Stocks, Gold, Money Supply and Debt

Here is a chart from Gary Tanashian through SlopeOfHope’s charting facility, which could be argued legitimises the current steep ascent in US stocks:

24nove1Parabolic money pump, steeply rising corporate profits, and therefore equities going vertical (on a long term view).

In fact the sharply rising monetary base is directly contributing to those rising corporate profits, as government spending (debt) has been the key driver of corporate profits since 2008:

24nove2Therefore, if the US Fed begins to withdraw stimulus, disappointment in corporate profits is likely, as the chart shows the traditional profits driver of private investment has collapsed and not recovered over the last few years. Once again, this fits with demographics, and we should therefore not expect private investment to ramp up significantly again any time soon. So it’s in the hands of the US government and Fed. Maintain or increase stimulus, corporate profits should keep rising; decrease or end stimulus, corporate profits should retreat.

Turning to the monetary base, equities are not the only correlated class. In fact, gold has had a tighter correlation, until 2013. Here 2000-2012:

24nove3Source: Fool.com

Gold displayed a similar correlation with government debt, also until 2013.

24nove4

Source: RockSituationReport24nove5

Source: SlopeCharts

The first shows the debt limit, which will be back on the agenda soon, and surely must keep rising, whilst they retain the need to stimulate, which they will due to demographics. The second shows debt as a percentage of GDP, which actually fell back a little in H1 2013 (my extension on the chart). The reason for that was better than expected economic growth and a trimming in certain areas of government spending. Total debt continues to rise at a historically rapid rate.

So are these correlations with gold broken, or is gold set to come back? One more chart shows that the US dollar and treasury yields have been largely inversely correlated with gold and the pair strengthening for much of 2013 has been a key factor in gold’s decline:

24nove6Source: SlopeCharts

In my opinion, gold’s relations with money supply and debt levels are logically sound, and both money supply and debt should continue to rise into the future under the demographic trends. I therefore I expect gold can restore its bull market if the US dollar and treasury yields tip again into sideways or declining trends. If the US economy strengthens and a little inflation is restored, then this is unlikely to happen and gold will remain in the doldrums. However, demographics and debt suggest the Fed will have to keep fighting to maintain growth and keep deflation at bay (taper disappointment, yields suppression, new measures to attempt to inflate), which could bring about such a reversal in fortunes.

I still expect equities can go a little more parabolic first, under a typical solar maximum speculation push. However the warning flags already in place of dumb/smart money, trading volumes, margin debt and trading credit balances, and overvaluations (e.g. Q ratio) suggest it is most likely limited in duration and size. I would go with something like this from trader Moe:

24nove7Source: Trader Moe

A further 10% gain in a rapid time, with a catalyst being collective major breakouts in the major global indices, to get to some crazy extreme indicator readings, and a subsequent termination. My first checkpoint is the start of December, because the 3rd is the new moon and as of the 4th geomagnetism is forecast to ramp up again. If equities can rally hard and fast into that point, with a spread of indicators flashing, then I would suggest that could be the earliest point for declines to set in (barring any external shocks). If, however, equities can rally through the seasonally strong Xmas period, and solar intensity stays high into the beginning of 2014, then the next checkpoint would be early January.

 

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Charts To Ponder

Major global equities breakouts or reversals, at these combined key levels?

21nove1Source: Chris Kimble

India’s Sensex is also flirting with a long term triple top, with peaks at the end of 2007, 2010 and now. Japan’s Nikkei has broken upwards out its consolidation range, and looks likely for another retest of long term downward resistance, joining the other indices at major resistance/breakout levels:

21nove13

Equities have struggled the last few sessions, but with various sentiment and contrarian extremes having been reached (see Sunday’s post) together with these collective technical positions, the bullish case would argue for a little consolidation to ‘deflate’ these indicators before collective breakout. Chris Puplava still sees no signs of a major top, at least in US equities.

Lately, Japan’s leading indicators and inflation data have both been positive. For me, that’s consistent with Japan’s positive demographic window and I believe it can (eventually) break free of that technical long term bear, moreover it is overdue. The case for the bulk of the other major nations is really the reverse: unprecedented collective demographic downtrends. Equities bulls have historically been killed by rising rates, excessive inflation or outright deflation, and it appears outright deflation – as collective demographics suggest should occur – is the nearest threat:

21nove8 21nove9 21nove10

Source: Ed Yardeni

21nove12

Source: Sober Look

21nove11

Source: Dshort

I revealed some charts in the last post that showed how equities (particularly developed world equities) have made notable divergences this year. I have some more to add to that collection.

Firstly, this chart shows the ‘snap’ in ‘risk-on/risk-off’ financial market correlations that occurred over the last year. Developed economy equities going separate ways from commodities and emerging market equities and currencies.

21nove7Source: Business Insider

In fact, if we look further back in time, such divergence is not so abnormal. Historically, it would normally signal a new secular bull had begun in equities, and that normal economic conditions in the major economies had been restored following financial/economic crisis. Global financial stress indices also are reflective of this currently, down to low levels, with the US government shutdown appearing as just a blip in the trend. The Vix also shows no perceived threats.

However, equities have diverged with the economy recently in the US:

21nove5Source: HighTowerAdvisors

And with consumer sentiment, which has been in decline since July:

21nove3

Source: Stockcharts

Consumer Confidence has made a similar divergence, and both measures show a fairly good historical correlation with equities over the longer term.

Global IPOs have also diverged from global equities:

21nove2

Source: IFR

Broadly speaking the reason for the decline in IPOs in the last couple of years is attributed to economic concerns. That seems reasonable, but why the divergence, when historically they have correlated with equities up and down?

