Friday, June 2, 2017

The silent economic boom

[Note: I was recently interviewed by Kenneth Ameduri who hosts the Crush The Street internet show.  In it I discuss my take on gold, stocks, Trump, the economy and Bitcoin.  The interview can be found here: https://crushthestreet.com/videos/live-interviews/economic-bubble-burst-trumps-watch-clif-droke-interview]

Though many Americans aren’t feeling it, the economy is quietly gathering forward momentum.  With consumers gaining in confidence and real estate heating up on both the commercial and residential levels, the U.S. economy is much stronger than it may seem at first glance.

One reflection of the strengthening economy is the equity market, which is in the eighth year of a bull market since the bottom of the credit crash.  The bromide, “As goes the stock market, so goes the economy,” is something that hardly needs explaining, yet so many investors lose sight of this cogent fact that it bears repeating.  Rising corporate profits and efficiencies in recent years have contributed in large part to the economic improvement. 

Another reflection of the recovery can be seen in our in-house New Economy Index (NEI), which combines the stock prices of the leading U.S. retail and business service stocks.  The graph below shows that NEI continues to hit all-time highs on almost a weekly basis and as such is reflecting a strong consumer retail economy.


With so many indicators pointing to a strong economy, why then are so many Americans acting as if recession is imminent?  That’s the question we’ll address here.

Ed Hyman is one of the most respected, and accurate, economists.  As Barron’s recent observed, he has been voted Wall Street’s top economist for 36 of the past 41 years in Institutional Investor’s annual poll.

In an interview conducted by Barron’s editor Randall Forsyth, Hyman said he sees cities around the U.S. “booming,” including smaller ones away from the megalopolises on the coasts. His conclusion is that this will benefit Main Street more than Wall Street.

Hyman has a rather old-fashioned, yet highly effective, method of gathering data from which to make his forecasts.  His team of researchers simply contact companies such as employment agencies, truckers, car dealerships and home builders and ask, “How’s business?”  A rating scale of zero to 100 is used by respondents to describe business conditions and from this tally Mr. Hyman is able to get a good read on what’s happening in the economy. 

According to Barron’s, Hyman’s surveys were trending higher well ahead of last year’s election.  “At that time,”  quoting the Barron’s article, “his model was forecasting real growth in gross domestic product of about 1.5%, although not as ‘uplifting’ as the recent ‘soft data,’ such as confidence surveys, indicate.  Now, the model points to 3% growth, bolstered by indicators such as tight credit spreads and high consumer net worth, which accords with what he calls a ‘scientific method.’”

Ad Ed travels around the country, he’s finding that “every place is booming,” he told Barron’s.  “Every major city, Chicago, Minneapolis, Kansas City, they’re doing great.”  Smaller cities are also outperforming, he says.

Hyman also reports that “millennials are coming on like locusts,” as they emerge from years of living in their parents’ basements.  “They’re getting jobs and apartments,” he told Barron’s.  “Millennials’ employment is growing at 3% while everything else is growing 1%.”

Hyman also pointed out that many observers have undervaued the extent to which central banks around the globe “are still flooding the system every week” with liquidity, with the Bank of England and the ECB having purchased more than two trillion euros’ ($2.14 trillion) worth of bonds in less than three years.  Meanwhile the BOJ and the Federal Reserve, along with the ECB, hold $13 trillion in assets, which has lowered interest rates around the globe.  This, he says, explains how the Fed funds rate at just 0.80% while U.S. companies are doing so well.

If Hyman’s macro optimism is to be believed – and our indicators strongly suggest he is right – then 2017 may prove to be the year that the U.S. economy finally takes off and leaves investors with no doubts as to its latent strength and momentum. 

Wednesday, May 31, 2017

Crush The Street Interview

I was recently interviewed by Kenneth Ameduri who hosts the Crush The Street internet show.  In it I discuss my take on gold, stocks, Trump, the economy and Bitcoin.  The interview can be found here:

Saturday, May 20, 2017

The bull market and Donald Trump's death knell

In the minds of many investors, the election victory of Donald J. Trump to the United States Presidency was nothing short of a miracle.  Following his shocking victory, expectations were high that Trump would, with the help of Congress, fulfill his promises of tax reform and infrastructure spending.  The lifting of the heavy penalties associated with Obamacare was another hope that investors cherished.  Many hailed his victory by declaring that it was “morning in America” again.  But after only six months since the election, Trump's presidency has hit a potentially fatal obstacle and he now faces the growing possibility of impeachment. 

By now the particulars of the political onslaught against President Trump are well known and there is no need to recount it.  Impeachment in the wake of recent developments has become an increasing likelihood, and it is said that even the Trump White House is preparing for it.    It now appears that the president will be investigated by a Congressional inquiry with the possibility of eventually being replaced by his vice president.  The powers-that-be, it seems, have decided they've seen enough of Trump's muscular leadership and controversial America-first plans. 

How did America come full circle so quickly?  What started as a widespread hope that a president who fully understood the needs of commerce and would do everything in his power to further America's economic future now faces an ignominious ending.   Can this be chalked up to voter's remorse or the volatile temper of the American voter?  Or is it simply a case of Trump's ideological opponents taking an aggressive approach to derail his ambitious reform plans? 

A more likely answer is that Trump's election was a fluke and that it was never intended that a man of such convictions could ever be allowed to lead today's left-leaning society.  There are a few basic principles which can be addressed here.  One is that the leader of a free country is generally a reflection of the people he represents.  Is it credible to assume that today's average American favors the type of free-enterprise capitalism championed by Trump?  America's shift to the left of the political spectrum has become pronounced in the last two decades and the long-term trend is conducive to more socialist activism, not less, in government.  France has only recently been reminded of that and the U.S. is now being faced with that lesson. 

If anything, Trump's election victory was an aberration – a counter-trend rally in financial market terms.  It was born of deep frustration among middle class voters.  After the painful experiences of the Great Recession and years of stagnation, Main Street America was in a rebellious mood.  Donald Trump represented a radical departure from Washington-as-usual and, unlike the other candidates, he addressed middle class concerns in the most vigorous terms.  Voting for Trump was essentially an act of defiance, a way of rejecting the Establishment which professed concern for the plight of the middle class but did nothing to help it.

