Friday, February 27, 2015
The Pathetic ‘Talk Therapy’ Of Janet Yellen
by David Stockman • February 26, 2015
What in god’s name does Janet Yellen think she is doing? Just a few weeks ago she established the ridiculous Fedspeak convention that “patient” means money market rates will not rise from the zero bound for at least two meetings. Now she has modified that message into “not exactly”.
As her Wall Street Journal megaphone, Jon Hilsenrath, was quick to amplify:
Ms.. Yellen signaled the Fed is moving toward dropping the reference to being patient from its statement, but sought to dispel the notion it would mean rate increases were certain or imminent.
“It is important to emphasize that a modification of the [interest-rate] guidance should not be read as indicating that the [Fed] will necessarily increase the target rate in a couple of meetings,” Ms.. Yellen told the Senate panel.
So two meetings is no longer two meetings. That’s worse than Greenspan’s double talk at his worst, and here’s why. It’s all make believe!
After 74 months of ZIRP, a hairline increase in the money market rate to 25 bps or even 100 bps will have absolutely no impact on the main street economy—–nor on whether the “in-coming” data deviates up or down by a few decimal points from 5.7% on the U-3 unemployment rate or 1.7% on the CPI.
The Fed is absolutely incapable of impacting the short-run ticks on its so-called inflation and unemployment “mandates” because its “credit channel” of monetary transmission is broken and done. The household sector is still saturated by peak debt and the ZIRP fueled runaway stock market rewards corporate executives for share buybacks and M&A deals, not investment in productive assets—even with borrowed money.
So there is absolutely no reason to peg interest rates at freakishly low levels. It has manifestly not enabled household to supplement spending from their tepidly growing incomes by means of ratcheting up their leverage ratios. That Fed trick worked for about 45 years until households used up their balance sheet runway in 2007 and thereupon smacked straight into “peak debt”.
The graph below shows household debt relative to wage and salary incomes, and the latter is the true denominator for computing leverage ratios. The Wall Street stock peddlers—who are pleased to call themselves economists—-always use personal income as the denominator, but that’s completely misleading. Upwards of 25% of personal income represents transfer payments including more than $1 trillion of Medicare, Medicaid and housing vouchers. Try sending you credit card bill to your Medicare carrier for reimbursement!
More importantly, transfer payments represent merely the shuffling of already produced income from taxpayers to entitlement recipients. The latter overwhelmingly do not borrow via credit cards, car loans and mortgages because they are not creditworthy, even by today’s lenient standards. So its middle class households which borrow money and which generate wage and salary income; and its the ratio of these two variables which measure the true condition of leverage.
During the four decades after 1971, the apparatchiks who run the Fed, and the economists who gum about its machinations, declared themselves to be monetary wizards. By deftly dialing the Federal funds rate up and down and flattening or steeping the yield curve, they claimed an ability to steer the entire US GNP to feats of growth and prosperity that were far beyond the halting, inferior performance of free market capitalism left to its own devices.
Needless to say, in return for conferring such blessings on the unwashed consumers and voters of the land they demanded an unfettered right to steer the economy by the lights of their superior wisdom. In due course this became the hallowed doctrine of Fed “independence” from democratic oversight through Congress. It amounted to a de facto appendum to the constitution by which the central bank instructed its legislative inferiors with the injunction———-you don’t ask, we won’t tell.
But this was all a giant hoax. The monetary politburo which has seized power in an economic coup d’ etat during recent decades had no magic power to levitate the economy or improve upon capitalism at all. What it actually did was trick and misled households and businesses about the cost of debt via the false price signals emitted by its interest rate pegging actions.
Not surprisingly, this did not lead to economic gains in the context of steady-state leverage ratios. Instead, the years before the 2008 financial crisis saw a relentless ratcheting of leverage ratios to higher and higher levels relative to incomes. At the peak household debt to wage and salary income ratio of 220% reached in 2007, the leverage ratio was triple the steady state ratio that had prevailed before the Fed was unshackled from the Bretton Woods gold standard by Richard Nixon in August 1971.
And, no, that action did not represent a fit of enlightenment by America’s palladium of darkness. As I outlined in The Great Deformation, it was a calculated ploy to permit a compliant Fed chairman, Arthur Burns, to slash interest rates and thereby goose the US economy into a roaring boom just in time for Nixon’s reelection.
Once Nixon and Burns figured out the trick, there was no looking back. At length, the Eccles Building inhabitants came to realize that there was absolutely no constraint on their ability to falsify the price of debt and, by the same token, the return on liquid savings.
But even as the Fed caused massive expansions of credit and leverage, it could not eliminate the laws of economics entirely. Accordingly, in the period since the financial crisis, an event which actually marked the arrival of peak debt, household leverage has been steadily reduced—–even though it still towers vastly above pre-1971 levels.
So there is no mystery as to why “escape velocity” has not been achieved despite annual projections of its arrival by Wall Street and Fed economists. The US economy is stuck in its 2% growth channel because that’s all the incremental labor and productivity that is being produced by the private sector. There are no longer any GDP afterburners from incremental leverage adding to the spending pie, as was the case during the long post-Camp David credit expansion.
The story is the same with respect to business debt—although the mechanics are slightly different. On the eve of the Lehman event, total non-financial business debt—including both corporations and unincorporated businesses and partnerships—was about $11 trillion—-a figure which has since ballooned to nearly $14 trillion. But unlike in earlier business cycle recoveries, this $3 trillion of incremental debt did not go into the purchase of additional plant, equipment and other productive assets. Overwhelmingly, it went into financial engineering in the form of stock buybacks, cash M&A deals and LBOs.
Indeed, these transactions have actually totaled more than $3 trillion since 2008, but it is their impact on the economy which is of even more significance. None of these funds went into the primary market for new assets; the entire tsunami of cash employed in pursuit of financial engineering circulated though the secondary market where it bid up the price of existing financial assets and showered their owners—-and especially the fast money hedge funds and other gamblers which dominate Wall Street—with completely unearned windfalls.
