2nd Fed Trend a Success… Pullback is Here

Yesterday, I wrote about the Fed statement day trends. History suggested, a pre announcement market of +-0.50% which was spot on with the day closing green; it closed neutral. Today, the post Fed model called for lower prices which is spot on as well. This is all in the context of the pullback I forecast two days ago.

Today’s action so far is nasty with my entire screen red except for the items that go up during a down market. Days like this bring the market closer to the eventual bottom, but it’s not there yet. Patience…

What is a little different right now is that very few sectors look appealing into the weakness, something that hasn’t been the case since 2011. Additionally, the treasury bond market, which I have been bullish on all year is flirting with the unchanged level when it should be sharply higher.

This will all sort out sooner than although I am very, very glad that we raised so much cash just a few days ago!

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Bulls Hangin’ Tough

With the bearish seasonal headwinds this week, the bulls have done a nice job not giving up any ground so far. In fact, the bulls powered ahead on Tuesday and held firm on Wednesday. It certainly looks like the Dow and Nasdaq 100 want to join the S&P 500 at new highs this week. Although the S&P 400 and Russell 2000 have been laggards, they have certainly led the parade over the past week.

The real news so far this week has been in the bond and gold markets. As you know, I have been very positive on bonds since late last year, often calling myself “the only bond bull in America” or more recently, “no one”, as in “no one called this rally in bonds.”

Long dated treasuries continue to trade well and I expect some of the bears to throw in the towel now. And that’s why I am getting a little nervous being so bullish. It’s time to tighten up those stops and contemplate taking some chips off the table. With the Fed continuing the taper and the economy supposedly doing better, the bond market ain’t believin’. Something dark lies ahead.

Gold on the other hand is now falling sharply towards the sub $1200 target I have mentioned of late. Unless the shiny metal immediately reverses course, it’s going to be ugly until the metal hits bottom, probably next quarter.

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All Time Highs on Tap

Despite significant warnings from the S&P 400 mid caps, Russell 2000 small caps, Nasdaq 100 and a host of sectors, the Dow Jones Industrials and S&P 500 are poised to see all time highs this week. The headlines will look nice and investors may cheer, but serious damage remains beneath the surface over the intermediate-term.

Yes, we remain long various indices and sectors, but we will likely lighten up or hedge on a quick spurt higher. If we do see a run to new highs, it will be very telling to see how the lagging indices perform versus the leaders.

Additionally, as I have written about many times before, I think I have been just about the only long dated treasury bond bull around. It has been a fantastic run. I am keenly interested in how treasuries behave should stocks breakout to the upside. For much of 2014, bond bulls have stepped up into every pullback and that indicates something negative brewing on the horizon for the economy or stock market.

Longer-term, the bull market is intact and certainly has the look and feel of being in the final stage which can last months, quarters or even a few years. Evidence for this conclusion can be seen in the divergence in the major indices as well as the fierce sector rotation into REITs, consumer staples and utilities.

The best scenario for the bulls would have stocks shoot higher and form a top over the next month. From there, a pullback or correction lasting into the summer would restore some pessimism and repair some of the internal damage. That could set the stage for a better leg higher later in the year above Dow 17,500 or even 18,000.

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Economy “Booming”

288,000 NEW jobs created in April.

Unemployment rate plummets to “only” 6.3%.

The U.S. economy is back!

Does it feel like that to you or your friends?

My thesis since the crisis began has been that post financial crisis recoveries are frustrating. They tease and tantalize on the upside but rarely deliver. GDP growth never hits “escape velocity” and unemployment remains stubbornly high. With the government printing a 6.3% that’s hard to still say “stubbornly high”.

Digging into the details a little more, the labor force participation rate fell to 62.8%, the lowest level since 1978. Almost 1 million people left the labor force. Zero Hedge wrote a good piece about this here.

With wages not growing and people giving up on looking for a job, this is the main reason markets are not celebrating the 288,000 number. Additionally, it seems like at least once over the past few years, we see a monthly print close to 300,000 new jobs created only to have cold water poured on it over subsequent months.

Remember, the actual news isn’t as important as the markets’ reaction to the news. Before you fire off an email to me that the Russia/Ukraine situation led to Friday’s underwhelming performance, stocks looked crummy in the pre-market minutes after the jobs numbers was released. We “should” have seen a huge up day in stocks and really bad day in bonds. That just wasn’t the case and yes, I understand that there were geopolitical events in the air as the day wore on. Monday could be a very telling day for the short-term.

