Courtesy of Dshort, here's an updated chart comparing the bear markets of 1929, 1973, 2000, and the present. We had previously looked at a chart earlier on in the crisis that compared the market returns during each respective decline and they all looked pretty similar. This time around though, there are some notable differences popping up.
Here's the chart:
The following is a guest post by Martin Hutchinson, Contributing Editor of Money Morning.
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The stock market is up 51% from its March 9 lows. The leading economic indicators have turned sharply positive, showing gains for each of the last four months. Manufacturing is on the rebound. And banks are promising to pay record bonuses, as their earnings have rebounded.
With this recent rush of upbeat economic news, it’s no wonder commentators are trumpeting the rebound of the U.S. economy.
But I think it’s time to short U.S. stocks.
Shocked?
Don’t be.
What most experts see as a strengthening U.S. rebound, I see as an increasingly dangerous “false dawn” – for these two key reasons:
A Foundation for Trouble
U.S. policies that were intended to combat the financial crisis that broke last year – as well as the recession that’s been plaguing us since December 2007 – have actually inflicted a lot of weakness upon our economic system.
For instance, the federal government has made $11.6 trillion in financing commitments, many of which will saddle us with debt for generations – some of it forever. Outlays of that magnitude in a $14 trillion economy are bound to have lasting implications: Think of the consumer who has a series of maxxed-out credit cards – he’ll make the minimum payments, but the actual balance will never get paid down.
And the foundation for this financial fiasco was actually constructed several years ago.
After the bursting of the 1996-2000 “dot-com” bubble, the U.S. Federal Reserve re-inflated the money supply. That caused stocks to resume their upward march, and as we now know, also inflated a housing bubble of such enormous size that it caused a general financial-system crash when that real estate bubble burst in 2007-08.
This time around, the Fed has been even more expansive. The benchmark Federal Funds Rate was 1.0% in 2002-04. This time it is 0.25%. What’s more, this time around we’ve had a $2 trillion expansion of the Fed balance sheet, a doubling of the monetary base and $300 billion worth of direct central bank purchases of government debt. Given this orgy of Fed expansionism, it’s likely that the onset of inflation – whether it’s in consumer prices or asset prices – will be correspondingly worse. In fact, we’re already seeing that gold prices are once again making a run at their all-time high. And crude oil hovers at about $70 per barrel, a level that would have been unimaginable before 2004.
Now that he’s been nominated for reappointment, U.S. Federal Reserve Chairman Ben S. Bernanke says he will tighten monetary policy in good time. But why should we believe him? If he tries to tighten significantly, he will incur the wrath of the Obama administration and the Democrats in Congress.
Even back during the 2001-04 time frame – when there was an administration in place that claimed to believe in monetary stringency – the Fed didn’t tighten. Bernanke himself was among the most aggressive opponents of tightening. Back in 2002, in fact, when inflation was running at a perfectly respectable 2%, Bernanke actually spun myths about the imminent onset of “deflation.”
Given what we know, it seems that if the current economic bounce shows even the slightest signs of faltering, Bernanke won’t tighten – he’ll pump even more money into the U.S. financial system. Rest assured that the administration, Congress, and much of the media will be cheering his move.
If an overly expansive monetary policy was the only problem we faced, it might not be so bad. Unfortunately, there’s more.
Lots more.
Unlike in 2002 – in fact, unlike any other time in U.S. history – this country now has a budget deficit in excess of 10% of gross domestic product (GDP). For fiscal 2009, that was forgivable: We’ve had a major recession, and a shattering financial crisis, which the federal government has tried to battle with aggressive bailout programs.
Here’s the problem, however: The projected deficit remains above 10% of GDP for fiscal 2010, even though no additional bailouts are contemplated and the Obama administration is projecting a modest-but-steady economic recovery.
The result is harder to predict – this country hasn’t travelled down this particular path before. This strategy bears some resemblance to the position Japan found itself in during its so-called “Lost Decade” of the 1990s. But even Japan’s deficit never reached this 10% threshold.