In fact, the process is even more insidious and destabilizing. Zero interest rates provide free funding cost to carry trade gamblers, while the Fed’s massive bond buying program and stock market “put” artificially reduce risk and inflate risk asset prices. But as the resulting financial bubble inflates, the pressure on corporate executives to channel cash flows and borrowings into even greater levels of financial engineering intensifies enormously.
At the end of the day, however, true economic growth flows from productive investments and improved productivity and increased labor inputs to the economy. Yet the rampant financial engineering in the business sector owing to Fed financial repression causes just the opposite. Namely, staff reductions and “restructurings” to artificially increase “ex-items” earnings; and the aggressive cycling of cash flow and borrowings into the secondary market via stock repurchases and buyouts.
So ZIRP and QE have been downright perverse. Since the credit channel of monetary transmission is a busted historical anachronism, the Fed massive balance sheet expansion has only functioned to reflate the financial bubble, not stimulate the main street economy.
And that’s the real reason that the presumptive adults who occupy the Eccles Building have been reduced to the kind of duplicitous babble which Yellen engaged in during the last two days on Capitol Hill. Yellen and her merry band of money printers are petrified that Wall Street will have a hissy fit, and that the whole edifice of financialization and drastically over-valued and over-leveraged financial assets will come tumbling down.
Indeed, it doesn’t take more than a moments reflection to realize that the U-3 unemployment rate is a completely artificial metric. It has virtually no meaning in the context of a global economy where the price of labor is set on the world market, not in a closed bathtub economy between the Atlantic and Pacific; and where there are 102 million adults who do not currently hold jobs—of which only 45 million are on OASI retirement.
Likewise, the CPI measure of inflation is so distorted by imputations, geometric means, hedonic adjustments and numerous other artifices—-that targeting to a 2% versus 1% or even zero rate of short-term consumer price inflation is a completely arbitrary, unreliable and unachievable undertaking. Yet, Yellen’s latest exercise in monetary pettifoggery is apparently driven by just that purpose:
Ms. Yellen said the Fed would act only if the job market keeps improving and once it is “reasonably confident” that inflation will move back toward the target.
That formulation could become central in Fed deliberations about rates in the months ahead. It could also lead to a new challenge. Inflation is facing downward pressure from low oil prices and a rising U.S. dollar. It is not clear at this point what will make officials confident it is heading back up toward 2%.
Here’s the thing. The single most important price in all of capitalism is the money market interest rate. That is the price of poker in the Wall Street casino; it is the cost of production for the carry traders and gamblers who provide the marginal “bid” for risk assets.
By supplanting free market price discovery with an artificially pegged price of zero, the Fed is unleashing the furies of greed and reckless speculation in the financial system once again. So it has truly become a serial bubble machine headed by a babbler who apparently believes in make pretend.
For six years the Fed has been engaged in radical financial repression that has had no impact on the main street economy because the credit channel of monetary transmission has failed. Now that is has inflated the mother of all financial bubbles instead, it remains completely blind to the financial disaster waiting in the wings.
And there is indeed a monster storm lurking on the horizon—-not the least in the emerging market debt and junk bond markets where trillions have been herded in a blind, central bank induced scramble for “yield”. As Wolf Richter noted earlier this week,
Bond specialist Martin Fridson, Chief Investment Officer at Lehmann Livian Fridson Advisors, summarized it this way, via S&P Capital IQ LCD:
A perfect storm is hitting the high-yield market. Secondary issues are extremely overvalued, and covenant quality is at a record low.
So another annual Humphrey-Hawkins testimony passes, and the Fed chairman indulges in yet another round of oblivious double talk. As one Kool-Aid drinker noted, perhaps not realizing the farcical implications of his words, Yellen caused the market to inflate to even more lunatic heights this week on the basis of a new low in central bank intervention—-namely, “talk therapy”.
“There is this kind of talk therapy going on,” said Ethan Harris, chief economist at Bank of America Merrill Lynch. “She tells the markets not to worry about this anddon’t worry about that. Today she told the market, ‘Don’t worry if we remove patience.’
Right. Don’t worry—–its already too late!
Alternative News Covering Finance, Economy, Politics, World News, Current Events image: http://images.intellitxt.com/ast/adTypes/icon1.png
image: http://images.intellitxt.com/ast/adTypes/icon1.pngimage: http://s3.feedly.com/img/follows/feedly-follow-rectangle-volume-big_2x.png
GREECE LATEST: HUGE GREEK BANK OUTFLOWS, EURO FALLING AGAINST THE £, BUNDESTAG BACKS GREECE MEMORANDUM
Submitted by IWB, on February 27th, 2015
BY JOHN WARD
If the Varoufakis memorandum ‘deal’ is so respectable, why do none of the players, or their Party bigwigs, or the markets, like it?
There’s a piece in the online magazine Counterpunch at the moment purporting to show how Greek finance minister Yanis Varoufakis has ‘kept Greece in the euro by its fingernails’. Without going over the same tedious ground yet again, nobody can do that, because Greece doesn’t need to cling onto anything: once you’re in the euro, there’s no way out.
The piece continues as follows:‘So, those who think that Varoufakis should have given the Eurogroup an ultimatum (“Reduce our debts or we’ll leave.”) simply image: http://images.intellitxt.com/ast/adTypes/icon1.png don’t understand the nature of the negotiations. Varoufakis was forced to operate within very strict parameters. Given those limitations, he nabbed a very respectable deal.’
don’t understand the nature of the negotiations. Varoufakis was forced to operate within very strict parameters. Given those limitations, he nabbed a very respectable deal.’
If I had a Pound for every expert who responded to an injection of reality with “no no, you don’t understand” I’d be a very rich man indeed. QE, derivatives, the gold price, the euro’s value, UK ‘growth’, fractional reserve banking, the Manchester United owning Glazer brothers, ludicrously over-priced bourses, the EC’s finances, and BoJ asset purchases have all been ‘sold’ to me over the years are the best way forward…when they are obvious disaster areas waiting to happen.