These charts, and those divergence charts from the last post, all suggest we have either broken into a new norm where equities are legitimately rising despite anomalies (charging ahead as a new secular bull gradually comes to light, or under historically unprecedented conditions of central bank support) – or – we are seeing speculative levitiation before sharp declines return these divergences to normal.

Here’s the thing. This time really is different. Unprecedented global ZIRP and QE and/versus unprecedented global collective demographic downtrends. But ultimately I don’t believe central bank actions can defeat demographics, and that’s because central banks can’t force people or businesses to do anything, they can only put the conditions in place to encourage or discourage. I believe the evidence in GDP trends, trading volumes, inflation data and more, as well as the lessons from Japan’s example from the 1990s, suggest the demographics are the destiny of the economy and markets, but how long we take to get there is the question.

 

Divergences, Ratios and Surprises

Here are the latest economic surprises indices for the major nations:

19sept5 19sept4 19sept3 19sept2Source: Citibank

Japan aside, economic surprises for most of the majors topped out as we turned into September. Historically there has been a fairly good correlation between economic surprises and stock market returns, but the correlation has deteriorated throughout 2013 and turned negative:

19sept7

Source: JP Morgan

Is there anything about that period from early 2009 to mid 2010 where correlations also were anomalously negative? My take is that by March 2009 most of the major stock indices were at p/e 10 or below, and thereafter we saw a period of post-panic bargain hunting at historic cheapness, despite and regardless of continued disappointing economic data. That doesn’t apply at today’s valuations.

Here’s another look:

19sep1I’ve charted the peaks in US economic surprises versus the SP500. It can be seen that from 2006 to 2012, trend reversals in economic surprises reliably brought about corrections in the SP500, but sometimes with the stock market eeking out a marginal new high and then rolling over. But since the end of 2012 the two economic surprises peaks have been largely ignored by the market.

There have been other notable divergences since the turn of the year.

Equities have diverged from geomagnetism:

19sept12

Junk bonds, which have historically correlated with equities fairly well under ‘risk-on/off’ sentiment, have parted ways with stocks and are actually down for the year. Commodities likewise:

19sept11Source: Yardeni

I have extended this commodities:stocks ratio chart from early 2012 to the current level in November 2013, showing the degree to which stocks are now valued versus commodities:

19sept13Source: Stockcharts

Down to 0.15, very close to the level reached at the 2000 equities peak.

Versus bonds, equities have also made a sharp run up in relative valuation this year:

19sept14Source: ispyetf

If this is the solar maximum at the end of 2013, then it would be normal, by history, for the secular asset class of the time to be bid up in a speculative finale, diverging from normal correlations and leaving models behind, in a final overthrow. If this is occurring with equities (perhaps disinflation has killed off commodities), then the above charts would be evidence for that, and we are left trying to look for clues as to how much further, both in time and price, the speculative finale has to run. If it isn’t equities, but rather commodities that are bound for a speculative finale (as they would rather befit the ‘secular’ asset class leading into this solar peak), then the above charts are warnings that the rug could be pulled from under equities at any time.

Right now, the balance of evidence suggests that it is stocks being bid up to a speculative finale, if my solar thesis is correct. Even without solar, we see various evidence for that, in my last post and this. See how margin debt has accelerated over the last 12 months, as it did prior to the last 2 major stocks peaks:

19sept10

Source: Dshort

And now look at the decline in trading volumes:

19sept15Source: Marketwatch

There are fewer and fewer participants in the market chasing it higher, and the margin debt and credit account levels (last post) suggest increasing leverage to do so. Unless more people and institutions come to the market, then that is a recipe for a steep decline or crash ahead. By demographics, those additional participants are unlikely to materialise. Recall that demographic trends in the US were up into around 2000 and have since been downward, continuing this decade. I suggest that is what we are seeing in the trading volumes ‘mountain’ above.

In summary, I believe the equities bull is on borrowed time and that risk-reward is stacking up on the short side. But it comes down to how much further in price and time stocks can extend first. If solar-inspired speculation is at work then parabolic becomes more possible. If on the other hand equities are to make a topping ‘process’ rather than a parabolic, then by normal measures this has not started in a meaningful way so should at least extend for several months and postpone a major decline until 2014. If commodities are to become the speculative target then they should take off as late cyclicals whilst stocks make a topping process. This remains theory only, and deflationary demographics are a headwind to this occurring, so I have my doubts.

On that note, if we look at when gold really took off in the past, it was under conditions of negative real treasury yields. Rises in yields over the last 12 months, together with shrinking inflation, have taken real yields positive and are a problem for gold. Deflationary winds, due to demographics, threaten to take inflation yet lower, whilst treasury yields by late 2012 had reached historic extreme lows, suggesting renewed downside may be limited. So, if I could speculate how fortunes could be reversed in gold, it would be either the world tips into deflation and gold performs more ‘uniquely’ (gold’s performance under deflation is limited in history, but I suggest it ought to perform as the default go-to asset under such conditions when all others are unattractive) – or – central banks take renewed action against the disinflation in progress by increasing rather than decreasing stimulus, e.g. the ECB launches QE and the Fed maintains QE rather than tapers.

19sept9Source: Dshort

State Of The Markets

Starting with the equally-weighted commodities index versus the world equities index:

17nov11Source: Bloomberg

Commodities remain depressed but still within a large triangle. Last chance though here as the triangle compresses and they test horizontal support again. Their underperformance, based on supply and demand, is consistent with the demographic trends now in place in most of the major nations.

