Bear Market

The death throes of the debt-based consumerist lifestyle are already visible beneath the glossy propaganda of "rising revenues this Christmas season." Those revenues were obtained by selling goods at below cost, in the absurd hope that income-strapped, over-indebted consumers would make profitable "impulse buys." As Mish has documented, the "impulse buys" are being returned even before Christmas to the tune of hundreds of millions of dollars. The Fed is desperately attempting to re-inflate the debt bubble by lowering interest and mortgage rates and buying up all sorts of semi-toxic/impaired debt. What the Fed dreads is the reality we all feel and see: fear of the future due to diminished wealth and insecure incomes. If your assets have fallen in value, you feel poorer because you are poorer. Borrowing more at any interest rate will not make anyone feel wealthier. People who fear their income may plummet due to layoffs or their hours being cut are not in the euphoric mood to borrow more, and banks which cannot dare to lose more money loaning to people who will default have cut off credit to millions of previously rabid consumers of debt. Ask yourself this simple question: how much stuff could people buy if they could only spend surplus cash, after all their expenses and debt servicing payments were paid in full?

Even a CDO was more collateralised than fiat currency....

A longer term view supports the notion that the gold bull market is not over.

For the first time in while, Gluskin Sheff's David Rosenberg recounts his always informative chat session with Bob Farrell and shares Farrell's perspectives on the market ("his range on the S&P 500 is 1,350 to the high side and 1,000 to the low side. He was emphatic that there is more downside risk than upside potential from here. His big change of view is that we have entered a cyclical bear phase within this secular downtrend (he sees the P/E multiple trough at 8x). Rosie also looks at Europe and defines the term that we have been warning against since May of 2010: "implementation risk" namely the virtual impossibility of getting 17 Eurozone countries (and 27 broader European countries as the UK just demonstrated) on the same page when everyone has a different culture, language, history and religion... oh, and not to mention animosity to everyone else. So yes: Europe in its current format is finished, but what will it look like in its next reincarnation? And why does he think the European liquidity crisis will become a full blown solvency crisis in Q1 2012? Read on to find out.

Gartman is a trader and is followed by hedge funds and prop desks of banks and does not appear to understand the proven diversification benefits gold brings to a portfolio. In November 2009, Gartman said that there “is a gold bubble.” Gartman said that to say otherwise was “naïve”. Gold was trading at $1,100/oz at the time. In August 2011, Gartman said that gold was the biggest bubble of our lifetime. Inconsistently, only last week, Gartman said on CNBC that he is “long gold” and has been for “six or seven months”. Gartman’s short term calls on gold and silver have been wrong more often than not in recent years. He tends to turn bearish after gold has already experienced a correction and is close to bottoming. Those wishing to diversify and add gold to their portfolio will use his call as a contrarian signal that we may be getting close to a low in this most recent sell off. Our advice is to ignore gurus, price predictions and noise – up and down – and focus on the real fundamentals driving the gold market.

The market rallied this past week, albeit in a very volatile manner, to end the week on a positive note as the hopes of a final resolution to the Euro crisis has been reached.   In reality, today's announcement of the EU treaty is only the first step and there are many legal challenges that will still have to be resolved.  While the reality is that there is still a very long road ahead before anything will actually be accomplished the implication that the with the ECB willing to buy bonds, at least for the moment, and the coordination of two bailout funds the Eurozone can play "kick the can" for a while longer.  Those headlines, even without much substance were enough to drive return starved managers into the market for the year end rush.

While consensus forecasts for next year continuing to be muddle-through mediocrity with a crashtastic defensive bias, BofA Merrill Lynch provides a very succinct outline of the bullish, bearish, and interestingly secular cases for risk assets going forward. The cross-asset class implications are noteworthy and provide an excellent jumping off point for asset allocation decisions. We are not sure the seeming knife-catching perspective of "buying humiliation and selling hubris" will work out, but one thing is for sure, with this volatility, relative-value remains the critical alpha as beta chops everyone up. Once again the bull case relies heavily on government printing presses and the bear case on the reality of debt saturation breaking through.

It seems the market's psychology has shifted, in its wonderfully temperamental and instantaneous manner, once again as the last great hope of Thomas Lee and his cohorts is removed. What better time than for David Rosenberg, of Gluskin Sheff, in his inimitable way, to introduce his outlook for 2012 in the form of eight behavioral changes that he expects to overwhelm market psychology in the coming months. Political, financial, and economic transitions for the US, Europe, and China respectively will dominate the coming year and as Rosie points out, the ability to recognize change at the margin (such as basis traders in European sovereigns) is going to be critical in 2012. The shift from one of cyclical extrapolation to secular change is always a hard one to navigate and tactical asset allocation will become foremost in most people's minds over longer-term strategic considerations. The global economy will be forced to endure the mother of all deleveraging cycles as we move through 2012 and capital preservation and income must dominate investment strategy as Rosie's 8 themes play out.

Market pundits would have you believe that corporate profits are the driver of stock prices. They're wrong. Ultimately, it is demand for stocks that drive prices. If demand falters for whatever reason (for example, loss of faith in a rigged market), then stocks will decline in price as organic selling pressure (people liquidating positions and accounts for whatever reason, such as paying their mortgage and buying food now that the household is surviving on one shaky income) is a constant that only rises as the economy sheds stable fulltime employment. The Federal Reserve has backstopped the stock market by destroying every other source of yield via zero-interest rates (ZIRP), effectively pushing anyone seeking a yield into long-term Treasury bonds or "risk-on" assets such as stocks and junk-rated corporate bonds. But Fed manipulation cannot overcome the much larger forces of demographics and employment for long. Despite all the brave talk of the manipulators on the Board of the Federal Reserve, they've run out of manipulative tricks. With interest rates already near zero, their most basic toolbox is empty. Now they're reduced to bleating about all the phantom tools in their possession and playing around with long-term bond yields and mortgage rates-- interventions that cannot possibly create jobs or organic (i.e. real, unmanipulated) demand for stocks and housing.

