Grab Your Shorts, The Correction Has Begun 34 comments
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As I’ve noted in previous essays, this stock market rally has come much too far, much too fast. All told the S&P 500 is up over 48% since the March lows. This is unprecedented in the post-WWII era.
As I’ve pointed out earlier, this rally is mirroring the post-‘29 Crash rally to perfection. In fact, we just hit the “peak” in terms of both gains and days. This does not bode well for stocks. 
At current levels, the S&P 500 is pricing in a 40-50% growth in earnings for 2010 AND GDP growth of 4.5% for the 3Q09. I put the likelihood of both of these items at less than 1 in 100. Earnings may have beaten Wall Street estimates, but they did so by laying off workers en masse and cutting back on inventory.
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REAL earnings (including credit write-downs), in contrast, have fallen off a cliff. And they’re not coming back any time soon. The reasoning is simple: the CONSUMER IS DEAD. Despite incredible stimulus efforts, consumer spending fell at a -1.2% annualized rate in June.
In simple terms, the government is finding it harder and harder to get growth out of debt: it now takes a record $5 and change in debt to stimulate $1 in GDP growth. Failing another Stimulus Plan (I’m not in favor of this), 3Q09 earnings will be a disaster. And even WITH another Stimulus, there is NO CHANCE of earnings rebounding 50% in the next six months.
Historically, as famed economist David Rosenberg notes, by the time the stock market rallies 48%, the following have occurred:
§ Real GDP had expanded on average by 4.5%
§ Employment had rebounded an average of 850k jobs
§ Corporate profits had recovered 12%
§ Bank lending had risen an average of 5%
This time around, NONE of those has occurred. This market has risen largely based on momentum NOT fundamentals. And it’s beginning to show serious signs of weakness.
First and foremost, the financial bell-weather, Goldman Sachs (dotted line), which has been leading stocks (S&P 500= solid line) on the upside, has broken down.
As you can see, GS peaked a few weeks ago and has since posted a significant decline of more than 5%. Meanwhile the S&P 500 has only just started to come unraveled.
Besides this, the Baltic Dry Index has failed to confirm the July rally in stocks. If you’re unfamiliar with the Baltic, it measures shipping rates around the world. When people are moving a lot of goods and ships are in high demand, the Baltic rises. In contrast, when things slow down and ships needed less, the Baltic drops.
And as you can see, the Baltic (dotted line) has been dropping steadily against stocks (solid line) since June, which indicates that claims of economic recovery and growth are just that: claims, NOT facts.
The S&P 500 has finally begun to acknowledge these realities and is tipping over. As my friend and colleague Brian Heyliger noted in Tuesday’s essay, we could well drop to 930 in the next week or so.
If you’ve not yet gone short, don’t worry. Thursday's performance gaming due to options expiration could very well offer you a good entry point.
You see, August’s options expire on Friday. Because of this, traders who are underwater on their positions will try to push the market higher in order to close out their positions for a gain. Historically the day before expiration (Thursday) sees the largest market jumps as traders pile in pushing the market higher.
In light of this, I would not at all be surprised if the S&P 500 rallies hard tomorrow. When and if it does, you should get a good entry point to establish some shorts. Once options expiration is over after Friday’s close, the fundamentals should take hold of the market again, pushing stocks lower.
Invest accordingly.
Good Investing!
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On Aug 19 02:15 PM Rick Urban wrote:
> Graham Summers is an irrational bear. All gloom doom. I made tons
> of money since March lows. Locked some gains in and put them in fixed
> income at 5-6%. Still left money in the market and I don't need this
> money for many years. So, the time is on my side. You can analyze
> your charts as much as you want. It tells you a lot about the past
> and very little about the future. Comparing something what happened
> 1929-1933 is also useless as we live in completely different times
> and economies. It just tells you that something happened in the past
> and could happen again. But anything could happen. What are the odds
> and when something can happen, nobody has an idea. Don't make any
> investments decisions on emotions. Yes it is hard! When I read, “my
> fear is…” I don’t need to read any further. In the market you have
> to act as a smart robot. No emotions what so ever.
