August 31, 2015

Retail investors likely to invest less money going forward

....It appears increasingly likely that after a series of body blows over the last few months (or really the last few years), individual investors will likely lose interest in the U.S. stock market for some time to come.

The possibility of deeper domestic economic pain and disappointment also seems more likely than most expect.

Monday's Flash Crash

One observer described Monday morning's market opening (in which the Dow industrials dropped by a quick 1,100 points) as "the simultaneous flash crash of over 1,000 stocks and exchange traded funds."

And as I mentioned above, it had the look of capitulation to me.

Here are some of the ETFs that broke down yesterday morning on the open:

-    The First Trust Dow Jones Internet ETF (FDN), First Trust Consumer Discretionary AlphaDEX ETF(FXD), iShares Global Healthcare ETF (IXJ) and others all lost more than 40% of their value.

-    The SPDR S&P Dividend ETF (SDY), Vanguard Dividend Appreciation ETF (VIG) and PowerShares DWA Momentum ETF (PDP) were among those that gave up 30 to 40%.

-    The PowerShares High Yield Equity Dividend Achievers ETF (PEY), Vanguard Small-Cap Growth ETF (VBK), the iShares Core S&P 500 (IVV) and others shed 20% to 30%.

The disorder wasn't confined to thinly traded ETFs and individual stocks. For example,  General Electric (GE) -- a $250 billion market-cap stock that trades over $2 billion of volume day -- lost 21% of its value on yesterday's opening:

 Nor was Monday's flash crash the first event of its kind that has the potential to alienate retail investors. There was, most conspicuously, the "Big Flash Crash" of May 2010.

There have also been some other powerfully disruptive events that could disaffect small investors for years, including:

-    The Ongoing Bear Market. The past week's market schmeissings had already been preceded by a devastating bear market in commodities-based and cyclical companies (especially energy-related ones). Big Oil and others hit by this bear market are often mainstays in retail investors' accounts. That's one strike against the individual investor.

-    A Broken Market Mechanism. A second strike, as I've written before, is that the market's mechanism has been virtually destroyed (as reflected in yesterday's flash crash) by increased and more-costly regulatory burdens. These serve to limit dealer inventories in numerous asset classes and impair market liquidity, creating a vacuum that's taken up by leveraged ETFs and high-frequency-trading strategies. Basel III and Dodd-Frank (two of the major culprits) are here to stay, so this won't change. Unfortunately, violent moves in a market without memory from day to day won't boost retailer investors' confidence. 

-    Weak Political, Fiscal and Monetary-Policy Leadership. A third strike facing retail investors is the lack of confidence in our political leaders -- and, increasingly, in the Federal Reserve. I can't see that improving much over the next year or two.

-    Demographic Headwinds. A fourth strike against individual investors (as if three weren't enough for an out) is our aging population, which reduces the demand for risky assets like stocks.

But as Los Angeles Dodgers' Hall of Fame pitcher Sandy Koufax (my cousin) would say, there are many more hard-to-hit fast balls being thrown at both the U.S. consumer and retail investor.

Slowing Consumption Ahead?
First, a period of slowing consumer consumption could lie ahead. 

The average Joe has already been victimized by so-called "screwflation," in which wages have stagnated but the costs of life's necessities have increased. The typical U.S. consumer has also been hurt by monetary policy that hits members of the "savings class" (many of whom are also individual stock investors).

On top of that, home prices and rents are well above levels of only a few years ago, hitting consumer pocketbooks. Add in the threat of a "negative wealth effect" from the recent stock-market drop and legitimate questions arise about personal consumption in the period ahead.

All of this creates the potential for more headwinds to domestic economic growth -- not exactly what the stock market needs right now.

What Are the Recent Crash's Ramifications?
I spelled out 20 lessons yesterday that we should all have learned in the last week. 

Well, here's a 21st one: Monday's schmeissing and the breakdown in the market's pricing mechanism could jeopardize what little confidence remains among retail investors.

This is potentially tragic to the supply-and-demand equation for stocks, as reliance on corporate buybacks is a slippery slope.

As I wrote back in April, "peak stock buybacks" could lie ahead. After all, companies face potentially widening credit spreads, lower high-yield and investment-grade debt issuance, pressure on corporate profitability and margins and a need to preserve cash amid bear-market fears.

