Posts Tagged ‘Wall Street’

My two sons love this book that I would read to them called The Bear Snores On. The story starts out with all of the bear’s friends sneaking into his cave and throwing a party while the bear “snores on.” They would do something outrageous and the author would note and the bear snores on. They would pop popcorn and sing and dance and the bear snores on. Everything is great until the angry bear wakes up.

Well, our bear on Wall Street took a nap back in March 2009. He briefly started to wake up April of this year. Since then, our bear has been in and out of sleep as everyone has been partying in the bear cave.

The unemployment numbers showed continued losses of 95,000 jobs last month…and the bear snores on.

Countries are saber rattling about a currency war…and the bear snores on.

The foreclosure process is in crisis as it has been halted in states all over the country…and the bear snores on.

Middle and lower America continue to face personal financial crisis…and the bear snores on.

The politicians have an agenda so big and it doesn’t include real recovery…and the bear snores on.

The Fed prints money, continues to accumulate at alarming levels, and there is talk about a second stimulus package…and the bear snores on.

Healthcare…and the bear snores on.

Higher tax rates next year…and the bear snores on.

An investor community oblivious to the risks in the structure of our economy system…and the bear snores on.

The problem is that the bear will not hibernate forever. My guess is that he will wake up in a very bad mood considering everything that has happened in his cave. You see, I don’t think that we ever left his bear cave as investors. He has just been asleep. Yes, I know, I have been talking about this risk with nothing materializing and the market continuing to go up. However, keep one thing in mind:

In the book The Bear Snores On, it was a small spark from a fire that woke him up. It wasn’t the big events happening all around him. It wasn’t the loud music or the dancing that woke him up. All it takes is the smallest problem to surface and the house of cards will come tumbling down. As an investor, what is your Plan B?

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What is the most difficult thing about managing money in this environment?  This is a question I get from time to time.  What separates this time period from any other is politics.  It is the most unpredictable risk out there.  The politicians are going to do whatever they need to pass their agenda.  Unfortunately, there is a great deal of agenda.  That agenda means that politics will influence the market positively or negatively.  Thus, you never know what actions Washington will take – either market friendly or unfriendly. 

Let me just get the obvious out of the way.  Wall Street needs to be reformed.  There is no question.  However, they don’t need to be reformed like the politicians want to reform.  There is reform and then there is control.  The financial regulation is all about giving the government more control.  That is the last thing that you want to do.

The politicians are having a tough time getting financial regulation and reform done because the Republicans see the power grab this legislation represents.  So, how do you fix that problem?  You shape public opinion by vilifying Wall Street.  Don’t even begin to think that Goldman Sachs is the only financial institution that the government pursues.  I will bet it is only the beginning. 

I was having a conversation with a close friend of mine who has been managing money for 20 plus years and made the comment that I don’t like the market at these levels as well in an environment with all of the indicators firing warning signs.  He replied that there is no catalyst.  Well, the catalyst is one thing that you don’t see in advance.  Politics has a great way of creating the catalyst. 

This does raise the stakes here at this level in the stock market.  It is too early to see if this is the start of a series of events that stops the bull market rally.  If anything, it welcomes a much needed correction.  For long-term investors, anything below 1081 on the S&P 500 creates a very large risk.  For the Dow, that level to watch is 9,234.  Those levels are a long way off.  Thus, the market could correct (which would be healthy) down to those levels.  That is roughly a 17% correction.  However, if the markets cannot rebound from that type of correction, this party might be over.

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You might want to put that Dow 11,000 party hat away for the time being.  Evidence of trouble ahead is getting much louder.   There are predictive indicators that would suggest that trouble is on the horizon.  These indicators simply suggest that risk levels are escalating.  They aren’t necessarily a great timing mechanism.   At the same time, as a stock market investor, you don’t want to ignore them.

They have been appearing throughout the first quarter. 