Indeed, Trump's election was tantamount to a full-scale middle class revolt.  As with all revolutions, however, this one appears destined to end at the point of origin with no net progress to show for it.  (A revolution, after all, consists in making a full circle according to a literal rendering of the word.)  Since his election victory was against the primary trend toward socialism, Trump's eventual replacement as president will almost certainly be in line with the status quo, and the middle class will once again be ignored.

Incidentally, the word revolution has more than one application here.  The long-term economic Kress cycle which bottomed around the year 2014 was described by the late cyclist Samuel J. Kress as the “Revolutionary Cycle.”  This observation was based on the cycle's tendency to usher in a new socioeconomic order when it bottoms (e.g. the transition of the U.S. from an agrarian to an industrial economy in the late 19th century).  Before his death, Kress forecast that the next bottom of the 120-year cycle around 2014 would witness the final transition from free-market capitalism in the U.S. to a much more aggressive socialist government.  His prediction proved prescient when one considers that the Affordable Care Act (a.k.a. Obamacare) was the first major legislative inroad to full-blown socialism since the New Deal of the 1930s. 


The revolutionary aspect of the long-term Kress cycle – which also answers to the Kondratieff wave, or K-wave – provides the context for the mass discontent we’ve seen develop in the U.S. and other countries in recent years.  From Occupy Wall Street to Arab Spring to Brexit, discontent has been widespread in the wake of the 2007-2012 economic malaise.  Students of behavioral finance are aware of the connection between financial market collapse and mass psychology.  After a major shock in the financial market/economy, it usually takes several years for the resulting psychological impact to fully disappear.  This is why revolutions are common occurrences in the years following such a shock, not during the actual shock itself.  Humans are reactive by nature and it takes them a while, in the aggregate, to psychologically process an economic shock, hence the delayed reaction to the economic event in question.

The mentality behind the above mentioned revolutions also resulted in Donald Trump’s presidential victory.  But since this revolutionary episode was against the grain of the prevailing political wind, its lifespan will likely be brief.  Many European countries are already rethinking their political reactions against the European Union.  Now America will soon be forced to decide whether it truly wants to commit to the path it chose last November. 

Free market capitalism can survive only when a country’s citizens are fiercely committed to preserving personal liberty and self-initiative.  It requires a healthy, but respectful, disdain of government interference and a reliance on one’s own ingenuity to thrive.  If the Obamacare debate was any indication, America lacks the internal strength and will to survive as a free-market economy.  For this reason and others, socialism will eventually reassert its sway in the U.S. once the wave of revolutionary fervor subsides.

Returning to the subject at hand, how would a Trump impeachment affect the markets?  Will the secular bull market in stocks continue if Trump were removed from office?  What about the potential impact on the price of gold?  A successful Donald Trump presidency replete with tax and Obamacare reform would not have been good for the price of gold.  Gold is primarily a barometer of investor fear and uncertainty.  Tax reform would almost certainly have benefited both corporate profits and the economy, and a booming economy isn’t normally conducive for a vibrant gold market (the exception being a war-time economy).  However, the uncertainty generated by an investigation and subsequent impeachment hearings would likely serve to buoy the gold price to some degree.  The greater the uncertainty surrounding the outcome of Trump’s trial by fire, the more likely gold will benefit.

As for equities, the secular bull market which began in 2009 for the S&P 500 is still alive and will likely remain intact even if Trump is impeached.  The stock market hasn’t been as vibrant in the last couple of years due to a variety of technical and fundamental factors, including the uncertainties surrounding the U.S. political outlook.  Yet throughout the ups and downs of the last two years, there has been one constant: the lack of interest among retail investors.  Americans by and large lost their appetite for equities several years ago and it shows little sign of returning to normal in the immediate future.  This factor alone will ensure the bull’s longer-term survival throughout the short-term uncertainties, for no major bull market can end until the informed “smart money” investors unload their holding on uninformed participants (“dumb money”).  The big money investors have to have someone to sell to as they can’t very well unload their stocks amongst themselves.  So until we see the return of equity mania, we can be assured of the bull’s continuance notwithstanding its reduced vigor. 

Saturday, April 8, 2017

What will finally break the market's lethargy?

To most individual traders, there is no bigger buzz kill than a narrow trading range.  It takes the wind out of the sails of breakout and momentum traders, and even expert stock pickers have a tough time finding the stocks which are bucking the sideways trend.

Wall Street would much rather see a lively bull market when stocks are roaring and participation is widespread among all classes of investors.  But sometimes even a trading range-type market is good enough for the Street , provided stock prices are near all-time highs.  For even when prices are making no headway, the aggregate yield on stocks pays enough in dividends to make the lack of action worthwhile. 

There are indeed enough listed companies which pay a high enough dividend to make buying and holding in a lackadaisical stock market an attractive proposition.  This is one reason for the torpor which currently infuses not only the financial market, but the rest of the country as well.  Why worry when you can sit back and live off the interest?  Widespread lethargy breeds a range-bound stock market, but it also contributes to a sluggish economy.  As we'll discuss here, there is a reason for the public's lethargy and within that reason lies the solution to the problem. 

If you needed proof of the trading range-induced complacency out there right now, the public's response to the U.S. airstrike on Syria is a good example.  While there was a modicum of shock and anger, the response to the military action was mostly lethargic.  Even the stock market seemed unimpressed enough to rally, which underscores the extent of the public's complacency. 

Even Congress is infected with the conservation bug.  Even as President Trump touts his ambitious plan to cut taxes, the U.S. House majority leader is pouring water all over that plan by saying Congress will balance any proposed tax cuts by finding ways to increase revenues (read more taxes, but in different areas).  Thus the old "paying Peter by robbing Paul" syndrome has infused America's elected leaders, who seem to afraid to risk anything like general prosperity.

One certainly can't fault the President for trying to break the lethargy that has dominated the economy in the last two years.  His attempt at lifting the huge burdens imposed on the middle class by reforming Obamacare were spurned by Congress.  His latest move appears  aimed at stimulating the economy via military conflagration, a tried-and-true (short-term) economic palliative to be sure.