In this case, it’s the idea that what Varoufakis signed last week was a ‘very respectable deal’. I’d like to put one simple question to the Game Players: if the deal is so good, why does no side – there are more than two – want it?
The Greek KKE doesn’t want it, 8 senior Syriza MPs don’t want it, and yesterday afternoon Merkel was given a seriously rough ride by her own CDU Upper Circle. I’ve yet to meet a single anti-federalist who likes it…but I’ve been told a dozen times that Varoufakis has “bought time”. He has: but is it peace in our time, or time for things to get worse for the Greeks?
Even the fairly large print of the Memorandum makes YV’s job impossible, and it isn’t helped by the obviously manipulated departure of bank deposits. Four months from now they will be back around the same table, and there is just one thing alone that might make Yanis’s hand stronger: Italy turning to sh*t – which it could do….and ought to do.
But if your main adversary is an Italian crook heading up the ECB, I wouldn’t hold your breath on it. In that four months, there’ll be 24/7 smearing and trolls, manufactured bank panics, and pretty much anything they can think of to take Syriza’s eye off the ball. Last month, a record €12.2 billion left Greek banks: that is more than any outflows experienced during any of the previous Greek crises and bailouts. Zero Hedge is now confirming the Slogpost of last week when it says ‘the Troika did everything in its power to accelerate the bank run in order to crush any negotiating leverage Varoufakis may have had’.
As for Tsipras himself, his hardest task will be to keep the Coalition together…plus social protests and unrest coming from the KKE and Golden Dawn…both of whom are virulently anti-euro.
I wrote earlier this week that Varoufakis missed his chance to exploit the enormous Bundesbank v ECB v France rift – the thing that will do for the entire EU in time regardless of anything else that might happen. But he failed to call the bluff. That’s all Draghi had: bluff.
Today, with this marvellous deal image: http://images.intellitxt.com/ast/adTypes/icon1.png nobody likes, the euro has fallen further, and now stands at 1.38 to Sterling. If he had walked last Friday, Troika2 would’ve been in l’ordure profonde. There is an old adage that says, “When you borrow £10,000 from a bank, it’s your problem. When you borrow $280billion and can’t pay it back, it’s the bank’s problem”. So far, EU citizens haven’t paid a red cent of any of the funny-money involved in bailing out Greece. Now they will have to…and it could tip at least two of them – Spain and Italy – over the edge. This is the size of the opportunity Varoufakis missed.
nobody likes, the euro has fallen further, and now stands at 1.38 to Sterling. If he had walked last Friday, Troika2 would’ve been in l’ordure profonde. There is an old adage that says, “When you borrow £10,000 from a bank, it’s your problem. When you borrow $280billion and can’t pay it back, it’s the bank’s problem”. So far, EU citizens haven’t paid a red cent of any of the funny-money involved in bailing out Greece. Now they will have to…and it could tip at least two of them – Spain and Italy – over the edge. This is the size of the opportunity Varoufakis missed.
On verra. But I remain at a loss to see what Greece has gained here…except the bewildered disrespect of a lot of the neutrals.
Read more at http://investmentwatchblog.com/greece-latest-huge-greek-bank-outflows-euro-falling-against-the-bundestag-backs-greece-memorandum/#0OexzwKVODH5YlDP.99
Alternative News Covering Finance, Economy, Politics, World News, Current Events and More
Buckle Up: Just When You Thought The World Could Not Spin Much Faster, Global Monetary Events In 2015 Have Picked Up Speed. The Currency Wars Have Begun. Time To Toss The Playbook.
Submitted by IWB, on February 27th, 2015
by Brian Pretti
Just when you thought the world could not spin much faster, global monetary events in 2015 have picked up speed.
Begun, The Currency Wars Have
A key macro theme of mine for some time now has been the increasing importance of relative global currency movements in financial market outcomes. And what have we experienced in this very short year-to-date period so far? After years of jawboning, the European Central Bank image: http://images.intellitxt.com/ast/adTypes/icon1.png has finally announced a $60 billion monthly quantitative easing exercise to begin in March. Switzerland “de-linked” its currency from the Euro, China has lowered the official renminbi/US Dollar trading band (devalued their currency), China lowered its banking system required reserve ratio, the Turkish and Ukrainian currencies saw double digit declines, and interest rate cuts have been announced in Canada, Singapore, Denmark (4 times in three weeks), India, Australia and Russia (just to name a few). All of the above occurred within five (!) weeks.
has finally announced a $60 billion monthly quantitative easing exercise to begin in March. Switzerland “de-linked” its currency from the Euro, China has lowered the official renminbi/US Dollar trading band (devalued their currency), China lowered its banking system required reserve ratio, the Turkish and Ukrainian currencies saw double digit declines, and interest rate cuts have been announced in Canada, Singapore, Denmark (4 times in three weeks), India, Australia and Russia (just to name a few). All of the above occurred within five (!) weeks.
What do all of these actions have in common? They are meant to influence relative global currency values. The common denominator under all of these actions was a desire to lower the relative value of each country or area’s currency against global competitors. As a result, foreign currency volatility has risen more than noticeably in 2015, necessarily begetting heightened volatility in global equity and fixed income image: http://images.intellitxt.com/ast/adTypes/icon1.png markets.
If we step back and think about how individual Central Banks and country specific economies responded to changes in the real global economy image: http://images.intellitxt.com/ast/adTypes/icon1.png historically, it was through the interest rate mechanism. Individual Central Banks could raise and lower short term interest rates in order to stimulate or cool down specific economies as they experienced the positive or negative influence of global economic change upon them. Country-specific interest rate differentials acted as pressure relief valves. Global short term interest rate differentials acted as an intentional relative equalization mechanism.
historically, it was through the interest rate mechanism. Individual Central Banks could raise and lower short term interest rates in order to stimulate or cool down specific economies as they experienced the positive or negative influence of global economic change upon them. Country-specific interest rate differentials acted as pressure relief valves. Global short term interest rate differentials acted as an intentional relative equalization mechanism.
