I have long argued that the main driver of this market was P/E expansion, caused by a return to normalcy of the spread between the earnings yield and the 10-year note among other mundane things like QE, Europe, and Japan. This was not a straight line, for sure. I first thought the bottom would be around 1190, back in July 2011, then I dared to venture a 1600 target in the middle of the October 2011 correction. The last upgrade to 2000 was easy, in April 2013. By then world had caught up with the P/E story, household net worth was making new highs, and it was Goldilocks all over again.
Well, even though we can debate whether sentiment has shifted or not, and whether the price of X should be Y, the fact is that President Obama has not heeded my call of a month ago: he is killing the Golden Goose by letting Chairman Bernanke go. Not only that, but the press reports today that he favors Larry Summers over Janet Yellen to replace him.
Larry Summers. Rarely have I seen such a one-sided Wikipedia report card. But the facts are hard to ignore. Not only the man lost $1 billion for Harvard by allowing it to dabble in derivatives, but he also had the University cough up $26.5 million to settle his protégé Andrei Shleifer's insider trading profits. For those of you who don't remember, Shleifer, under a U.S. government contract, bought Russian stocks while advising Russia on its privatization program. Why was he Summers' protégé? That's unknown and immaterial at this point. Suffice it to say that in 2005, the Harvard Faculty of Arts and Sciences voted a motion of no confidence against Summers, and that he resigned a few months later. This reminds me of when Jon Corzine was rumored to be in the running as Treasury chief …
Be it as it may, we will get what we voted for. What concerns me is the impact on the economy of course, and the markets. On the economy, it will be difficult to do much damage. Already, ObamaCare is postponed, and with housing and corporate profits picking up, the deficit picture is improving. That too was to be expected. The last thing this Administration wants is to derail the train, as it is lining up the troops for 2014 and 2016. The risk I see with Summers is simply his obvious political agenda. If you want Fed independence, this is the wrong person. Since the risk to QE is inflation, I have started to buy Silver (HL) and I just shorted the Ibbox High Yield Corporate (HYG).
As for stocks, here is where we are at. Short term, we are breaking the bottom of the regression channel that goes back to the June 24 lows, exactly a month ago. For those who are not familiar with this fairly conventional analytical tool, a regression channel is defined by the grey line in the middle called the regression line, and the two bands below and above, in red and blue, which are the parallels to the regression line at a distance of one standard deviation. That being said, in the meantime, we went from S&P 1560 to S&P 1698, intraday, for an 8.8% move. So a correction could naturally happen, especially since Q2 earnings are now in the box.
However, the longer term picture is more concerning. I posit that the whole move from the 2009 lows has been led by Chairman Bernanke's policy. We climbed a wall of worry until recently, which yielded a 155% return from the 666 intraday low of 3/6/09. If you are a numerologist, have fun.
But look to the right of the chart. I simply drew two additional regression channels, one going back to the March 2009 lows, the other one to the October 2011 lows. The top standard deviation lines converged at S&P 1701 on July 16, mas o menos. We did not test this level, and the HYG is now weakening pretty quickly. I posit that to break this long term resistance, we will need a new wave of believers. If I throw Bernanke out, and Summers in, the odds are we are going to have a new wave of disbelievers instead.
I am back to 40% net long for starters, to include a short HYG. For the record, this is July 24, 2013, 11:50 EST. The S&P 500 (SPY) is at 1691, the Composite 100 (QQQ) is at 3595, the 10-year note is at 2.59%, and silver at $20 an ounce.
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