Bear Market

As unemployment rose toward 10%, the January 1975 cover of Ramparts magazine blared: The End of Affluence: The Last Christmas in America. (TLCIA). Now statistics are echoing that last great recession: rising prices for essentials, systemically high unemployment and stagnant wages. So how does a society deal with the End of Work when it also means The End of Affluence, even for many of those with jobs? How does government deal with declining tax revenues and rising interest rates? The death throes of the debt-based consumerist lifestyle are already visible beneath the glossy propaganda of "rising revenues this Christmas season." 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 shaky incomes.

It must be pointed out that gold is certainly no longer the bargain it was at the lows over a decade ago (at which time Warren Buffett undoubtedly hated it just as much as today). This is by no means akin to saying that there is no longer a bull market in force though. What seems however extremely unlikely to us is that the long term bull market is anywhere near to being over. After all, the people in charge of  fiscal and monetary policy all over the globe are applying their 'tried and true' recipe to the perceived economic ills of the world in ever bigger gobs of 'more of the same'. Until that changes – and we feel pretty sure that the only thing that can usher in profound change on that score is a crisis of such proportions that the ability of said authorities to keep things under control by employing this recipe is simply overwhelmed – there is no reason not to hold gold in order to insure oneself against their depredations.

"what you realize is that the lessons of ’08 will actually result in a much quicker process, a process that I would describe as a “black hole” if and when there is the next financial crisis.... Nobody in America has actually seen, or most people probably can’t even contemplate, what an actual loss of confidence may look like. What I’m trying to struggle with as a money manager, who really seriously doesn’t like to lose money, is how to protect our capital and how to think about the next crisis."

If you want to send a roomful of 100 wealth managers into an icy chill, have Russell Napier address them. Napier’s presentation, “Deflation in an Age of Fiat Currency,” is thought-provoking, and the precise polar opposite of investing as usual. US stock markets aren’t cheap, not by a long chalk. Napier, like us, favors the 10-year cyclically adjusted price / earnings ratio, or CAPE, as the best metric to assess the affordability of the market. At around 21, the US market’s CAPE is near the top end of its historic range. The S&P 500 stock index currently trades at a level of around 1400. Napier believes it will reach its bear market nadir at around 450, driven by a loss of faith in US Treasury bonds, and in the dollar, by foreigners.

We have long been pounding the table on what in our view is the biggest detriment to any future growth for not only corporate America, but the entire US (where, sadly, government investment IRRs just happen to be negative - a fact that most won't understand until it is too late, especially not self-anointed economic wisemen whose only solution to everything is "do more of the same" yet who thought the utility of the Internet would be eclipsed by that of the fax machine): the complete lack of capital expenditures at the corporate level, and lack of (re)investment spending. It turns out that, however, that there is more to the story, and as the following chart from SocGen's Albert Edwards shows, not only are companies using up what actual free cash flows they have for such stupid stock boosting gimmicks such as harebrained M&A (just look at the recent fiasco between HP and Autonomy to see how rushed M&A always ends), and of course buybacks, but they are now levering to the hilt to do even more of this. The last time they did this? The golden days of the credit bubble.

I was a super bull of long-term bonds. I stated my case over 3 years ago with a yield target on 30-year maturities of 2.5%. Back then, the timing and structure looked right for another run to new highs. Discussions about hyperinflation were premature.

Until recently, the only question traders had to ask themselves was "how much more to buy?" The last week or so has left traders across the market now suddenly plagued by numerous questions. Will an Obama speech continue to be the catalyst for selling pressure to resume? Why is VIX 'low' when all around is asunder? When do the BTFD crowd step back in? Where's the 'wall of money' flowing now? From new issue demand to Italy's ratings agency trials and from bounce-buyers waiting for Godot to VIX's complacency, FBN's Michael Naso and Mint's Blain cover some of the conundra.

Back in the late 1980s, the entire business world was obsessed with Japan. It's no wonder that this was the case: here was a country which had emerged from the ashes of World War 2 and had become the world's second-largest economy. They made high-quality cars, consumer electronics, semiconductors, plus they seemed to have a management style and work ethic that put the "good old USA" to shame.

