Monday, August 4, 2014

CAN “YES WE CAN CONTINUE “? PART 2


CAN “YES WE CAN CONTINUE “?  PART 2

Wow has time flown from Part 1 of “Yes we can”.  From the DJIA low of 6545 in March of 2009 to just over 17,000 this bull run has been full steam ahead.  There have been only 2 occurrences since 2012 of the DJIA being down for 4 consecutive weeks namely one in 2012 and one in 2013. But wait, the SPX being down for 4 consecutive weeks since 2012 HAS NOT HAPPENED!  The worst has been 3 consecutive down weeks.  The Russell 2000 index which is small-cap stocks closed down for 4th straight week.  This hasn’t happened since 2011.  This week’s debacle was across the board.  

The conference board reading on consumer confidence surge to over 90.  The last time it was above 90 was back in October of 2007 at the SPX peak.  Of course we know what followed for the next 1 ½ years as Mr. Bear showed up taking the market and confidence down to under 40.  Is there a correlation?  Not really as confidence during the latter part of the 1990’s was between 120-140 and even during the 2001 selloff the eight month average was just over 109. 

What has been very noticeable over the past 6 months is the sharp increase of consumers driving Mercedes, BMW’s and Lexus’s.  They are buying or leasing the cheaper models which are still very expensive.  My guess are these people are making 30-40K a year but with the low interest rates and the savings they are getting from OBAMACARE (if they qualified for a subsidy) are using that money to feel like a millionaire.  This is reminisce of the 2006-2007 period when using the housing ATM card with just a sign here mentality created a housing boom.  We all know that ending.

Now let’s get back to the good stuff of a trillion in student loans, the FED’s increasing balance sheet, the debt and the inflated market prices in bonds, stocks and the high leverage users.  The FED lets the air out of QE infinity as seen by the markets happening this Fall and interest rates start to rise too fast, that will sharply increase our nation’s interest expense.  The FED decides to drain liquidity and those with leverage get into deep, deep trouble nothing will stop the markets both bond and stocks to cascade into sharp decline.  At the beginning it will be deemed a buying opportunity as for the bond market the 10yr. has been held up by the Chinese buying every slight decline.  The Chinese banks are super charged with leverage.  As for the stock market, the same page is rewritten – Stocks Fall Sharply on Profit Taking.  This line only works for the first 10% down move, but what will happen when as I expect the market is down 35-45%?  Remember crashes don’t happen at the top!  Therefore, a 50-70% decline is very possible over the next 12-16 months.  Keep your stops close!!

The Yellen “put option” just like Greenspan and Bernanke’s put will become “in the money”.  Back in 1987 the crash was blamed on the futures market.  This decline will be caused by insurance companies and other retirement accounts that want to hedge annuities written that give the holder no downside risk and a partial portion of the upside.  Other products that give a set rate  7% return for example do not work very well for the seller of the product in a declining stock market and rising rates meaning falling bond prices(unless they have short duration).  It’s a house of cards waiting to happen.  Remember for every seller there is a buyer.  Everybody can’t be hedged!

Besides the technical reasons behind the upcoming decline there are numerous fundamental reasons.  Congress has little chance in passing anything over the next 6 months.   The only headlines we see are companies getting fined by the government namely McDonalds, Hewlett-Packard and Bank of America this week.  The President wants to raise not only wages but change laws through execute order rather than Congressional procedures.  The immigration reform that the President wants isn’t being dealt with so the president has decided to handle it the “Chicago Way”.  There are current immigration procedures but unfortunately just because there are laws are in place doesn’t mean they are being enforced.  The special treatment that certain firms get from the government is getting out of control. 

When it comes to foreign policy it’s non-existent until after the fact.  Over the past few years all the money spent on trying to get democratic policies to take shape in the Middle East to Africa to Asia are total failures.   The World has been moving toward a less civilized one and this alone is a major factor in the instability that’s expected to continue over the next few years.

In short, the free money policies and over leverage use will not end well.  It’s hard to believe a few years ago if one stated the future of 10 yr. bonds in the Euro-zone namely Spain, Greece and Italy in some cases would be lower than the U.S. 10 Yr. bond.   Germany’s 10yr bond is half the yield than the U.S.  Margin debt is at levels seen at previous tops and is a warning that over leverage could cause a sharper downside reaction once the momentum accelerates.  One worry is the carry trade between European low rates vs. the higher rates here.  This activity could last for a while longer and keep the bubble in bonds from bursting soon.   

This week’s sharp decline woke up all those thinking volatility was a thing of the past.  There is still a lot of money waiting to buy the dip.  There is a good chance that the highs are already in place.  Keep stops on a scaling degree.  Market breadth has been in decline while some of the indexes reach new highs.  The next big 20% move is down but the timing is the tricky part.  As the world’s stability weakens, the markets will get spooked.  People are realizing the U.S will not be aggressive in keeping world peace and therefore over the next few years, wars will be popping up creating a very unstable scenario.