The Second Chance

Into the end of last week we saw a two day rally for the stock market, making for a partial retrace of 2014’s declines. So how do things stand heading into this week?

1. Capitulative Breadth has reset from 10 to zero. So no further edge from this for the bulls: its rallying potential from Wednesday fulfilled.

2. Both volume and breadth on the down days in 2014 have exceeded volume and breadth on the up days, which is bearish.

3. The volume surge in January dwarfs anything from 2012 and 2013, suggesting this correction has further potential.

4. Citigroup’s panic/euphoria model is still in Euphoria, suggesting further declines are required for mean reversion:

10fe1

Source: Barrons/Citi

5. Put/call ratios (both CPC and ISEE) did not wash out sufficiently in the correction-to-date, suggesting further downside:

10fe2Source: Fat-Pitch

6. Nymo also failed to reach typical wash-out levels for a 5%+ decline.

7. Investors Intelligence latest bull-bear spread down to 29, but some way from the levels of previous correction bottoms:

10fe3Source: Astbury Research / UKarlewitz / My annotation

8. NAIIM sentiment down to 51, but durable lows historically sub 30, suggesting a deeper correction (Source: Fat-Pitch)

9. Skew remains historically elevated, suggesting more of a wash-out required

10. From Sentimentrader “Every time, since 1928, when SPX went from a 52-week high to a 70-day low within two weeks, it was higher in three-months, averaging gains of 8%”:

10fe4Such a drop from 52WK high to 70D low has occurred again in 2014. U Karlewitz has added the green dots to show that when these instances occurred there was some of kind of second low, before the rally to new highs.

In short, I have listed 8 indicators that argue for a deeper correction from here, and 1 indicator that argues for new highs, but before that some kind of second low, in the form of a double bottom or lower low. Plus 1 indicator now neutral: capitulative breadth. So that’s pretty good odds that the rally of the last two days of last week gives way to renewed declines ahead, and maybe we can time that.

11. Drawing on the 1929, 1987 Dow and 1989 Nikkei analogies (see previous posts), the peak of the ‘second chance’ partial declines retrace (the last chance to exit longs and the optimum point to short) occurred around 28-30 trading days from the high in each case. From the 31 December 2013 highs in the Dow and Nikkei, that would take us to this Wed 12 February – Fri 14 February, as a guide.

12. Looking at the biggest down days in history, there is a clustering around both new and full moons, as well as Mondays (after weekend reflection). This coming Friday 14 February is a full moon, and gives us the potential set up of falls into the Friday close, followed by a major heavy down day on Monday 17th February.

13. There is a geomagnetic storm in progress this weekend, for which we typically allow a lag of up 5-6 days on the markets. The pessimistic influence of geomagnetism together with the negativity into and around full moons, makes for dual negative pressure in the week ahead.

In short, I have a case for rally of the end of last week to give way to renewed declines during the week ahead, potentially making for large falls in the window Fri 14 Feb to Mon 17 Feb.

So what news or events are coming up as potential triggers for market movement?

14. Earnings season continues and currently shows a positive 65% earnings beat rate and 64% revenue beat rate, which may bolster the bulls, but we should be aware that this is set against a very low bar through record low earnings guidance. A more valuable picture comes from the blended earnings growth rate (8.1%) and blended revenue growth rate (0.8%) which is the sum of earnings reported and the projections for those still to come. So sales continue to be weak, as companies get by on cost-cutting, and that remains a negative for the markets.

15. The postponement of the debt ceiling issue ended on Friday and the US is projected to run out of funds to pay its bills by the end of this month, unless the Republicans and Democrats can agree on the criteria for increasing it. Whilst neither party would wish to risk default, this issue may now become a market mover again until resolved.

16. Emerging market issues may return to the fore as they continue to simmer.

17. Sunspots remain strong. This would become a threat (to the bearish case) if February produced the highest monthly spike in solar activity of solar cycle 24, understanding this is a driver of excitement and speculation. However, as previously noted, forecasts are fairly united in expecting the solar maximum to wane as of the turn of the year, and the fairly comprehensive set of cyclical bull topping indicators that already congregated support this from a different angle.