In Japan, the effect seems to have been the gradual abandonment of small business finance, and the resulting starvation of the most critical factor in economic growth – entrepreneurship.
The small-business sector creates most of the new jobs in the U.S. economy. But in a challenging environment, it’s easy to see why this sector gets overlooked. Without political connections or large contracts to hand out, the small-business sector ends up being last in line in the financing queue when the economy faces strong headwinds. Why should banks or other people lend to small businesses when the U.S. government bond market stands as such as huge, safe parking place for their cash?
Interest rates will also become an issue. With the inflationary pressures we expect to see from the overly expansive monetary policy we’ve described, long-term interest rates are likely going to rise anyway. As was the case in Japan’s decade-long malaise, these forces will combine to spark high default rates in the banking system, low or zero economic growth, and a general downward trend in the stock market.
All of this will make it tough for small businesses to obtain the cash they need to grow, meaning this key job-creation engine will have to sputter along.
It’s still early in the game, and there are many factors to consider, so the future economic picture remains a bit murky right now. But my guess is that the bubble in asset prices will be largely confined to commodities, that economic growth after this current initial burst will relapse, and that U.S. stocks will prove to be the same generally unattractive investment that they were in 1970s – the era of the so-called “Nifty Fifty.” If the stock market bubble gets even more exuberant from here, the relapse will be correspondingly more painful.
Despite this dour backdrop, three things are worth remembering:
Thanks to the fine folks over at Bespoke as always for flagging this data. We now see that short interest in the S&P 1500 is at the lowest levels since February 2007, sitting currently at 6.6%. Take it for what it's worth:
(click to enlarge)Interesting story out of Bloomberg yesterday citing our friends over at Tudor Investment Corp and Clarium Capital Management. Paul Tudor Jones and Peter Thiel's hedge funds are bearish on a macro level and think the true recovery will be delayed. We've already seen that Tudor has called this a bear market rally and Clarium has been net short US equities numerous times this year.
From Bloomberg,
“If we have a recovery at all, it isn’t sustainable,” Kevin Harrington, managing director at Clarium, said in an interview at the firm’s New York offices. “This is more likely a ski-jump recession, with short-term stimulus creating a bump that will ultimately lead to a more precipitous decline later.”
Tudor, the Greenwich, Connecticut-based firm started by Jones in the early 1980s, told clients in an Aug. 3 letter that the stock market’s climb was a “bear-market rally.” Weak growth in household income was among the reasons to be dubious about the rebound’s chances of survival, Tudor said.
Clarium watches the unemployment rate that accounts for discouraged job applicants and those working part-time because they can’t find full-time positions, Harrington said. July joblessness with those adjustments was 16 percent, according to the Department of Labor, rather than the more widely reported 9.4 percent.Clarium, which oversees about $2 billion, is positioned for an equity bear market through investments in the U.S. dollar, Harrington said. Falling stock prices will strengthen the currency by forcing leveraged investors to sell equities to pay down the dollar-denominated debt they used to finance those trades, he said.
High unemployment, lower wages and potential missteps by policymakers around the globe may stifle economic growth in 2010, Tudor said. The firm, which manages $10.8 billion, is at odds with 55 economists projecting an average of 2.3 percent growth next year, according to the Bloomberg survey.
Macro managers’ pessimism is fueled in part by the U.S. government’s response to last year’s financial crisis, which they say fails to address the root cause. Banks still hold hard- to-sell assets on their balance sheets, the managers said.
Clarium, whose assets were mostly in fixed income, dropped 6 percent this year through June. Horseman’s fund slid 16.3 percent. Tudor’s BVI Global Fund Ltd. returned 11 percent.
The funds held up in 2008 amid the industry’s record 19 percent loss. Horseman’s Global Fund USD, which focuses on stocks, made HSBC’s private bank list of top 20 performers by gaining 31 percent. Tudor’s and Clarium’s funds fell 4.5 percent.