The subdued mood of the market can only be understood in terms of the long-term economic cycle, or K-wave.  This cycle is divided into four "seasons" of economic activity over a period encompassing roughly 60 years.  Each season approximates to 15 years.  The winter season of the cycle was between 2000-2014/15, with the last 60-year cycle bottoming at the end of 2014.  We're now in the early stages of K-wave spring, which should last until about 2029/30. 


So if economic spring has sprung, what is keeping the economy from flourishing?  The answer to that is best seen in a timely analogy.  Even as the Northern hemisphere experiences the early phase of spring in April, there are still lingering signs of the previous winter.  While most days are fairly warm, temperatures can still be sometimes chilly and even winter-like.  It takes a while for a new season to fully establish itself while the vestiges of the preceding season gradually fade away.  In like manner, it will probably take a few years for K-wave spring to become established -- especially given the severity of the K-wave winter season a few years ago. 

The question everyone is concerned with is what will it take to finally break the psychological shackles which have held back profligate spending and retail-level investing?  The answer to that question can be found in the previous paragraph: the immutable laws of the economic K-wave will eventually lay the foundation for a fundamental change in mass psychology. 

At some point in the current K-wave spring season the zeitgeist of contraction and fiscal restraint will give way to expansion and liberality.  Until then, expect to see occasional flare-ups of the winter mentality that predominated in the last decade.  These flare-ups should become more and more infrequent, however, as the K-wave spring season gradually warms the blood and increases the animal spirits. 

When K-wave spring finally hits full bloom, it will bring many economic benefits.  There will be a few signs to watch for to let us know that spring has fully arrived.  First and foremost, watch for higher yields on U.S. Treasury bonds.  There is no surer sign that the long-term economic cycle is accelerating than rising bond yields. 

As the new K-wave upward phase progresses we'll also see increasing real estate activity as prospective home buyers and commercial builders alike look to lock in still-attractive mortgage rates before they get too high.  As real estate timer Robert Campbell addressed in his latest newsletter (www.RealEstateTiming.com), U.S. home prices have broken out of a two-year doldrums phase and are rising at their fastest pace since 2014.  The momentum of real estate activity is on the upswing. 

Finally, look for speculative interest in both stocks and commodities to increase on a large scale.  Risk aversion is a lingering symptom of the contractionist psychology of the K-wave winter season.  When K-wave spring blooms in full, however, investment activity will pick up as participants shed their anxieties and trade them in for a more optimistic outlook.  

Tuesday, March 28, 2017

Book Review: Mind, Money & Markets

Most books in the financial genre tend to be, quite frankly, boring.  Books on the subject of stock market speculation are prime culprits of this tendency toward the tedious.  Every now and then, though, a book appears which breaks out of this mold and is truly as entertaining as it is educational.  Such is the case with Dave Harder and Dr. Janice Dorn’s recent book, Mind, Money & Markets.

The fruit of their collaboration is a useful guide for investors, traders, and business people and is rich in examples of how psychology influences markets.  Dr. Dorn is imminently qualified to address this subject as she is a Board certified psychiatrist as well as a long-time investor and investment writer.  Mr. Harder also brings long experience as an investment adviser and is currently vice president and portfolio manager with Canada’s largest financial firm.  The decades of experience between them provides the reader with a far deeper insight into investor psychology than is available in most works on the subject.


I personally found Mind, Money & Markets to be an engaging and insightful read.  At over 400 pages, there’s a lot of info to digest but the writing is smooth and the chapters seemed to fly by.  The book is richly illuminated with many colorful charts and illustrations and is lively with many accounts of how psychology influenced the financial market debacles from the distant pass to the present. 

Chapter 6 affords the reader with an in-depth discussion of market trends and momentum and is alone worth the price of the book.  There are also chapters dealing with the cycle of investor emotions, emotional management, identifying market tops and bottoms, and portfolio management.  Chapter 28 entitled, “It Is Time for a Revolutionary Change in Portfolio Management”, is also worth the price of admission.  


I heartily commend Mind, Money & Markets as a worthy addition to every trader/investor’s library.  The book is available from Amazon.com or click here.

Saturday, March 25, 2017

What Obamacare’s failure means for America

The first legislative setback of the Trump Administration is being celebrated by many, but not by middle class taxpayers and business owners.  A Republican-led Congress last week failed to generate the consensus required to overturn key provisions of the Affordable Care Act (ACA).  In a frank admission of defeat, House Speaker Paul Ryan declared that Obamacare would remain "the law of the land." 

The stock market wasn't too thrilled about it, either, although there wasn't a concerted selling effort on the part of the bears.  The major indices were down for the week, but the tech sector continued to show resilience with semiconductors in the leadership position.  There was a suggestion in the press last week that the stock market "couldn't care less" about Obamacare, and perhaps that's true.  But there's one thing that will be seriously impacted by the lack of Obamacare reform and that's the middle class economy.

Performing a postmortem of a failed political reform effort is seldom a gratifying task, but in this case there are a couple of things that need to be addressed.  From the start, the mainstream press tried to control the debate by constantly reminding everyone of the 24 million Americans who stood to lose coverage should Obamacare be repealed.  Never mind that is only about eight percent of the entire U.S. population, hence an extreme minority.  In a representative-style democracy such as ours, public policy is supposed to benefit the majority -- not the minority at the expense of the majority. 

What too many pundits have failed to consider in their treatment of the Obamacare debate is that the legislation which mandates health insurance for Americans is at root a personal liberty issue.  It's not about providing free (or cheap) coverage for the needy or the underinsured.  The main issue, which seemed to escape most commentators, is that Obamacare is a form of redistributive economics: socialism in its essence.  Obamacare represents the government putting the proverbial gun to the individual's head and saying, "You will buy health care whether you need it or not...or else!" 

I found it shocking that Obamacare was passed in the first place with little of the impassioned protest among individuals which characterized the first attempt at establishing socialized medicine in America (in 1993).  Even more surprising was the limp-wristed effort with which the current Congress failed to address the underlying problem with Obamacare, viz. the individual mandate.  An easy solution to the Obamacare reform debate would have been to simply eliminate the individual mandate and leave everything else intact.  This would have highlighted the single biggest problem with the legislation while avoiding direct confrontation from those who insisted that Obamacare not be entirely repealed.