In conclusion, even if we allow for the lower probability of the solar max continuing to strengthen and a higher high in stocks still to come, we can nonetheless draw together all the points in the post above and argue that the stock market should first decline, likely starting in the week ahead and probably to a lower low, to fulfil a more satisfactory wash-out and based on a cluster of bearish signals. That would make the current ‘rip’ a sell, and thereafter we can assess again the clues for whether the ‘dip’ would be a buy. However, drawing together all the evidence of my recent posts, I maintain the balance of probability is that we have just experienced a major stock market top and that such a ‘dip’ will in fact turn out to be waterfall declines, and as such I will be adding to my short positions this week. I believe the current partial retrace of 2014’s falls-to-date will turn out to be the ‘second chance’, or rather last chance, to move from long to short on equities.

Something Happened At The Turn Of The Year…..

1. Treasury bonds bottomed / yields topped out:

7fe22. Gold bottomed and broke out:

7fe3

3. Bitcoin peaked:

7fe44. US Consumer Discretionary and other cyclical stock market sectors peaked:

7fe55. US stock market sentiment made a historic high peak:

7fe66. The put/call ratio made a historic low bottom:

7fe87. Trading volumes surged:

7fe98.Equity funds had their largest ever weekly outflow (whilst bond funds had a record inflow):

7fe1

9. Investor leverage spiked to real and as a percentage of market cap records:

7fe1110. The solar maximum peaked and the stock market peaked (prediction):

7fe10Plus, leading indicators (narrow money and OECD derived) forecast that global economic growth peaked out around the turn of the year.

And why? This is the part that is unpalatable to many: because we are less intelligent creatures of free will and more dumb subjects of natural forces:

7fe12 7fe13 7fe14 7fe16Caveat: If NASA/NOAA/Solen projections are wrong and the smoothed solar maximum extends further into 2014 together with another larger monthly spike in sunspots then it is possible the stock market makes a higher peak with it, close to another future new moon. However, the collective evidence (united solar forecasts plus comprehensive cyclical stocks bull topping checklist (my last post)) suggests this is low probability.

Timing Major Market Peaks

Starting on the smallest timescale, and working up to the largest.

1. Timing within the month

Lunar phasing influences human sentiment. It produces fortnightly oscillation in the stock market: positivity/optimism around the new moon and negativity/pessimism around the full moon. The cumulative influence of this can be seen in stock market returns over the last 20 years:

LE1

In keeping with this, we find that major market peaks typically occur close to new moons, around maximum optimism/positivity:

NewMoonMajorPeaksThis adds to the case for a peak having occurred in equities on 31 Dec 2013 (Dow and Nikkei, plus SP500 double top with 15 Jan), associated with the Jan 1st new moon. If that proves to be false and equities break higher, then a future new moon (next one Jan 30th) may produce the timing of the major peak.

2. Timing within the year

Geomagnetism influences human sentiment, with higher geomagnetic disturbance associated with negativity/pessimism. The inverted seasonality of geomagnetism correlates closely with stock market seasonality, and typically we find that major market peaks occur close to the peak in both, around the turn of the year:

13jan50

13jan11Gold made its secular peak on 21 Jan 1980.

Again, this adds weight to equities having peaked 31 Dec 2013, but if that proves false, then we might expect a final peak still to be at hand, in January, before the seasonal model turns down.

3. Timing within the decade

Solar maxima occur roughly every 11 years and produce human excitement, which translates as protest, war, and speculative excesses in the markets. Major market peaks typically occur at the solar maximum, close to the smoothed peak and on a monthly spike in sunspots.

SolarMaximaParabolicPeaksWe can measure speculative excesses in terms of market valuations, sentiment readings, leverage and technical indicators and we see a cluster of these in US equities currently. Solar forecasts, solar pole flips and sunspot counts collectively suggest the smoothed maximum and monthly sunspot spike may be occurring Dec 2013 into Jan 2014, which in association with those speculative excess readings, again adds to weight to a possible peak in the Dow, SP500 and Nikkei.

4. Timing within the century

Demographics drive secular bull and bear markets, as swells in investor or disinvestor age groups produce periods of upward or downward demand for equities. Japan’s secular stocks bull ran through 4 solar cycles due to a long positive demographic trend from the late 1940s to around 1990. Japan’s middle-to-old, middle-to-young and net investor ratios all peaked in the late 1980s, and accordingly we saw Japanese equities terminate with a speculative excess at the 1989 solar maximum, and thereafter move into a secular bear in line with demographic downtrends.

US demographic measures for equities demand peaked around 1965. The real SP500 peaked November 1968, terminating with the solar maximum of November 1968. Thereafter US equities entered a secular bear market, whilst gold, as the anti-equities or anti-demographic asset, entered a secular bull market. Demographics and equities bottomed around 1980, whilst gold made its secular speculative peak, all timed with the Dec 1979 solar maximum.