World equities broke out of their mid-year range, rendering the potential topping process redundant. That means equities need either to start over a multi-month topping process at some point ahead, or make a parabolic top instead. The increasing rate of gains, shown by the trend, suggests the latter could potentially occur (or be occurring), and this is supported by increasing evidence of a solar maximum taking place now:

17nov13Historic solar maximums have been correlated with speculative manias, such as Nasdaq 2000, Nikkei 1989, gold 1980 (last 3 solar maximums). I anticipated that commodities would be the speculative target for this solar max but there is reasonable evidence that such speculation froth is taking place in equities, as the next 5 charts show.

Firstly, Hussman’s long standing bearish call on the markets has to be taken with a pinch of salt, but the ‘bubble’ technical overlay shows what could be occurring:

17nov6Source: Hussman

Secondly, the steep wedging of both the SP500 and volatility indices is also indicative, and suggests both could be heading for a pop:

17nov5Source: Chris Kimble

Third, the situation for free cash in margin accounts together with margin debt levels reveals a dangerous extension, which is also suggestive of excessive speculation:

17nov3Source: Dshort

And fourth, a lack of hedging to go with that:

17nov2Source: Sentimentrader

Finally, fifth, the rally is now much more weighted into the hands of traditionally ‘dumb’ money rather than ‘smart’ money participants:

17nov1Source: Sentimentrader

On the flip side, we do not see significant deterioration in breadth nor rotation into defensives that would ordinarily warn of a top in the markets. The next 2 weeks are the positive lunar fornight so there is a reasonable chance that equities continue to rally through that period, and indeed could feasibly carry that through the traditionally strong Xmas period into the beginning of 2014. I believe the technical breakouts and steepening trends in stock indices together with the solar-inspired excitement could potentially make for a parabolic finale here. It’s a tough one to call because of the extremes already reached in some of the indicators above. Complacency is high and it has been a long time since a 10% correction. Stocks are also overvalued, historically, as the Q-ratio and CAPE reveal:

17nov7

17nov8The 2000 outlier shows how much further overvalued stocks could feasibly yet become, but that anomaly aside we can see that by both measures warning signs are flashing. What could tip the market over? Rising rates (bond yields are back on the rise), an inflationary shock, or a deflationary shock. Normally, stocks would tip into a cyclical bear under excessive inflation. Right now we see the opposite. Take a look at the rate if disinflation in Europe:

17nov9Source: Yardeni

Add to this a crisis emerging again in emerging Europe, and I can see a case for the ECB taking to QE. If that were to occur, then maybe commodities can catch a bid again and make their speculative rally, under a brief but significant inflationary shock. Chris Carolan’s solunar model for crude oil paints the possibility that oil could come back here:

17nov12

Source: Spiralcalendar

If the whole class cannot rise again, then precious metals alone could, under a deflationary shock, i.e. the world tips into a deflationary recession. This could occur with further commodity falls dragging global inflation rates yet lower. Emerging markets such as India and Brazil are in trouble again with low growth and high inflation, sinking currencies and debt problems. And leading indicators suggest global growth could be tipping over as of year end in the developed nations:

17nov10Source: Moneymovesmarkets

Under deflation, equities would normally fall hard and fast, to the lower ranges for CAPE and Q ratio above. That would likely mean sub 2009 lows in nominal terms. But under inflation, equities normally more slowly wind down to those valuation levels, and in nominal terms the damage is less severe. Under deflation the US dollar should rally, whereas under inflation the US dollar should break down. The US dollar was on the cusp of a major breakdown several weeks ago but has since rallied away from oversold and overbearish conditions, leaving both possibilities on the table, and its performance from here should be a key signal.

Right now, the deflationary outcome looks the most likely, which would make a short on the stock indices a very tasty trade. However, before that there is the potential for stocks to climb further, and possibly at an increasing trajectory. That makes for difficult timing. With the positive lunar fortnight right ahead, and momentum still with equities, I am expecting stocks can rally further in that period, barring any external shocks. But with various high danger levels already reached for this stocks bull, I am looking to build short here, not chase long. Regarding commodities, I continue to watch and wait, still long the complex, but not adding. I believe precious metals will come again, due to the unprecedented demographic downtrends, but am less sure about the broader complex due to the demographic impacts on demand. But let’s see – the moment of truth draws nearer – see below – and I don’t want to try to front-run or second-guess it. A speculative and final rally in commodities remains a possibility whilst the complex continues to consolidate up high. Yet if they cannot rally, and break down below the major support, I believe the global tipping into deflation will accelerate and kill equities in due course.

17nov14Source: Martin Pring

Demographics In Play

Demographics may be a long term theme but I believe it very much has relevance in trying to work out what’s next for the markets.

US demographics turned around 2000. Here we see US GDP changed trend around the same time, and with US demographics negative for this decade, that trend should continue. To be clear there are large oscillations within that but the overall pressure is down.

25sep20131Source: Scott Grannis

Here is my demographic (weighted) composite again for the main 5 economies of the world.

5May20131

And here is real global GDP, which again matches the trends in global demographics (represented by the line overlaid):

25sep20132Source: TheNextRecession

In short, the demographic trend is recessionary, and I believe the global economy will at some point get the trigger or catalyst to tip into negative growth again, either through excessive bond yield rising tightening or through excessive commodity price rises, which would be a temporary inflationary shock. I say temporary as I previously also showed the relation between demographics and inflation/deflation which show the trend in place now is price deflationary:

https://solarcycles.net/2013/06/23/demographics-disinflation-and-deflation/

“A swell of people aged 15-20 entering the workforce works up price inflation through spending, whereas more people entering old age relative to the work force is disinflationary through saving and disinvestment.”

The Fed is targeting 2.5% inflation, but the demographics say this is unlikely to be achieved. Also, GDP is going to remain weak and central banks are going to need to maintain intervention.