(1)               Percentage of Mutual Fund Managers in Cash Holdings

This has always been a great indicator.  When mutual fund managers hold low levels of cash, it has always been a sign that the market is headed for trouble. 

We are currently at the record level of low cash reserves held as in 2007 when the market turned into a bear market and in 1987 when we experienced the second greatest stock market crash of all time.

 (2)               The January Indicator

The old saying goes “so goes January so goes the rest of the year.”  During the last 59 years, January has had a negative return 23 times.  If you will recall, we had a negative January this year.  Of those years where there was a negative January, 56%  the stock market produced a negative result for the year.  

 (3)        P/E Ratios

I will resist getting into the mechanics of how a Price to Earnings Ratio works and its relation to the stock market.  You don’t need to understand how all of that works to get the point.   The bottom line is that new bull markets start when P/E ratios are low.  Bull markets end when the P/E ratio gets too high.

 The top of the bull market in 2007         P/E was 25.5

The top of the bull market in 2000         P/E was 44.2 (due to internet bubble)

The top of the bull market in 1966         P/E was 24.1

The top of the bull market in 1937         P/E was 22.2

The top of the bull market in 1929         P/E was 32.5

The top of the bull market in 1902         P/E was 25.1

 According to Robert Schuller’s valuation model, which looks at reality and makes no assumptions about the future, the current P/E ratio is 25! 

(4)               The December Low Indicator

 Lucien Hooper, a Forbes columnist and analyst, coined a stock market warning sign called the December Low Indicator.  If the stock market anytime during the first quarter goes below the lowest price level of the preceding December, a sell signal takes place.  This occurred during the first quarter. 

 The Stock Market Almanac further researched this sign and found that this has occurred 30 times since 1952.  If you get the combination of a negative January along with the December low indicator, the stock market has ended negative for the year 75% of the time. 

(5)               Decennial Cycle – 10th year of the decade

The 10th year of a decade has carried some significance.  Tenth years have the worst record within the Decennial Cycle and 2010 is a midterm election year, which has the second worst record of the 4 year presidential election cycle.  Of the last 12 occurrences dating back to 1890, the stock market lost money 8 out of the 12 times during the 10th year.  The average loss has been -7.2%.  

 Year                 % gain or loss

 1890                       -14.10

1900                       + 7.00

1910                       -17.09

1920                       -32.90

1930                       -33.80

1940                       -12.70

1950                      +17.60

1960                         -9.30

1970                          4.80

1980                        14.90

1990                         -4.30

2000                         -6.20

2010                        ?????

(6)  Low Volume

This is one thing that really perplexes the market pros.  If you have a strong rally, typically you have strong buying volume.  There are a lot of buyers stepping up to the plate.    A hallmark of market tops is a rising stock market on low rally.  If anything, it is a warning sign.  Today, we have very low volume on the way up. 

The number one job of Wall Street is to convince the world that risk doesn’t exist.  They would prefer if investors just go back to sleep and not pay attention.  The signs of risk are building.

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To listen to the politicians in Washington, the unemployment problem is well on its way to getting solved.  Just like that, the unemployment rate fell to 9.7% from 10% and we only lost 20,000 jobs.  As a rule of thumb you never want to fully trust the sound bite that leaves the mouth of a politician.  As another rule of thumb, you don’t want to fully believe the headline number that the government is reporting either.

Politicians don’t care how you get to the more positive numbers; they are just going to run with it and call it reality.  January’s unemployment numbers are far from reality.


The Drop in the Unemployment Rate

How can you get to a lower unemployment rate with so many people unemployed?  It is pretty easy.  You just don’t count them.  Hundreds of thousands of people have fallen out of the system since they have been unemployed for so long.  Then there are the ones who have given up.  They are just not being counted.  As a result, you get a lower rate.

Seasonality also plays a part.  There are a lot of part-time employed workers that are hired depending on the time of the year.  For this report, seasonality gave the report a positive bias. 