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Stocks Remain in Pullback Mode

With the major indices down 4-8% I am once again getting questions whether the bull market has ended and a multi-year decline is unfolding. I don’t think so.The New York Stock Exchange Cumulative Advance/Decline line recently scored an all time high. When bull markets end, we typically see this indicator peak months, quarters or even years before the Dow and S&P 500. The same can be said of the high yield bond sector. Bear markets are usually associated with restrictive monetary conditions and excessive valuations. It’s very hard to argue we are seeing those right now.

This decline continues to look like a pullback, meaning less than 10% in the Dow and S&P 500. It will end when the weaker bulls give up hope and thrown in the towel, something that has not happened yet. Sometimes that takes a few weeks while others it takes months or even quarters. Remember, my 2014 forecast called for a digestive type year like 1992, 2004 and 2007. That’s what we have seen so far.

Stocks are very oversold in the short-term and on their way to oversold in the intermediate-term. However, as we saw on the way up, overbought and oversold can get more overbought and oversold until a reversal takes hold. Just watching the volatility (fear) index, VIX, breach 20 should give us a hint that the decline is coming close to the end. We have already seen volume in inverse ETFs begin to spike which indicate that investors are running for downside protection.

What’s making headlines right now is the veracity of the decline in the former high flying market leaders like biotech and Internet. Those sectors led on the way down and I am keenly watching them for signs of stability and life. I am also watching them because we now own sizable positions in our sector program. It’s too early to tell if they have peaked for good, but once the market bounces, these should rally hard.

It doesn’t look like the stock market has hammered in a good bottom yet. The typical pattern would see a rally that lasts more than a day or two followed by another decline below the previous low. Today was only day one of a rally. Aggressive and nimble traders can look to sell a 1% rally and try to buy again at new lows, but that should only be contemplated for traders who can sit and watch and have a plan. Otherwise, there should be a better buying opportunity this quarter. Investors continue to hide in consumer staples, utilities and REITs on the equity side and my favorite investment that everyone hates, long-term treasury bonds which we happily have a big position in our global macro strategy.

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2014 Fearless Forecast

It’s really embarrassing that it’s been almost two months since I began speaking about my thoughts for 2014, yet I have been unable to mass distribute them. Shame on me! So far, to those folks who have read them, the comments and questions have been great. Keep them coming!

Regular readers of Street$marts and this blog won’t be surprised at most of the forecast, but I did throw in a few new items. As always, I had a lot of fun thinking about it and creating it, although it has no bearing on how we manage money for our clients.

U.S. Stock Market – After an epic 2013 for the stock market, what can we expect for an encore? To begin with, it’s a mid-term election year and the second year of the president’s term. Historically, that hasn’t been so kind to investors with some of the largest declines in history as well as the end of some bear markets. More recently, however, 2010 and 2006 were kind in the end, but volatile during the year.

Looking at the big picture, there are no signs yet that the old and wrinkly bull market is ending anytime soon and my analysis still has upside projections to at least 17,000. We typically see a number of warning signs with various leads times, but only one of those are in place today and that may be corrected. Those warnings signs may set up later, but at this time, stocks remain the place to be on any dips. With that said, a routine, normal and healthy 5-10% bull market pullback should be seen during the first quarter that leads to more all-time highs later in the year.

On the index front, although the major US indices are highly correlated to each other, it’s time for the Russell 2000 index of small caps to cede leadership to its large and mega cap cousins.

U.S. Stock Market Sectors – Technology is usually the group of choice each January and I continue to rank it as a market performer at best. I wouldn’t run out and load up on this sector unless we saw a sizable market correction. As the economy and markets are late in the cycle, sectors like REITs and energy should provide solid relative performance, especially later in the year. Even perennially hated utilities should grab a bid.  With my long-term positive stance on the dollar, it makes liking commodities more difficult but I do believe 2014 will reward buying the dip and selling the rip in this area.

On the wild side, biotech, pharma and healthcare should go parabolic during the first half of the year with the social media group also a possible candidate. Investors should keep in mind that parabolic rallies like the Dotcoms never, ever end by going sideways to rest.  They end in disaster and ruin like we saw with crude oil in 2008.

It’s rare for me to really hammer on sectors in the annual forecast, but after five years of strong outperformance, I am very negative on consumer discretionary and retail. I think 2014 will be the beginning of the end for this trade and similar to my stance on the small caps in general, I would pair this with a long in large or mega caps.

All in all, 2014 looks to be more of a digestive year, like 2011, 2004 and 1992 than a full fledged bull or bear year.