Macro managers are examining China for hints on how to place currency and commodities bets. Tudor said the country’s spending spree on raw materials inflated commodity prices and weakened the U.S. dollar.
.... At the very least for the short-term. While we could throw out all kinds of economic data and a laundry list of fundamental problems, we instead want to focus on two market related datapoints. Firstly, short interest was recently released and the fine folks over at Bespoke have highlighted that, "the average short interest as a percentage of float for stocks in the S&P 1500 is currently at 6.9% This is the lowest level since February 2007." They also point out that extremes typically happen in each polar direction. When short interest is high and all the late-to-the-party bears have arrived, the market can run. Conversely, when short interest is at the lows, be scared.
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Noted shortseller and Seabreeze Partners hedge fund manager Doug Kass has had impeccable timing recently. Market timing is a b*tch, but Kass has flipped that statement upside-down and made the market his b*tch. Back on the March lows, Kass was calling 'the bottom' and buying when everyone else was calling for the end of the world. This time around, he's calling for a top in the market for the year and has been assembling a short position. His contrarianism is the polar opposite this time around as he writes, "To most investors, today the fear of being in has now been eclipsed by the fear of being out as the animal spirits are in full force. Bears are now scarce to nonexistent in the face of steady price gains in equity and credit prices. As if the movie is now being shown in reverse, the bull is persistent, stock corrections are remarkably shallow, cash reserves at mutual funds have been depleted, and hedge funds hold their highest net long positions in many moons."
We first noted Kass' bearishness a few weeks ago and he has since deepened his stance. He brings up great points and it really has all the elements of another great contrarian call. Time will tell and we'll wait and see. Back in the beginning of March, we penned a piece entitled, Ranting, Raving & Contrarian Signals to highlight the extreme bearish sentiment as if the world was imploding. We have been considering penning a piece again on this topic, only in reverse. Looks as if Kass has beat us to it and we'll gladly let him take that honor.
His point about mutual fund inflows is exactly what we were recently looking at as well and we tweeted about these inflows. Many a contrarian will say that when the retail/'dumb' money rushes in, it is time to get out. Another interesting statistic was the fact that hedge funds have had high net long exposures for the first time in forever. And, as we also tweeted about, hedge funds were *buying* financials hand over fist the past few quarters. Today, we also saw a unicorn and bigfoot; that's how crazy things have been getting.
In order for the market to truly recover, many fundamental problems must be addressed. Kass outlines his signs needed for a market recovery and it's a great reference to have. But in the mean time, he lists 10 things that will weigh on the economy:
1. Cost cuts are a corporate lifeline and so is fiscal stimulus, but both have a defined and limited life.
2. Cost cuts (exacerbated by wage deflation) pose an enduring threat to the consumer, which is still the most significant contributor to domestic growth.
3. The consumer entered the current downcycle exposed and levered to the hilt, and net worths have been damaged and will need to be repaired through higher savings and lower consumption.
4. The credit aftershock will continue to haunt the economy.
5. The effect of the Fed's monetarist experiment and its impact on investing and spending still remain uncertain.
6. While the housing market has stabilized, its recovery will be muted, and there are few growth drivers to replace the important role taken by the real estate markets in prior upturn.
7. Commercial real estate has only begun to enter a cyclical downturn.
8. While the public works component of public policy is a stimulant, the impact might be more muted than is generally recognized. There may be less than meets the eye as most of the current fiscal policy initiatives represent transfer payments that have a negative multiplier and create work disincentives.
9. Municipalities have historically provided economic stability -- no more.
10. Federal, state and local taxes will be rising as the deficit must eventually be funded, and high-tax health and energy bills also loom.
He ends this list by stating that he is looking, "over the visible green shoots of recovery toward a hostile assault of nonconventional factors that few business/credit cycles and even fewer investors have ever witnessed."