The latest US inflation rate came in at 1.5% annually. This is lower than most current treasury yields. The Fed wants inflation to be higher than yields in order to reduce its ballooning debt (by inflating away). Bond yields may still be historically low, but the demographic trends in place mean that inflation is low and growth is low. It wants to stop yields rising to 3% for fear that this level would be enough to tip a weak economy and to prevent it entering a deflationary trap where bond yields exceed inflation. Indeed the Fed’s Bullard has said that if inflation dropped to 1% annual he would want QE to be increased.

Which brings us to commodities. Can they rally? The demographics are largely against, as demand should erode and hard assets perform best in inflationary trends. On the flip side, the easy money conditions mean a loss of appetite for stocks could see money flows into commodities in a speculative momentum rally. History would suggest they probably can as late cyclicals, but history has not seen this collective demographic downtrend before between most of the major economies.

If I was to advise on a buy-and-hold portfolio for the next few years (I am not an advisor, don’t follow me etc) it would look something like this: long japan equities (positive demographics for stock market), short usa/europe/china equities (negative demographics), long gold (go-to asset as anti-demographic), short energy, short real estate, long cash with bias to asia currencies (all deflationary).

Russell Napier believes that there is trend-following in place in equities currently, but that eventually perception will turn to how QE and ZIRP have failed over 4 years to return the US to normal growth and stocks will turn bearish. I agree that this will happen and see developments ahead that can force it. If the US pulls back on government spending (debt ceiling 30 Sept) or stimulus then earnings should decrease (as per recent post) and yields should rise further, respectively. If commodities make a speculative rally they are likely to tip the weak economy over, and if they continue to decline in a deflationary trend then US inflation is likely to fall yet further beneath bond yields. In short, the Fed is in a trap, and it is a demographic trap, and a particularly potent trap because of the collective demographic downtrends amongst most developed countries, making for a downward global pressure. I don’t believe it can create sustained inflation or normal growth UNTIL demographic trends change. Collective demographics do start to improve once we get to the end of this decade, but over the next couple of years I believe there is really no way to avoid a global recession and harsh nominal stocks bear. Either yields, commodities, reduced goverment intervention or increased government intervention should tip a fragile economy over.

What does that mean for trading? Well, for me personally, I like to play an asset one way, siding with the longer term trend. If it goes against me nearer term, then I can use money management and averaging, with the conviction the longer term trend will ultimately drive it. So my anchoring would look something like that imaginary buy-and-hold portfolio I posted just above. Right now I am long energy (oil and gas commodities) which is a concern if deflationary trends dominate. However, solar cycles / historic topping order / easy money speculative conditions may yet deliver the decisive rally that I seek, so I’m going to carry on holding for now. With equities I am looking to build on the short side from the current position but am looking for more evidence of stocks topping. The technical action of the last few days has added weight to this, but we still don’t have ‘enough’ all round evidence. But this is trying to be as accurate as possible with timing, for the yearly trading P&L. I have sold my other longer term equity-related investments over the last couple of months and moved them to cash.

Weekend Research

Time for a more in-depth post.

1. SOLAR CYCLES

By my work the secular (more accurately demographic or anti-demographic) asset class should be bid to a peak in a solar-inspired speculation blow-off close to the solar maximum, which for this solar peak should be commodities to round off a decade long (plus) bull market. If the smoothed solar max has passed and was Feb 2012 and the CCI commodities index made its ultimate peak April/May 2011 then neither should now be exceeded. If this turns out to be the case in hindsight, once the solar max has been agreed, then the commodities peak would have occurred 9 months prior to the solar peak and would within normal parameters to continue to validate the theory.

24sep3

Source: Gary Tanashian / Stockcharts

If, alternatively, the solar peak is ahead late 2013 into early 2014 (which is SIDC’s second option, and also Leif Svalgaard’s prediction – shown below), then that 2011 CCI peak is too far away and if the theory is correct we should get another commodities peak closer to the solar peak, which would mean a higher peak in the CCI ahead. We have the possible seed for this in a fledgling CCI uptrend following a base established in July/Aug 2013 together with their historic performance as late cyclicals in what is possibly a cyclical topping process in equities occurring. However, this CCI uptrend is currently tentative, devoid of momentum and without broad participation thus far. The dips in oil and precious metals at the end of this week cast further doubt for now, but their drops coincided with money flowing back into equities. If equities are in a topping process then money should flow back to commodities in due course as they go outperform as late cyclicals. I would suggest the higher peak in CCI to be possible as speculative money pours in, under these easy money conditions globally. ZIRP and QE may not be able to generate growth but they can generate bubbles.

24sep4Source: Leif Svalgaard / WattsUpWithThat

If the first alternative turns out correct, and both the solar peak and commodities peak are behind us, then historically we have seen a new long term bull market in equities underway at this point, and the current easy money conditions could spell big momentum into equities (which would be the polar opposite to the second alternative of equities in a new bear and commoditites sharply rising, thus vital to call correctly). However, my demographic research shows that this is unlikely to be the case, at least not yet, as the positive demographic support for a new global secular stocks bull is absent. Indeed, the collective demographic trends of the major economies, bar Japan, are in an unprecedented collective downtrend.

2. DEMOGRAPHICS

This brings me to the question of whether central bank policy actions have been aggressive and potent enough to compensate for demographic headwinds. If that were to be the case then perhaps an enduring stocks bull and sticking economic growth could be achieved, albeit only whilst ZIRP and QE are maintained. I can very much recommend a read of the next link, which nicely summarises what QE can and can’t do and what Japan’s most-aggressive-to-date QE is likely to achieve:

http://www.scribd.com/doc/137092515/Richard-Koo-Quantitative-and-Qualitative-Easing-2013-04-16

In a nutshell, QE and ZIRP aren’t that potent as they cannot force people and companies to borrow or spend or invest. In the 1990s Japan tried to offset demographic downtrends with QE and ultra low rates and other stimulus tools. Even though most of the major economies were in demographic uptrends in that period (with booming asset markets and economies), this positive global environment AND these central bank actions were not enough to get people and companies to borrow, spend or invest.