The lower drop in jobs

As we have discussed throughout the year, the government estimates how many jobs were created through the “birth/death” formula.  Typically, this adds hundreds of thousands of jobs throughout the year.  These aren’t verifiable jobs.  These are jobs that the government “assumes” are created from small business.   In January they typically revise that number and subtract jobs from the system.  These are pretty large revisions.  This revision was a job loss of 427,000 jobs for the month.  Yet, we only lost 20,000 jobs?  Really??

That is the magic of revision.  They wait until time has passed and then subtract jobs from past months and even years well after the fact.  They will get that figure in there some way.  Getting it into the system can happen well after the fact when it will not affect the market.  Can you imagine the carnage on Wall Street had they really reported the truth?  They will report it when it matters the least.

I am currently reading a very detailed account of all of the financial crises that this country and other countries have faced through the decades.  The premise of the book is that it is not different this time and this is not unprecedented.  As I get through the book, I will write about it.  The authors write that a common thread exists amongst all financial crises.  It is the crisis of confidence.  Confidence can quickly escalate to crisis levels. 

My greatest concern is that this Government continues to sell the American people on a story that does not jive with reality.  Confidence could be severely damaged when reality come into full view. 

For a good example of this in real time, just watch the implosion of Toyota.  You are looking at a car company that has been hiding problems for years.  Now that the truth is coming out, there might not be enough confidence left for consumers to want to buy a car that has had a bad sudden acceleration problem.  It looks like they really don’t have an answer for it and they are buying time. Well, more on that story at a later date!

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Cracks in the foundation are starting to rear their ugly heads and investors need to wake up smell the risk.  In my latest client newsletter, I wrote about the great disconnect that exists between Wall Street and Main Street.  On the one hand, you have Wall Street who just assumes that this is a normal cycle and the worst is behind us.  Then you have Main Street that is really suffering.  We all know several people who are facing tough financial times or at least have heard the stories. 

The Wall Street Journal reported last week that 1 out of 4 homes are underwater.  That means these homeowners owe more than the worth of the home.  If you look into the stats even more closely, you get a real disturbing picture.  The numbers show that 65% of the homes in Nevada, 48% of the homes in Arizona, and 45% of the homes in Florida all have values of the home less than what is owed on the home. 

This translates into a large number of potential foreclosures.  The real estate markets cannot even get close to starting the recovery process until the foreclosure crisis starts a recovery.  I think that we are a long way away from that starting.  Overall, I don’t think that we can get a healthy recovery until you fix the real estate and foreclosure problem.  All of these problems tie together spelling risk for the economy and risk for the markets. 

There is no question that these risks are known by the market.  However, the market expects that this recovery will take place much sooner.  Therein lies the problem.  I don’t think that Wall Street’s time table is even close to reality. 

Wall Street also thinks that most of the debt crisis is behind us…well maybe until last week when Dubai revealed they are going to stop making the interest payments on 60 billion dollars worth of debt.  Dubai is on the verge of defaulting on 60 billion dollars worth of debt.  That would have some serious implications for a global economy that is already walking a tightrope. 

Todd Harrison, president of Minyanville.com, described how the crisis would unfold. 

  • Dubai defaults.
    European banks (such as HSBC (HBC) and Royal Bank of Scotland Group (RBS)) are counter-party on much of that risk.
  • The virus spreads through the fragile region (debt insurance has now spiked in Bahrain, Qatar, Turkey, Russian, Ireland and in particular, Greece).
  • The strain migrates to stateside financial institutions, as you would expect with $500 trillion in derivatives tying the world together.  We see a “flight to quality” with a sustained rally in the US dollar.
  • Santa has a grumpy Christmas
  • It was announced on Sunday that their central bank would bail them out.  Oh good, another bail-out.  It might be a little early to see how this plays out. 

    How many more Dubai’s are out there that the market doesn’t know about?  We are talking a debt crisis of epic proportion.  I still don’t think that we have seen the end of the debt crisis. 