But in today’s world of largely 0% interest rates, the interest rate “pressure relief valve” is gone. The new pressure relief valve has become relative currency movements.
This is just one reality of the historically unprecedented global grand Central Banking monetary experiment of the last six years. Whether for good or bad, it is simply the environment in which we find ourselves today. And so we must deal with this reality in ongoing investment decision-making.
Pressure Is Mounting
There has been one other event of note in early 2015 that directly relates to the potential for further heightened currency volatility to come. That event is the recent Greek elections.
We all know that Greece has been in trouble for some time. Quite simply, they have borrowed more money than they are able to pay back under current debt repayment schedules. The New York consulting/banking firm Lazard recently put out a report suggesting Greek debt requires a 50% “hair cut” (default) in order for Greece to remain fiscally viable. The European Central Bank (ECB), largely prompted by Germany, is demanding 100% payback. Herein lies the key tension.
Of course the problem with a needed “haircut” in Greek debt is that major Euro banks holding Greek debt have not yet marked this debt to “market value” on their balance sheets. In one sense, saving Greece is as much about saving the Euro banks as anything. If there is a “haircut” agreement, a number of Euro banks will feel the immediate pain of asset write-offs. Moreover, if Greece receives favorable debt restructuring/haircut treatment, then what about Italy? What about Spain, etc? This is the dilemma of the European Central Bank, and ultimately the Euro itself as a currency. This forced choice is exactly what the ECB has been trying to avoid for years. Politicians in the new Greek government image: http://images.intellitxt.com/ast/adTypes/icon1.png have so far been committing a key sin in the eyes of the ECB – they have been telling the truth about fiscal/financial realities.
have so far been committing a key sin in the eyes of the ECB – they have been telling the truth about fiscal/financial realities.
What does the last minute late February stick save in again kicking the can down the road another four months for Greece really accomplish? Absolutely nothing. The exact thing that has been accomplished over the last 2.5 years since Mr. Draghi uttered his infamous “whatever it takes” commentary. At least the Euro area has been 100% consistent in accomplishing zero in terms of real reforms and reconciliation, right? But we all know time is running out. We need to watch the capital markets carefully.
Time To Toss The Playbook
What does this set of uncharted waters circumstances mean for investment decision making?
It means we need to be very open and flexible. We need to be prepared for possible financial market outcomes that in no way fit within the confines of a historical or academic playbook experience.
This may sound a bit melodramatic, but it’s something I have been anticipating for some time now, ever since a very unique occurrence took place in Euro debt markets in early February. Nestle´s shorter term corporate debt actually traded with a negative yield. Think about this. Investors were willing to lose a little bit of money (-20 basis points, or -.2%) for the “safety” of essentially being able to park their capital in Nestle’s balance sheet. This is a very loud statement and may be a very important “signal” for what lays ahead.
Academically, we all know that corporate debt is “riskier” than government debt (which is considered “risk free”). But the markets are “telling us” that may not be the case at the current time when looking at Nestle´ bonds as a proxy for top quality corporate balance sheets image: http://images.intellitxt.com/ast/adTypes/icon1.png . Could it be that the balance sheets of global sovereigns (governments) are actually riskier than top quality corporate balance sheets? And if so, is global capital finally starting to recognize and price in this fact? After all, negative Nestle´ corporate yields were seen right alongside Greece raising its hand suggesting Euro area bank and government balance sheets may not be the pristine repositories for capital many have come to blindly accept. This Nestle´ bond trade may be one of the most important market “signals” in years.
. Could it be that the balance sheets of global sovereigns (governments) are actually riskier than top quality corporate balance sheets? And if so, is global capital finally starting to recognize and price in this fact? After all, negative Nestle´ corporate yields were seen right alongside Greece raising its hand suggesting Euro area bank and government balance sheets may not be the pristine repositories for capital many have come to blindly accept. This Nestle´ bond trade may be one of the most important market “signals” in years.
As I’ve stated many times, one of the most important disciplines in the investment management process is to remain flexible and open in thinking. Dogmatic adherence to preconceived notions can be very dangerous, especially in the current cycle.
As such, we cannot look at currency movements and investment asset class image: http://images.intellitxt.com/ast/adTypes/icon1.png price reactions in isolation. This may indeed be one of the greatest investment challenges of the moment, but one whose understanding is crucial to successful navigation ahead. In isolation, who would be crazy enough to buy short term Nestle´ debt where the result is a guaranteed loss of capital in a bond held to maturity? No one.
price reactions in isolation. This may indeed be one of the greatest investment challenges of the moment, but one whose understanding is crucial to successful navigation ahead. In isolation, who would be crazy enough to buy short term Nestle´ debt where the result is a guaranteed loss of capital in a bond held to maturity? No one.
But within the context of deteriorating global government balance sheets, all of a sudden it is not so crazy an occurrence. It makes complete sense within the context of global capital seeking out investment venues of safety beyond what may have been considered “risk free” government balance sheets, all within the context of a negative yield environment. Certainly for the buyer of Nestle´ debt with a negative yield, motivation is not the return on capital image: http://images.intellitxt.com/ast/adTypes/icon1.png , but the return of capital.
, but the return of capital.
If we think about what this cycle has been up until now, things we’ve never seen in our lifetimes (let alone in history), now seem familiar. ZIRP, QE, etc. Ho Hum.
It’s this very premise that keeps me up at night when translating this philosophical question to equities and other private sector assets (corporate bonds, etc.). Again, I’m simply forcing myself to abandon preconceived ideas and contemplate what may appear the impossible. Will things we’ve never seen before in private sector assets (equities, corporate credit, etc.) seem familiar before this cycle is over?
In Part 2: Investing In The Age Of Anomalies, we examine the heightening importance of global capital flows in today’s market environment. As the system become more unstable, capital seeks safety — and that can lead to non-intuitive outcomes, at least in the short term.
For example, despite their obviously stretched valuations, US equity prices may power higher from here for longer than many expect, as capital suffering from negative interest rates elsewhere in the world is attracted to the relative safety and higher return of ‘blue chip’ stocks.