Unfortunately, individual investors -- many of whom have already vacated the stock market -- will likely further lose confidence in stocks after Monday's flash crash.

Indeed, yesterday could have been the virtual death knell for the retail investor. And importantly, any resulting market weakness could bleed into (and adversely impact) the trajectory of the U.S. consumer's recovery.


August 28, 2015

Feels like 1984 and its a market for opportunistic traders

It might be the year 2015 but the markets are beginning to feel like 1984.

We live in a dystopian investment world who's markets (currencies, commodities, stocks and bonds) have morphed into an Orwellian backdrop of omnipresent government intervention and manipulation that is increasingly dictated by the Quant community (who worship at the altar of prices and price momentum and are agnostic to values).

via Twitter

Buying some stocks today

The conventional view is that after this week's schmeissing the market can't rally from here on a Friday, as who wants to be long over the weekend?

I would say, by contrast, if there is a growing likelihood of a Chinese "shock and awe" over the weekend and in light of the magnitude of the drop, who wants to be short over the weekend?

I am judiciously adding to banks and selected longs this morning.


Why the Markets sold off [VIDEO]

August 26, 2015

Fair market valuation and scenarios for markets in 2015

My "Fair Market Valuation" for the S&P index is at around 1990, and I expect it to be breached in the fullness of time as markets move quite often to extremes and overshoot equilibrium levels. More importantly, there are more dire economic scenarios that could signal much lower market price targets.

Below is a summation of the criteria and methodology I use to evaluate the "fair market value" or equilibrium level of the S&P index:

Scenario #1: Economic Acceleration Above Consensus (Probability: +10%) -- +3% Real U.S. GDP growth, +2.0% to +3.0% inflation and +8% to +12% profit growth. Stocks climb by 7.5% over the next 12 to 18 months. 
S&P target is 2245

Scenario #2: Status Quo (Probability: 25%) -- +2% to +3% Real U.S. GDP growth, +1.5% to +2.0% inflation and +5% to +9% profit growth. Stocks climb by 5% over the next 12 to 18 months. 
S&P target is 2195

Scenario #3: Muddle Along (Probability: 25%) -- +2% Real U.S. GDP growth, +1.5% inflation and +3% to +5% profit growth. Stocks climb by 0% to 5% over the next 12 to 18 months. 
S&P target is 2140

Scenario #4: A Garden Variety Recession (Probability: 25%) -- Negative Real U.S. GDP growth, less than +0.5% inflation and a decline in profits: Stocks drop by 13% to 17% over the next 12 to 18 months. 
S&P target is 1775

Scenario #5: A Deep Recession (Probability: 15%) -- Negative Real US GDP growth, deflation and a large drop in profits: Stocks drop by more than 20% over the next 12 to 18 months. 
S&P target is 1625

The buy-the-dip mentality has been ingrained -- we see it 24/7 from talking heads paraded on the business media -- so the Bull Market will likely end not with a bang but with a saw-tooth move lower.

August 24, 2015

Shorts pays off as market declines

I have a great deal of respect for the capital I have managed to accumulate and for the investments made by my investors.

Though my risk profile is relatively conservative for a hedge fund manager, at times I get aggressive when the upside or downside is compelling.

I believe that this is one of those times where some should consider being relatively aggressive and bearish -- and short -- in portfolio construct.

As I have often written, shorting is not for most traders and investors. Accordingly, most market participants should err on the side of conservatism now by maintaining above-average cash positions in this time of uncertainty.

From my perch, 2015 will be seen as having made a broad and important top for global equities. Contributing to my concerns have been both fundamental and technical issues.

My specific technical concern, which has led up to the summer schmeissing, had been the narrowing market leadership, which nearly always is a signpost of impending market weakness. As I wrote in "The Market Without Memory From Day to Day" in early August:

    -"One of the most important investment-history lessons that I've learned is that when leaders begin correcting as laggards rally (which happened last week), that's historically a precursor to a larger, meaningful correction.

Examples of major sector changes occurred most prominently in 1973, 1981 and 2000 and were all followed by bear markets:

     -   In 1973, the Nifty Fifty consumer-growth stocks led the market while industrials lagged. But when relative weakness began to emerge in the Nifty Fifty, the depressed industrials began to stabilize and exhibit relative strength -- and a bear market emerged.