I have overlaid the overall US demographic trend against Doug Short’s real US GDP growth chart here:

24sep1

Underlying Source: Dshort

The yellow dots reveal that real US GDP is currently lower than any previous recession start point. I suggest this shows the relative impotence of QE and ZIRP, and would argue that the demographic downtrend which should be in place for the bulk of this decade, suggests that real GDP growth level should fall negative again in the near future and another recession kick in. The question is whether this occurs with or without the tipping help of a speculative rally in commodities.

Here is the same for Japan: real GDP growth versus overall demographic trend.

24sep2Underlying Source: Economonitor

By demographics, Japan should be able to nurse along positive real GDP growth for the next few years. It should also be able to succeed in stopping price deflation:

23jun10Source: Andrew Cates

Note that both should be feasible by demographics alone, without ‘Abenomics’. The demographic trends for Japan mean that we should see underlying growth, price stabilisation, and rising asset markets, which I believe will be touted as positive results of Abenomics when in fact largely written by the demographic change of trend.

3. JAPANESE EQUITIES

So is Japan a buy? Not all recent economic data has been supportive, but manufacturing and service PMIs are indeed in runs of positive growth, revealing underlying economic improvement. The Yen and Japanese bonds both dropped sharply following the launch of Abenomics but have since retraced some. However, the Yen now appears to have broken down out of a bear flag, whilst Japanese bond yields are shaping for a higher low and a potential push on from there. The Nikkei also consolidated following the big run up earlier in the year, but has now broken upwards out of two consolidation patterns shown:

24sep6The line you can see coming into picture at the very top is the 2-decade declining resistance, the containment of the long term bear. I believe a retest of this should be on the cards and I have decided to add to playing Japan equities on the long side. However, if US equities are in a multi-month topping process and soon to enter a new cyclical bear market, then I would not expect Japanese equities to go their own way, only rather to relatively outperform, which would mean decline less. Nonetheless, a new bull market in Japanese equities is belated relative to demographics and I feel happy here trying to make profits on the long side – expecting any downside is more limited than other markets – whilst still trying to assess where US and global stocks are headed. The supporting evidence for Japanese equities to rise should come in real GDP, real economic improvement, and indeed an underlying bid in Japanese risk asset markets. So I will continue to watch the data releases.

4. USA

So back to the US. Here is the latest picture for ECRI leading indicator growth:

24sep7Source: Dshort / ECRI

ECRI leading indicator growth fell beneath zero prior to each recession shown in grey. The break into the negative often historically occurred close to the stock market topping, with stocks typically being a leading indicator of the economy. We can see there have been several breaks beneath zero that did not give way to a recession, not least the fairly deep fall in 2011 that helped ECRI (incorrectly) announce a recession. However, my take on the current reading of 4.1 is that we should see this fall towards zero if we are to see a cyclical bear erupt in equities and a recession to occur ahead. This growth measure has been in a declining trend since early 2013, so to add weight to an equities top being formed, we should continue to see this dropping. For now though, this leading indicator, and other leading indicators (such as Recession Alert or Conference Board) point to continued economic growth into year-end.

Weak but sustained growth and low rates are typically a good environment for equities, which would be a framework for equities to move higher and reveal the consolidation since May as digestion in an ongoing cyclical bull. In supportive of this, the Nasdaq is now convincingly at new highs for this cyclical bull, and the Dax is back testing its high-to-date (which is also the all-time nominal high). If other indices break up and away from the ‘topping range’ then we would be looking to 2014 for a cyclical top as a multi-month topping process would have to start over. As noted in a recent post we have some evidence for a topping process in play since May, but also some normal signs missing. This should be resolved one way or the other soon.

5. COMMODITIES AND BONDS

Which brings me to the two main threats to the economy and the equities cyclical bull: excessive inflation from sharp rises in commodity prices and/or excessive tightening from rising rates in escalating bond yields. Bond yields in the major economies continue to rise albeit from low levels. If economic growth persists further and the Fed begins to taper QE then we could expect yields to continue to rise. Historically, the tipping point has been when 10 year treasury yields hit 6%, however today’s demographic and debt interest pressures mean that trouble level is likely to be lower.

Regarding commodities, the most important is oil, as quick major escalations in oil prices have historically correlated with tipping the economy into recession, due to its importance as an input in so many processes. Despite the slack and weakness in the global economy, crude prices have hung around the $100 level the last 3 years. A speculative move into this asset, for any number of reasons, could under current easy money conditions swiftly lead to $125 oil, which I believe would really test a demographically-challenged weak global economy.

On the flip side, the same demographic trends could further erode commodity demand and also limit the exit from bonds. Further commodity price drops, together with yields stabilising relatively low, would again provide the backdrop for equities to march on and economic growth to persist – unless the potency of the collective demographic downtrends drag the economy down into recession on their own.

If Martin Pring’s normal historic topping order is playing out, then we have seen the top in bonds already, we should now see evidence of equities topping and of a transfer in momentum to commodities which should make a peak last as the economy rolls over. This would imply yields and commodities rise despite demographics, and for my work this would be a better fit if the solar peak were still ahead at the turn of 2013/14, with commodities making a final and bigger peak in the months around that.

