In "Some Funnymentals"(below) I wrote about some of the factors which explain why most stock indices markets have gone nowhere in 2004-2005.
The main reason is that despite enormous growth in corporate profits, both M2 money growth and the ten year treasury bond yield minus the FED funds rate have depressed growth potentials. See the analysis based upon Paul Kasriel's arguments earlier this summer which were buttressed by the Conference Board's Leading Economic Indicators.
A second reason was the rising household debt to disposable income ratio which Kasriel and I showed as historically impacting spending, and hence GDP, thence stocks.
Nothing goes in a straight line, and we have had a substantial 5-10% sell off in market indexes which validates much of the above. However, in the past three months both M2 money and MZM money (cash) have begun growing again after a year's pause. FED actions affect these short or no duration moneys, but so do stock market moves. When people take money out of stocks it's either because of profits or fear of losses. In either case it means there is more money for expenditures or for investment. Currently with short term rates rising, cash may also be a preferred investment, with some money market funds (Vanguard's Prime Money Market Fund comes to mind) yielding close to 3.4%. Neverthlesss there is no penalty or loss of investment principal when you take cash money for another purpose, so cash is always "hot money" in a sense. If you are familiar with Terry Laundry's T Theory of cash build ups, you'll have a good idea where this can lead: http://ttheory.typepad.com
On another subject, I promised earlier last week to write about market analogies between now and 1934-35, because I think this may be the bullish "sleeper" amongst all the gloom and doom scenarios after a stagnant period and pullback.
Over the past four months, four different people have drawn my attention to the similarity of the NASDAQ 100 chart since 2000 and the DJIA chart from 1929 to 1935. I don't believe any of these four knows any of the others, and each approaches the markets from a different perspective and with different tools. It's possible they all are being influenced by someone else of course. Two are very successful private traders, one in central Europe and one in the US, and two are money managers who publish investment newsletters.
There are whole websites devoted to comparisons of "now" and "before" with percentage similarities on a day to day or week to week basis. Moore Research Center is one such: http://www.mrci.com/special/
I have always been biased against such minute comparisons as they seem to be favored especially by "crashistas" looking for a 1929 or 1987 crash next month or next week! But there are some superficial similarities of the economies and the markets of 2000 and 1929 and their aftermaths.
Disinflationary booms created manic bull markets followed by three year "crashes" of about 90% in the 1929 Dow and 2000 Nasdaq. Then there were major bullish recoveries of a year or less followed by nearly two years of high level consolidation when the market went nowhere. Don Hays of http://haysmarketfocus.com (this requires a signup process for a three day free look), one of my four sources, adds that the recovery off the 1982 multi year bear market low was much the same. Each of the three markets, 1933-35, 1983-85, and 2004-2005, spent 22 months, 27 months, and 22 (currently) months respectively before taking off in major bull market extensions for two years more.
One of my other sources showed that the position of the 50 and 200 day moving averages of the current Nasdaq100 and 1935 DJIA are quite similar, and another source has cogent Gann timing reasons which are virtually identical to 1935. Also it's probably a coincidence, but each of these examples ended in year 5 of its decade. This reminds me of the famous "Tides in the Affairs of Men", the original decennial pattern of Edgar Lawrence Smith, discussed and/or extended by many including W. D Gann and Edson Gould. 2005 looks to be an exception to the general rule so far, unless............................
Here are the three charts involving the 1935, 1985, and 2005 ends of high level consolidations after runs up from major bear market lows. You be the judge. (Left click on the images for a large version .)
The plunge to the consolidation lows of the past 2 1/2 weeks was only three days long, and was due to leaked information about the purported New York subway terror threat. (See "Homeland Securities" below.) The rest of the month after the 13th was what a cyber-friend calls a "commercial loading zone".
And indeed they did load up. George Slezak of http://www.cot1.com combines all the CFTC legal professional portfolio hedgers who use stock index futures and futures options. There are about 200 of these entities worldwide, representing the very largest portfolio managers. Slezak adjusts the emini's, and other contracts (Dow's, SP400, Russell's, Nasdaq's, etc. to the size of a large SP500 futures contract ($250 times the index) and adds them all up each week.
The total net positions of these big boys each Tuesday from the October 4th to October 25th reporting days were: -37,945, -13,382, +23,037, +42,199 total contracts. 37,945 + 42,199 = 80,144 contracts purchased. This is equivalent to $24 billion of stock which was held long which is no longer hedged short, or, for logical completeness, $24 billion of stock held short which is now hedged long. As a practical matter most very large stock portfolios mostly hold stocks long.