Now that you've seen the rationale for Kass' shift in sentiment, we now want to turn our focus to a timeline of Kass' sentiment as compiled by our friend FirstAdopter. We've mentioned our 'tweets' a few times in this article and we further want to highlight the utility of Twitter as it pertains to financial markets. The rest of this article is a guest post by FirstAdopter, whose blog and twitter we've been following for some time now.
Doug Kass is widely regarded as the guy that called the exact bottom in March by Barrons, New York Times, and CNBC anchors. Here are some tweets from his Twitter Feed. I will let them speak for themselves:
SP500 August 26th 12:17PM: 1027
SP500 August 10th: 1007
SP500 August 5th: 1003
SP500 July 28th: 980
SP500 July 22nd: 954
SP500 July 2nd: 896
SP500 June 19th: 921
SP500 May 8th: 929
SP500 April 29th: 874
SP500 April 16th: 865
SP500 March 26th: 833
SP500 March 18th: 794
Actual Low Close of SP500 March 9th: 677
SP500 February 26th: 753
SP500 February 18th: 788
SP500 February 12th: 835
While we haven't covered the musings of Doug Kass in a while, we found his latest piece on TheStreet.com to be timely and insightful. Some of you may remember that Kass, noted short-seller and manager of hedge fund Seabreeze Partners, was very bullish back in March and essentially nailed 'the bottom' as a great trade. Our hats off to him as that was an excellent market timing call. He seems to zig when others zag and this occasion is no different. While bullish sentiment is reaching highs and everyone seems to think that risk has abated from the markets, Kass thinks otherwise. He is bearish now and points out many signals telling him to be so, writing
"
1. Cost cuts are a corporate lifeline and so is fiscal stimulus, but both have a defined and limited life.
2. Cost cuts (exacerbated by wage deflation) pose an enduring threat to the consumer, which is still the most significant contributor to domestic growth.
3. The consumer entered the current downcycle exposed and levered to the hilt, and net worths have been damaged and will need to be repaired through higher savings and lower consumption.
4. The credit aftershock will continue to haunt the economy.
5. The effect of the Fed’s monetarist experiment and its impact on investing and spending still remain uncertain.
6. While the housing market has stabilized, its recovery will be muted, and there are few growth drivers to replace the important role taken by the real estate markets in the prior upturn.
7. Commercial real estate has only begun to enter a cyclical downturn.
8. While the public works component of public policy is a stimulant, the impact might be more muted than is generally recognized. There may be less than meets the eye as most of the current fiscal policy initiatives represent transfer payments that have a negative multiplier and create work disincentives.
9. Municipalities have historically provided economic stability — no more.
10. Federal, state and local taxes will be rising as the deficit must eventually be funded, and high-tax health and energy bills also loom.
The legendary hedge fund manager Michael Steinhardt has recently voiced his distaste for Treasuries over the long-term. In a recent Bloomberg television interview, he said, "To be a long-term investor in Treasuries at this point I think is foolish. The rates are low, and the danger is high." If you're unfamiliar with Steinhardt, he ran one of the first truly successful hedge funds, garnering a 20% return each year for almost thirty years. His Steinhardt Management Co, which he opened in 1967, earned 24% a year for multiple decades. He truly is a successful hedge fund manager with a proven long-term track record.
And, with that in mind, it's interesting to see that Steinhardt has joined numerous other well-tenured investors in his dislike of treasuries. He thinks that government bonds are not safe investments and shares Jim Rogers viewpoints on this subject. Rogers, of course, has a solid background as well, having run the successful Quantum fund with ex-partner George Soros. So, we now see that both Steinhardt and Rogers see Treasuries as poor investments for the future, as we noted in our Jim Rogers portfolio update. In the past, we here at Market Folly have even gone as far to lay out the rationale behind shorting treasuries. (That play has picked up steam as of late and we still need to do a follow-up post on that subject).