Aside from personal liberty considerations, the other main consequence of leaving Obamacare intact is that it does nothing to alleviate the problems faced by individuals and small business owners who are forced to shoulder the burden of expensive healthcare coverage or else pay a hefty penalty.  One of the big reasons why the current economic recovery since 2009 has been the slowest on record is because of the exorbitant tax and regulatory burden imposed by Washington in the wake of the credit collapse.  Rather than remit taxes, the tried-and-true palliative for getting out of recession, the Washington establishment did the exact opposite.  No wonder then that Middle America has struggled to restore its financial condition ever since the housing bust laid waste to it some 10 years ago.  

If you want to see just how the middle class business economy is doing right now, take a look at the following graph.  It combines the stock prices of some of the leading U.S. publicly traded companies which cater primarily to the average American.  As you can see, it's hardly a picture of health and prosperity. 


Had Congress signaled its sympathy with middle class struggles by remitting the Obamacare taxes, there would almost certainly have been a strong consumer spending boom in its wake.  Lowering taxes always has a stimulative effect, and there's no better way to facilitate economic health than to make it easier for individuals and businesses to spend more of their hard-earned dollars into the economy than by letting them keep more of it.  Failure to lift the burden imposed by Obamacare means that the millstone remains tied firmly around the necks of millions of Americans.  It also means the economy won't be returning to a vigorous state anytime soon.

The failure of the Obamacare reform attempt also paves the way for the continued dominance of financial engineering in steering the economy.  Congress let slip an opportunity to regain the control over the economy that it surrendered to Wall Street and the Federal Reserve in the wake of the credit crash.  Instead of economic healing via fiscal stimulus and tax remittance, the economy will for now continue to be dominated by financial sector and central bank policy.  Any economic improvement from here will likely be due to the trickle-down effect of a rising stock market.  The direct stimulating effect of Congressional tax policy would have been far preferable.  

While the tone of this article might be construed as fatalistic, by no means should it be assumed that the die is cast.  There's still a chance, however remote, that the Congress will come to its senses in time to at least address some aspects of tax reform before the 2018 mid-term election.  By failing to seriously address one of the leading issues facing the middle class economy, however, Congress has telegraphed the message that it lacks sympathy with the majority of U.S. taxpayers.    An overnight change in this attitude would seem unlikely.

Tuesday, March 14, 2017

What’s preventing the Dow from exploding?

The stock market has once again entered a period of consolidation as investors wait for the results of the most important legislative decision of the year.  The fight to repeal and replace Obamacare has taken the spotlight as Congress debates the passage of legislation that would eliminate its most burdensome aspects for businesses and individual taxpayers alike.

Internally, the NYSE broad market has been unsettled for the last several days after a period of relative calm in the months following the U.S. presidential election.  There have been more than 40 stocks making new 52-week lows on a daily basis since last week.  This makes almost two weeks that the number of daily new lows has exceeded 40, which reflects an increase in internal selling pressure.  Most of that selling pressure is coming from consumer/retail stocks, bond funds and, increasingly, energy stocks. 

The extremity of internal selling pressure isn’t yet great enough to cause any major concerns about the strength of the stock market’s intermediate-term uptrend.  If the new lows don’t soon diminish, however, it could eventually cause problems for the interim trend as internal weakness spreads from the above mentioned sectors to the broader market.

Following is a graph of the daily cumulative NYSE new highs-new lows.  It’s telling that for the first time since the Nov. 9 election, the highs-lows have stalled out.  And while the trend is still technically up for the highs-lows, that trend could be broken if the new lows continue to expand in the next couple of weeks.


It’s clear that the honeymoon phase of President Trump’s election is over as investors aren’t giving a free ride to the stock market until he delivers on some of his campaign promises.  The most critical of these promises concerns the proposed overhaul of the Patient Protection and Affordable Care Act (a.k.a. Obamacare).  The mainstream news media are in full swing right now with negative stories which undermine the Congress’ effort at eliminating the onerous taxes surrounding Obamacare.  The tantalizing prospect of having the bill’s individual and employer mandates (which forces individuals to purchase health care or else pay a steep penalty) repealed is one big reason why the middle class turned out in droves to elect Trump. 

Now it’s time for the Republican-controlled Congress to “spit or get off the pot” as the saying goes.  Congress has an excellent chance to relieve a massive tax burden on individuals and small business owners by approving the proposed repeal of the Obamacare mandates.  Unfortunately, there is now a concerted effort underway within Congress designed at undermining the proposed overhaul.  It can’t be emphasized enough that the repeal of the Obamacare taxes would be of tremendous benefit for the economy by relieving the stress created by years of burdensome taxation.  That pent-up energy would likely express itself through a massive rally in the Dow and major averages, which have been tethered by the uncertainty surrounding the Obamacare reform debate in Congress. 

A repeal of the individual and employer mandates would also likely result in a hiring spree by small business and would give the stock market the euphoric burst of investor confidence needed to achieve heights undreamed of by even the most optimistic bulls.  This in turn would stimulate even more business activity due to the stimulative effect of America’s financially-driven economy.  

It’s sobering to think that how the rest of 2017 turns out for investors and wage earners alike might very well rest in the hands of Congress even as we speak.  All we can do now is pray for the best outcome and hope the Congress is able to deliver what would be the most extraordinary gift that Washington could possibly give the American taxpayers.   

Thursday, February 23, 2017

Another bubble? Bring it on!

Anytime the Dow makes a new high you can be reasonably assured of hearing the B-word bounced around in the media.  Memories of the last bubble are still vivid and painful enough to trigger flashbacks of the bubble’s collapse.  It’s only natural then that investors fear a return of irrational exuberance.  Despite these fears, the evidence of a newly formed bubble is surprisingly lacking, as we’ll uncover here.

Asset manager Jeremy Grantham famously defined a bubble as any asset whose price has moved at least two standard deviations above its longer-term statistical mean, or norm.  This definition is too rigid, however, and can sometimes be misapplied to see bubbles where none actually exist.  Markets can sometimes exceed the 2 standard deviation rule in non-bubble environments, as when the utilities sector last year experienced a 3 standard deviation event. 

This definition also is overly reliant on statistics and is lacking in the psychology department.  Investor psychology, after all, is a primary driving force of the pricing mechanism in all free markets.  What Grantham’s 2 standard deviation event rule fails to consider is that if a market experiences a record-breaking and sustained run-up, it can sometimes occur without widespread participation by small traders and investors.  And without large scale participation among retail traders the psychology of a bubble is lacking, i.e. there is no bubble.