     -  Similarly, energy and other inflation-oriented stocks led the market in the early 1980s. But then energy stalled in 1981 and the depressed consumer sector stabilized and began to rally -- a shift that preceded the 1981-82 cyclical market correction.
     -   The big bear market of 2000-2002 emerged when the Nasdaq faltered in early 2000 and consumer-defensive stocks rallied.

Though today's bifurcated market is occurring under the umbrella of easy money, it still closely resembles the three cycles mentioned above as the relationship between leaders and laggards changed (which is happening now).

    The most popular and extended stocks -- like Apple (AAPL), which broke its 200-day moving average for the first time in two years amid the weakest relative action since 2012 -- are becoming victims. And as in the past, such drops are swift -- providing little chance for trend-chasing traders and investors to exit stocks that had previously been in clearly defined uptrends (think Disney (DIS) or Comcast (CMCSA)).

    And just as in 2000, a loss of momentum in IPOs could presage broader weakness."

    --"The Market Without Memory From Day to Day" (August 2015)

At best, the reward versus risk ratio is unattractive and, as captured in my recent columns, at worst The Big Short is at hand.

My "Fair Market Valuation" for the S&P index is at around 1990, and I expect it to be breached in the fullness of time as markets move quite often to extremes and overshoot equilibrium levels. More importantly, there are more dire economic scenarios that could signal much lower market price targets.

As Warren Buffett has written, "The Market is here to serve you .... This imaginary person out there -- Mr. Market -- he's kind of a drunken psycho. Some days he gets very enthused, some days he gets very depressed. And when he gets really enthused, you sell to him and if he gets depressed you buy from him. There's no moral taint attached to that."

Mr. Market has been enthusiastic (and, at times, borderline drunk) for six years. It's time for it to take a collective chill pill and for investors to be more concerned with return of capital than return on capital.

There will be plenty of buying opportunities -- at some time -- in the period ahead. But just not now.

Risk happens fast.

Position: Short SPY

Originally published:  August 20, 2015 


Why the markets are falling now [VIDEO]

August 17, 2015

Most of us are not as fortunate as Warren Buffett to hold stocks forever

Investors have in essence been the central bank's slaves for the better part of a decade, but monetary policy's influence is waning and almost all of the monetary levers have been pulled. And as the curtain separating the Wizard of Oz from Emerald City is opened, our social and other vulnerabilities and weak foundation of economic growth are being uncovered.

A week ago I argued that the "Big Short" might finally be at hand, and that a return to natural price discovery in global stock markets is likely after seven years of artificial pricing served up by the world's central bankers.

The market deterioration/bifurcation that's surfaced and recently accelerated, coupled with the eroding global economic picture (a world essentially short of demand and facing deflationary influences) underscore my belief that a flight to safety might be upon us. In the face of already subpar growth, that means a flight out of stocks.

China, the engine and driver of global economic growth, has stalled.

Now, there's little difference to me between the Chinese and U.S. authorities that have both cajoled investors into buying equities -- except that one has done it explicitly and the other implicitly.

Unfortunately, neither group will have our back when things get out of control, as they appear to be doing right now.

In today's leveraged investment world, the knock-on effects to economic growth (i.e., a "negative wealth effect") are real and should be considered. They're now on the front burner.

T.I.N.A. is B.S.

Yesterday's market schmeissing brought on more arguments from the business media that "there is no alternative" to stocks (the "T.I.N.A." hypothesis), and that inestors should buy on the recent market dip.

Well, I think T.I.N.A. is B.S., as cash is an asset class and performs the job of insulating one's portfolio from wild gyrations and drawdowns.

I watched numerous commentators suggest on TV yesterday that the market would rebound in the days ahead.

It might or might not, but I would remind all of you that those who are self-confident of view and offer advice in the business media often don't take material risks to capital themselves.

They should be seen as investment commentators, not as investment coaches. Always be independent of view and weigh upside vs. downside according to your own risk profile and timeframe.

An interconnected world holds risks

With little margin of safety remaining at current valuations and a bull market in complacency among us, the market decline appears real.