Our framework centers on the idea that humanity is facing a set of predicaments quite unlike anything else in the history books. Because this time there are no borders to cross in search of safety; the entire world is involved. On a global basis, we've never experienced collective debt loads of this magnitude. Never before has an entire set of intertwined currency systems -- all debt-based money -- collectively been backed by nothing more than the hope of a larger future, and never before have this many people had to figure out how to move from more-concentrated to less-concentrated energy sources (from fossil fuels to sun- and wind-based alternatives). The convergence of exponential trends in population, energy depletion, debt accumulation, and an economic model that is hooked on growth will combine to produce quite an interesting, if not challenging and disruptive, future. The funny thing about complex systems is that they are unpredictable, and therefore preparing for what may come is a non-trivial (yet absolutely essential) task. The immediate question for most people is What should I do?  We break down the intelligent responses into three big buckets: financial, physical, and emotional. In this report, I detail the financial steps that everyone should undertake right now to manage future risks using the framework that I use to assess and understand the financial world and markets. My approach is founded as faithfully as possible on facts and data. But my views on how the markets operate are formed from personal experience, observation, and connecting a few dots that rely on opinions and sometimes beliefs. Therefore, this financial and investing framework is something that you should only accept if it works for you -- and reject if it does not.

Even as Italian bonds surged on hopes that the $40 billion Italian austerity plan (putting this to scale, $400 billion in Italian debt has to be refinanced in the next 12 months) proposed by Monti which is supposed to lower the nation's debt load (putting this to scale, Italy has €1.9 trillion in debt), coupled with expectations that this time (we lost track of which one this actually is) the European summit on December 9 will actually achieve something, the liquidity situation, and not just any liquidity but EUR-funded liquidity (the one that the Fed can do nothing to help by lowering the OIS swap rate) deteriorated massively overnight, as European banks deposited a whopping €20 billion in additional cash with the ECB despite the coordinate central bank intervention yesterday. Total deposits are now at €333 billion, just €50 billion short of the all time high hit in June 2010 when Greece failed for the first time and there was no clarity that the Bernanke Put had gone global, implying the need for an eventual Mars bail out. And confirming that the liquidity crunch is now shifting to the local currency, another €7 billion was borrowed from the punitive Marginal Lending Facility. So now what we have is a liquidity crisis that has been confirmed to not be only USD-based but also EUR. Congratulations Fed. Yet since the market is slow in understanding complex things it is surging, as it looks at Italian bonds which as noted earlier are soaring on nothing but hope, it will take a little before this filters to all the right places.

A 787 point gain on the Dow this week, second only ever in absolute points gained to w/e 10/31/08, ended on a disappointing note as equities gave back significant early gains around the NFP print to end the day practically unch (128pts off the highs). Equities underperformed credit on the day with another strangely impressive (given NAV and HY spread differentials) outperformance by HYG. On a medium-term basis, equities began to revert back to where broad risk assets are more supportive but on a short-term intraday basis, risk assets (most notably EURJPY, AUDJPY, and TSY levels and curves) were in a more aggressive derisking mode. ES definitely maintained strength for longer than many expected today before giving it all back into the close, but financials (especially the majors) were surprisingly positive today even after such a good week - quite a squeeze.

To suggest financial markets have been volatile as of late is simply a wild understatement.  Although we've certainly seen this type of volatility in terms of percentage moves over short spaces of time in the past, we can't remember when we've last seen this degree of volatility within the context of whipsaw back and forth movement.  Although it may sound hard to believe, if one looked only at closing S&P prices and added up the interim high to low and low to high movements of the SPX since literally May 1 of this year, the S&P has traveled 1,233.83 points!!!!  More than the entire value of the SPX as of the close the day after Thanksgiving.  Now how's that for volatility over a seven month period? Has this played havoc with fragile human emotions?  C'mon.  You may remember that we saw many a headline Street soothsayer turn outright bearish at the end of September, lowering equity allocations as well as equity index targets.  Speaking of defensive portfolio postures and the chance for the S&P to breach 1000 to the downside.  Four short weeks and 186 S&P points to the upside later, giddy strategists and other assorted Street fortune tellers rushed to upgrade equity outlooks literally right on top of the highly anticipated late October Euro bailout plan (which in hindsight has turned out to be neither a bailout nor a plan). We watched in strange amusement as increasing beta exposure recommendations flooded the Street, of course coming after a blistering four week 17% run to the upside in the SPX.  The immediate result of these recommendations of the pros?  A very quick four week 10% loss in the S&P, as a proxy for equities broadly.  It’s never easy, is it?

If the mid-summer sell signal of 2011 plays out similarly to the one in 2008, there may be a long, dramatic decline straight ahead. 

Our good friend Doug B., a financial advisor based in Boulder, CO, has done well for his clients by keeping them heavily weighted in bonds. In the essay below, he explains why he intends to stick with this strategy even though many of his peers expect a rebounding stock market to outperform fixed-incomes in the years ahead.  For Baby Boomers in particular, the deflationary trend that buttresses Doug’s strategy holds stark implications.