Hmmm… Initial rebound after yesterday’s bashing was rather modest, settling on a bit better and awaiting US input. Spain overdid its auction, which looked just good in the sense of being able to say it sold a new bond for size – to its dealers. ECB, happy to have provided the idea of OMT to save the world from simple panic, now going pessimistic (in non-panicky way). It’s just soft out there… It’s the economy, Stupid! And it is weak.
"Bop 'Til You Drop " (Bunds 1,36% -2; Spain 5,84% +16; Stoxx 2479% +0,1%; EUR 1,275)

UPDATE: Within the first 90 minutes of the open, AAPL has traded down to under $564 - officially entering bear-market territory (down 3.4% today)... These are 5-month lows for AAPL

From the $705.07 jubilant highs on 9/21, the most widely held stock among hedge funds is sliding in the pre-market very close to its bear-market barrier. A 20% slide from those 'peak AAPL' levels is around $564, less than $10 away. For some this is the buying opportunity of a lifetime as those $1111 price targets and Apple TVs are far from 'priced in'; for others, every VWAP rip is now faded and orderly lines are being formed at the 'get me out of this' window... What was the alpha-generating master-of-the-universe-making stock in the last few years, is now the overweight, over-crowded, waiting-for-the-straw-on-the-camel's-back holding that managers love to hate as their bogeys drift and portfolios plunge. So much for buying high-beta to chase performance eh?

What a roundtrip! After starting off November with a bang, and after nearly retracing all October losses in the aftermath of the NFP headfake in less than 2 trading sessions, the S&P futures literally imploded, and dropped 23 points from the intraday high, the same distance traveled as it crossed yesterday, only to the downside and on very strong volume for the second day in a row. While the 1400 support in ES is once again in play (ES closed literally on the lows of the session at 1405.5), as we suggested earlier, the far more ominous news is that the AAPL bubble appears to have popped (but, but, it is so cheap on forward multiple basis: guess what - forward multiples are based on forward earnings, which may very well never materialize! and thanks to the dividend, not even AAPL's cash hoard is the bastion it one was) and is now close to entering bear market territory, down just shy of 20% from its all time highs of $705.07 hit on September 12. Now with the 200 DMA taken out, the next support is the 20% retracement from the high which is at $564. After that it is freefall for a long time as a very deep gap needs filling. It is unclear just how much of the selling was there to cause max pain for Dick Bove and Rochdale, for whom every tick lower in the stock means a bigger margin call.Finally, news hitting literally seconds ago that MSFT may be launching its own phone if its partner strategy falters, means there go even more margins.

With the election right around the corner, the chickens are going to come home to roost.  Our ability to print our own currency and buy all the commodities we want with it is the exorbitant privilege that allowed us to export most of the problems within the monetary system elsewhere first.  As Nixon’s Treasury Secretary John Connelly said when confronted by a group of European Finance Ministers: “it’s our currency, but your problem.”  At the time he was correct, as we were at the very beginning of the fiat dollar standard.  41 years later the system is in its final days and our currency is about to become our problem as well. There were always going to be massive consequences to keeping this ponzi alive. The main point here is one I was hammering on in my last piece The Global Spring.  You can only push people so far into hardship before things snap.  They snapped in North Africa.  They snapped in Southern Europe.  They snapped in China.  They are about to snap here.  Oh, and one last thing.  What do you think all of this signals for corporate margins?

Modern Portfolio Theory (MPT) is broken. That is how we interpret Niels Jensen's (Absolute Return Partners) latest missive as he draws a concerning line between the number of managers who rely sheep-like on the diversifying 'artifacts' of MPT in a new normal world of undiversifiable systemic risks. The shifts in intra- and inter-asset class correlations (both long- and short-term) have been incredible both in terms of direction change and magnitude - for example (as Nielsen notes) - In the 2000-03 bear market commodities were an excellent diversifier against equity market risk with the two asset classes being virtually uncorrelated (+0.05). Nowadays, the two are highly correlated (+0.69). This shift to a risk-on / risk-off world, fed by central bankers, makes the empirical Sharpe ratios of olde and track records of your favorite balanced-fund manager entirely useless for any investor seeking protection from not just volatility risk but ultimate risk - the permanent loss of capital.

Market indexes and recessions are two very different data series...

~ Doug Short

There has been a lot of ink spilled about how the stock market performs during Presidential election years generally leaning to why investors should be fully invested to the hilt.  The current election year, with just three months remaining, has certainly played out to historical norms with the markets advancing on expectations of continued government interventions even as economic and fundamentals deteriorate.  To wit Bespoke Investment Group wrote back in July: "We have highlighted the similarities between this year and prior Presidential Election years numerous times. Most recently, in early July we noted the fact that based on the historical pattern, the S&P 500 could see a modest pullback in mid-July coinciding with the kick-off of earnings season. Sure enough, the market saw some choppiness about a week and a half ago and subsequently rebounded in the middle of last week. Holding to the historical pattern, that rebound came right at the same time that the market historically sees its summer low.  If the pattern continues, the S&P 500 could be set up for a nice rally to end the Summer. Will it hold? Only time will tell, but if the historical pattern has worked so far, what's to stop it from continuing?"