood by Kondratieff. The result of pushing easy money onto an economy in cleansing is a series of speculative bubbles from real estate to oil to agriculture to bonds to precious metals to equities. Over the last decade we have seen them take turns in making parabolic rises. Be aware though that much of this action is in nominal terms, i.e. net of inflation the gains are much less impressive. Nevertheless, if Kondratieff theory is valid, then our current K-winter is as much dominated by assets that perform well under inflation, such as commodities, equities and real estate, as dominated by gold and bonds as safe havens.

What if there is a K-winter finale ahead, in which outright deflation reasserts itself and just gold and bonds rise (perhaps in a parabolic)? Those who advocate that we are tumbling into recession currently and that this will reveal central banks to be powerless (given rates at zero and stimulus back on) could perhaps buy into that scenario. Let’s compare the last K-winter and see if this happened.

The last K-winter was the late 1930s and the 1940s. As now, equities were in a secular bear market, economies were in trouble following the excesses of the preceding decades. The world war pushed debt to high levels and so governments had to keep rates low. Inflation was problematic accordingly, and we saw a similar inflation/deflation mix to the current K-winter, in that economies shrank but assets such as commodities performed well due to easy conditions. The K-winter did not draw to a close with a deflationary assertion and a huge money flow into just bonds/precious metals and out of pro-risk, but rather a general commodities peak and associated inflation peak in 1947, followed by a gentle coiling of equities and then true secular equities bull momentum as of 1949.

I have maintained that the 1940s is our closest mirror to our current period since 2000, due to the secular commodities bull and secular stocks bear, the combination of ultra low rates and problematic inflation, and by solar cycle timing. The Kondratieff cycle would calculate this too, as it was the last comparable K Winter season. So let me now draw together solar/secular cycling and Kondratieff cycling (click to enlarge):

This diagram is an idealised cycles model, all based around solar. In my previous work I have demonstrated that solar peaks occur roughly every 11 years and that secular peaks in equities and commodities occur close to solar peaks. There is a sine wave in long term real stocks and an opposite-polarity sine wave in long term real commodities, both which have around a 33 year (equivalent to 3 solar cycles or 1 lunisolar cycle) duration, as shown in the charts below. Treasuries (or inverse rates/yields) move in around a 66 year cycle (2 lunisolar cycles) with peaks and troughs converging with secular commodities peaks. The result is we see two different kinds of secular commodities bulls: one set against rates moving to a peak, and one set against rates moving to nothing.

I believe that idealised combined cycles model fits very well with Kondratieff theory. The only adjustments I have made were to slightly shorten the summer and winter seasons by slightly extending the spring and autumn seasons, which doesn’t stray too far from his time ranges for the seasons. The combined model does suggest that there are differences between our current period and the 1970s or 1910s, which were both previous secular commodities bulls and secular stocks bears. They were K-summers where inflation was the only ‘flation in town, whereas today’s K-winter and the 1940s K-winter both had elements of inflation and deflation: a natural deflationary cycle offset by inflationary central bank actions. Regardless, the K-summers and K-winters ended in a similar way: with an inflationary peak and a general commodities peak, and a range-trading for equities.

Picture the current K-winter without central bank intervention. A deflationary depression would likely have occurred. Unemployment and defaults would have been much more severe, cleansing much deeper. Social conflict would likely have been much greater. But the natural process of cleansing would have given way to a new cycle of growth ahead in the same way with or without intervention. What the intervention has done is make the K-winter process less severe all round by some can-kicking (a lot of the ‘bad’ has been absorbed into new public debt, which will have to be paid for at some point, but not now). By keeping rates ultra low and bailing out companies and countries that could have had much wider impacts we are moving towards that new K-spring and cycle of growth with a significant helping hand (putting future generation implications aside).

I suggest that Kondratieff found evidence of cycles that were actually approximations of solar cycles. In other words, he uncovered repetitions in time in the economy and financial markets that ultimately are caused by the sun’s cycle of activity and its influence on humans. The long term sine wave to which he refers is apparent on my charts above for real equities and real commodities due to the speculative pulls into the solar peaks, and there is a similar relation with treasuries/rates. The idealised model that I have produced shows that the relations between these 3 asset classes and solar peaks produces one 66-year cycle within which there are 4 different periods, as the different assets are pulled to the solar peaks with different frequencies and alternations. These four periods fit very well with Kondratieff’s seasons by their characteristics, and the whole cycle likewise. I believe that a few tweaks are needed to K-theory to make it more accurate: the two shorter and two longer seasons per my model, and the K-winter now featuring central bank intervention and a mix of inflationary characteristics as well as deflationary (with associated implications for hard assets).

Friday Roundup

Posted on Posted in Commodities, Currencies, Indicators, Macro, Stocks7 Comments

1. Chinese stocks are making another attempt at bottoming, and this one has promise. A falling wedge, positive RSI divergence and a potential fakeout beneath support as stocks rallied strongly yesterday and again today (today’s rise not shown), taking us towards 2100.