Volatility – There are many ways to discuss volatility, but the one that resonates well with me is that of a sine wave. It moves fully from one side all the way to the other, like a pendulum. While the market may not operate so neatly, low periods of vol are usually followed by higher periods of vol and vice versa Put another way; volatility compression leads to volatility expansion and volatility expansion leads to volatility compression.

2012 was largely a non volatile year, but 2013 was downright boring from a volatility standpoint. That can be traced to the Fed’s QE Unlimited, which will be going away. So 2014 looks to be a whole lot more volatile than 2013 and probably 2012. If so, that will likely lead to 2015 being even more so as volatility normalizes.

In short, the investment play is to buy vol anytime it heads back to the low end of the range and sell it into spikes, which there should be many.

Long-Term Treasuries -I am so beyond sick and tired of hearing the pundits proclaim that “bonds are in a bubble”. Statements like those absolutely wreak of ignorance. Bubbles are all about greed, clamoring and fear of missing the boat. They are formed in many stages with the final one being a total rush into the asset, primarily by the public. During the modern investing era, new products are launched to give greater access to Main Street. Your neighbors all own the asset and it’s all over the media. There is nothing about bubbles that has pertained to the bond market and there never will be.

The secular bull market in bonds may have officially ended in mid 2012,  but that doesn’t mean and shouldn’t mean that interest rates are heading higher in spike fashion. Clearly, over the coming years and decades, rates will normalize and head back to mid single digits unless the Fed makes a huge blunder like the Arthur Burns led Fed did in the 1970s.

I envision rates heading higher like we saw in the 1950s and 60s, slowly and gradually. Two steps up and one step back. We have already seen the 10 year note yield double as the first stage of the bear market began. I do not believe we will see anything close to a doubling anytime soon. Rather, as I first wrote about and publicized last November, bond market sentiment had become so negative that a rally in bond (decline in yields) wasn’t too far off.

For 2014, the bond market should offer a solid risk/return profile, at least for the first half of the year as inflation remains nearly non-existent, our economy slows and Europe deals with deflation, all against the backdrop of the Fed reducing its purchase of treasuries, for now. While the 3.50% to 4% area on the 10 year looks like a good intermediate-term target, it should not get there right away and investors should not become perma bears on bonds.

Corporate bonds – This group has seen a much stronger rally from their 2013 lows than their treasury cousins, but still behaves well and should see strength during the first half of 2014. Further down the risk spectrum, high yield bonds will continue their 2013 position of lagging and underperforming as the slightest ripple in the liquidity stream could upset this apple cart quickly.

Dollar – I am posting the exact comments as I did last year. Since THE bottom in 2008, the dollar has been in a trading range which I have stated is the beginning of a new, long-term secular bull market. Anyone who has bought strength or sold weakness has been punished and that’s likely to continue for a while before the greenback finally breaks out above 90 on its way to target number one at 100 over the coming years.

I remain very bullish on the buck long-term and believe it can be bought into weakness for a long time, especially given the Fed’s exit from QE, the ramping up of QE in Japan and the anticipated QE in Europe.

Gold – The yellow metal’s secular bull market is not over and it will take another year or so to reinvigorate it. Gold saw twin price lows in the $1180 area that should lead to test targets of $1360, potentially $1440 with a chance of seeing north of $1500 before ultimately turning lower again. When the ECB hops on board the QE bandwagon, look for gold to break out above $2000 later this decade on its way to $2500 and higher.

Commodities – I continue to favor the agricultural and tropical commodities like wheat, corn, beans, sugar, coffee and cotton over the rest with corn being among the candidates for trade of the year. They have been under pressure for a while and weakness should be viewed favorably.

Inflation – I still feel like a broken record year after year after year after year, but I don’t have many concerns about inflation, at least not until we get to the other side of the next recession. The Fed is trying to engineer some healthy inflation, very unsuccessfully I might add. $5 TRILLION in QE didn’t produce any. Money velocity continues its downward spiral. Housing prices are stable. Wage growth is essentially zero and the banks are holding trillions of dollars on reserve with the Fed. This economy still has rolling whiffs of deflation, but nothing compared to the outright deflation in Europe and Japan.

Economy – As we start another new post financial crisis year, no one should be shocked to learn that the masses are positive on our economy yet again with projected GDP growth rates in the mid 3s. I think I have said it every year since the recovery began, but I will repeat it again. We are living through the typical post financial crisis recovery that teases and tantalizes on the upside and worries and frets on the downside. As with other post financial crisis recoveries around the globe, our economy will not return to an historical sense of normalcy until we get to the other side of the next recession.