The latest rally in the major stock market averages has once again fueled talk of a mania for equities in the popular press.  As discussed in previous commentaries, though, there is as yet no evidence of widespread direct participation in the equity market by small investors.  Much of the movement behind the rally to new highs is courtesy of institutional activity, with the public participating only indirectly via retirement savings funds.  Nowhere to be seen is the incessant preoccupation with day trading, swing trading and stock picking which were symptoms of the last two bubbles. 

One explanation for this startling lack of bubble psychology despite the all-time highs in stock prices is the K-wave.  Readers of this commentary should be familiar with this most basic of all long-term economic cycles, which answers roughly to the 60-year equity market cycle.  The K-wave deflationary descent bottomed in 2014 based on the Kress cycle count.  K-waves are often divided into four sections or “seasons” with each section being assigned a season of the year (e.g. winter, spring, summer, fall).  The following graph was devised many years ago by P.Q. Wall and does an admirable job of describing the K-wave seasons.
                                                                                                                            

If we assume that K-wave winter season ended in 2014, we’re now in the early phase of K-wave spring.  Early spring can easily be confused with winter due to the occasional freeze or snow storm that sometimes happens during the transition period between the two seasons.  But as the season progresses the signs of new life and warmth that always accompany spring gradually become more evident.  In that same vein, the last couple of years might easily have been confused with winter due to periodic outbursts of deflation in the global economy.  Yet we’re starting to see unmistakable signs that K-wave spring has truly sprung, even in the weakest performing foreign markets. 

To take one example, China’s stock market is starting to show renewed signs of life after being in a bear market the last two years.  China has also recently begun trying to increase its economic growth by providnig plenty of credit.  As Dr. Ed Yardeni has observed, “During January, total ‘social financing’ rose by a record $542.3 billion.  That’s not on a y/y basis, but rather on a m/m basis!  On a y/y basis, social financing totaled $2.7 trillion over the past 12 months through January.  Bank loans, which are included in social financing, rose $335.7 billion during January m/m and $1.8 trillion over the past 12 months.”

The emerging markets have experienced a similar rebound along with several euro zone markets.  As the U.S. leads the rest of the world out of global recession, there can be no denying that the K-wave is beginning to work its spring-time magic.

The aggressive policy stance by China’s central bank has led to worries that China’s real estate and stock markets may soon experience another bubble.  This in turn has added to fears that the U.S. will soon experience another bubble event in the stock market.  This need not concern us, however, since painful memories of the credit crisis are still strong enough among central bankers to prevent a bubble from forming, let alone get out of control.  Even China’s last taste of an equity market bubble ended prematurely when frightened policy makers quickly tightened money and credit in fear of the consequences. 

Now let’s assume for a minute, though, that a bubble was allowed to form in the U.S. equity market this year.  Would this be such a bad thing?  Considering that the biggest advances in technological progress and development, to say nothing of widespread prosperity, have occurred during bubbles it’s easy to answer that question in the negative.  While the naysayers focus on the negative aspects of a bubble’s implosion they neglect to mention that even after the inevitable popping, society is still immeasurably better off than before the bubble began.  Indeed, a bubble might be just what is needed to put the U.S. economy back on the right track for vigorous growth.   

It should be added that when it comes to economic policy, it’s always best to err on the side of too much growth than on too much austerity.  The events in Europe of recent years serve as a stark reminder of this fact.  Thus whenever fears of a bubble are discussed, it would do policy makers well to consider that the benefits of a loose monetary policy always outweigh that of a tight one. 

Probably the biggest argument used by the bubblemongers right now is the chart of the NASDAQ 100 Index (NDX).  This chart can easily be used to justify the fear of an incipient bubble, yet the investor psychology and mass participation factors are curiously missing right now. 


Before we arrive at the bubble stage, we should see increased interest bordering on obsession among small investors as the stock market becomes a primary focus among the masses.  As this hasn’t yet happened, the inescapable conclusion is that the long-term bull market hasn’t reached bubble proportions yet and therefore has a ways to go before expiring.    

Tuesday, February 14, 2017

The bull market no one believes in

The stock market continues to make new highs, yet none of the signs which accompany a market bubble are evident.  Investors are asking, “When will the Dow finally correct?”  By “correct” they mean “decline.”  However, a market correction doesn’t always entail a decline for the major averages and can sometimes take the form of a lateral consolidation or trading range.  That appears to be the case for the 2-month period from December through early February when the Dow and S&P made little headway.

In fact, in January the Dow Jones Industrial Average (DJI) recorded its tightest trading range of only 1.1% in over 100 years.  This continues a prolonged sideways pattern in the Dow and other averages since mid-December when the post-election rally reached a plateau.  The question everyone was asking was whether this plateau was merely a temporary “pause that refreshes” in an ongoing rally or the end of the rally and the prelude to another market setback.  The Dow provided the answer to that with the last week’s breakout above the top of the trading range ceiling.  It has rallied each day since, putatively on the hopes generated by President Trump’s forthcoming tax-related announcement.


While the bull market in equities continues, a surprising number of investors are either mistrustful of the rally or outright bearish.  According to a recent article in BBC News, there are a growing number of wealthy and politically liberal U.S. citizens who are doing things in the wake of Donald Trump’s election that were commonly seen by politically conservative citizens during the Obama years.  That is, they are buying guns, becoming survivalists, and preparing for an impending catastrophe related to the Trump presidency, the article reported. 

It was also reported that a number of wealthy Americans are preparing for what they believe is the apocalypse.  According to Business Insider, some have purchased underground bunkers while other wealthy individuals are planning to emigrate to New Zealand.  “Saying you’re ‘buying a house in New Zealand’ is kind of a wink, wink, say no more,” said Steve Huffman, CEO of the Reddit web site.  “Once you’ve done the Masonic handshake, they’ll be, like, ‘Oh, you know, I have a broker who sells old ICBM silos, and they’re nuclear hardened, and they kind of look like they would be interesting to live in.” 

