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Musings Report #31 8-2-14 Is This the Real Deal?
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For those who are new to the Musings reports: they are basically a glimpse into my notebook,the unfiltered swamp where I organize future themes, sort through the dozens of stories and links submitted by readers, refine my own research and start connecting dots which appear later in the blog or in my books. As always, I hope the Musings spark new appraisals and insights. Thank you for supporting the site and for inviting me into your circle of correspondents.
Is This the Real Deal?
To avoid boring my non-finance readers, I usually avoid addressing markets and economics twice in a row. But the cascade down in stocks this week sharpens the question that at least indirectly impacts everyone in advanced economies: is the Great Bull Market of the past 5 years breaking down?
In other words, is this week's decline just another minor blip in the Great Bull's ascent, or is it the real deal, i.e. a harbinger of a Bear Market? I hope this discussion might be of interest to those with no interest in stocks per se, as the discussion reveals how interconnectedness leads to unintended consequences and how extremes revert to the mean for one reason or another--the reason matters less than the realization that extremes don't last.
As I noted in last week's Market Musings, there are many articles highlighting the multiple technical signs that a major top has been put in; for example, The Macro Picture.
Rather than re-hash all the chart-based evidence, I'd like to discuss what I see as fundamental drivers of a sea change from Bull to Bear.
Before we dig into these secular forces, I want to mention that I fully expect the next few months to be a jagged, volatile process of topping rather than an easily identified one-time spike. Markets that are breaking down don't make it easy to get on board a trend and ride it to big profits; the end of Bull markets tend to be choppy, high-volatility affairs with numerous breath-taking spikes down and equally impressive recoveries.
I sold my puts (bets on a market decline) purchased on the 18th and 21st of July on Friday, Aug. 1; I now expect a retrace rally of some kind this next week. That will likely run out of steam in a week or so (i.e. enough time for oversold to shift to overbought) and set up the next decline. To make money and keep it will require nimble trading--being in the right trade at the right time and exiting at the right time.
So while trading will likely be especially challenging over the next few months, the fundamental drivers of a reversal to a Bear market are more easily predictable. I have discussed these fundamental drivers in depth in the blog over the past year:
1. The political weakness of the Federal Reserve. Very subtly, the Status Quo narrative that the Fed "saved us from a fate worse than death" in 2008/09 is being replaced by a new and troubling (at least to the Fed) narrative: the Fed has failed to help the Main Street economy while it has greatly enriched the Wall Street financier class.
Many observers are convinced the Fed can print/loan money without constraint to keep stocks elevated at a "permanent plateau." I disagree; I see the Fed as having expended its political capital on a fruitless and destructive campaign to boost stocks at the expense of financial prudence, discipline and transparency.
The bottom line: those who see the Fed as an all-powerful force immune to public or political opinion are sure the Fed will "save" the stock market from a serious decline. I think such a "save" would be A) politically catastrophic for the Fed and B) much more difficult than the 2009 "save" due to the diminishing returns of Fed tricks.
In the larger perspective, I see the Fed and Wall Street as losing influence within the Deep State as the failure of the Fed's policies become undeniable.
2. The U.S. dollar (USD) will strengthen, crimping corporate profits. As I have discussed many times, U.S. corporate profits have been driven by A) reducing labor costs and B) the weak dollar, which has boosted earnings reaped overseas when stated in USD.
This is of course interconnected to the tapering of the Fed's liquidity/"free money for financiers" programs, which have served to weaken the USD. So as the Fed ceases creating money and interest rates tick up, the USD will strengthen.
Though many observers have made a career of predicting the demise of the USD, I see things a bit differently; as defaults like Argentina's default on its bonds become more common, swapping weakening currencies for dollars will make ever-more compelling financial sense.
Another factor is the need to service debt denominated in USD; to make the payments, debtors need dollars.
Lastly, as I have often discussed in terms of Triffin's Paradox, the Fed tapering its money creation and the decline in Federal deficits both actively reduce the flow of new dollars into the global economy. As hoarding of USD becomes the favored risk-averse strategy for those with liquid assets, the demand for USD will rise while the supply diminishes.
This is a classic economic dynamic for an increase in price: in this case, of the USD. Every tick up in the value of the USD in relation to other currencies suppresses U.S. corporate profits earned overseas, which are roughly 50% of all global corporations' earnings.
3. Lastly, much of the stock market advance was based on multiple expansion: a market that values earnings at 18 times earnings will be double that of the one valued at a Price-Earnings multiple of 9.
Any decline in corporate profits will reduce the multiple as participants realize they cannot look forward to ever-expanding profits to justify high multiples.
Combine these three forces and the case for a Bear market strengthens considerably.
