Background: As we know, there are complex, interesting relationships between stocks, bonds and oil prices. Having written about all three macro topics this summer, I wish to update and re-evaluate my comments, with additional comments on gold and silver thrown in as well. I'll begin with stocks.
The U.S. stock market: I have not been overtly bearish on stocks since spring-summer of 2011, when I was blogging on The Daily Capitalist (which has closed), though I have from time to time expressed substantial caution. One of those times was this past August, when I wrote Gold 2011, Apple (AAPL) 2012, Stocks 2013?. That article raised the question of whether U.S. stocks were a good asset that had temporarily gotten too expensive, as had occurred in the eyes of Mr. Market with gold and AAPL in 2011 and 2012, respectively. Here are some of the points made therein:
Stocks are serving too many purposes, I believe. Just as the no-show of inflation or crisis in 2011 did gold's price in, and a business cycle peak did AAPL's trading price in, so may the profits trend for stocks plus rising interest rates finally take its effect on trading prices of public companies.
As in 1977, 1978, and briefly in 1987, this could occur in the absence of recession. Investors could simply change their minds about trading prices, just as they did for gold and AAPL.
Later, I alluded to the quant Jeremy Grantham's 7-year multi-asset return forecast, writing:
If U.S. large caps were to "reset" to give the modest positive 2.4% annual projected real 7-year appreciation that Grantham projects for int'l large caps, I estimate a 27% drop in the SPY. This is because GMO projects a negative 2.1% annual return below inflation for U.S. large caps.
If U.S. large caps were to reset to give their historical 6.1% real return annually for 7 years, I estimate a 46% decline in the SPY.
The numbers are worse for U.S. small caps versus international small caps using Grantham's numbers.
Grantham has an exceptional long-term record, and I find his estimates numbers a bit chilling. I concluded as follows:
If the Fed can lose control of the bond market, how can investors be certain of a "Fed put" forever for stocks?
Here are some additional points that engender further cautiousness in yours truly. One is technical. The "generals" are rolling over. These are the mega companies that dominate the economy. For the first time since 2007, the Dow has broken below a bullishly-configured 50-day exponential moving average three separate times in a four-month period. It now sits at the 150-day ema. The above-linked chart is that of the SPDR Dow Jones stock prices occurring.
As was the case in 1999, the stock market has trended up even as corporate profits have stagnated or declined. One never knows, but the possibility of a significant correction or a bear market as followed the excitement of 1999 is real in my mind. Again, this is my concern based on the facts of stagnating corporate earnings.
Today's equivalent of the "sexy" NASDAQ of that bubble era is the Russell 2000, and unsurprisingly, it is showing good relative strength versus the DIA or the S&P 500, just as an overpriced Nasdaq did then. Here's a chart of the SPDR S&P 500 ETF (NYSEARCA:SPY) versus the iShares Russell 2000 Index ETF (NYSEARCA:IWM):
For thoroughness, here's the SPY versus the DIA:
We have been here before, in 1999-2000. The most speculative parts of the market have moved up the most.
Back then, the mantra was growth forever, so that ultra-high P/Es for very large companies were rationalized that they would grow 14% or so annually more or less forever. So, who needed 6% Treasuries?
Now, of course, the mantra is that it's all about the Fed. One of the these days, the Fed will have expanded its balance sheet from about $1 T to about $4 T - but it will have taken about five years. Meanwhile, despite moderate intrinsic economic growth assisted by deficit spending, the stock market has put on many more trillions of valuation than those $3 B extra Fed balance sheet dollars. Plus, importantly, the bond and commodities markets have added many trillions of additional valuation. The markets have moved much, much farther than the Fed's new money/bank reserves creation has. Thus the valuations can move back down, Fed notwithstanding.
In other words, the nonsense about new eras of stock valuations was the "hook" that sucked in the unwary in 1999-2000. Now supposedly problems related to bad debts can be solved, and are being solved, by the creation of new debts "paid for" by the Fed. Yet the debts remain; Fed liquidity has not cancelled them. If the Fed were really monetizing debt wildly and irresponsibly, would silver still be trading at 2008, and 1980 prices? Would not the hyperinflationists have more market action going their way?
There are other correlations that exist and cannot be wished away. One, which has no graph here, involves the lagged effects of tax increases (early 2013), reduced deficit spending (the sequester and the current impasse), and interest rate increases. More immediately, there is this from Gallup:
October 4, 2013
Americans' confidence in the U.S. economy has dropped sharply as the partial government shutdown caused by Congress' inability to pass a spending bill has become reality. Gallup's Economic Confidence Index's three-day rolling average stands at -34 for Oct. 1-3, down 14 points from Sept. 27-29, and the lowest such average since December 2011.Economic Confidence Plummets as Gov't Shutdown Begins
Please also click through to Gallup's multi-year interactive chart of confidence. This shows the current extreme degree of loss of confidence, similar to that seen in 2008 and 2011. Crashes were imminent then; might at least a correction be seen soon?
This loss of confidence leads to the second topic. Oil prices may be poised for a sharp fall, which paradoxically almost always means short-term weakness in stock prices, even though in the intermediate term, lower oil prices allow consumers and many businesses to attain increased real spending power.