Steinhardt goes on to say that he thinks the current market rally will not last and that we are not out of the woods yet. He says, "The economy is still a scary place. My net feeling is that this rally doesn't have all that much more to go and the dangers out there remain consequential." Clearly he sees this as a bear market rally and thinks we have large fundamental problems still unsolved.
Nowadays, Steinhardt is the chairman of WisdomTree Investments, a firm that creates exchange traded funds (ETFs). Steinhardt also has an autobiography out entitled No Bull. It is a fascinating read detailing the life of one of the first true hedge fund managers out there, as his firm survived the collapse of the 1960's. This book also recently appeared on hedge fund Blue Ridge Capital's suggested reading list, in their biographical/historical category. We'll continue to track Steinhardt's words of wisdom whenever he makes a sporadic appearance.
Great chart from The Chart Store that illustrates just how volatile and seesaw-ish this market has been over the past 2 years. There have been rapid, massive declines and equally massive rallies. The current rally from the lows in March 2009 extends over 39%. Maybe we should highlight contrarian signals more often, as we did back in early March. Those signals we highlighted turned out to be a great barometer for a short-term turn in the markets.
Buy when there is blood in the streets and pessimism abounds. Sell/short when everyone is plunking money down in the market thinking they're invincible.
The ultimate question now is, what's up with the current action? Typical bear market rally? Foundation for something constructive? Time will tell.
(click to enlarge)In a shocking development, Nouriel Roubini, a.k.a. the harbinger of doom himself has been thrust in the spotlight yet again. And by shocking, we mean not shocking at all. Anyways, the FT recently gave us a glimpse into what Roubini himself invests in,
"Just ask Nouriel Roubini of New York University, who has a reputation as the most pessimistic economist in academe. He deserves it. His most recent paper, published last week, is entitled: “Can the Fed and Policy Makers Avoid a Systemic Financial Meltdown? Most Likely Not.”Nobody is more aware of the gravity of the financial situation, and nobody has done more to point out the risks of a systemic crisis.
So how are Roubini’s own funds invested? They are 100 per cent in equities. In the long run stocks do best and he is not yet close to retirement, so he keeps putting more money into index funds each month.
Fully aware of the gravity of the financial situation, he is also aware of the futility of trying to take action or to time the market. Those tempted to make the investing equivalent of a goalkeeper’s depairing dive should take note."
Here's noted short seller Jim Chanos' latest interview where he talks investment opportunities in the current market on the PBS Nightly Business Report, citing his distaste for the Healthcare and Defense sectors: Video
We've chronicled some of his previous interviews as well.
Stewie outlines the stages of a bear market:
"Stage 1. Distribution
Just as accumulation is the hallmark of the first stage of a primary bull market, distribution marks the beginning of a bear market. As the "smart money" begins to realise that business conditions are not quite as good as once thought, and thus they begin to sell stock. There is little in the headlines to indicate a bear market is at hand and general business conditions remain good. However stocks begin to lose their lustre and the decline begins to take hand. After a moderate decline, there is a reaction rally that retraces a portion of the decline. Hamilton noted that reaction rallies during a bear market were quite swift and sharp . This quick and sudden movement would invigorate the bulls to proclaim the bull market alive and well. However the reaction high of the secondary move would form and be lower than the previous high. After making a lower high, a break below the previous low, would confirm that this was the second stage of a bear market.
Stage 2. Movement With Strength
As with the primary bull market stage two of a primary bear market provides the largest move. This is when the trend has been identified as down and business conditions begin to deteriorate. Earnings estimates are reduced, shortfalls occur, profit margins shrink and revenues fall.
Stage 3. Despair
At the final stage of a bear market all hope is lost and stocks are frowned upon. Valuations are low, but the selling continues as participants seek to sell no matter what. The news from corporate America is bad, the economic outlook is bleak and no buyers are to be found. The market will continue to decline until all the bad news is fully priced into the stocks. Once stocks fully reflect the worst possible outcome, the cycle begins again."
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