I believe evidence in support of or against this could become clearer as soon as next week, watching the markets’ reactions to the FOMC output. Some mild tapering is being widely touted as a done deal, but the size and the wording we don’t know. Regardless, I expect a big reaction in the markets and it will be telling how commodities, precious metals and the US dollar, fare afterwards. If commodities are going to make a final big rally then the tentative uptrend of the last couple of months should cement and a US dollar breakdown out of its long term triangle (see HERE) would be a great partner for such a development.

6. TRADING

We are over 3/4 of the way through the year and my PnL is currently showing my worst year of performance to date since going full time, due to the run against commodities longs this year, particularly precious metals. This would repair itself if commodities did begin an uptrend in the last couple of months and now continue into year end, but it could yet go worse if they are in a bear market since 2011 and have further falls ahead. So I have decided to use the Autumn to do what I can to make sure of a good result by year-end. This means I am going to add shorter term trading to my game in this period, whilst running the more medium-term-focused global macro positions. Short trades are something I’ve done before, but not for some time due to success (and personal preference) with the longer term methods. So, I just wanted to share with you that this is what I’m going to be doing different. I am looking for liquid markets that I can play more aggressively for quick gains. So I am looking for candidates amongst the major markets that I can play confidently repeatedly either long or short (i.e. fundamentals/technicals align in favour of one way or the other), and this will include increasing exposure if movement goes the other way. One such play-thing is going to be the Nikkei on the long side, as mentioned above. I am going to pour over some other markets (stock indices, commodities, fx) to find others that I consider suitable, so will share when I decide. You may disagree with my choices and indeed the method, but I’m just sharing what I’m doing, and will let you know the results.

One last thing. Almost all my money is in sterling and I am looking to transfer this to Euros, now I am in Austria. The EUR-GBP exchange rate has therefore become part of my daily watch. A one cent movement in either direction makes a massive difference when considering the amount I am going to be transferring and getting this ‘right’ is as important as my other trading, in terms of the impact on my wealth. So I’ll share my current thoughts, but if any reader is more of a regular in the FX market, please step forward and share your knowledge.

EURGBP has been in a large declining channel since the start of 2009, with the last 3 year snippet shown below. In July of this year the Euro tried to break out, as the Eurozone recovery became more apparent, but it turned out to be a fake-out, and recently UK economic data has surprised to the upside, which has helped not only turn it back down into the channel but also break down beneath the rising Euro support shown. The Pound is fairly overbought now versus the Euro and EURGBP spent last week trying to base. However on Friday there was a further breakdown in favour of the Pound, taking the pair beneath 84. The latest UK inflation data is out this coming week which should influence the pair one way or another, however I believe that ultimately the Euro can drop further here against the Pound, given the technical developments and the change in the fundamental backdrop, and I’m going to hold out for 82- at this point and will review.

24sep8

Macro And Markets

It’s the start of the lunar negative fortnight today. I think this lunar downward pressure can be realised in price action in US equities, for these reasons.

1. Bonds may put in a rally here. Yields look to be arching over.

8aug20131Source: Sentimentrader

2. Rydex equities involvement and sentiment at contrarian levels:

8aug20133

Source: Sentimentrader

3. Diverging bullish percent over call put ratio – note the previous occurences here:

8aug20134Source: Stockcharts

4. Breadth divergence. There are a few indicators showing this such as % stocks above 50MA, Mclellan Summation index, and, here, advance-declines (making a double top versus the higher high in equity prices):

8aug20135Source: Cobra

No devastating decline in overall market internals. but enough to warrant a pullback. Countering this, the latest economic surprises, service PMI and manufacturing PMI, and overall earnings beat rate for the US have all been good. For a cyclical stock market top, we would need to start seeing some degradation in such data. However, if this is a topping process, then I expect we are only in the middle of it at this point, with a last push up to come ahead into September (assuming a decline can be realised over the next 2 weeks). By September I would then expect to see some macro reasons emerging to complete a topping process in equities.

I have doubled my short position on the Dow today and have specifically tallked about and targeted US equities because of the current divergence around the globe. The latest Markit PMIs really showed a vast difference between emerging and developed economies. Sober Look suggests this spread in economic cycle positioning:

8aug20137

Source: SoberLook

UK and Eurozone are looking particularly impressive and USA ticking along nicely. Australia has suffered since China lost momentum, and its central bank reduced rates again this week. This is the collective picture for the major central banks:

8aug20136

Source: Action Forex

Despite the QE tapering talk in the US, the graphic shows that we are still in an era of easing, with interest rate reduction still being pursued. As you know, I believe demographic trends are the source of the global economic weakness, ensuring we will be in an era of negligible rates for some time. Maybe the Fed will start to taper as early as next month, but I believe an end to QE and a renewed rate-increase policy will not be seen soon.

So, China has cracked, in my opinion, since its demographic trends reversed circa 2010. Those developing nations that boomed directly as China partners and those commodity-economies that benefitted from the long rising trends in commodity prices (through China demand) are currently suffering. This would include Brazil and Russia. India’s issues have been more internal and it needs reforms to help realise its demographic potential.

For most of the 2000s, this China plus emerging markets story was the fuel for the global economy, but now we are looking back towards the developed world to take the batton. Unfortunately, the US and Europe have significant demographic headwinds. I therefore don’t believe that we are now going to see sustained growth in the West. I continue to believe that either another rally in commodities will tip the world into a global recession, or the world is heading that way in a deflationary trend.

And that remains the key question for my account. Will my commodities longs prosper, or continue to sink? Right now, the commodities indices are potentially carving out a higher low than late June, which could spell an end to their downtrend. I believe this is the time for that to occur, because of my belief that equities are in a topping process. Historically they should now outperform and largely act as late cyclicals. I see this next month as critical for commodities. If they cannot make a higher low than June at this point, paricularly as the USD weakens, then it would look bearish for commodities.