This new net long position is the most, or highest or most positive, that it has been in five years. This means that portfolio managers are quite a bit more confident than they have been in five years that stocks will go up. While you and I have been bombarded by politicians and the news media in October and scared out of our longs, as well as our wits, these big boys have been on a buying rampage.
This is the most direct and vivid description of what the the big boys have been doing, but there is much other evidence that the little guys have been absent from the market or getting short.
By courtesy of and with permission from Rainsford Yang of http://www.markettells.com the following chart of the daily NASDAQ/NYSE volume, with a 20 day simple moving average, show the small boys (NASDAQ players) volume relative to big boys volume falling to levels not seen since the dramatic lows of 2002 and 2003. And we were but 6% off the SPX top, not at a long and dramatic crash low. Also see Yang's chart of the percent of shorts at the NYSE held by the public. (Always left click on graphic images for larger pop-up versions.)
There are many more examples I could show you of the terrorized condition of the average investor compared to the confident buying of the big boys. None of these indicators is the equivalent of the next day weather forecast, of course. they are not for timing: they are for a general sense of the market climate at this time. That climate is very favorable over the near to intermediate term.
I'm finally beginning to get the picture. The movement which started in early August is a "flat" in the traditional or in Elliott wave terminology for corrections. The 4th part or wave of the third section of the flat began either at the October 6th or October 13th low. It may have ended on the 19th and the 5th and final section of the flat may have ended on the 20th. Or the 4th part may have ended at today's high and the market will dip down again to the lows for Hallowe'en.
The bigger question is what will this three section flat have corrected? Did it correct the advance from the April low(s)? Its duration and size would be appropriate for an advance of that size and duration.
Did this flat from the August high instead correct the whole larger advance from August 2004? It doesn't seem quite long enough in time although it has retraced about 3/8 of that August to August move in about 1/4 of the time.
This flat cannot be considered to have corrected the whole move up from October 2002 to August 2005. Therefore one must look as honestly and objectively as one can at one's feelings about the state of the market at this time. If you go down the page and look at the article "Some 'Funnymentals'", you see that I have begun to get a little defensive or looking for the exits. I have been bullish most of the time since early 2003.
The SPX has barely gone up at all since January 2004 to now, although many other indices, stocks, and funds have done extremely well indeed. The economy recovered quite well overall, and corporate profits have soared. The Lagging Economic Indicators peaked this summer, and some people regard this as being "as good as it gets" for a normal cycle. Clearly it was timely for the markets to begin discounting a slowdown in advance of the actual event, and this may be what is happening.
If this is the case, and if the comments above about what the markets have been correcting have merit, there is almost certainly more time and "size" to correct. That in turn suggests that what we have seen to date is the first section itself of a larger three section correction either of the 2004-2005 rise or the 2002-2005 rise. There will be plenty of time to get into details on those issues, but if we have completed a first section, or are about to, then the next section is going to be upwards. It could even go to new highs above those of August.
Based upon sentiment and other factors, some of which I've mentioned or hinted at, I think there is a good chance of going all the way back up or more into December. The forest (longer term) is very important, but we must not forget to look at the trees (shorter term) first.
I'll put up an illustrative chart later. This is just to think about while looking at your own chart.
This bottom is much like the one in April/May 2005 and many before it. I won't even get into sentiment which is hard to talk about without insulting your best sources.
Falling below everyone's favorite 200 day moving average and my favorite range bisects (thick blue lines) is typical, with repetitive spiky moves. If this one wants to replicate April and May exactly, it will rally some more and fall to a secondary low above the bisect line about November 8 when I have a major timeline. But it needn't do that.
I hope to have time in the next few days to present some evidence that we may track the 1935 to 1937 market move. In general I don't like pattern repetition games very much, but the current mood and economy mirror that period as well, so it's worth a look.
Paul Kasriel, economist at Northern Trust in Chicago, has been forecasting a slowdown in the US economy based upon his estimation that the FED has already pushed short term interest rates past the so-called neutral point. The closest Kasriel has come to the "R" word is to mention in passing a possible "growth recession" for 2006. He recommends the ten year treasury note yield minus the FED funds rate and real M2 money growth rate as leading indicators of economic growth, as indeed does the Conference Board in its Leading Economic Indicator.