The analysis and understanding of these capital flows may well be more important than any other factor in determining investment performance during this next phase of the markets. As they say: Follow the money.
Read more at http://investmentwatchblog.com/buckle-up-just-when-you-thought-the-world-could-not-spin-much-faster-global-monetary-events-in-2015-have-picked-up-speed-the-currency-wars-have-begun-time-to-toss-the-playbook/#3HurGfX0VQ8UKvb0.99
Wednesday, February 25, 2015
Growth, registered investment advisor, portfolio strategy, large-cap
Wholesale Prices Fall For The Fifth Straight Month
Feb. 25, 2015 5:33 AM ET
Editor's note: Originally published on 23 February, 2015
Last Wednesday, the Labor Department announced that its Producer Price Index (PPI) declined 0.8% in January, the fifth decline in the past six months. Crude oil prices declined 10.3% in January, while wholesale gasoline plunged by a whopping 24%. January now represents the largest one-month drop ever in the PPI. In the past 12 months, the PPI is unchanged. Excluding food and energy, the core PPI declined 0.3% in January and has risen only 0.9% in the past year. So overall, deflation is alive and well.
Deflation is becoming a worldwide problem. On Thursday, the French statistics agency Insee reported that its consumer price index declined 1% in January and has declined by 0.4% in the past 12 months. In addition, Germany’s Federal Statistics Office recently announced consumer prices declined 1.3% in January and 0.5% in the past 12 months. And now, it looks like Europe is exporting deflation to America.
With Deflation Rising, the Fed Will Not Likely Raise Rates
Since the U.S. is now importing deflation from the eurozone, especially as a strong U.S. dollar pushes down commodity prices, the Fed will likely have no intention of raising key interest rates any time soon. The Fed’s intention became crystal clear when its latest Federal Open Market Committee (FOMC) minutes were released last Wednesday. Although several Fed officials wanted to raise key interest rates by around the middle of 2015 (if the U.S. economy keeps performing well), that will likely not happen. Due to a soaring trade deficit and truly horrible retail sales in the last two months, economists will have to reduce GDP estimates. As a result, most Fed officials will be content to wait as long as they can before raising rates.
The latest FOMC minutes seemed more confusing than usual. Some economists commented that the Fed may have intentionally tried to be ambiguous to confuse Fed watchers, probably because the FOMC does not know what to do next. If the Fed raises key interest rates that would strengthen the U.S. dollar and increase the risk of deflation, since most commodities are priced in U.S. dollars. The deflation risk is rising and the last thing the Fed wants to do is make deflation worse.
Also, on Thursday, the Conference Board confirmed why the Fed cannot raise key interest rates soon, namely because its Leading Economic Indicators (NYSEMKT:LEI) were decelerating, rising only 0.2% in January.
Overall, as this “Goldilocks” environment of low interest rates and slow but steady economic growth persists, Fed Chairperson Janet Yellen will be the Fairy Godmother that continues to sprinkle fairy dust on the stock market, due to her sustained 0% interest rate policy and reluctance to raise interest rates.
Yellen will testify before Congress this week, and I believe she will counsel “patience,” saying that the job market has improved, but that wage growth is insufficient to raise key interest rates.
Europe and Japan Surprise the World with Decent (2+%) Growth
Interestingly, while U.S. economic growth is decelerating, other countries (with weaker currencies) are accelerating. Germany’s Federal Statistics Office reported last week that its GDP grew at a 2.8% annual pace in the fourth quarter as its exports picked up and benefitted from a weak euro. Another country benefitting from a weak currency is Japan, since it also announced last week that its GDP grew at a 2.2% annual pace in the fourth quarter. Both Germany and Japan are big export-oriented economies that naturally benefit from their weaker currencies, since it makes them more competitive around the world.
In this ultra-low interest rate environment, the “tail is wagging the dog,” as I said on Fox Business last week, i.e., many investors continue to pile into high dividend stocks. The stock market also continues to reward companies with strong earnings. That is the good news. The bad news is that thanks to a strong U.S. dollar destroying the sales and earnings of many of the largest multinational companies in the S&P 500, the S&P 500 is now expected to post a 3.6% earnings decline in the first quarter. As a result, I expect to see a continuing flight to quality, including mid-cap stocks with more domestic sales than overseas sales.
Disclosure: *Navellier may hold securities in one or more investment strategies offered to its clients.
Disclaimer: Please click here for important disclosures located in the "About" section of the Navellier & Associates profile that accompany this article.
Kick-The-Can Has Morphed Into A Blatant Farce
by David Stockman • February 24, 2015
Kick-the-can has morphed into a blatant farce. Everywhere in the world central banks and financial officialdom are engaging in desperate, juvenile maneuvers to buy time—–amounting to hardly a few weeks at a go. Never before has the debt-saturated, speculation-ridden global casino rested upon such a precarious foundation.
This week, for instance, Janet Yellen will again waste two days of Congressional hearings in forked-tongue equivocations about an absolutely stupid issue. Namely, the exact date when money market interest rates will be permitted to blip upward from the zero bound by even 25 basis points.
But this “lift-off” drama is flat-out surreal. How could it possibly matter whether ZIRP will have been in place by 80 months or 83 months from its inception point way back in December 2008? There is not a single household or business on main street America which will change its behavior in the slightest during the next year regardless of whether the federal funds rate is 5 bps, 30 bps or 130 bps.
The whole Kabuki dance in the Eccles Building is about hand signals to Wall Street carry traders; its a reflection of the desperate fear of our monetary politburo that having inflated for the third time this century the mother of all financial bubbles, they must now keep it going literally one meeting at a time—lest it splatter again and destroy the illusion that an egregious spree of money printing has saved the main street economy.
Likewise, it now transpires that the bruising political war of words between the Germans and the “radical” Greek government has been suspended for another few weeks. And the reason is a pathetic fear that unites the parties despite their irreconcilable substantive policy differences. Namely, that the markets will crater upon even a hint that a real solution is on the table, and that the way to keep the beast at bay is to cover their eyes, kick-the-can and hope something turns up to avert the next crisis a few weeks down the road.