X1

US demographic ratios were collectively positive from 1980 to 2000, enabling a secular bull market in equities lasting 2 solar cycles through the speculative finale of March 2000, which was again a solar maximum. Gold endured a secular bear market through those two decades, bottoming out as demographics turned down around 2000, and entering a secular bull market.

Looking forward we see a slight divergence in the 3 charted demographic measures: the middle-to-young ratio bottoms out around 2015 but the middle-to-old and net investor ratios not until around 2025 (shown boxed above). When we draw in collective downward demographic trends for Europe and China, the greater likelihood is of a secular bear in US equities (and a secular bull in gold) lasting through to around 2025, rather than ending now. Solar cycle 25 is predicted to peak around 2023-2025, which would provide the timing for a speculation secular peak in gold.

There is a correlation between solar cycles and birth rate, with evidence of an 11 yearly peak in births. There is also evidence of a link between economic prosperity and birth rate, whereby births decline in recessions and bear markets and increase in the good times. Combining the two, we have the framework for alternating positive and negative demographic swells which peak or trough around solar maxima, and hence we have historically reliably seen demographic trends and associated speculative asset bulls/bears peak and terminate around sunspot peaks.

Therefore, the secular bear in US equities that began in 2000 is likely to continue through to around 2025, and the secular bull in gold that began in 2000 is likely to continue to and peak around 2025. In support of this we see current historic overvaluations in US equities that argue for further reset in stocks ahead, and a lack of speculative mania for gold at the current solar maximum.

17ja1 17ja2Both charts above model the historic trends in US demographics and the terminations at solar maxima, and the projections forward are the extensions of these phenomena. The ‘mean reversion’ common to to them both reflects the transience of demographics (a young dependents swell headwind will become a middle-age swell tailwind which will become an old-age swell headwind) and the double-excess produced by solar maxima (demographics stretch demand by population, solar maxima stretch demand per capita) before sunspots cycle down again. The biggest mania of all-time is clear to see on that second chart: the dot.com boom. Not only does mean reversion subsequent to that mania have some way to go (a wash out to -50%) but demographics support this occurring.

To summarise all the above, and make it useful looking forward, we can time major asset peaks by probability (there are no dead certs, and exceptions occur). Any major asset peak will probably occur close to a new moon, typically around the turn of the year, and normally at a solar maximum. Demographics guide at which solar maximum a secular asset peak will likely occur and whether a solar maximum should deliver a secular or cyclical speculative excess.

Forecasts for gold and equities

We are currently at the likely solar maximum for solar cycle 24, at the turn of 2013 into 2014. Demographics are supportive of a secular bear in equities (that began in 2000) continuing through to the next solar maximum circa 2025, and similarly a secular bull in gold (2000-2025). The speculative excess in equities that we are seeing in association with SC24 maximum should be a cyclical peak. The timing of that cyclical peak in stocks has good odds of being around the turn of the year (2013 into 2014) and close to a new moon. That makes a top close to Jan 1st 2014 a contender, and failing that one near Jan 30th 2014 (the next new moon). Again, these are just probabilities, but if we take a different angle and look at indicators such as II sentiment, put/call ratio, skew, deviation above MA, yield-tightening ROC and margin debt, then we have a case for equities to begin to fall ‘imminently’, regardless of solar maxima and lunar phasing. Combining both, the case becomes more compelling for a top here.

Gold’s secular bull began in 2000, and like all secular bulls, it has been in a strong dominant uptrend punctuated by occasional cyclical bears or corrections. Below we see the US equities secular bull progression 1980-2000 contrasted with gold’s secular bear in that period (cyclical bulls and bears within an overall downtrend).

17ja3Source: Stockcharts

Gold’s secular bull of 2000-2025 should be a strong dominant uptrend like stocks 1980-2000, or like an extended version of gold’s last secular bull of the 1970s.

17ja4The cyclical bear of Dec 1974 to Aug 1976 occurred as the Dow rallied from a Dec 1974 low to a Sept 21 1976 top, with gold’s secular bull momentum resuming as equities topped out. We could therefore expect something similar to be occurring now, and this is supported in the oversold, overbearish extremes reached in gold and miners and the technical basing that appears to be currently taking place.