The common denominator in these accounts is fear among the upper class.  The dread of an uncertain future which was pervasive among America’s middle class for much of the last eight years has now been transferred to the upper class.  While it might be premature to ascribe this to the recent rush back into gold, bond funds and other safe-haven investments, it would seem that there is just enough uncertainty among the upper crust to account for the lack of movement in the major stock market indices since December. 

Tight, narrow trading ranges in the major indices are launching pads for major moves in either direction.  In the context of a bull market, they typically represent rest and consolidation before the next move higher.  The odds technically favored this outcome, yet a substantial number of investors still don’t believe in the strength of the bull market.  This is reflected in the manifestations of fear among the upper class mentioned above, as well as in the path the market rally is taking. 

There is talk among some observers that the market is undergoing a “melt-up”.  This is an erroneous application of that term.  A classic melt-up is characterized by a runaway, almost straight-up and sustained market rally on high volume with widespread participation.  The trajectory of the major indices since November can hardly be described as “melting up.”  Rather, the market’s path has been measured and well-ordered, as the daily chart of the NYSE Composite Index (NYA) attests. 


The real melt-up phase of this bull market hasn’t even started yet.  We’ll know it has arrived when we see runaway stock prices coupled with increased participation among the legion of retail investors still on the sidelines.  Even institutional investors are surprisingly tempered in their usual optimism, as expressed in their collective 2017 forecasts.  Melt-ups have a way of surprisingly even the bulls in how high they carry the market averages before peaking.  For now, though, a combination of fear and cautious optimism holds sway among investors and this alone is enough to argue that the bull market still has legs.

Monday, February 6, 2017

The danger of being bearish in a bull market

One of the biggest contributors to losses for traders in the financial market is the temptation to sell short.  Borrowing shares of a company that are not owned by the seller in the hopes of making a massive profit has shipwrecked more traders than probably any other factor.  With stories abounding of the quick and easy profits to be made in selling stocks which are supposedly on the verge of plummeting, it’s no wonder that the allure of “shorting” is so irresistible to so many. 

Selling short is a simple enough proposition: place a short sale order with your broker for a company whose shares you believe are overvalued or technically “overbought”.  Then just sit back and wait for the profits to start rolling in.  If only it were that easy!  The trouble with selling short is that in most cases the odds are against the short seller.  This is due to a number of factors, some of which we’ll examine here. 

Perhaps the biggest risk for short sellers is the crowded short trade.  A high-profile example of what happens when too many traders pile into a single stock on the short side occurred recently – a cautionary tale if ever there was one.  It involved the loss of one man’s entire fortune due to a misguided attempt at selling short one of the most widely traded U.S.-listed stocks.  It’s a textbook case of what can go wrong when attempting one of the most dangerous of all trading maneuvers. 

According to MarketWatch, Canadian investor F.S. Comeau bet his last $249,000 against Apple Inc. (AAPL) in an attempt to reclaim $2.5 million lost in poor investments.  At the time of the trade, shares were valued around $122, and MarketWatch reported that an increase of just $6 would deplete Comeau’s savings. 

Apple shares screamed higher last week when the tech giant released an impressive Q1 earnings report and Comeau lost substantially.  As of this writing, AAPL shares had risen to a 52-week high of $130.50.


Before Apple released its earnings report, Comeau, who live blogged his reactions while wearing a wolf mask, acknowledged the capacity of investors aware of his short position to fade his trade.  “With 14,000 people watching, you guys could really mess with me,” he said.  When the company released its report his reaction was terse but poignant: “Oh, no.”

YahooFinance described Comeau’s reaction to Apple earnings as follows: [Comeau] kept howling.  And crying.  And throwing his pre-popped, celebratory champagne bottle.  There was a timeless stretch of blank camera stares, and then the sound of dry heaving. With mask still on, he pulled out a trashcan, and vomited more than his life savings.”

This misguided trader can perhaps be excused for his desperation born of inexperience.  What’s inexcusable, though, are the far more experienced trading advisors who gave assurances to their followers that Apple was a prime short-sale candidate despite all the technical and fundamental evidence to the contrary.  This misleading advice undoubtedly led to many hundreds of traders making the same mistake as Comeau. 

More than anything, the Apple experience provides a wonderful cautionary tale for all would-be short sellers.  The lesson here is that in an established bull market it’s best to avoid selling short altogether.  Trading against the prevailing trend is especially dangerous when one considers that short interest can quickly reach critical levels, thus the slightest bit of contrary news can catalyze a massive rally.  Short-covering rallies tend to involve wealth-destroying upside gaps, as the latest Apple stock experience proved.  These gaps are products of the urgency among short sellers to exit the trade.  They frequently represent losses on an unimagined scale.

Since naked short selling involves borrowing, the debt component of this trade ensures that the volatility factor will be greatly magnified vis-à-vis buying outright.  While this can sometimes work to a trader’s advantage in a bear market, it can prove catastrophic in a bull market.  The best policy is to avoid shorting unless a major bear market is underway and downside momentum has been thoroughly established.  Even then, your timing must sometimes be perfect. 

In a bull market the trend is truly your friend, and trading against the grain is usually a fool’s errand.  Best leave that to the men wearing wolf masks.  

Thursday, February 2, 2017

Financial Sense News Hour

I was recently interviewed by Cris Sheridan of the Financial Sense Network (www.financialsense.com).  The interview can be downloaded at the following link:


In it we discuss the possibility that 2017 will witness an extreme "blow-off" in the stock market followed by a major sell-off later in the year.  Special thanks to Cris and everyone at FSN.

Why stock market analysts will be wrong about 2017

We’re already a month into New Year and there has been an ample amount of sentiment data to suggest that investors, both retail and institutional, aren’t terribly enthusiastic on the stock market outlook for 2017.  Granted that institutional analysts are still bullish, as per usual, but in the round table type opinion polls I’ve seen they’ve apparently lowered their expectations.  Everyone seems to be preparing for a somewhat disappointing year based largely on the assumption that after eight years of a bull market, surely another major rally is out of the question.

The decennial rhythm we discussed in an earlier commentary argues against these diminished expectations.  Indeed, seventh year of the decade tends to be one of unusual volatility for stock prices.  While it’s true crashes, corrections and panics are quite common in the seventh year (e.g. September 1987, October 1997, February/August 2007), the seventh year also sees a pronounced tendency for sustained rallies in the first seven months of the year.  Accordingly, 2017 could be a year filled with tremendous opportunity for making money in the stock market – in both directions. 