Still, this is getting beyond juvenile. If there were any adults in the room they would focus on quickly shaping a workable Greek default and exist—-not on perpetuating the lie that Greece can ever recover from its debt servitude to the EU superstate and IMF.
Ironically, the fire breathing leftists who have taken over in Athens have compliantly strapped on the poodle collar left behind by the Samaras government. It seems that their game-theory spouting Keynesian financial spokesman, Yanis Varoufakis, also fears a thundering upset in the casino. So the Syriza government stumbles forward——now visibly toting the massive debt imposed on them by the Eurozone and IMF in order to bailout the German, French and Italian banks.
Indeed, in a new variation of the Stockholm syndrome, Syriza has not only embraced the views of its debtor’s prison jailors, but has actually invited them to secretly author their own attestations of subordination. As Zero Hedge noted about today’s shocking revelations regarding the so-called Varoufakis letter to the Troika, aka “institutions”:
As it turns out, the reason why not only the Troika received an agreed to version of the Greek reform proposals “before midnight on Monday”, but rushed these through with a favorable agreement today, is that, drumroll, the European Commission drafted the entire letter!
And, no, this isn’t tin foil hat stuff. Here’s the smoking email which reveals that the “first list of comprehensive reform measures” submitted by Greece, which is actually a six-page air ball completely devoid of numbers and specifics, was actually written by one Declan Costello, an apparatchik at the European Commission.
This is all truly pathetic, but it should be a reminder that there is no escaping the global regime of central bank financial repression and state manipulation of debt saturated economies and gambling-infested financial markets. It took Syriza all of four weeks to hoist the white flag. As on astute Greek worker commented,
“We went through two months of agony, emptied the banks, to realize we are still a debt colony,” 54-year-old electrician Dimitris Kanakis told Reuters. “The paymasters call the shots.”
It is no different on the East Asian side of the world. Japan has reported another quarter of sputtering economic performance. Notwithstanding the small rebound reported for Q4 based on highly implausible export deflators, real GDP is barely higher than it was in December 2012 before Abenomics launched its truly monstrous money printing spree—–a wave of QE so massive that it is literally draining the Japanese government bond market of any and all securities available for sale.
Yet, the Abe government and BOJ does not hesitate to threaten even more monetary carnage—even as the abysmal failures of current policies are reported month after month.
In China the scene is even more tortured. As McKinsey’s charts so dramatically document, the overseers of red capitalism in Beijing have driven China into a monumental debt trap. Its massive spree of construction and fixed asset investment has created an utterly deformed economy that will literally implode unless its keeps building empty luxury apartments, phantom cities, silent shopping malls and hideously redundant roads, bridges, subways and airports. Yet whenever the short-term indicators stumble, the government finds some new, convoluted way to release more credit into the system.
This too is reaching the farcical stage. During the six-short years since the financial crisis, China has boosted it credit market debt outstanding by the staggering sum of $20 trillion or by 4X the growth of GDP during the same period. How in the world could anyway believe that China’s tottering house of cards can be rescued by piling on even more debt financed construction and fixed asset acquisition?
Needless to say, as China veers ever closer to a crash landing, the China-dependent EM economies are rapidly faltering. It now appears that Brazil will suffer back-to-back years of GDP decline for the first time since 1930-1931. Indeed, the China- led global commodities and industrial production boom is cooling so fast that global CapEx in mining and energy, materials processing, manufacturing and shipping is on the verge of a huge downward correction. And that will hit the high end machinery and engineering exporters like Germany and the US, creating a further negative loop in the gathering deflationary crisis.
Nevertheless, during the past week the robo-traders and gamblers have painted the tape on no volume—-and for no reason except that central banks and government officials are still lamely kicking the can. Yet in so doing, they are driving massive debt burdens and speculative manias to the verge of collapse everywhere.
Accordingly, today’s S&P index ended-up at 3.21X its March 2009 bottom. At more than 20X reported LTM earnings for the period ended in Q1, the stock market is now an accident waiting to happen—-a super bubble searching for a pin.
But surely today’s news that the Greeks outsourced their so-called rebellion to the very EU apparatchiks who have put them into permanent, debilitating debt bondage is a wake-up call. As we learned in March 2000 and September 2008—–even the Wall Street gamblers eventually get the joke.
Tuesday, February 24, 2015
ETF investing, CFA, portfolio strategy, long/short equity
The VIX: What It Is, What It Isn't, What To Do About It Now
Feb. 23, 2015 5:17 PM ET
Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. (More...)
- Widely regarded as the "fear factor" forecaster of stock market price declines, it has an irregular, unreliable pattern of prophecy.
- Perversely, it is a much more reliable forecaster of general market index recovery.
- What should we believe it is telling now?
- How best to profit from its ODDS and PAYOFFS of prior outcomes?
Where the VIX comes from
The basic equation of stock option valuation contains several interrelated factors, including the underlying stock's price, which when solved provides an appropriate price for each of the several available strike-price and expiration-dated option contracts. One of the key input factors common to all the contract price solutions is the issue of uncertainty present for the underlying stock's future price.
From the start of trading in listed stock options over 40 years ago, options traders turned the contract pricing formula around and accepted the market's options trading prices as inputs, in place of the uncertainty component of the equation, and solved for the stock's "implied volatility." Traders discovered that the degree of "implied vol" for each stock tended to have a usual level of uncertainty across time, and being aware of current variances from its norm, provided them with profitable trading insights into future prices.
By applying this approach to options on a market index, the Chicago Board Options Exchange [CBOE] in 1983 devised and copyrighted the term VIX to designate an index measure of the S&P 500's implied volatility. The VIX Index is quoted in percentage points and represents roughly the (thus derived) expectations of potential change of the S&P 500 in the next 30 days.Direction of change is not indicated.
If it's a Fear Index, why does that matter?