Here is corn, showing a potential rally set up.

8aug20132Source: Sentimentrader

And copper looks to be breaking out following a month-long basing pattern.

To draw the above themes together, can emerging markets strengthen into year-end, positively-infected by current developed economy performance? If so, the commodities rally would appear more likely. If on the other hand developed markets begin to join emerging economies in weakness, then a deflationary downdraft would be more likely. The wildcards remain the solar cycle (if the peak is ahead, then a speculative push in commodities could occur with increased geopolitical conflict an associated input) and climate (drought, flood and very high historical temperatures remain very much in play – it depends whether we see a devastating coming-together at the critical time and global location for agricultural crops).

OECD leading indicators just released today are more supportive to the first scenario of emerging markets strengthening and joining developed nations, with Russia stabilising and India improving:

8aug20138

8aug20139Source: OECD

Roundup

This is the latest geomagnetism forecast versus the SP500. The forecast extends to the beginning of September and as can be seen has further transformed from a downtrend to a sideways/up trend.

5aug1The SP500 notably diverged from the model throughout July, more so than other indices which have more closely tracked the model. The outperformance of the US stock indices has meant p/e valuation has now increased to make the US amongst the world’s more expensive:

5aug4Source: FT

Is this justified? Not by demographics. Here once again is my real US equities plus real US house prices model versus 3 demographic ratios for the US:

X1That model has edged further up now in mid-2013 as real equities are back at 2007 levels and real house prices have edged up a little more (though are still a long way from the real 2007 peak). Yet the 3 demographic trends call for the model to collapse once again, as in 2001 and 2008. What makes demographics more potent this time around is that China has joined Europe and the USA in an unprecedented collective downward demographic pressure.

If we take the best of the three demographic measures, middle to young, only, then this is how it looks:

5aug5Source: PFS Group

Is it possible that the 2014-15 bottom is near enough and that stocks have taken off already? Well that p/e10 now stands at around 25, having bottomed in early 2009. That would mean p/es bottomed out around 5-6 years before the M/Y ratio, whereas in 2000 and 1982 the two peaked and troughed at very similar times. In the  1960s there was more of a gap, with demographics topping out a few years before p/es, but note it was demographics rather than p/es first, and this is echoed in my demographic work on Japan and UK, namely that if there is any lag it is demographics changing course first. In short, another cyclical bear in US stocks still looks the most likely course to me, and this is further cemented when we draw in all demographics measures, demographic pressures in China and Europe, and other US market valuations such as the Q ratio.

However, current leading indicator data is still largely positive for the USA at the moment (e.g. latest Markit PMI), and Europe is showing renewed strength (Markit PMIs, Conference Board). In fact it is the demographic-positive markets such as Brazil which are showing particular weakness. So what’s going on? I suggest commodities have played a key role in this. Lower input prices have boosted the developed economies and stocks. Commodity-economies such as Brazil have suffered. If commodities can rally again and make a historically-normal late-cyclical peak after stocks have peaked then I suggest the demographically-challenged major economies won’t be able to handle the renewed input price pressure. I believe the weak global recovery will topple over if commodities, particularly oil, rise in a meaningful way again.

Here is 30 year treasury yields with CCI comodities index, world equities index and Euro-USD. Euro-USD and commodities could be in a new uptrend that began in early July, IF they can make a higher low here.

5aug6Source: Bloomberg

But too early to say anything more. For me, it remains a game of patience, waiting to see if commodities can start to outperform here. Gold and silver had a very up-and-down week last week. Oil has maintained its breakout but appears to be stalling.

I believe the solar cycle still has a key role to play in the fortunes of commodities. Here is the latest SIDC update which continues to show two possibilities. If the solar max was Feb 2012 then I suggest commodities peaked out in 2011. If this were the case then I don’t believe a new secular bull market in stocks is underway because as per my work secular actually is demographic and the major economy demographics don’t support a new secular bull. I rather expect a deflationary recession to come to pass in due course. If the solar max is ahead as per the second SIDC option then I believe we will see the historically normal late outperformance of commodities from here into 2014 and that will tip the world into recession.

5aug3

Source: SIDC

In the near term, I am looking at the window from tomorrow’s new moon through to Friday’s end-of-lunar-positive period to take profits on some equities longs and potentially add more short equities. I would like to see stocks advance further this week to do so.

All Round Update

I’m back. Here’s an updated look at the main pillars of my work.

First, demographics. The key overarching macro issue going forward, in my view, is whether the combined price-deflationary and asset-deflationary demographic trends now in place between US, Europe and China will tip the world into recession and deflation despite the best efforts of central banks. Someone else has picked up on the theme and produced this:

1aug1Source: Nakedcapitalism

I continue to look at leading indicators for evidence. There is no doubt central banks have some impact on behaviour in the economy and financial markets by deploying policies to discourage savings, cash and fixed income, and to encourage lending, risk-assets investment and spending. But is it enough to offset the demographics?

The latest data shows Europe strengthening (PMIs, economic surprises), USA possibly having peaked (ECRI, economic surprises), and the overall global economy potentially weakening towards late 2013 but not until then (narrow real money). This week’s US GDP release surprised to the upside for last quarter, however the upside surprise matched the retrospective reduction in the previous quarter’s data. Nonetheless, the overall global picture is still fairly ‘safe’. Europe’s relative strength ahead should bode well for the Euro v USD, and a relatively weakening USD should bode well for commodities, and if we are to see the normal late cyclical outperformance in commodities (once stocks peak) then we need leading indicators to at least hold up a little longer.