For 2017, the 10-year rhythm equates to 2007.  As you recall, 2007 was a momentous year characterized at once by great volatility alternating between great fear and euphoria.  It was the year that saw the last major stock market top and also the onset of the credit tsunami which overwhelmed the market the following year.  If the decennial pattern holds true, 2017 should witness both a meaningful rally to new all-time highs as well as a decline of potentially major proportions.  In short, it could turn out to be a big year for the bulls as well as the bears.

As for the idea that the bull market is getting “long in the tooth” and has therefore exhausted its upside potential, consider that the previous two years could well be characterized as a stealth bear market.  The major large cap indices essentially went nowhere in 2015-2016 while the Russell Small Cap Index (RUT) experienced a 25% decline.  That’s a bear market by anyone’s definition. 

Retail investors have also been quite pessimistic since 2015 in the overall scheme of things.  From the start of 2015 up until the election, more than $200 billion was pulled out of U.S. equity funds and ETFs, while a bit more than that was funneled into bond funds and ETFs.   That two-year stretch of risk aversion, however, is apparently ending as investors have gradually embraced more risk tolerance since the election.  Since the election nearly $46 billion has flowed into U.S. equity funds, while nearly $3 billion has left bond funds, according to money flow statistics.

The evidence strongly suggests that the past two years served the purpose of clearing out the excesses generated by the long-term bull market which began in 2009.  In other words, the market is rested and ready to resume its potential as we head further into 2017.

Another concern among investors is that the rise in interest rates since last year could stifle the stock market’s upside potential.  While it’s true that sustained periods or rising Treasury yields have often proved a hindrance to higher stock prices, there is an exception to that rule.  According to LPL Research, there have been 11 periods of rising interest rates (at least a 1% rise in the 10-year Treasury note) since 1996, each lasting an average of six months.  During those times, the S&P 500 rose an average of 5.44%, thus proving that in the early stages of rising interest rates stocks and yields often rise simultaneously.

We’re at a point in the long-wave credit cycle where interest rates are ready to rise after being depressed for years.  According to K-Wave theory, after the 60-year economic cycle bottomed in 2014 we should see a gradual increase in rates as the economy recovers its former vigor.  Of course this process will take a long time to complete – possibly decades – but we’re likely at a point in the newly formed 60-year cycle where even a temporarily sharp run-up in rates won’t damage the economy or even necessarily hinder the stock market.  In fact, rising rates at this point indicates increasing demand for credit and a corresponding improvement in the economy. 

Following is a 10-year chart of the 10-year Treasury Yield Index (TNX).  The double-bottom in the interest rate is clearly visible between the years 2012 and 2016.  I believe this marks the long-term low in interest rates for the previous long-term cycle.


As long as rates don’t rise too high, too fast it’s very possible that stock prices will rise along with Treasury yields without much interference along the way.  An added bonus to the rally in T-bond yields is that bond prices are now in a downward trend.  This should serve to discourage investors who piled heavily into the bond market in the last few years.  It should also cause them to look more closely at stocks as a long-term investment once again, especially as painful memories from the 2008 crash gradually wear off.  The underperformance of corporate debt vis-à-vis equities should also encourage investors to take a second look at the stock market.  Below is the 1-year graph of the Dow Jones Corporate Bond Index.


The bottom line is that 2017 should see an increase in business activity across the board as the U.S. returns to a normal business cycle after being artificially suppressed by the actions of central banks for years.  Moreover, the decennial rhythm suggests that except for a period of potential weakness in the August-October time frame, year 2017 will likely prove to be a memorable one especially from the standpoint of the upside potential in both the equity market and the U.S. economy.

Thursday, January 19, 2017

Dow 20,000: A new beginning…or the beginning of the end?

After touching the benchmark 20,000 level last month, the Dow Jones Industrial Average has spent the last five weeks in a tight, narrow trading range just under this level.  Famed trader Jesse Livermore theorized in his pseudonymous book, Reminiscences of a Stock Operator, that stocks are attracted to major round number levels.  In the case of the Dow, the 20,000 level has generated more press and speculation among investors than any number since the formerly mythical 10,000 level was crossed in 1999.  Clearly Dow 20,000 carries a tremendous psychological significance, even if it’s a simple case of self-fulfilling prophecy. 

While the technical significance of Dow 20,000 can be endlessly debated, the action of the Industrials in the weeks following the first test of this level is of more immediate concern.  To wit, does the action of the last several weeks represent a normal consolidation (i.e. a “pause that refreshes”), or is it indicative of distribution (i.e. informed selling)?  The NYSE tape doesn’t suggest distribution since the new 52-week high-low differential has been mostly healthy in the last few weeks while market breadth has also been confirming, and in some cases leading, the advance.

It’s possible, however, that the extended effort to push above Dow 20,000 could be the prelude to a distribution phase.  In an earlier commentary we discussed the distinct possibility – based on the “echo” of the 10-year cycle – that the coming months could witness a blow-off interim top, followed by significant decline at some point later in the year.  Historically such declines have occurred in the late summer/early fall months, particularly in the seventh year of the decennial rhythm. 

A run-up above the Dow 20,000 level, should it occur, would undoubtedly generate lots of enthusiasm among the hold-outs in the retail investor camp.  There’s still a huge amount of money on the sidelines right now with small investors still skittish about buying stocks at current valuations.  But greed is a persuasive argument, and if the Dow breaks out decisively above 20,000 in the coming weeks it would serve as a magnet for sidelined money.  One thing that investors can’t stand more than anything else is watching an historic rally while they’re sitting in cash and not participating.  A breakout above 20,000 would likely trigger the primal instincts of these non-participants. 

Although the 20,000 level carries great psychological significance its technical significance hasn’t yet been cemented.  In order for 20,000 to become technically significant it must be established as a “seldom crossed line.”  A seldom crossed line is a concept developed by the late market technician P.Q. Wall.  Wall emphasized that when an individual stock or market index crossed an important price level only a few times in its history, the level takes on added significance as both a support and resistance level.  He wrote:

“If cycles exist at all there must by that very fact be equidistant lines of price on a vertical scale that rise as more energy enters the market.  These should be seldom crossed lines between which price tends to cluster about equilibrium points that mathematicians would call strange attractors but that we call magnetic midpoints….Electrons in an atom rise and fall in just such stair steps.”