> First, the March lows were reached because of huge fear and panic,
> accelerated with articles such as this. It had absolutely nothing
> to do with most of the company’s fundamentals. That is why it is
> important to have good solid companies in your portfolio.
> In slow economic times the revenue is going to go down. But just
> look at how healthy these companies are. It is really impressive.
> When growth returns, and you bet it will the earnings will be spectacular
> because of the cost cutting during slowdown.
> Bottom line is I am making money. I know absolutely nothing about
> the future, however common sense is telling me this is not the end
> of the world, especially not the end of America. Having said that
> I believe that my stock portfolio will be higher two years from now.
> All I am doing is that from time to time I lock some gains in and
> sell some stocks to replace them with the one I believe will do better.
> That requires some homework though.
> If you check my posts you will see I was saying the same in March
> and as a result of it I made money. Be a pessimist or an optimist.
> It’s your choice. I prefer to be the latest. All I can say is good
> luck to all of you.
On Aug 19 02:15 PM Rick Urban wrote:
> Graham Summers is an irrational bear. All gloom doom. I made tons
> of money since March lows. Locked some gains in and put them in fixed
> income at 5-6%. Still left money in the market and I don't need this
> money for many years. So, the time is on my side. You can analyze
> your charts as much as you want. It tells you a lot about the past
> and very little about the future. Comparing something what happened
> 1929-1933 is also useless as we live in completely different times
> and economies. It just tells you that something happened in the past
> and could happen again. But anything could happen. What are the odds
> and when something can happen, nobody has an idea. Don't make any
> investments decisions on emotions. Yes it is hard! When I read, “my
> fear is…” I don’t need to read any further. In the market you have
> to act as a smart robot. No emotions what so ever.
> First, the March lows were reached because of huge fear and panic,
> accelerated with articles such as this. It had absolutely nothing
> to do with most of the company’s fundamentals. That is why it is
> important to have good solid companies in your portfolio.
> In slow economic times the revenue is going to go down. But just
> look at how healthy these companies are. It is really impressive.
> When growth returns, and you bet it will the earnings will be spectacular
> because of the cost cutting during slowdown.
> Bottom line is I am making money. I know absolutely nothing about
> the future, however common sense is telling me this is not the end
> of the world, especially not the end of America. Having said that
> I believe that my stock portfolio will be higher two years from now.
> All I am doing is that from time to time I lock some gains in and
> sell some stocks to replace them with the one I believe will do better.
> That requires some homework though.
> If you check my posts you will see I was saying the same in March
> and as a result of it I made money. Be a pessimist or an optimist.
> It’s your choice. I prefer to be the latest. All I can say is good
> luck to all of you.
This seems to be the conventional thinking because it is counter to intuition: if the market hasn't behaved according to fundamentals for the past five months, why should it now? I posit that the govt can only manipulate things so far. Just look at the desperate comments from JP in Asia on commodities to prop up those markets earlier this week to prevent a further slide. Then you have El Erian and Buffet simultaneous trumpeting the decline of the dollar today. Finally you have this pathetic oil market manipulation to boost up equities today; the floating storage is so large people have lost an accurate count! Folks, the BDI is crashing - cnbc hasn't mentioned it once...hmmm!
All of the above indicates to me that the powers that be are running out of ammo, and faster than you think They've done great job of wringing out shorts so far with all of these jerky moves of late. Just when you think we are about to push up and when all the bears are looking to scalp on little up moves, is when things slide down. It will be a gradual descent imo. People seem to think the govt has infinite power in keeping this thing up. Without a second stimulus (which would seal our fate down the road)...fuggetaboutit! Lets not forget that the first stim. is 37% tax cuts which wont do anything. And we've spent 600k per job to create each new job of late! Nice one.
Yes, perhaps we pilots are all the same, however being a pilot or an investor requires among other things discipline, taking calculated risk, homework, planning and fear control.☺
> Folks, the BDI is crashing - cnbc hasn't mentioned it once...hmmm!
