| | The Daily Reckoning | Friday, December 17, 2010 |
- The "sideways" market straight ahead...and how best to play it,
- Eric Fry on the Delphic Cult of Central Banking,
- Plus, Bill Bonner on parallel universe economics and plenty more...
|  | | Delusions of Power
| The Effects of Central Banking on Gold and Paper Currencies
| |  | | Eric Fry |
Reporting from Laguna Beach, California...
"When will the gold bubble burst?" CNBC's Larry Kudlow wondered aloud this morning.
A question to which your California editor would reply, "We know what gold is and we know what a financial bubble is, but we don't see any gold bubbles."
Perhaps Kudlow is referring to the fact that the gold price is rising...in response to the Central Banking Bubble. On its face, the idea is ludicrous that one man can steer an entire economy, simply by adjusting one little interest rate. The idea is a doubly ludicrous that one institution can nurture economic growth, simply by printing money. And yet, a nation of investors places its faith in the Cult of Central Banking, as folks like Larry Kudlow pay homage to Ben Bernanke every business day.
So far, the true believers have profited from their faith. It has paid well to embrace this cult and to trust the Delphic utterances of its high priests like Alan Greenspan and Ben Bernanke. But this whole central bank thing is getting a little out of hand.
The early central bankers admitted their fallibility. They would adjust interest rates up or down, depending on the prevailing economic circumstances, then hope for the best. But the more that the central bankers' tinkering and meddling appeared to succeed, the more they tinkered and meddled, and the more they believed in the power of their tinkering and meddling.
Eventually, the central bankers not only believed in the power of their intrusions and manipulations, but also in the wisdom of them. Before long, the central bankers considered their activities to be not merely a responsibility, but an imperative, a social duty; perhaps even a "calling" - a kind of Divine Right of Central Banking.
Armed with these potent delusions, central bankers around the world continue to meddle, day by day, month by month. And the investor-flock continues to trust in their mystical powers. This nearly universal faith in a priesthood of monetary medicine men is an extreme idea...taken to an extreme. It is a bubble - the effects of which are as varied as they are non-quantifiable. But one effect is very clear: currency values are perpetually in decline.
The more the medicine men prescribe their remedies and elixirs, the faster the purchasing power of their paper currencies erodes. Observing this trend, rational, forward-looking investors scout around for assets the central bankers are not trying to protect - assets that require no protection whatsoever. Gold is an obvious choice. It is the timeless choice of all investors who reject the Cult of Central Banking and who, therefore, distrust paper currencies as a store of value.
Gold is rising because Central Banking is in a bubble. But the gold bubble, itself, will not arrive until the Central Banking Bubble bursts - the moment when investors universally spurn the cult of Central banking as heresy, and rebuke central bankers, themselves, as agents of wealth destruction. At that moment, when gold is trading north of $10,000 an ounce...or $20,000...or $100,000, the gold bubble will have arrived. And when it does, we will be there to issue a "sell" recommendation.
Speaking of "sell" recommendations, Jay Shartsis, a seasoned options pro at R.F. Lafferty in Lower Manhattan, warned his clients on Wednesday, "A big stock market decline is coming."
To support his bearish call, Shartsis has highlighted a variety of market signals and sentiment indicators. Late last week, for example, Shartsis noted that the "CBOE equity put/call ratio hit .27 - the lowest in my memory. And now 8 days in a row, this ratio has been sitting below .60 - that's a sell signal."
Then earlier this week, Shartsis observed, "With the stock market near the highs for this move, there are only 127 new highs on the NYSE and 88 new lows. The new lows number is way above where it would be if this market was in good underlying shape. Yesterday saw 3% of all NYSE stocks at new lows - a condition that has happened only 36 times in the past. Two months afterwards, the S&P 500 was lower on 32 of those 36 instances."
Chart Source: SentimenTrader |
Lastly, Shartsis called attention to the nearby chart, as he remarked, "The chart displays the Options Speculation Index. It is a measure of total call buys plus put sales (those are bullish transactions), divided by total put buys plus call sales (bearish transactions). So this is a very comprehensive gauge and it now reflects the most bullish option trader sentiment probably ever recorded. No fear at all. Note that the index is considerably higher than it was before the flash crash last May. A big market decline is coming!"
Shartsis has been wrong before, of course. But he has also been right. We predict he will be one of the two this time around.
| | | The Daily Reckoning Presents
| Making Money from Nothing
| |  | | Vitaliy N. Katsenelson |
We are in a Cowardly Lion market, whose occasional bursts of bravery are ultimately overrun by fear that leads to a subsequent decline.