Take for example the chart of the Dow Industrials shown below.  While many investors touted Dow 10,000 as a critical level back in the late ‘90s and early 2000s, that particular level was actually crossed many times on both the upside and the downside.  By Wall’s reckoning, this invalidated the 10,000 level as having major significance as a long-term support or resistance level – as history subsequently proved. 


Wall believed that when a stock’s price encountered resistance at a key level without breaking above it then finally succeeded in breaking out the rally that followed would be noteworthy.  For the Dow, the closest thing to a seldom crossed line is the 14,000 level.  This was established as a pivotal level when the Dow broke out above it in 2013, then proceeded to rocket all the way to the 18,000 level before wavering.  In the future, any major decline that tests 14,000 is likely to be turned back due to the established technical significance of this level.

As for Dow 20,000 you can see in the following snapshot of the last three months’ worth of trading action that the level in question hasn’t been penetrated on the upside yet.  This is an important first step toward the establishment of a seldom crossed line.  The Dow has yet to lay claim to this important designation of the 20,000 level, however.  The key ingredient here is time and the reaction of the Dow’s price line to this pivotal level in the coming days.


If Dow 20,000 turns out to be a seldom crossed line then the next attempt at breaking above this level should see an explosive rally with no immediate reversal.  In other words, it should cross above 20,000 only once and not look back for a while.  Accordingly, the next few weeks should be quite interesting and potentially historic depending on how the market behaves once 20,000 is finally crossed.

Thursday, January 12, 2017

Biggest challenge of 2017 directly ahead for gold, stocks

If you thought the pace of the head-spinning political events of the last two months couldn’t get any faster, think again.  One of the most critical decisions of President-Elect Trump’s reign will soon be decided.  The final verdict will have a direct impact on the direction of stocks, gold, and the economy in the months to come.

The decision in question is the Congressional challenge being made against the Affordable Care Act (ACA), also known as Obamacare.  Specifically, the requirement that individual Americans carry health insurance or else pay a stiff financial penalty is being challenged.  Earlier this week, Trump directed the Republican-led Congress to begin efforts at repealing and replacing the health care law “very quickly.”

The mainstream news media is sparing no expense in its efforts at turning public sentiment against a repeal of the healthcare law.  CNBC reports that “the number of people who owed Obamacare fines last year dropped by about 20 percent, while the number of Americans who benefited from financial aid for Obamacare plans grew to more than 5 million.”  The latest data was culled from 2015 tax returns to the Internal Revenue Service. 

IRS Commissioner John Koskinen said the number of people receiving Obamacare subsidies was up from 3 million in 2014.  For that year, customers got more than $10 billion in tax credits, with an average subsidy of $3,430 annually, according to the IRS.  Obamacare subsidies are available to wage earners with low and moderate incomes.  People who earn less money get more in assistance than higher earners.

Koskinen wrote that about 6.5 million taxpayers last tax season reported owing a total of $3 billion in such tax penalties for failing to have coverage in 2015.  In contrast, about 8 million people owed an Obamacare fine for lack of coverage in 2014.  Fines related to lack of coverage in 2014 totaled $1.6 billion.

CNBC reported that some 12.7 million people claimed one or more exemptions from the ACA-coverage mandate when they filed their taxes last year.  “The exemptions are wide ranging and can include having very low income, being incarcerated or having a close family member die recently,” according to CNBC. 

While pro-Obamacare media outlets such as CNBC are touting this news as confirmation that the ACA is “working,” the gorilla in the room is conveniently ignored.  The reason for the decline in Obamacare fines last year is that millions of Americans experienced a significant drop in income, which ironically is a direct result of the economic damage inflicted on businesses by the financial strictures of the ACA. 

CNBC also reported that the Republican-led Congress last week began taking steps toward repealing key parts of the ACA, which include the funding of premium subsidies and the individual mandate.  For the middle class’s economic sake, let’s hope the effort is successful.

You may be asking what all of this has to do with the price of gold or the stock market.  The answer is “everything!”  Repealing the individual mandate would serve as a huge catalyst for the U.S. economy and financial market.  It would lift a grievous burden from the shoulders of working-class Americans and would serve as a stimulus to consumer spending.  Economics 101 establishes that when wage earners are allowed to keep more of their income, they’re less likely to think twice about spending and investing it. 

One of the big reasons for the Nowhere-ville sideways trend in stock prices in the last couple of years is because people have been forced to think twice before spending or allocating money into investments due to the constraints of the ACA.  Pollsters have consistently underestimated the number of healthy individuals who choose not to carry expensive health insurance because they don’t consumer healthcare services.  Now those healthy individuals are being punished for their lifestyle choices by being forced to pay upwards of $1,000 per year in the Obamacare tax simply because they choose not to be insured.  This is an assault on personal liberty and common sense, and it has created a massive obstacle to full economic recovery. 

What can investors expect if the Obamacare tax penalty is soon repealed?  First, there will be an immediate uptick in consumer spending and overall economic activity.  Americans are always looking for an excuse to spend, and if they’re provided with what amounts to a massive tax cut they’ll express their relief by purchasing the items on their wish list that they’ve held off on buying due to personal budget constraints.  Businesses, moreover, will begin to pick up the pace of hiring since the healthcare mandate is no longer acting to suppress business investment spending.

A repeal of the ACA’s individual mandate would also revive the fortunes of publicly traded companies which serve the middle class.  Many of these companies’ stocks are components in our Middle Class Index (below).  The Index has been languishing for the last two years, but I’d venture that an upside breakout from the lateral trading range would shortly follow an Obamacare repeal.


As for gold, a repeal of the individual mandate would also likely have far-reaching consequences.  Gold’s fortunes would be helped, ironically, by success in getting the Obamacare tax removed.  While gold is primarily a safe-haven asset which feeds off investors’ concerns about the economic and political outlook, gold’s moves over the last two years have been closely correlated to the direction of the Middle Class Index.  As the fortunes of companies which serve middle class consumers have risen, so has gold’s price.  Conversely, last year’s major peak and subsequent decline in the Index has coincided with the July 2016 peak in the gold price and corresponding mini-collapse.