A threat to bullish resumption in gold is the current excess leverage we see in evidence in margin debt, net investor credit and Rydex leverage. If sharp falls erupt in equities then a period of forced redemptions could mean blanket selling of assets, as occurred in Autumn 1929 and Summer-Autumn 2008. Gold /miners escaped neither, in short-lived but sharp pullbacks. In THIS post I compared the topping process analogies of 1929, 1987 and Nikkei 1989 to the Dow today, and based on that we might expect sharp falls to erupt as of mid-February. There is a history of steep falls occurring at the seasonal geomagnetism peaks of around March/April and October, and occurring on Mondays once investors have had a weekend to mull over doubts. So by probability we might this time look to the particular potential of Mondays in the period March-April 2014 for heavy falls to erupt. Potentially then, we could see gold and miners rally until then, but be dragged back during such heavy stocks selling, thereafter resuming the secular gold bull in earnest.

Equities should now enter a new cyclical bear market, and continue to alternate cyclical bulls and bears within a secular stocks bear through to around 2025. By demographics (and as is becoming evident in economic data) this should be under deflationary rather than inflationary conditions, and this makes an important difference to nominal prices. The path of US equities for the next 10 years should look similar to the 1990s to early 200s Nikkei or the real inflation-adjusted 1970s SP500, with lower highs and lower lows:

17ja5Source: SeekingAlpha

Using Russell Napier’s maths (taking valuations back to historic washout levels), then we have a target of around 3500 on the Dow by my target of around 2025. Again drawing on history, odds are we get there in a couple of cyclical bull-bear oscillations, and hence something like this:

17ja6It is an initially shocking chart, but it is in keeping with deflationary demographic projections and valuations washout. Plus, this has already happened before: to the Nikkei, under the same twin circumstances.

Expecting the Dow to be sub 4000 by 2025, and gold to be making a parabolic solar-max finale to a strong secular bull, the Dow-gold ratio should bottom beneath 0.5, potentially even beneath 0.1. But the one factor that I have not mentioned so far is central bank intervention.

It is certain that a tipping over into deflationary recession and equities bear will draw further response from central banks. If equities start to decline for the next couple of months but in a measured way and economic data disappoints (as predicted by certain leading indicators) then I would expect the Fed to stop tapering QE and wait-and-see, and otherwise little change. If equities then start to accelerate declines and economic troubles escalate and we enter a dangerous feedback looping, then we should expect the Fed, and other central banks, to up the ante and go more unorthodox. Quite what that will entail remains to be seen, but drawing on history, recent and past, this could mean imposing restrictions on shorting shares, preventing capital from leaving the country, ‘strong-arming’ into treasuries, and more direct, targeted inflationary tactics. There is of course the potential for increased nationalism and for hostilities between certain nations to increase (USA-China, China-Japan) as internal problems escalate.

I don’t want to speculate too far ahead, but I see major lasting opportunities at hand in short equities and long gold, tempered by realism over what central banks will do should my projections come to pass. Monetising debt whilst tipping over into deflation under unprecedented collective demographic downtrends which should mean a further decade of secular stocks bear and global economic weakness is a very bleak outlook. As a trader, I think the biggest gains are potentially to be made at the front-end of that, in case the rules get changed. Speculators making money out of an economic crisis are an easy target. It very much depends on how things come to pass, whether we are nursed through another ‘lost decade’ or whether things are about to become acute, under a global deflationary recession, a debt-monetisation end-game or a de-railing and bubble-bursting of China’s economy.

In the near term, I continue to look for clues in the markets for the equities/gold, bull/bear switch. I am long gold, short equities, and looking to add to both on further confirmations of reversals in fortunes.

Equities Red Flags

1. Nasdaq Big Money Shorts:

7jan1Source: Sentimentrader

2. Percentage Of Indicators At Bullish Or Bearish Extremes:

7jan2

Source: Sentimentrader

3. NAAIM Sentiment Survey:

7jan4

Source: PensionPartners

4. Margin Debt Relative To GDP:

7jan3

Source: GuruFocus

5. Lunar Geomagnetic Model January Peak:

Guide2014

6. Citi Panic/Euphoria model further into Euphoria (to +0.6 from 0.52):

7jan5Source: Barrons/Citi

State Of The Markets

I think Bitcoin isn’t coming back. Bubble popped as per the bubble anatomy model below, and now at fear-capitulation:

8dece1Source: Bitcoincharts

8dece2Source: PortfolioProbe

Now what about the stock market bubble? No bubble?:

8dece3

8dece4

Source: Dshort
8dece5

Source: John Hussman8dece6 8dece7

The Citigroup Panic/Euphoria model is a composite of NYSE short interest ratio, margin debt, Nasdaq daily volume as % of NYSE volume, a composite average of Investors Intelligence and the American Association of Individual Investors bullishness data, retail money funds, the put/call ratio, CRB futures index, gasoline prices and the ratio of price premiums in puts versus calls.