Federal Reserve – It’s a whole new ball game for the Fed in 2014; or is it as Janet Yellen takes over for one of my financial heroes, Ben S. Bernanke. I believe history will judge Bernanke as the single greatest Fed chair of all-time who should have been given hazard for having to sit and endure so many hours in front of the incompetents in Congress.

With all of the permanent voting members but Jeremy Stein in the dove camp, Richard Fisher and Charles Plosser will have their hawkish hands full this year dissenting on any vote that doesn’t involve continued tapering. Keep in mind that Fisher, Plosser and Jeff Lacker were the three amigos who fought cutting rates and turning on the fire hoses during the summer of 2007 when the sub prime crisis was unfolding.

The Fed’s multi-year money printing program or QE will sadly come to an end in 2014 reaching my longstanding target of $5 trillion. I vividly remember throwing out that number almost four years ago on CNBC’s Squawk Box and was almost laughed off the show. That one comment generated more emails than any other forecast I have made on TV.

As I have said for more than a year, I absolutely do not believe the Fed should even consider tapering until we get to the other side of the next recession, even though QE is having diminished results. It’s the wrong thing to do at the wrong time. It was wrong in 1937 and that caused the Great Depression Part II. It was wrong in Japan more times than I can count over the past 25 years. The Fed should not stop QE.

Obviously, I am also 100% against even considering raising short-term interest rates at all in 2014 and likely much longer into the future. I am sure the three amigos of Plosser, Fisher and Lacker are foaming at the mouth in anticipation of higher rates, but if history has shown us anything about these bankers, they are usually dead wrong.

Unemployment – If you told me that the unemployment rate would fall towards 6.5% in 2013, I would have fallen on the floor and passed out from shock. The economy would have to have grown at 4% or more. Had I any inclination that the labor participation rate would fall to levels not seen since the mid 70s, I would have questioned the accuracy of the government’s numbers. Both occurred last year and those trends should continue in 2014 creating a conundrum for the Fed and economists. The raw unemployment number is strong, but certainly not for the right reasons.

Japanese Yen – And I thought Bernanke’s QE was the greatest financial experiment of all-time. Silly me! That title now belongs to the Bank of Japan. Not only is the yen in a confirmed bear market after a 15 year secular bull market, but the Bank of Japan remains committed to an historic money printing program that will dwarf that of the Bernanke Fed.

It’s Abe, Abe and more Abe. The yen has much, much farther to fall and all rallies can be sold until further notice. The BoJ has learned from their mistakes of the past when they prematurely ended QE. Look for them to go overboard in hopes of ending what has essentially mounted to 25 years of economic malaise and rolling bouts of deflation.

As the world saw in the previous “greatest financial experiment of all-time” with leverage, mortgages, artificially low rates, the alphabet soup of exotic financial products that no one understood and on and on, they rarely end well. Long-term, I have serious doubts, but for now…

Japan – If the Bank of Japan is going to print baby print, it’s very difficult not to be positive on the Nikkei for 2014. If their economy doesn’t respond quick enough or if their markets fall too fast, the BoJ will just crank it up a notch until it works. I remember arguing on TV that investors should never fight with the guy who owns the printing press and that certainly holds true in Japan. The Nikkei should be a leading developed market index in 2014.

Europe – Euro zone problems are far from over, but have taken a breather over the past year. ECB chief Mario Draghi’s jawboning to save the Euro currency has certainly worked in the short-term with sovereign bond yields declining precipitously in the PIIGS countries. At the same time, however, austerity is causing all sorts of economic issues with deflation being chief among them. If that genie gets out of the bottle in meaningful way, look out below!

Additionally, all is not well beneath the surface as a major, major crisis looms in France possibly late in 2014, 2015 or even into early 2016. Germany was certainly not happy about the bailouts in Greece and Cyprus or the ECB programs designed to save Spain and Italy.  The big test comes when the Germans have to figure out how to save a country that is too big to fail and too big to save. I smell a constitutional battle brewing to allow the ECB to outright print money.

Emerging Markets – Coming off an horrific 2013, emerging markets begin the new year on their heels with continued unrest, currency dilemmas and slowing growth. I will go out on a limb and forecast that the sector sees a significant low in the first half of 2014 and outright leadership and strength during the second half of the year led by the secondary countries. The macro trade would be owning a broad emerging markets ETF against a short in the US small caps.

