Bear Market

Moments ago shots were fired when a (French) bank broke the unspoken Omerta code among sellside bankers: it downgraded another bank in a time when the S&P is just shy its all time highs (downgrading banks when the market is tumbling is usually a-ok). The note came from SocGen's Andrew Lim, whse thesis is rather simple: "Valuation too expensive in light of regulatory and revenue challenges."

That's the conundrum investors must face if they want in to this market now.

The past can offer clues to the future but it doesn’t give us a blueprint. The bigger message is that today’s valuations don’t bode well for long-term returns, where long-term means beyond the next market peak. Prices could surely bubble upwards from here, but bubbles are invariably followed by severe bear markets. More importantly, we shouldn’t be fooled by traditional valuation measures. P/Es, in particular, have several flaws. We’ve shown in past articles that we get completely different results when we adjust earnings to account for mean reversion. Either way, our conclusions are a far cry from the “nothing to see here” that we keep hearing from the Fed.

Sales of gold coins are booming even as the precious metal's price is falling (and it's not just central banks). Despite gold futures 28% drop in 2013 (its worst since 1981), the WSJ reports that demand for gold coins shot up 63% to 241.6 metric tons in the first three quarters of 2013.

• Heavy snowstorm hammers northeastern U.S. (Reuters)
• Coins Remain a Bright Spot for Gold (WSJ)
• Gross’s Mistake on Fed Taper Echoes Across Pimco Funds (BBG)
• China December services PMI falls to four-month low (Reuters)
• General Mills Starts Making Some Cheerios Without GMOs (WSJ)
• U.S. considers flammability risk of Bakken crude after accidents (Reuters)
• China Mobile’s Costly iPhone Deal with Apple (WSJ)
• Hezbollah Upgrades Missile Threat to Israel (WSJ)
• UK House Prices Cap Best Year Since 2006 as Mortgages Surge (BBG)
• China tells police to be loyal to party amid graft crackdown (Reuters)

While US stocks are taking off, there are other, potentially much larger opportunities outside of it.

The ubiquitous sell-side strategist, opining from his ivory tower of market-proven recency-bias based invincibility, appears to have coalesced on the 'group-thunk' case that we have entered into a new "secular" bull market as last seen in the early 1980's. However, while the thesis is interesting, it is based on some flawed assumptions interest rates, valuations and time frames. Of course, with virtual entirety of Wall Street being extremely bullish on the markets and economy going into 2014, along with bullish sentiment at extremely high levels, it certainly brings to mind Bob Farrell's Rule #9 which states: "When all experts agree - something else is bound to happen." Hold on to your hats friends - 2014 could well turn out to be an interesting year for all the wrong reasons.

To put this into perspective, this means investors put more money into stocks this year than they did in 2000: at the very peak of the TECH BUBBLE!

For the 3rd day in a row, traders in credit and equity markets bid for protection. VIX rose 1 vol to 13.5% (diverging notably from stocks) and High-yield and investment-grade credit protection is back at 1-week wides (again diverging notably from stocks). USD weakened back to pre-FOMC levels (-0.4% on the day) led by EUR liquidity needs by the look of it, was ignored by the commodity markets which saw silver and gold tank (gold < $1200) and WTI crude back under $100. Treasuries rallied modestly (yields -3bps) as stocks wriggled sideways on super-low volumes (with NASDAQ underperforming and Dow outperforming to break the new record-high 16,500 level). Homebuilders outperformed even after the dismal home sales data with Energy worst on the day.

For the second time in its brief life as a publicly-traded stock, the latest exhibit in 2013's FOMO meme has hit a bear market. Twitter has dropped 20% from its all-time high and must - must - be a bargain here?

Someday, and I cannot say when, Gold will catch its next leg up. When it does, we’ll finally see the market action that a $10+ trillion expansion in Central Bank balance sheets warrants.

The biggest problem facing investors today is that “the rules” of the game change almost every year. What I mean is that any basic rule investors took for granted could be thrown out the window. Indeed, in the last five years we’ve seen:

From the United States to Europe and Asia: The world's central banks are flooding markets with liquidity and pushing deeper into unknown monetary policy territory. Jim Grant tells Germany's Finanz und Wirtschaft that he "fears that this journey will not end well." The sharply thinking Wall Street veteran doesn’t trust the theoretical models of the central banks and warns of irrational exuberance in the financial markets adding that "the stock market is increasingly full of stocks that are borne aloft by hope rather than demonstrated performance."

Chinese demand may once again stem the decline in gold prices. Chinese buyers eagerly scooped up gold at bargain prices overnight after the 4% price fall. Gold volumes for the benchmark cash contract on the Shanghai Gold Exchange (SGE), China’s biggest spot bullion market, climbed to a 10 week high as lower prices led to increased buying.

The financial crisis is surely a touchy subject at the Fed, where the biggest PR challenge is “bubble blowing” criticism from those of us who aren’t on the payroll (directly or indirectly). But Foote, Gerardi and Willen are, of course, on the payroll. They tell us there’s little else that can be said about the origins of the crisis, because any “honest economist” will admit to not understanding bubbles... " Unfortunately, the study of bubbles is too young to provide much guidance on this point. For now, we have no choice but to plead ignorance, and we believe that all honest economists should do the same." This smells to us like a strategy of gently acknowledging criticism (of the Fed’s interest rate policies), while at the same time attempting to neutralize it.