Oil: Please consider this chart of WTI futures from FINVIZ:
Speculators in oil futures are at peak levels seen since 2008 (see green line for the opposite positioning of the speculative net long position represented by the sum of the red and blue lines). Yet when large bullish speculator consensus was seen in 2011 and again last year, oil prices were poised for sharp selloffs, as were stocks. In other words, those periods were "risk off" weeks. Worse from the bulls' standpoint, each of the speculative peaks in bullishness have occurred at similar or lower levels. Nothing is certain, but if past is prologue, look out for a consumer-friendly move lower in WTI prices (which would help to prolong the economic expansion).
A secondary reason to be cautious on oil is that it has held up so well against other hard assets such as gold, silver, and copper. Oil just might "catch down" to those metals and many other commodities that have declined sharply in price from 2 1/2 years ago is in my view a realistic one.
For completeness, What Might Speculative Extremes In Oil And Copper On The Futures Markets Imply? was the relevant August article that discussed the topic of oil prices and extreme speculative long positioning.
Now, to complete the trifecta, bonds:
The bond market: Also in August, I asked about A Bernanke Put For Bonds? and opined:
Many stock market bulls are complacent or confident, however one wishes to look at it. There is a common meme that there is a Bernanke put under the SPY. Of course, there is a belief that the long downtrend in interest rates is over...
In conclusion, I believe that there are good reasons to think that any "Bernanke or Fed put" would at this point be in favor of the beleaguered bond complex. Looking out to a possible new recession, even lower lows in Treasury bonds could (not "will") await us in this strange financial landscape.
Then, the 10-year Treasury note yielded 2.90%, almost 30 basis points above where the bond is trading now. That means nothing per se, except for continued massive bearish sentiment on bonds. From @not_jim_cramer comes this twitpic:
This is interesting.
Once again we are seeing this played out via the FINVIZ array. Every time the bond speculators have gotten aggressively bearish, the bonds have rallied in price (i.e. yields have declined) until the bearish specs have gone neutral or even net bullish:
The 30-year bond has a similar appearance (not shown; viewable on the same FINVIZ link).
I think that bonds may indeed be benefiting from a "Bernanke put," even though there is little doubt that their yield is "too low" for the level of nominal GDP growth the economy has been experiencing (or that which it has appeared to be experiencing).
Interim summary: In my view, a coherent case can now be made that difficult economic times may lead to an end (for now) of the bizarre "bad is good" investment theme. Bad is actually bad. Weak economic data, a poor earnings season, disquieting news out of Washington, etc. could finally lead markets to reprise, at least for a while, their behavior of summer 2011.
The scenario laid out herein is by no means a prediction. Given certain extreme sentiment/positioning data, it's one I am watching carefully and making provision for in asset allocation.
Addendum- precious metals: One of the interesting implications of this possible scenario involves gold, silver and gold mining stocks. In the above scenario, gold almost always bottoms and rises sharply. Perhaps with a lag, silver outperforms gold. Now that investors can own metals indirectly via ETFs, ardor for gold mining shares has cooled, but the miners have done well when gold prices have risen while oil prices have fallen. (This is logical, as energy is the second largest cost input for the miners, after labor.)
As many readers know, the most popular ways in the U.S. to invest in gold bullion is via the SPDR Gold Shares (NYSEARCA:GLD), and the most popular way to invest in silver other than physical ownership is via the iShares Silver trust (NYSEARCA:SLV). The easiest way to own a basket of large-cap gold mining stocks is via the Market Vectors Gold Miners ETF (NYSEARCA:GDX).
Investing/speculating in precious metals could be interesting right now. Silver has had virtually no correlation with the stock market. Silver is currently trading below the $25 level it reached after the Iran-Iraq War broke out in the summer-fall of 1980.
Any tangible asset that is below a reaction high price of 33 years ago may well have a requisite margin of safety that could satisfy a conservative investor. That said, one can look back to the 1950s and find that silver has tended to appreciate over time, and on a very long-term historical record, the current price around $22/ounce is not depressed. (In my view, very few assets in the U.S. financial markets are truly depressed right now.)
Of interest is that the Continuous Commodity Index may be making "the bearish-to-bullish turn," based on early technical data.
Conclusion: Every now and then, without warning (or with warnings visible only in the rear-view mirror), important trend changes occur, and another "New Normal" appears in the financial world, at least for a period of time. My opinion is that a coherent set of macro asset moves could be about to occur that involve drops in stock prices, oil prices and interest rates. If so, precious metals might be a refuge from such a storm.
All the above is stated as a possibility with little mention of the Fed. At some point, financial asset prices must tie in to the real economy and must relate to security of principal, distributable cash flows, etc. Bad economic news must again be bad for stocks and good news good for them. That's the Old Normal, and over time, there is no other way for markets to function. Might now be one of those times, leading to the scenario discussed above actually occurring sooner rather than later? Or, might Fed optimism about an end to quantitative easing spark a "risk off" move? (This would be a continuation of the "bad news is good" and vice versa current scenario.)
One way or another, we just might see the sentiment data described above turn out to be quite wrong, at least from a trading perspective, with the trading outcome in the weeks or months ahead as described in the title.
Additional disclosure: Not investment advice. I am not an investment adviser.