As I have repeatedly noted, we in America live in a flat, networked and interconnected world (see the three questions I ask every morning at the beginning of today's opening missive). As such, the notion that America can maintain itself as an oasis of prosperity in a troubled world seems far-fetched.

The near-universal message in the media yesterday was that the global markets' reaction to China's currency devaluation was an overreaction and not likely to have a sustainable influence on equities.

Respectfully, those observers are ignoring the historic impact of lesser influences on markets (i.e., the Thai baht, Long Term Capital Management, Greece, Latin America, etc.). They're also ignoring the vulnerability of a tepid global recovery.

Warren Buffett and Berkshire Hathaway are among the few that have the luxury (and the devoted limited partners and investors that think "forever") to be unconcerned with the next three to five years. But most of us don't have that luxury.

August 6, 2015

Could a buying opportunity be coming ahead for Gold and oil

I've spent a lot of time over the years discussing how the consensus is often too self-confident and wrong.

Well, the current consensus is to stick with high-growth market sectors and to avoid cyclicals. (Jim "El Capitan" Cramer captures this excellently in his opener this morning.)

But I wanted to discuss a possible contrary opportunity that might not be at hand just yet -- but could be soon. I'm talking about the bear market in commodities, which has gained steam to the downside over the past week.

Oil is possibly about to test its early 2015 low of $43/barrel, while gold is closing in on its 2008-09 breakout support of $1,000 and gold-mining stocks are back to 2002 lows. As such, we should probably be on the alert for a selling climax -- and a buying opportunity -- in the market's much-hated areas of industrial commodities and precious metals.

The three most important factors that have pummeled commodities are a strengthening U.S. dollar, the interest-rate picture and the prospect of slowing Chinese industrial demand.

The general consensus is that the U.S. dollar will continue to firm as rising interest rates buoy our currency, while China's economic weakness will continue to weigh on commodities and commodity-dependent currencies.

But an offset to that could be a final throw-up as sentiment moves to the far end of the spectrum and towards extreme bearishness. Already, the Market Vane poll of commodities traders is showing that gold bulls have dropped to 28% -- their lowest level in 14-plus years. It's a similar story with other commodities.

A potential short-term plus for commodities might be that the U.S. dollar could be vulnerable if I'm correct and interest rates move lower instead of higher.

While the 10-year U.S. Treasury yield rose recently to 2.5% from its 1.65% January low, momentum is faltering and the yield is back down to 2.22%. If rates drop further, a new headwind to the U.S. dollar could emerge and commodities could reverse back higher.

Let's watch this for an opportunity to trade the weakest part of the U.S. stock market in the weeks and months ahead.


August 4, 2015

Chinese Farmer loses his savings in stock market

This e-mail is making the rounds today:

    "Watch this truly amazing video on CNBC this morning showing how out-of-control the China stock bubble became and how early it may be into the crash. Chinese farmer puts $164k savings into China stock market, following the Gov'ts lead last year. The broker gives him ONE MILLION DOLLARS in margin credit; a Third World farmer levered (some) 6x in high-risk stocks. He bet it all on one China mining company, (but) the market fell ... and now he OWES the broker (for a) margin call."

This story is likely not the exception in China from this market crash.

All day long on financial TV, people say "but the China market is still up 15% this year. That's great." This ignorant assumption means somebody had to buy the broad index on Jan. 1 and hold until today. Few do that. Most buy on the way up and double-down at the top.

The small percentage of people who did make a fortune in the Chinese stock bubble over the past 18 months have been driving up house prices on the U.S. West Coast. They often don't care about anything but winning a bidding war, and they probably don't even know the meaning of the term "comparable-sale price."

After watching this video, one can easily believe that this is just the beginning of the Chinese crash.

August 3, 2015

History Rhymes

Perhaps an explanation of the market rise over the last years in the face of growing evidence of a slowdown in economic and profit growth is as simple as Paul Tudor Jones reminding us in the above quotes that lost sensibility and irrational behavior often occur at or near the terminal stage of important market moves.

Of a more substantive concern to me of late is that the market's leadership has been narrowing, and increasingly a bifurcated market has developed that is consistent with prior periods in which markets topped in early 2000 and late 2007.
"What we have learned from history is that we haven't learned from history."
-- Benjamin Disraeli
History rhymes.