    We are also seeing the reality of the condition of the consumer.  Consumer sales were not that great this Black Friday  and don’t look to translate into a strong Christmas buying season.  Be careful if you are drinking the kool-aid.  These markets can go down as fast as they went up.

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    The recession is declared to be over or over soon states many media outlets on Friday.  Unemployment was not as bad as expected and it appears that we are starting to lose less jobs. All of that is good news and it took the media and Wall Street no time at all to react positively. 


    I really do regret taking the opposing view on this one.  I would like for it to be true.  There are just a few problems.  We have 14.462 million people unemployed.  The number is likely higher. This is the estimate from the Department of Labor.  Where are these people going to get jobs?  Unless you are ready to pick up a shovel and get on the Obama job creation bus, you might just be out of luck.  Once again, the Obama administration does not have a plan in place to fix the job situation. 


    Looking back to 1948 (as far back as records take us), there has never been as big of a spike in the number of those unemployed.  The closest spike that you can find was between 1979 and 1982.  In 43 months, the unemployment numbers jumped 106% to a high of 12.051 million people. Today, in just 33 months the unemployment numbers jumped 125% to 14.462 million.  The following is a chart from www.freelunch.com that illustrates this dramatic rise.

    I think that the monthly unemployment numbers could continue to look better.  However, that doesn’t mean that companies are hiring. I think that it means that companies have cut as far as they can cut.  Those lay-offs might start to slow.  Until there is a solution to the problem that over 14 million people are facing, we will continue to have this crisis. 


    Regarding the market…the 1929 comparison that I wrote about still tracks very closely.  I would still suggest that there is extreme risk on the table.  As long as we stay below 1020 on the S&P 500, that will remain the case.

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    Those of you who have been reading my analysis are probably wondering when I am going to throw in the towel and just admit that the bear market is over and start talking about buying stocks again.  Well, I hate to disappoint you.  It is not going to happen yet.  Let’s take a much bigger picture look at what is occurring.  First, we are in a financial crisis produced by the bear market and those don’t just go away without a strong fight. 

    Second, how could a 40% plus rise in stocks not mean the bear market is over?  Well, let’s take a look at history for that answer.  In 1929, a bear market started as a result of a credit/debt crisis.  There are many similarities between that period and today.  The big difference is the type of debt crisis.  The bear market eventually bottomed in 1932 after an 86% decline.  The first “crisis” decline in 1929 saw the market drop -44%.  Following that -44% decline, the stock market went up 46% over the next 147 days.  If you compare that to today, we are going through a similar experience.  The crisis of last year resulted in a -48% decline.  Thus far we are a little over a 40% increase in the stock market over 137 days.   This is not in any way unprecedented.  The problem for stock market investors in 1929 was what followed the 46% increase.  Following that incredible stock market rally was an -82% loss over the next 3 years. 

    Third, the market has been rising over the past two weeks as a result of earnings season reports.  Over 70% of the companies of the S&P 500 have reported better than expected profits.  However, a closer look would reveal that the vast majority of these “profits” were due to cost cutting and not real growth.  These are clearly not sustainable. 

    Fourth, Wall Street is beating the drum that the recession is just about over.  The index of leading indicators came out last week “and is rising at a rate that has accurately indicated the end of every other recession since the index began being compiled in 1959” (Dallas Morning News).  Is that really valid when we are dealing with the worst recession since 1929 when no leading indicator index was even around? It is important to compare apples to apples.  Wall Street has a history of claiming the recession over prematurely many times before.

    Finally, unemployment is a major crisis and there is nothing in the works to fix it.  Of course, you can always get a job working an Obama induced construction job. 

    Let’s not get to ahead of ourselves.  I was premature to write that the stock market rally was nearing the end.  Obviously it still has more to go.  I don’t think that I am wrong to suggest the bear market is over.

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