For the US stock market, the past ten years have earned the title "the lost decade." The next ten years probably will not be much different: The market will likely set record highs and multiyear lows, but index investors and buy-and-hold stock collectors will find themselves not far from where they started.
Every long-lasting bull market of the past two centuries (and we had a supersized one from 1982 to 2000) was followed by a sideways market that lasted about 15 years. The Great Depression was the only exception. Despite common perception, secular markets spend a lot of time in bull or sideways phases, and roughly an equal amount in each. They visit the bear cage only on very rare occasions.
This doesn't happen because the market gods want to play a practical joke but because stock prices are driven in the long run by two factors: earnings growth (or decline) and price-earnings expansion (or contraction). Though economic fluctuations are responsible for short- term market volatility, long-term market cycles are either bull or sideways if the economy is growing at a close to average rate.
Prolonged bull markets start with below-average P/Es and end with above-average ones. This vibrant combination of P/E expansion and earnings growth - which doesn't have to be spectacular, just more or less average - brings terrific returns to investors. Sideways markets follow bull markets. As cleanup guys, they rid us of the high P/Es caused by the bulls, taking them down to and actually below the mean. P/E compression - a staple of sideways markets - and earnings growth work against each other, resulting in zero (or near-zero) price appreciation plus dividends, though this is achieved with plenty of cyclical volatility along the way.
Bear markets are the cousins of sideways markets, sharing half of their DNA: high starting valuations. But whereas in sideways markets economic growth softens the blow caused by P/E compression, during secular bear markets the economy is not there to help. The US, however, has never had a true, long-lasting bear market like the one investors have experienced in Japan, where stocks have fallen more than 80 percent from the late 1980s to today. If the US economy fails to stage a comeback with at least some nominal earnings growth over the next decade, what started sideways in 2000 will turn into a bear market, as high valuations are already in place.
I should mention the role interest rates and inflation play in market cycles. They are secondary to psychological drivers, but important. They don't cause the cycles, but help shape their magnitude and duration. For instance, if interest rates and inflation had not been scraping low single digits in the late '90s, the bull market would have ended sooner and at lower P/Es. The higher inflation and interest rates that are around the corner will take their toll on the duration and P/E of this market too.
In sideways markets you as an investor need to adjust your strategies:
- Become an active value investor. Traditional buy-and-forget-to-sell investing is not dead but is in a coma waiting for the next secular bull market to return - and it's still far, far away. Sell discipline needs to be kicked into higher gear.
- Increase your margin of safety. Value investors seek a margin of safety by buying stocks at a significant discount to protect them from overestimating the "E." In this environment that margin needs to be even more beefed up to account for the impact of constantly declining P/Es.
- Don't fall into the relative valuation trap. Many stocks will appear cheap based on historical valuations, but past bull market valuations will not be helpful again for a long time. Absolute valuation tools such as discounted cash flow analysis should carry more weight.
- Don't time the market. Though market timing is alluring, it is very difficult to do well. Instead, value individual stocks, buying them when they are cheap and selling them when they become fairly valued.
- Don't be afraid of cash. Secular bull markets taught investors not to hold cash, as the opportunity cost of doing so was very high. The opportunity cost of cash is a lot lower during a sideways market. And staying fully invested will force you to own stocks of marginal quality or ones that don't meet your heightened margin of safety.
What if a sideways market isn't in the cards? If a bull market develops, active value investing should do at least as well as buy-and- hold strategies or passive indexing. In the case of a bear market, your portfolio should decline a lot less.
Regards,
Vitaliy N. Katsenelson,
for The Daily Reckoning
| | | | Bill Bonner
| Why the Correction is Winning the Fight
Against Fed Stimulus | |  | | Bill Bonner |
Reckoning from Baltimore, Maryland...
Here's the latest report from Bloomberg:
Industrial production in the US increased more than forecast in November and consumer prices slowed, indicating the recovery is gaining momentum without generating inflation.
Output at factories, mines and utilities rose 0.4 percent, the biggest gain since July, after a revised 0.2 percent drop in October, a Federal Reserve report showed today in Washington. The consumer-price index climbed 0.1 percent in November after a 0.2 percent gain the prior month, the Labor Department said.
Assembly lines are speeding up as business investment and exports grow and consumer spending accelerates, helping to buoy an expansion that Fed policy makers said yesterday isn't strong enough to reduce a jobless rate hovering near 10 percent. Price increases that are below central bankers' goal will boost the case to maintain the Fed's purchases of $600 billion in securities through June to spur growth.