Underlying Source: Cobra/Stockcharts

2. The German Dax bounced yesterday at rising support. The technical situation is shown below – for my bullish case, the most important is to hold above the March 2012 highs – a previous resistance that should now be support. If the Dax can hold that rising support line then the next target is the cyclical bull highs to date of mid-2011.

3. The US SP500 index is already at new cyclical bull highs and so holding above that s/r line is again the priority for my bullish case. Again, it will be interesting to see if the index can hold the rising support and after a little small range consolidation around this weekend’s full moon, resume bullishly with that angle of trajectory. Recall that Presidential seasonality supports further gains all the way to the November elections, and whilst I wouldn’t specifically trade that phenomenon, it has been fairly reliable historically.

4. The Dow Transports continue to languish, but a little indecision at the bottom of the range could spell another reversal back into the range. It’s an important one to continue to watch.

Source: TSP Talk

Here is Ryan Puplava’s assessment of whether stocks are likely in a topping process here or not, and the Transports divergence is the only flag currently, he suggests:

  • A shift out of risk assets and into defensive sectors. (false)
  • Leading economic numbers and Fed surveys roll over (false)
  • Transport or Industrial indexes not confirming each other in new highs (true)
  • A lower high, or at least a break, in the market trend (false)
  • Momentum failure (false)
    • Flat/sideways market from support to break (false)
    • Momentum divergence at a higher high (false)
  • Distribution with 2400 or more declining issues on the NYSE in a given day (false)

Source: Ryan Puplava

5. Gold is also climbing a rising support and if about to face resistance close to 1800. It arrives here on fairly frothy sentiment, however, given its preceding 9 month range coiling and its peak seasonality period currently, I don’t place too much weight on the frothy sentiment. I rather suspect it will have a run where sentiment remains elevated. But let’s see how it deals with that horizontal resistance.

6. Euro-USD pulled back having reached overbought/overbullish, and could pull back a little further to rising resistance. The key question is whether it has made a medium term trend change given the renewed confidence in Euroland and the dollar-debasing US QE-without-end. We know that QE1 and QE2 announcements made for enduring rallies into pro-risk (after the initial spike and correction couple of weeks), which would suggest Euro-dollar, commodities and equities all rallying. There are no guarantees third time round, but market participants may lean more pro-risk, aware of that history.

7. The correction in pro-risk this week has done a reasonable job of deflating other overbullish/overbought indicators, in equities and crude oil amongst others. As previously noted, equities typically flirt with extremes for a period before rolling over, as opposed to hitting once and then collapsing, and we are generally looking at first touches.  Indicators such as stocks above 50MA and bullish percent over call/put have reset sufficiently to enable stocks to rally again, if that’s the will of the market. The two US equity sentiment surveys of II and AAII both continue to show fairly neutral readings, and as I am looking for the next market top to be a cyclical bull market top, we really should see these reach extremes.

Source: Schaeffers Research / Investors Intelligence

Source: Bespoke / AAII

8. Natural Gas has been the stealth hit of 2012. Below is a weekly chart as of the end of last week and this week it has risen to 3.3. If you bought at the bottom in April, you would be up 75%. Well, my story is this: I was one to buy in long in 2010 and 2011 as it dipped several times below 4 (at what appeared excellent historic value and historic extreme cheapness versus oil), only to see dire performance continue and even worsen. Hence my aggregate position is still underwater but as the excess gas inventories have been declining it looks like it may eventually turn a profit. I consider this asset to really have been a good example of ‘the market can stay irrational longer than you can stay solvent’. My exposure was never that significant in my account, but it has taken a lot of patience to see a turnaround.

Source: TradingCharts

9.  On the macro front, we saw a couple of bad US data reports this week, the worst being durable goods orders. As a result, US Economic Surprises has taken a sharp fall and although still positive, needs watching closely in case of a trend change. Due to aggregate leading indicators trending up, I don’t expect that to be the case, but let’s see ECRI’s latest reading later today.

Source: Sober Look / Citigroup

As can be seen from the Dhort chart (hat tip Antonio), there is a relationship between the durable good orders and the SP500 performance that makes the data dip alarming:

Source: Dshort

There is a history of volatility in the durable goods number but that dip is one of the most dramatic. It’s a flag, but not on its own enough to make me want to take profits on stock indices longs at this point. With the improvement in aggregate leading indicators, the positive technical picture for equities, the renewed global stimulus, and the Presidential seasonality, the balance is still bullish. But for that to remain, other forthcoming data (of a leading style) needs to return better. Something to watch next week.

10. US earnings season starts the week after next and there is a fairly compelling relationship between the ISM PMI and SP500 earnings year over year (hat tip Gary). As can be seen below, the latest data for August was just below 50, i.e. around zero growth. The expectations for this earnings season are for earnings growth over the same quarter last year of -3.4%, i.e. a drop. That does potentially set us up for earnings to come in between zero and -3.4, i.e. to be bad but to beat expectations, which would normally be enough to rally equities. Clearly, both the ISM PMI and the analyst expectations are only guides, but there is a potential scenario there to fulfil the technically bullish picture for stocks, in October.

Source: Calculated Risk

Have a great weekend everyone.