Add in the declining trading volumes and I believe we have a recipe for a crash ahead – the question is when. An overleveraged, thinning stock market participation, trading at historic overvaluation and euphoria extremes. That said we have to understand the current context: surpressed cash and bond yields makes equities relatively more attractive, so worthy of higher valuations. Here’s a model I’ve used before to assess the environment for equities:

1. Inflation rate – Stocks have historically risen when the official inflation rate is between 2-5%

Inflation is below, so this is a negative.

2. Bond yields versus stock yields – Long term gov bonds yields should not exceed stocks yields by more than 6%

Equities are largely yielding more than 10 year bonds in the major nations, so this is a positive.

3. Interest rates – interest rates should be low.

Ultra low – so again positive.

4. Yield curve – should be normal.

Yield curve is redundant under a balance sheet recession, and I believe that’s the current circumstances. Therefore irrelevant.

5. Stock valuations – Stocks P/Es should be historically reasonable (historic average 17)

Overvalued by CAPE, Q ratio and a number of measures, so negative.

6. Investor sentiment – II, AAII, Market Vane should not be overly bullish

Overly frothy sentiment, e.g. II bull-bear ratio at highest since 1987. Negative.

7. Money supply – should be growing and strong

Collective narrow and broad money measures weakening to flat of late suggesting we may be seeing a top in global industrial production as we turn into 2014. But no clear trend, so I suggest neutral at this point.

8dece8Source: Moneymovesmarkets

Overall it’s a mix of positives and negatives, but notably both at extremes. Stock-bond yield differential at extreme in favour of equities, but equities overvaluations extremes, for example. So which is ‘right’? You know my view: unprecedented collective demographics point to deflation and declining equity and real estate markets that cannot be overcome by government intervention. But this may yet take time to unfold.

Corporate bond yields are also into extreme territory, putting investors into the same kind of risk predicament as in equities.

8dece9Source: SoberLook

As my trading focus is currently short term, I’ll end with my view on that. In line with excessive sentiment readings reached at the start of December, most major stock market indices pulled back last week. A notable exception was the leader, the Nasdaq, which consolidated sideways and then broke out on Friday to end the week at new highs. So more Nasdaq parabolic?

My opinion is the Nasdaq is actually going to reverse this coming week and be the last to join the correction. Volume was notably lower on Friday on that breakout, which is a sign it could be reversed. We are into the lunar negative period and there is a geomagnetic storm in progress this weekend. The Nasdaq shows a breadth divergence for the last 2 months, which again is suggestive of a correction:

8dece10Source: IndexIndicators

When the stock market reached those kind of sentiment levels in the past, normally a correction period of several weeks followed:

8dece11Source: Sentimentrader

Monentum has also waned. So it’ll be an interesting week, and for commodities too. Some signs of life last week which energy breaking out on the growth story, and some volume in the gold and silver buys in their range-bound week, whilst sentiment levels against gold, silver and miners are again at extreme lows. The US dollar is once again looking weak. The commodities indices remain in those large technical triangle noses since 2011, so still watching and waiting.

Disclosure: short stock indices, long commodities.

 

 

 

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.

 

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

Update

Stock indices rose into the full moon, making for a third consecutive lunar inversion. Here is the updated lunar-geomagnetic model versus the SP500:

21oct20131Forecast geomagnetism is fairly benign and we are now into lunar positive fortnight, however the three back-to-back inversions leave me less confident as to the direction of the stock market. Normal service may resume here (i.e. a two week uptrend) but the triple inversion maybe has some significance.

Breadth broke out, as in Advance-Declines:

21oct20132Source: Stockcharts

This development casts doubt on a stock market topping process. However, other developments have added weight to my criteria list for a top (last post), namely treasury yields fell again, commodities indices edged up again, ECRI leading indicator growth fell further, narrow money leading indicators for the G7 have worsened, Citigroup economic surprises for the major nations have all turned into downtrends, bar China which has turned flat. Here are the CCI and CRY commodity indices:

21oct20133

 

Source: Bloomberg

Still tentative uptrends short of momentum, still too early to say if they are going to take off. Crude oil has flattened out but is still in a downtrend for now, whilst gold broke up beyond downsloping resistance on Thursday and held the break on Friday:

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Follow through is still required though, so also tentative but more promising.