Crashing? It's down what, 33% in 2.5 months? Sounds like a huge move, until you consider that:
1. It was up 200% in the 2 months prior.
2. It was down a similar amount between July 1 and September 1 last year - and then fell another 50% in September, and then another 75% in October. All told, it fell about 91% in four months.
Now THAT's a crash.
The consumer is dead for 3-10 years, depending on if we become Japan or Japan light. The people that think the consumer will spend as they have the last 10 years just don't understand the metrics.
Alex
On Aug 19 07:09 PM Rick Urban wrote:
> All I can do is to ask you bears out here: DID YOU MAKE MONEY THIS
> YEAR? The way you view the world, I doubt it. The growth will come
> where it always comes from. Consumer! It may take some time, but
> it'll come. I don't understand why it is so hard to comprehend.
>
> Yes, perhaps we pilots are all the same, however being a pilot or
> an investor requires among other things discipline, taking calculated
> risk, homework, planning and fear control.☺
>
On Aug 19 09:54 PM Alex_G wrote:
> Current equity bear, added in march, been taking money off the table
> the last 2 weeks, went all in w/ leverage in distressed debt starting
> in April, have taken the leverage off the debt but have kept the
> profits invested. So, yes, we have made a boatload this year.<br/>
>
> The consumer is dead for 3-10 years, depending on if we become Japan
> or Japan light. The people that think the consumer will spend as
> they have the last 10 years just don't understand the metrics.<br/>
>
> Alex
1 - My sales are down 60% from last year, and 80% from '05 highs, yet my fixed expenses have all shot through the (it ain't inflation though just ask "experts" and WDC) roof. AND China is chopping prices on any commodity item so I would have to sell below profit IF it was even selling. By the way, the whole "inventory restocking" theory is moot with Just-In-Time and the fact the last two employees at most businesses are doing nothing (the recent "uptick") except fixing machines, painting and cleaning the shops. Without sales, these customers' employees won't last much longer employed either. Good news though, so many will come off the back end of unemployment and no longer be counted so the statistic will look great!
2 - All I have left in the market are holdings for the long haul. Since I'm not selling, I haven't "made" anything. But I'm sure the morons in WDC will be changing that little rule as soon as we close the year high.
Those two reasons are why I haven't made money. Not because I irrationally believe in falsified accounting reports coming from the banksters on Wall Street.
On Aug 19 07:09 PM Rick Urban wrote:
> All I can do is to ask you bears out here: DID YOU MAKE MONEY THIS
> YEAR? The way you view the world, I doubt it. The growth will come
> where it always comes from. Consumer! It may take some time, but
> it'll come. I don't understand why it is so hard to comprehend.
>
> Yes, perhaps we pilots are all the same, however being a pilot or
> an investor requires among other things discipline, taking calculated
> risk, homework, planning and fear control.☺
>
Mr. Summers does bring out the differing viewpoints.
Long run, no question, whether as a result of
1. currency devaluation (think 1982-2000 market coming on heels of 70's recognition of the 40 year period of currency devaluation from 1930-1970)
2. increased population growth and accumulated and aggregated innovation which drives all economic activity (think caveman and indoor plumbing)
3. bounce off of panic driven redemption based forced selling of non owner managed equity positions (think funds of any sort, not individual traders or investors such as ourselves)
4. believe it or not, much better accounting transparency than the "emerging" market world (trust me, gripe all you want, the US is incredible in its ability to disclose what other cultures use a large broom for)
the US equities market will explode to the upside.
Period.
How high? Oh, how about somebody tells you in 1981 that the S&P 500 of 100 will be fifteen times that in less than 20 years; or in 1950 tells you five times in less than 15 years.
How about simply twice its latest peak by 2020, say 3000 to 3500 or 2100 by 2013?
Great.
Now look at nominal versus real.