Fed Chairman Ben S. Bernanke "is unlikely to withdraw accommodation until he sees a clear upward turning point in core inflation and a downward turn in unemployment." Hold on.
Are you telling us that after the Fed increases the core money supply by 300%...and says it is going to up it another 100%...consumer prices are still flat?
Yes? Hmmm...
And are you saying that slowing consumer price increases show that the "recovery is gaining momentum?"
Are you kidding?
Oh, dear reader... What claptrap! What nonsense! What balderdash!
The feds make the biggest stimulus effort in history. The Fed pumps $1.7 trillion into the banking system...with a promise of $600 billion more.
And consumer prices don't even budge? What happened to the most fundamental laws of finance? Have they been suspended? Have we entered some perverse, parallel universe?
Or does this mean what we think it means...that the downward tug of the Great Correction is so strong it overwhelms all the feds' efforts...the zero percent prime lending rate...the $700 billion stimulus bill...the $1.3 billion federal deficit...QE I, QE II...
That's no success story. That's a disaster.
Of course, all this money has to go somewhere. And there's no mystery about where it has gone. Commodities are hitting new highs. Oil seems headed back to $100 a barrel. Gold was over $1,400 an ounce.
Even US stocks are up about 25% this year.
As predicted, the feds' easy money has gone into speculative assets...not into the real economy. That's why one out of 10 people in the workforce is officially unemployed...and why, unofficially, it's probably more like one out of every 5.
And it's why consumer prices are NOT rising. Imagine what would happen if this were a real recovery? Imagine that the Fed increased the core money supply by 4 times. Imagine what would happen to consumer prices!
Poor Ben Bernanke must be tired of imagining. He will keep printing money - or so Bloomberg concludes - until he doesn't have to imagine anymore. He'll print until he reads about inflation in the paper!
But when will that be? How much wood pulp will Ben Bernanke have to chuck into the printer until consumer prices rise and unemployment falls?
We'll find out!
And more thoughts...
Is the US the "sick man" of the globe, asks a Reuters article?
It's a provocative headline. And the answer is probably "yes," in many respects.
"Report drunk drivers," says one sign. "Report Suspicious Activity," says another. "Report Unclaimed Bags," says a third.
Americans are being trained to denounce their neighbors. There's something a little sick about so much tattling.
And here's something that is not only sick, but fatal:
"Tax deal cruises through Senate," said yesterday's Washington Post headline. The House is supposed to follow.
Now, you take a place like Italy or Greece. The papers report that there are riots in Italy. And in Greece, anti-austerity demonstrations have turned violent.
You don't see that sort of thing in the US. Nope. Because in America our public servants really serve.
Some of the members of the Senate wanted the rich to pay more in taxes. Others just wanted to be sure the poor got more unemployment benefits and other giveaways.
But after hours of argument, the world's greatest deliberative body thrashed out a compromise. Forget the taxes. Forget the cuts. Everybody gets something.
Yes, dear reader, that's what makes America great. You might think it is reckless to extend the tax reductions, what with the nation going broke and all. Or you might think it hardhearted not to give more handouts to the little guy, what with the Great Correction underway. But it's always inspiring to see the peoples' representatives joining hands and doing something that is truly stupid. Lower taxes AND more spending too!
*** Meanwhile, the poor Europeans just can't seem to get with the program. They're cutting services. They're working to balance budgets. They're raising taxes.
And even still, investors sell their bonds!
No kidding.
"Spain debt yields near euro-era high," says The Financial Times.
See what good it gets you? You try to do things right and investors stab you in the back.
So you see, the Americans are right. Better to spend, spend, spend...until you go broke.
Regards,
Bill Bonner
for The Daily Reckoning
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Here at The Daily Reckoning, we value your questions and comments. If you would like to send us a few thoughts of your own, please address them to your managing editor atjoel@dailyreckoning.com
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| | The Daily Reckoning: Now in its 11th year, The Daily Reckoning is the flagship e-letter of Baltimore-based financial research firm and publishing group Agora Financial, a subsidiary of Agora Inc. The Daily Reckoning provides over half a million subscribers with literary economic perspective, global market analysis, and contrarian investment ideas. Published daily in six countries and three languages, each issue delivers a feature-length article by a senior member of our team and a guest essay from one of many leading thinkers and nationally acclaimed columnists. |
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