Cultcha/Culture
Steve Fraynes--3 tricks: (via C.N.F.) walking on water, mobile phone transported into a beer bottle....
Moonshot Thinking (3:45) (via G.F.B.) ...aiming for the 10X leap rather than the 10% improvement.
Incredibly rare photographs reveal the intricate and beautiful design inside Iran's magnificent temples (via Katharine K.) wow!
Hildegard von Bingen - Voice of the Living Light (1 hr 16 min) (via Lew G.) -- ethereal and beautiful -- read the Wikipedia entry linked to her name for the story of this amazing 12th century female polymath.
Yo-Yo Ma playing Morricone's "The Mission" (5:46) (via Lew G.)
Summary of the Blog This Past Week
It Doesn't Take Much Land to Grow A Lot of Food 8/1/14
Why Wait for the Shoe to Hit the Floor? The Case for Selling Now 8/1/14
Substituting Debt for Income Is Not Success--It's Failure on an Epic Scale 7/31/14
The Fed's Failure Complicates Its Endgame 7/30/14
Our Marginal Economy 7/29/14
The Case for a Bull or Bear Market in Two Charts 7/28/14
Best Thing That Happened To Me This Week
Posting photos of our messy but productive garden and a few of the meals we've prepared with the bounty.
See the From Left Field link on how dirt is an anti-depressant....
Market Musings: Gold Reaching a Decision Point
Here are two similar charts of gold that make slightly different points. I've marked them up to highlight the repeating pattern of the past few years: a long consolidation characterized by a declining line (lower highs) and a double bottom that is followed by a wedge consolidation: lower highs and higher lows, squeezing into an apex that usually breaks big up or down.
On balance volume (OBV) and stochastics have rolled over and are bearish, while MACD is rising positively. As with so many technical set-ups, there is thus evidence to support both possibilities, a break up or a break down.
There are many bulls seeing $3,000+ /ounce gold in the future, and some bears who see gold dropping to $800.
In my view, the ideal conclusion would be a test of support around $1,190 that would set up a bullish rise from the 13+ month consolidation. That said, we would be remiss as analysts not to note that the previous consolidation was broken to the downside and gold fell $400 in the subsequent cascade.
There are all sorts of complexities in the gold trade (not to mention outright manipulation), but keeping it simple offers some valuable clarity: the direction of the break, up or down, will help us identify the trend.
From Left Field
The Suburbs Will Die: One Man’s Fight to Fix the American Dream (via Joe H.) "Most U.S. suburbs are now on their third life cycle, and infrastructure systems have only become more bloated, inefficient, and costly."
7 reasons I love my boss: Here’s the case for working for yourself
Run 5 minutes a day, live 3 years longer -- more on the miracle of exercise....
The rise of data and the death of politics (via Lew G.) Tech pioneers in the US are advocating a new data-based approach to governance – 'algorithmic regulation'. But if technology provides the answers to society's problems, what happens to governments?
Colonial Folly, European Suicide (via Joel M.) Adam Hochschild: Why World War I Was Such a Blood Bath
"Where were these illusions born? They came from the way generals cherry-picked previous wars to learn from. the men who led Europe into the First World War found it more comforting to look elsewhere — at battles where victory was swift and the enemy had little firepower. In 1914 Europe had not had a major war in more than 40 years and, except for the Russians, almost all officers who had actually seen combat had done so in lopsided colonial wars in Africa and Asia."
In Church Attics, Clues to the Private Life of Early America (via Joel M.)
Air Force Plans Shift to Obtain High-Tech Weapon Systems (via Joel M.) The Air Force called for a shift away from big-ticket weapons systems to a move toward high-technology armaments that can be quickly adapted to meet a range of emerging threats. (but only after we've squandered $500 billion on the F-35.... arggh)
Who Wins in the Name Game? From dating to job prospects, a name has remarkable power over the path of its owner's life. -- glad I have a traditional name and a middle and last name of one syllable each....
The Art of Ancient Hands -- nice depiction of craftsmanship....
Antidepressant Microbes In Soil: How Dirt Makes You Happy -- contact with dirt helps the immune system and microbiome, too....
Humpback whale surprises dog on beach (via C.N.F.) Foraging mammals pursue anchovies within 50 yards of shore in Monterey Bay, allowing for unique photo opportunities.
Gödel Incompleteness For Startups (via Lew G.) "Over the years, I started to notice certain meta-patterns common to all startups, the patterns that give a tantalizing premonitions on their chances of success or failure. The specifics of an industry or investment cycle might change, yet these patterns remain the same in every decade. I see them as two big groups of patterns: human patterns and mathematical patterns."
"Anyone who tries to make a distinction between education and entertainment doesn't know the first thing about either." Marshall McLuhan
Thanks for reading--
charles
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