That should be obvious, but let's test it out. We go to a reliable, available source for data, like Yahoo Finance, and obtain all the available daily data history for the VIX Index (since 1/2/1990) and for something appropriate that we can easily trade, like the SPDR S&P 500 Fund ETF (NYSEARCA:SPY). It is available from 1/29/1993, downloaded in .csv (comma separated values) for easy use in a spreadsheet tool like Excel. There are well over 5,000 days of data to use, over ten years worth, plenty to offer statistically reliable inferences.
Matching up the dates from the two data sets, we calculate what has been the worst possible price change for SPY in the coming 3 months after each day, and compare that with the VIX Index value at the initial date. Figure 1 shows what we get.
The VIX Index in these 11 years never got much below 10, and days measuring above 30 start to get sparse. Much of the time between its 10 to 15 value looks to be completely random. There the worst next-3-month market declines are concentrated around -5% to -7%.
Days with VIX above 15 start to see a shower of more substantial declines, plus a lot of the less than -5% kind. The best-fit line confirms the general relationship of higher index numbers with larger market declines. But the far fewer large outliers seem to dictate the fit relationship, compared to scads of close-in, small-scale comparisons.
Just to be fair, let's look at the other side of the coin: What were the market's best days in the next 3 months, compared to the "fear-factor" advance warning? Check out Figure 2.
This looks strangely like a mirror of Figure 1's market moves to the downside, hinged along the zero% change line. Now the relationship line shows increasing market price gains as the VIX Index is higher. Where the index is small, the level of determination is small to any degree of specificity.
Figure 2's contrast with Figure 1 demands some more inclusive measure of the usefulness of the VIX as a forecaster of coming market behavior. In Figure 3, we attempt this by relating the index levels to a fixed holding period price change in SPY. Our first effort, using 3 months as a test period does not provide any motivation to believe that a longer or shorter holding would create much difference.
VIX Index values over a long period of observations have proven by themselves to be a truly rotten forecaster of likely subsequent market price changes, either to the downside, the upside, or simply on average. Figure 3 has a relationship line basically independent, one of the other.
One encouraging thing about this is that the presence of the VIX Index may have helped keep the market balanced, as evidenced by there being no sign of a pattern of advantage created by the presence of this sophisticated analytical measure. Its early benefits, if any, were quickly arbitraged away by astute observers.
Inherent in the nature of the VIX Index's creation is that it tries to define uncertainty, rather than differences of value from some norm or standard. The statistics involved can identify levels of uncertainty, but lack any useful directional sense in their derivation.
When the game changed
In early 2006, options on the VIX Index (VIX) itself were listed by the CBOE and began trading on a daily basis. That permitted us to show what the market's own actions have as a forecast of this presumed market forecaster. But now dimensions of price change direction now are being shown, when the means of making such forecasts are known, as we do using behavioral analysis principles.
What are today's directional indications for the VIX?
Figure 4 presents this past Friday's closing-prices-based forecast for the VIX Index in its most right-hand vertical bar. It represents a range of that index's potential market quotes in coming days, weeks, and few months.
(used with permission)
Readers of our Intelligent Behavior Analysis articles on Seeking Alpha are familiar with the measure we use to identify likely directional emphasis resulting from the analysis. We term our measure the Range Index [RI], calculated from the price range being forecast by the analysis of the investment subject. It indicates what proportion of the whole range lay downward from the current price.
In Figure 4, the RI of the VIX is 7. That means 93% of the forecast range is to the upside, a typically strong condition. With a current market quote of $14.30 for the VIX and an upside limit to the range of $18.82, a rise in price by +31.6% is viewed as likely enough to be possible that parties becoming at risk to changes in its price are willing to pay for protection against the change, should it happen. The possibility of a complementary price decline works out to a -2.5% change. At these extremes, there is about a 13-to-1 prospect of advantage on the "reward" side over the "risk" exposure (of a bet on the VIX).
We have devised a simple, but powerful, investment portfolio management discipline that functions very effectively using this kind of information. We use it as a standard of behavior to compare the investment desirability of virtually all of the roughly 3,500 equity securities examined daily. Applied to the VIX, its results appear in the row of data between the two blue-background pictures of Figure 4.
The results are that in the 124 prior instances of the 1,261 market days in the last 5 years where a 7 RI of the VIX occurred, 76% of them were profitable experiences. The net gains in all 124 earned +24% gains in average holding periods of 36 market days, which would have produced an average annual rate of return of +355%.
If the VIX were a security that could be bought and sold, most likely this would be a good point in time and price to buy it. But the VIX is an index that cannot be bought or sold as a security. There are, however, ETFs that are based on movements of the VIX Index that can be traded conventionally.
Ready to get confused?
This is where two logical inversions take hold of the task of making money from what can be known about the VIX, its dependent ETFs, and the market as evidenced by the S&P 500 Index, or SPY.
The first inversion comes from investors' normal association with being "long" in assets that rise sympathetically when the "market" goes up. The "price" of the VIX is a measure that rises when the market unexpectedly goes down, reflecting increasing investor uncertainty. And uncertainty is what the VIX measures. So, when market prices go down, VIX Index goes up.
The second inversion comes from investors' usual attempts to find forecasting tools that will anticipate market moves, allowing them to position themselves to be drawn along by or accentuated by the market's investing gravity. As we showed in our prior article about the VIX, the sequence is reversed here. It is the market's actions that forecast subsequent VIX-related price moves, not the other way around.
Then there is simply a complexity in that the ETFs related to the VIX are most directly denominated not by the VIX Index itself, but by the prices of futures contracts on the index. While there are logical parallels, each security has its own markets, with frequent individual local influences that may obfuscate otherwise reasonable expectations. Arbitrage here is not a game for the casual practitioner or the dilettante.