In a report from this past summer http://tinyurl.com/d9oqm Kasriel overlays a chart of quarterly GDP with a one quarter forward-shifted (1QF-GDP) line which combines those two indicators above. Since 1959 these indicators turned down one to several quarters before GDP growth, and this is what we have already seen, as the 1QF-GDP and GDP growth peaked in early 2004. Each of eight prior occurences resulted in a growth slowdown and five of them led to true recessions.
Kasriel has also looked at the household (consumer) increase in debt as a percent of disposable income. http://tinyurl.com/8dhh7 In general the comments one sees on this issue bemoan the long term "implications" of this debt burden. Currently the four quarter moving average of debt/household disposable income is about 12.2%. In both 1977 and 1986 the figure was about 10.5%, so the peak of last year was not astronomically above previous peaks. Nor should we forget that debt/income fell to about 4% in 1992-93, and that it is quite cyclical with peak to peak periodicity of approximately 4-6 years. This is not a parabolic rise.
What I found more interesting than the "long run" about this debt indicator was that it peaks during the rise to, but ahead of, inflationary peaks. One could say that the household (consumer unit) begins to cut spending and pay down some debt as prices increases materially squeeze their budgets. We've been hearing anecdotal stories about this phenomenon recently with gasoline prices, but here is a data series which confirms it as a real event.
On a hodge podge chart I stacked a logarithmic Dow Jones 30 chart on top of the household debt/income chart from Kasriel on top a chart of year over year increases in CPI, on which recession periods are shaded pink or salmon. Clearly the debt/income downturns precede recessions, but even if a recession doesn't occur, there is a decline in CPI. This latter was the case in the early 1960's and 1986-87.
Even more interesting for investors is that downturns in household debt/income often, but not always, precede stock market highs. 1999, 1976, 1973, and 1955 were excellent examples. Even more compelling is the observation that upturns from lows in household debt/income occur at or shortly before market bottoms. (Keep in mind that the household debt/income chart is a one year moving average.)
While we have a downturn in the one year moving average of household debt/income from about 13% a year ago to just over 12% now, we don't of course know if this is just a wiggle in the rise from 2001 or a meaningful event which will lead to a major drop in CPI, a recession, and a major fall in stocks.
However, Kasriel's chart of M2 growth and the spread between the ten year treasury note yield and Fed funds have great reliability and are also pointing in the same direction as household debt/income.
"What does it all mean?", as my history professor was wont to ask after a long lecture. How do we take this to the bank?
My hunch is that should be looking over our shoulder as we saunter down Wall Street. If we see evidence of technical deterioration in the stock markets, given this fundamental background, we should take the money and run.
I do see some technical deterioration in a number of sentiment measures, although short term it looks quite bright. The first hour minus last hour Dow 30 price differential points to long term distribution since early last year. SP500 futures' cumulative on-balance volume line has fallen below its quarterly (65 day) averages for the longest time since the 2003 low. SP500 futures open interest has also fallen on an expiration to expiration (3 month) basis since June. And so forth.
My timing and my hunch suggest another fourth quarter run up to Christmas before a larger decline perhaps lasting through 2006. Final runs are often more powerful than one would suspect, so even if one's hunches are correct, it's best to stay the course. Then too, one's hunches may not be right.
No wonder persistent selling through all supports hit early last week and this. I had a suspicion that a lot of people knew about the New York subway threat well ahead of the rest of us. What a bunch of crap!!!!! It's even worse than the LTCM fiasco of 1998 when the FED and a million brokers and banks knew and told friends, but "don't scare the public, just take their money." Some scores of heads should roll on this one.
The past week's plunge took me by surprise. My sentiment measures suggested the market would hold up into Thursday's timeline cross, whereas the market fell into Thursday. The public's share of all NYSE shorts rose to 59% this week, the highest since the terror crash of September 2001. People I mentioned this to on internet trading sites wrote off the public short ratio as being due to less shorting activity by the NYSE specialists which in turn is written off to the specialists' declining fortunes with the rise in program trading. I still say that the public is not going to be correct in being that bearish so near the year's high, at least not for long. But they were right for three days .
The plunge took SP500 futures back down to the July 7 London terror low, yet another connection with this week's terror threat and the public's most bearish stance since 9/11/01. I also suspect there were leaks of the New York subway threats earlier in the week.
On-balance volume of futures has fallen below its 65 day moving average for the longest period of time since 2003. But the Money Flow Indicator suggests that a divergence low has been set. Futures open interest remains below the trendline at quarterly rollovers since June.