Very Short-Term Bounce on the Way

Stocks closed last week on a very ugly note with an across the board rout after underwhelming earnings and continued problems in the emerging markets. This is exactly the type of decline I spoke about for the past few weeks. All of the necessary ingredients were there and price finally succumbed.

Friday was so ugly that it can actually be construed as okay in the very, very short-term. Days like that either lead to higher openings on Monday to relieve the little oversold condition or one more hard down day followed by Turnaround Tuesday. Either way, history says that stocks should be close to a very short-term bounce. Stress short-term.

Until proven otherwise, the bull market remains alive and is undergoing some routine and normal leadership rotation. At some point energy is going to lead before the bull market ends and that may be just around the corner.

For now, keep your powder dry and enjoy the rally in bonds!

There is Always Something to Buy

Like a broken record, stock market sentiment remains at rally killing levels as it has for the past two months or so, but that certainly didn’t prevented us from taking full advantage of the Santa Claus rally. Now that the calendar turned and the most bullish period of the year has ended, the tailwind for stocks isn’t as strong. As the market has been for some time, it is stretched, very overbought and in need of good 5-10% pullback.

The very short-term can probably go either way with one more all-time high push this week or an immediate decline, but I do not believe a push higher will ignite another leg higher. Once last week’s low is closed beneath on a daily basis, the market should smack in the middle of the 5-10% pullback. Again, the bull market is not over and any weakness remains a buying opportunity until proven otherwise. Dow 17,000 or higher remains in sight.

The secular bull market in the dollar turns a very quiet 6 years old in March and we should see some real upside fireworks this year. I am most intrigued by the Treasury bond market here as sentiment continues to be awful and price is just starting to percolate. We have already seen very strong moves in the investment grade bond market which you can see using LQD and the much maligned muni bond market is showing some good signs this year. Use MUB as a proxy for that.

While I do not like commodities as a whole, copper has a short-term set up that has at least 2:1 risk reward to the long side. Corn looks really interesting here as sentiment has been at bear market killing levels and price is just beginning to turn around. Hmmmmm. That could be just a short-term play or end up being the trade of 2014.

Fox Business, Stocks, Bonds, Gold and Oil

I am going to be on Fox Business’ Markets Now at 1:05pm today (Wednesday) discussing the stock market’s recent assault on Dow 16,000, a target I gave several times here and in the media. Now that the market is there, what’s next?

I can tell you that from my perspective, risk has increased substantially, but by no means should the bull market be over. Stocks are overdue for at least a pullback (2-8%), but probably more on the downside next year, especially if they continue to run into year-end.

Both gold and the bond market are very close to their own lines in the sand. A closing move by gold under $1250 opens the door to all kinds of bearish scenarios that frankly, I did not think would come this year. Likewise, the treasury bond market also has a line or two in the sand, but it’s farther away. All year, I have forecasted a late year bond rally, but this one is on the verge of petering sooner than expected if the recent highs cannot be exceeded. The last thing the Bernanke and the Fed and the stock market want to see is the 10 year note yield more than 3%.

Finally, crude oil is trying to find a low above $90 here. If energy cannot stabilize soon, that will usher in more negative scenarios into the $80s.

 

Stocks Growing Tired

With the major indices going vertical since October 9, I am starting to see some signs of tiring. “Tiring” is a lot different than forecasting a full fledged correction or even a deep pullback. It just means that the odds favor either some sideways action to help restart the engine or some sort of mild price decline to shake out the Johnny Come Latelys.

During this rally, we saw the S&P 500, S&P 400 and Russell 2000 hit all time highs with the NASDAQ at its highest levels since 2000. The Dow has been the laggard index, but I do expect that to get in gear after this pullback and also see new highs.

Gold has cooperated nicely from the recent bullish call and I think more upside is ahead for the shiny metal. As I have discussed all year, especially of late, this is the bond market rally I have been waiting for. The train began to leave the station in late August and September and is now in full motion. Treasuries, quality corporates and government bonds all look higher, especially if they see the slightest bit of weakness first. Our clients have owned high yield bonds for some time and that rally has been the strongest so far and may be growing a bit tired itself.

The US dollar has been under pressure for almost four months and it looks like a major bottom is about to be formed this quarter. My long, long-term view remains very, very positive for the greenback. Uncharacteristically, energy has been hit hard even though we have seen dollar weakness. That indicates strong selling beneath the surface with even lower prices to come.

I am about to start working on a Canaries in the Coal Mine update and I hope to post it on Friday.