Bear Market

Another volatile day ended with the Dow is down around 5% in January - the worst start to a year since 2009 (and 2nd worst since 1990) and the worst month since May 2012 (a 3-sigma miss of the average +1.5% per month gain since 2009's lows). Japan, Brazil, and Russia suffered greatly on the month as gold miners, Egypt?, and US Biotech did well. There is a huge 380bps spread between the performance of the Industrials and the Transports YTD. Gold had its best month in the last 5; Treasuries rallied with 10Y yields dropping their most since May 2012; USD rallied the most in 8 months with JPY's biggest rally (and Nikkei's biggest loss) since April 2012.

Rothschild has identified four different scenarios that, in their view, are the most likely to occur. The series of scenarios for GDP growth and inflation in the main western economies, Japan and China may guide investor thinking but their somewhat ominous conclusion is worth bearing in mind: "Further monetary 'experiments' are becoming less probable. However, significant imbalances and risks persist. This is the reason why we have left the size (probability) of our depression scenario unchanged," and while they remain exposed to equities they warn "valuation support is limited, exposing equities to a potentially sharp correction."

While stock prices can certainly be driven much higher through the Federal Reserve's ongoing interventions, the inability for the economic variables to "replay the tape" of the 80's and 90's increases the potential of a rather nasty mean reversion at some point in the future. Inflation-adjusted, the current rally of 115.56% is the 6th longest in history with the market still below its 2000 peak. We are currently at valuation levels where previous bull markets have ended rather than continued. Understanding the bullish arguments that support markets rise is important, however, the real risk to investors is the eventual and inevitable "reversion to the mean".  In other words, what comprises that "light at the end of the tunnel" is critically important to the future of your investment success.

As the investing world waits with baited breath for the outcome of the Turkish Central Bank's emergency meeting (released at 2200GMT) to see if they hike rates 300, 400, or 500bps and finally manage to persuade Erdogan that raising rates are essential; the Turkish stock market investors are voting (and selling). The Istanbul 100 index has plunged to its lowest level since July 2012 (and the Lira strength from spike lows has stabilized - just two days shy of record lows).

If we break below these... LOOK OUT BELOW.

One of the big disconnects over the past year has been the divergence between the price of paper gold and the seemingly inexhaustible demand for physical gold, from China all the way to the US mint. Today we get a hint on how this divergence has been maintained: it now appears the main culprit is the massive boost in supply by gold mints around the world working literally 24/7, desperate to provide enough supply to meet demand at depressed prices in order to avoid a surge in price as bottlenecked supply finally catches up with unprecedented physical demand.

"... either way 2014 is already proving to be more challenging, more volatile, more illiquid and more bearish than the significantly bullish positioning and sentiment indicators warranted as we came into this year, and way more bearish than the enormously bullish consensus emanating from the sell-side. We will see painful counter-trend rallies, perhaps even to marginal new highs (3A above) – never underestimate the willingness and ability of central bankers to persist with flawed policies – but overall I think the end of the post-2009 QE-driven bull is at hand (or very soon to be at hand) and the onset of the next significant (post-QE) deflationary bear market, which I think will run deep into 2015, should now begin to guide all investment decisions." - Bob Janjuah

After the worst week for the market in over a year, the US knows the drill. Must. Distract. Population. And if a drunk-driving, prepubescent Miley Cyrus Canadian lookalike on a work visa won't do the trick, then by all means resort to ye olde faithful - bombing the feces out of some "independent" nation. In this case Somalia. CNN reports that earlier today, the US conducted a missile strike in Southern Somalia. The target: a "senior leader" affiliated with al Qaeda and Al-Shabaab, al Qaeda's affiliate in Somalia. Supposedly this is the Al Qaeda that the US isn't officially funding and supporting in Qatar's desperate and ongoing attempt to push its pipeline under Syria.

Between 2008 and 2013, China’s credit market increased from $9 trillion to an incredible $23 trillion.

"What will drive this "strength"? More of the same I suspect – any weakness in earnings will be ignored (virtually all of last year's equity market gains were NOT earnings or revenue growth driven, but were rather virtually all multiple expansion driven), any bad economic data will be ignored – the weather provides a great cover,  and instead markets will I think see (one last?) reason to cheer the Fed and/or the BOJ and/or the ECB and/or the PBoC.... The only real "success" of these current policies is to create significant investment distortions and misallocations of capital, at the expense of the broad real economy, leading to excessive speculation and financial engineering. If I am right about the final outcome over 2014 and into 2015, the non-systemic three-year bear market of early 2000 to early 2003 may well be a better "template". Of course the S&P lost virtually the same amount peak-to-trough in both bear markets, and in real (as opposed to nominal) terms actually lost more in the 2000/03 sell-off than in the 2007/09 crash." -Bob Janjuah

For gold to hit a new all time high adjusted for inflation, it would have to clear at least $2,193 per ounce. If you go by 1970 dollars (when gold started its last bull market) it’d have to hit $4,666 per ounce.

Despite much hope that the current breakout of the markets is the beginning of a new secular "bull" market - the economic and fundamental variables suggest otherwise. Valuations and sentiment are at very elevated levels which is the opposite of what has been seen previously. Interest rates, inflation, wages and savings rates are all at historically low levels which are normally seen at the end of secular bull market periods. Lastly, the consumer, the main driver of the economy, will not be able to again become a significantly larger chunk of the economy than they are today as the fundamental capacity to releverage to similar extremes is no longer available.

In his 712-page tour de force, The Great Deformation, David Stockman dissects America’s descent into the present era of “bubble finance.” it’s hard to refute Stockman’s perspective on the Fed’s role in the housing bubble. But that won’t stop some from trying, and especially the many academic economists beholden to the Fed. Research papers have stealthily danced around the Fed’s culpability for our crappy economy, as we discussed here. More importantly, if Stockman is right about bubble finance, there’s more mayhem to come. Consider that denying failure and persisting with the same strategy are two sides of the same coin. Just as investors avoid the pain of admitting mistakes by holding onto losing positions, Fed officials who claim to have done little wrong are also more committed than ever to propping up asset markets with cheap money. For those concerned about another policy failure, a key question is:  “As of today, where do we stand with respect to bubbles and bubble finance?”

If you’ve ever sought advice from a financial advisor, you probably asked the question: “How much of my portfolio should I hold in stocks?” Somewhere in the answer, you were probably offered long-term return estimates. These estimates probably placed stock returns at approximately inflation plus 5 or 6%. But what if standard estimates are too optimistic, as they were in the 1990s when advisors typically predicted double-digit long-term returns? Shouldn’t this change your investment allocations? We’ll argue that the usual estimates are overoptimistic, and that investment allocations should be based on more realistic expectations. Worse still, the discrepancy has reached enormous proportions.

It would seems Reuben Kressel nailed it. The retail investor perfectly top-ticked his 500-share sell order on 12/27 and since Twitter shares have tumbled 25% - with plenty of volatility in between. As the world waits breathlessly for the firm's first earnings call later this month, it seems 'taking profits' is the new norm as firm after firm shifts their buy-buy-buy reccomendations to 'hold' or 'sell'.