If the unprecedented coming together of demographic downtrends in US, China and Europe mean the global economy is heading for recession no matter what (given China has now peaked demographically), then I believe this will mean a severe nominal decline in equities, as central banks will be revealed as impotent, and panic will ensue. If we slip into global recession without the ‘agent’ of commodity price acceleration then I would expect the SP500 to complete an overall megaphone formation since 2000 with a potentially lower low than 2009.

Next, solar cycles. Experts still don’t know if a solar peak is ahead or behind. Here’s the latest sunspot chart:

A2

It’s clearly a weak sunspot cycle, and fairly messy. Some scientists believe there is a second peak ahead this year, which may exceed the existing smoothed max (Feb 2012). On the other hand, an overlay of SC5 suggests that existing peak may have been it:

1aug2Source: WattsUpWithThat

If the peak was Feb 2012, then I would point to 2011’s commodities speculation including a silver parabolic together with extensive Arab revolutions as normal behaviour patterns associated with solar maxima. It should mean that we have passed the speculative peak in commodities, that global temperature may have already peaked, and that we should expect the geomagnetic disturbance peak that follows a solar max normally 1-3 years later and is associated with recession. In this scenario I would expect commodities to continue overall weakness and deflationary recession to occur.

If the peak is still ahead later this year then we may see global temperature hitting extremes and more geopolitical trouble, together with a speculative peak. All three could push up commodities in a late cyclical outperformance into 2014 with bonds already having topped and stocks topping this mid-year. In this scenario I would expect an inflationary spike to help tip the global economy into subsequent recession.

Next, geomagnetism. All models have been updated for this week, and drawing in the next 3 weeks geomagnetism forecast, we see this (mapped against the commodities index):

1aug3A flattening out in cumulative geomagnetism in August following a downtrend May-July. By normal seasonality, geomagnetism should be troubling again by September and October. August-September would therefore be a suitable time for US equities to make a final peak in a topping process, if one began in May. Did one?

Well, so far the process is developing like a typical top. A marginally higher high is currently being played out with some weakening in breadth versus the May peak (% stocks above 50MA, Mclellan summation index). Margin debt still looks like it peaked in April, and in 2000 and 2007 this peaked 3-6 months before the stock market finally rolled over. However, this would all be invalidated if stocks push on again here and away from the topping range, with breadth strengthening again. US earnings may play a role in this and so far have made an impressive earnings beat, but a poor revenue beat rate. This means companies are making profits by cutting costs. This could be a warning if the economy shows signs of weakening, which brings us back to the importance of leading indicator readings as they come out. If central banks have been able to juice the economy just enough to offset demographics, through rate cuts, QE and verbal support (do what ever it takes) then it is feasible that this already long cyclical bull (by historical comparisons) continues. But I side with the multi-month topping process currently playing out until counter-evidence increases.

Next, lunar phasing. I have updated The Lunar Edge page and this is how the two of the most ‘sensitive’ indices to lunar phasing have performed so far this year:

LE43 LE23

The German Dax has delivered all of its annual gains so far within the lunar positive fortnights (4 days after full moon through to 4 days after new moon), whereas the Singapore Straits has really delivered no lunar edge of any note so far this year. Nonetheless, a strategy playing the lunar edge equally across both would still have returned well overall. I continue to look to the start of lunar negative periods for adding short and to the start of lunar positive periods for adding long, in order to time my longer term trades. On that note, the current lunar positive period ends by Friday next week. If equities have been able to rise further by then, I will look at taking profits where in profit, and adding short at that point if evidence continues to support a topping process.

Because we are in a lunar positive period currently, and Japanese equities fulfilled what I last suggested look liked occurring (the arching-over turning into falls) I have entered long Nikkei again, but just a starter position. My main exposure currently remains long commodities, with greatest weighting precious metals. I have various significant loss-making positions in commodities. I continue to believe that because of demographic trends precious metals will come again as the anti-demographic. I suggest central banks in US, China and Europe will continue to have to support the economy for some time to come and that renewed dovish talk will benefit gold. For other commodities, I return to the solar maximum unknown. If the solar maximum is ahead still, then I believe temperature and geopolitical disturbance and speculative mania can inspire a historically normal commodities peak following a peak in equities. Crude oil’s breakout in June gave this more credibility. Crude has now pulled back a little, and it will be important to see if this is consolidation before further gains.

If commodities as a whole have peaked and deflation continues to press them downwards, then I will be holding increasing loss-making positions. What to do? I will be looking to average down and time mean reversion. Nothing goes down in a straight line and I will be looking to convert them into winning trades in a ‘trade your way out’ style by leveraging up. Not easy, and no doubt some would view that as too risky, but that’s what I will be doing. Don’t follow me, etc, I’m just sharing with you what I’m doing, as the money management is as important as the analysis, right? But first, let’s see if commodities can outperform in the rest of 2013, as the previously detailed evidence suggests is possible. I want to give them a little more time to gather momentum, before using aggression.

Some key assets. Gold reached important resistance around 1344. Can it break through? If not then the basing process in precious metals will need some time longer. It is confidence restoration versus short squeeze, but if the latter is to occur then we will need triggers in the news. The US dollar has been in decline since the Fed backtracked on QE-tapering-hastiness, turned away at key long term resistance. However, it could yet be consolidation before another charge. I believe it will weaken as the Eurozone relatively improves, but the Fed’s actions will play a key role. Since I sold out of short-treasuries they tracked overall sideways. This could be consolidation before further rises in yields, but as there has been no pullback I don’t wish to yet rejoin.

I am writing this post US GDP release and pre FOMC output. Both market movers, and it will take until tomorrow for the dust to settle and we see where different assets want to go. But I wanted to get the post out as my trip gave me no opportunity. Thanks for your comments and emails whilst I have been away.