1950 S&P 500 average = 18
1950 world gold price = 35
ratio= 0.5
1960 S&P = 55
1960 gold = 35
1.6
1970 S&P = 82
1970 gold = 36
2.3
1980 S&P = 120
1980 gold = 600
0.20
1990 S&P = 330
1990 gold = 400
0.83
2000 S&P = 1500
2000 gold = 300
5.0
2010 S&P = 1200
2010 gold = 1200
1.0
2020 S&P = care to make a prediction?
2020 gold = ditto
point of the foregoing is that while the currency numbers are bigger, the purchasing power and yields vary widely
1970, $2500 bought a nice reasonable car
2010, $20000 buys the same (maybe)
solve for i and you get 5.3% annualized rate of devaluation
the 1960 S&P 500 with 50 years and 5.3 plus pop growth and productivity gains equals say 7.5 and you get 2045 in 2010
in March 2009, 680 on the S&P 500 represented a 15% discount to the devaluation adjusted S&P 500 of 1967 whose average was 92 using my example discount rate of 5.3% (check the 1967 base of 100 on the CPI All Urban not the current mickey mouse base year and you'll see you get a cpi of 880, which is a slightly higher discount rate)
what does this say... simple, today's equity market values are cheap by half to 2/3 or to say, an S&P 500 of 2000 to 3000 is very realistic given the devaluation of the currency;
however, if you reduce it all to real returns and factor in the effect of tiered income taxes, then the long run really pales because of the confiscatory nature of fiat currency devaluation, thus you are left with the classic try and buy low and sell high and do so with a turnover that fits the market parameters not some pre-conceived investment notion or conformance to tax law reqs (ltcg)
and that's where the market manipulation that David Fry refers to and that Dubrunner herein referred to comes into play
Mr. Summers is right. There will be an orchestrated Labor Day drop sufficient enough for the powers that be again to cover THEIR mid August shorts and pick up the cast off bargains ala mid Nov 08, late Feb-early Mar 09, late June-early Jul 09. However, his use of prior period charting and examples is useful only to illustrate that this game has been played for a very, very, very long time. If you trade, I learned that opinions hamper one's flexibility on a daily, hourly, and minute to minute basis. Better to have a morning view and see which way the wind blows. If you invest, hey, by golly, go with the flow and right now the S&P 500/gold ratio of 1 or below says buy baby buy, only keep tight rein on those equities and don't let others stampede you off guard
say what you want about economic difficulties, Guy Lerner calls a topping market an affair that takes time and a bottoming market an event which happens boom and for good reason, things go up more than they go down.
Personally I'm seriously short at the moment but the inevitably of "da Boyz" and their need for greed will most assuredly give me the out and from there, long until the November blowoff and then zero until real data shows up in 2010 because the late 40's malaise in the US is proof enough of the fact that the public sector is no equal of the private one when it comes to sustainable growth
I know you can argue that 20% of the recent S&P 500 was overheated financial mickey mouse (witness AIG et al). I know you can argue that 15% real unemployment is a serious drag on the economy. I know you can argue that a liberal Democrat regime is hardly conducive to supporting private sector initiatives. I know you can argue that China is indisputably going to reign supreme.
Guess what? China has an absolute impossible to mitigate demographic disaster awaiting them in less than half a lifetime. Japan is already feeling it. On politics, hey Roosevelt and his cronies outright stole our "Lawful Money" with the gold confiscation along with socialization at that time which was unbelievable and the pendulum swung back. The majority of un and under employed people will be absorbed over a period of time that represents a relative blip in economic time. The last item is a biggie and one that I wonder what will fill the gap.
So, because we have no free markets only "managed" ones, I trade. Otherwise, I would invest in the American miracle because until you live abroad (not just travel, but live), it is unfathomable just how different the US is and in the economic sense, better.
Graham, just in case of the infinitesimal possibility that you are wrong about this, I hope that you man up and post a series of articles, say every two weeks as the charts diverge, explaining the cause for the divergence. And what the sensible stock investor ought to do about it.
Headline says
Data paving recovery's path......
then below it a list of other articles
• Mortgage delinquencies hit another record | Loan rates dip
• U.S. jobless claims rise by 15,000 in latest week
Say what? Is anybody home at MarketWatch?