My current best guess is that we will rally into December, and then have a decline. However, several talented people I know in very different locales have independently come to the conclusion that the market is following the same price and time pattern as it did from 1932 to 1937, and that we are ready to go up for several more years. There are many economic parallels to that period as well. Early in a long term inflationary cycle the breakouts in stocks are more likely to be to the upside. The most committed bears I read are those who think we are still in a deflationary cycle. Crude goods (commodities) and consumer price evidence say otherwise.
The public or non-institutional private investors now hold >55% of the total NYSE short interest. This is a greater percentage than at the October 2002 low. Granted that we pubs are really smart....NOT
It's no secret that Robert Prechter's persistently bearish bent since the early 1980's created a whole amateur underclass of market bears and pessimists who have made internet chat sites their home. Less well-known is the fact that early in his public career Prechter accepted the traditional interpretation of the Kondratieff Long Wave cycle. In the second edition (1981) of Jack Frost's and Prechter's "Elliott Wave Principle", the "orthodox" Long Wave schematic chart is presented (page 148) with the LW inflection peak said to be early 1970''s, the top formation "plateau " end in the early 1980's, and the final low scheduled for the early 2000's.
Here it is in Prechter 's own 1979-81 words: "As we interpret the Kondratieff cycle, we have now reached another plateau, having had a trough war (World War II), a peak war (Viet Nam), and a primary recession (1974-75). This plateau should again be accompanied by relatively prosperous times and a strong bull market in stocks. According to a reading of the wave, the economy should collapse in the mid 1980's, and be followed by three or four years of severe depression and a long period of deflation through to the trough year of 2000 A.D."
This is, of course, almost exactly what did happen, and right on the time line. The depression of the early 1980's was extremely severe for wages, employment, crude goods prices, and mining, agriculture, and oil sector devastation, and rates of GDP growth slowed dramatically and stayed far lower that they had been from the 1950's through 1970's.
Where Prechter and his legions of intellectual followers missed the boat was that "creative destruction" of modern Kondratieff Wave depressions happened earlier and far more effectively than in the credit-deficient 19th century. As soon as labor unions lost their grasp after 1980, and both interest rates and prices began to fall, a tremendous energizing of American enterprise was set in place, led by technology. The industrial heartland became the Rust Belt and Silicon Gulches, east and west, replaced it.
So while economic growth rates remained lower than they had been until the late 1970's, interest rates and crude goods prtices continued to fall to 1999 and even later for some goods and rates. The Prechterite Kondratieff folks were (and still are!) waiting for the vicious deflationary crash of 19th century dreams. But the initial crash was over by 1982. As one would expect there were further deflationary interludes through out the two decade period which followed, as in 1989-90 and 1996-99 and again in 2002. For all practical purposes, the Long Wave Kondratieff trough was in 2002, even though gold and other selected crude goods prices (oil) bottomed in 1999.
The Prechterite Kondratieff folks have come up with a panoply of reasons why gold and oil and economic growth are up: mostly focused on market "manipulation" and intervention. We began to see this remarkable rationalization develop in the gold market after 1996 when gold bugs turned deflationist and switched to market manipulation and "credit risks" as reasons for gold's bear market, never mind that nearly all commodities were down and the dollar up. I wrote a gold newsletter in the 1990's, and I was shocked to see gold bruited about by these folks as a deflation hedge while it fell by nearly 50%.
Now that gold is but a rally away from doubling its 1999 low and crude oil up seven fold, many are nervous, and my mailbox is full of deflationary ads for newsletters. No one who is bullish will deny that bull markets have to exhale and will do so after advances. Both gold and crude oil could reasonably be expected to have substantial pullbacks. But today I saw an analysis of why that may not occur.
George Slezak is a self-proclaimed "perma-bear", but he is wise enough to know when bullish times are upon him. As far as stocks are conerned, he was short for most of 2000-2002, long from the summer of 2002 for two years, and he has recently turned bullish again on stocks. George's main analytical weapon is the net hedging position of the commercial portfolio managers, but in this gold and stock analysis he is using Long Wave cycles to project much higher prices for gold after a probable pullback due to increased commercial hedging. And I agree.
Gold was a central bank fixed market for a very long time, so we have no decent price data before the late 1960's. But Slezek understands that gold went through a rolling bear market from 1980 to 1999 just as stocks did from 1929 to 1949, and surmises that the outcome will be a much longer bull market like the stock market had fr0m 1949 to 1972. This is a "bottoms up" Long Wave analysis unlike the usual "tops down" application of derived cycles.