The result is I am watching the markets at the start of this week: can stocks rally and the SP500 break upwards out of its wedge on good breadth, or is another pullback going to come to pass (earnings revenues disappointing so far but the season only still getting under way); can commodities (particularly gold) rally and gain momentum; can the US dollar break beneath another support level at 79 (expectation has switched again to no QE taper in the near term)?

For a more definitive judgement on whether equities are topping cyclically we need more time, and more developments. On balance I believe we are in the early part of a topping process, pending further evidence. Next we would require a deeper correction ahead to produce a lower low, followed by a rally back to the highs whilst leading indicators fall. Rising commodities would normally play a role too, and if they are in a new uptrend, they need more time to rally some way higher. But all this could take weeks or months to fully develop.

I am also watching the sunspot count as the sun has woken up again. If the solar max is still ahead then we ought to see a sustained period of higher solar activity.

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Update

I’ve been busy with the shift of focus, towards shorter term trading. I advised recently that a poor year for commodities threatens my year end PnL, so pending the validation or invalidation of solar cycle and demographic theories, I am taking action to try to ensure a good year-end figure. What this means in practice is (i) taking profits on markets where applicable (ii) using shorter term indicators and leverage to bring other positions to profit and then close out and (iii) as the range of markets I am involved in narrows, attacking the remaining markets, plus (iv) trading in and out of other opportunities where I see them. So I am gradually reducing the range of markets I am involved in whilst leveraging up on the remaining markets: a combination of decreasing and increasing exposure to keep risk levels satisfactory. And no longer term strategic positioning any more – that will be resumed following this exercise. It’s an enjoyable challenge, as I haven’t used this approach for some time. No guarantee of success though, and only in the early stages.

It remains to be seen whether the solar peak is ahead or behind us, and if it is ahead of us whether the anticipated correlated commodities peak will occur. It is also still not yet clear whether commodities are changing trend into an uptrend, or still in a bear market since 2011. Below, both commodities index and sunspots versus Sp500.

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8oct20132Similarly unclear yet is whether equities are in a cyclical topping process. We see breadth divergences, but not yet deterioration in leading indicators. We see the kind of price oscillation within a range that would mark a top, but as yet no real marked shift in sector performance that would be typical of a top. By my demographic work, we should tip into another global recession and equities bear in due course, but it would be historically typical if this was triggered by tightening: bond yields rise too far (not yet there) or government cuts back on spending/stimulus. On the latter, the US government shutdown, if prolonged, threatens to do the equivalent job of reducing government spending; or the government may agree to spending cuts to raise the debt ceiling (deadline Oct 17th); or the Fed may taper QE (next FOMC output Oct 30th). The near term prospect of a taper looks less likely with the government shutdown potentially shaving off GDP, but it remains out there as unknown, and on that note, commodities typically perform historically (as shown in the first chart above) once equities have topped and the economy has topped, once rate cuts are underway. Clearly that isn’t our current scenario, which adds to the uncertainty over commodities. Plus, again referring to demographics, we have an unprecedented collective global downtrend in place which could potentially overwhelm any possible commodities/inflation rally. Which brings me back to the start: nothing has been validated or invalidated yet in terms of solar, demographic, commodities, equities, bond yields and government spending/stimulus. Gradually developments in all these areas will make it clear, but pending that, my focus is making money shorter term.

So to the near term. Below I show the position of the SP500: at support in a rising wedge. That rising wedge could spell a breakdown ahead, but first a bounce may be in order.

8oct20133The US government shutdown and debt ceiling uncertainty is affecting market sentiment, but news of a likely agreement could at any point provide a relief rally. If the impasse remains however, then the next two weeks are the negative lunar period which takes us up to the debt ceiling deadline and could therefore keep downward pressure on stocks.

Below is the latest geomagnetic-lunar model versus the commodities index. The geomagnetic trend has flattened out and has a positive edge looking out over the next 3 weeks. Indeed we are into the last quarter of the year, where we typically see more benign geomagnetism and positive seasonality for pro-risk (which I believe are correlated). If equities are not yet making a cyclical top, then there is both a backdrop and a time window in which to rally away from the price range of the last few months.

8oct20134The US dollar is flirting with major breakdown, but arrives there oversold and overbearish. A breakdown would add weight to a commodities rally, so I continue to watch. Crude oil is typically the main driver of an inflationary commodities rally and looks to have formed a short term low over the last couple of sessions. I am watching that too, as further drops back into the range of the last couple of years would cast doubt on commodities making a meaningful uptrend.

*Updated short term lunargeomagnetic model versus SP500 10 Oct*:

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