The array of ETPs at hand includes:
- iPath S&P 500 VIX Short-Term Futures ETN (NYSEARCA:VXX)
- ProShares VIX Short-Term Futures ETF (NYSEARCA:VIXY)
- ProShares VIX Mid-Term Futures ETF (NYSEARCA:VIXM)
- VelocityShares VIX Short-Term ETN (NASDAQ:VIIX)
- ProShares Ultra VIX Short-Term Futures ETF (NYSEARCA:UVXY)
- ProShares Short VIX Short-Term Futures ETF (NYSEARCA:SVXY)
Their MM forecasts and forecast history details are in Figure 5.
Remember please that the orientation of this data is from having or taking a long position in the designated security. All except SVXY are expected to go up in price when the S&P 500 goes down meaningfully. SVXY, being a security that is short its VIX futures holdings, should rise when the VIX futures go down.
Further, all of the historical data (in columns 6 and 8-15) is from the standard portfolio management discipline applied to prior appearances of forecasts with upside to downside balances like today's, as indicated in column (7). Tomorrow or a week from now, these balances are likely to be different, and if so, decisions at that time need fresh historical backgrounds.
But at this point, the attractiveness of a long-position bet in each is ranked by the figure of merit in column (15). It attempts to blend odds of profitability with win-loss ratios and frequency of prior opportunities specific to each issue under conditions like the present.
On this basis, the VIX Index itself is the best bet, but one not directly placeable. Certainly, the efforts of Greeks and the EU keep the VIX uncertainty pot boiling. The implication is that the S&P 500 Index is likely to encounter a decline in the next 3 months, significant enough to pop the VIX from 14+ to near 19. But the cost of making that bet through VIX futures is already priced high enough that the odds of making money at it are less than a coin-flip and as little as one in 8 or one in 12.
The sole exception to such a dismal proposition is that over the course of the coming 3 months, the S&P is seen likely to rise sufficiently to generate a profit in SVXY from here in nearly 8 out of 10 tries. In the past, such propositions (43 market days out of the nearly 3 years of that ETF's existence) have generated net gains of over 8% in less than 6 weeks of average position holding times for a +98% annual rate of gain.
Now, that's pretty attractive. But there is a possibly better strategy than just buying SVXY here. If the market pros who daily express their views about the near future of the S&P 500 via hedging in the index futures markets are right and the VIX odds say they are right 3 out of 4 times (76 out of 100), the SPX and the SPY are likely at that new lower point of the S&P 500 to be supporting an even better (lower) buying price on SVXY than it now has.
Many variations of action implementation can be imagined.
Look, it should be obvious to anyone with even a basic knowledge of economics that the stage is being set for a massive financial meltdown.
Submitted by IWB, on February 24th, 2015
Sub-prime auto loans all time high and delinquencies are rising. Existing home sales implode while home price fall. Baltic Dry Index falls and ship builders are filing for bankruptcy.
Greek 4 month extension does nothing for the people of Greece. Sub-prime auto loans all time high and delinquencies are rising. Existing home sales image: http://images.intellitxt.com/ast/adTypes/icon1.png implode while home price fall. Baltic Dry Index falls and ship builders are filing for bankruptcy. US blimp in Maryland used to watch the people. Ukraine bans Russian media and sets up their own propaganda media. Poroshenko wants Crimea back as they pull more weapons to the front line. US and the coalition forces getting ready for a major offensive in the middle east. DHS budget in trouble, using fear and a false flag event to get their budget approved.
implode while home price fall. Baltic Dry Index falls and ship builders are filing for bankruptcy. US blimp in Maryland used to watch the people. Ukraine bans Russian media and sets up their own propaganda media. Poroshenko wants Crimea back as they pull more weapons to the front line. US and the coalition forces getting ready for a major offensive in the middle east. DHS budget in trouble, using fear and a false flag event to get their budget approved.
Why The Price Of Oil Is More Likely To Fall To 20 Rather Than Rise To 80
This is just the beginning of the oil crisis. Over the past couple of weeks, the price image: http://images.intellitxt.com/ast/adTypes/icon1.png of U.S. oil has rallied back above 50 dollars a barrel. In fact, as I write this, it is sitting at $52.93. But this rally will not last. In fact, analysts at the big banks are warning that we could soon see U.S. oil hit the $20 mark. The reason for this is that the production of oil globally is still way above the current level of demand. Things have gotten so bad thatmillions of barrels of oil are being stored at sea as companies wait for the price of oil to go back up. But the price is not going to go back up any time soon. Even though rigs are being shut down in the United States at the fastest pace since the last financial crisis, oil production continues to go up. In fact, last week more oil was produced in the U.S. than at any time since the 1970s. This is really bad news for the economy, because the price of oil is already at a catastrophically low level for the global financial system. If the price of oil stays at this level for the rest of the year, we are going to see a whole bunch of energy companies fail, billions of dollars of debt issued by energy companies could go bad, and trillions of dollars of derivatives related to the energy industry could implode. In other words, this is a recipe for a financial meltdown, and the longer the price of oil stays at this level (or lower), the more damage it is going to do.
of U.S. oil has rallied back above 50 dollars a barrel. In fact, as I write this, it is sitting at $52.93. But this rally will not last. In fact, analysts at the big banks are warning that we could soon see U.S. oil hit the $20 mark. The reason for this is that the production of oil globally is still way above the current level of demand. Things have gotten so bad thatmillions of barrels of oil are being stored at sea as companies wait for the price of oil to go back up. But the price is not going to go back up any time soon. Even though rigs are being shut down in the United States at the fastest pace since the last financial crisis, oil production continues to go up. In fact, last week more oil was produced in the U.S. than at any time since the 1970s. This is really bad news for the economy, because the price of oil is already at a catastrophically low level for the global financial system. If the price of oil stays at this level for the rest of the year, we are going to see a whole bunch of energy companies fail, billions of dollars of debt issued by energy companies could go bad, and trillions of dollars of derivatives related to the energy industry could implode. In other words, this is a recipe for a financial meltdown, and the longer the price of oil stays at this level (or lower), the more damage it is going to do.
The way things stand, there is simply just way too much oil sitting out there. And anyone that has taken Economics 101 knows that when supply far exceeds demand, prices go down…
have gotten crushed for the last six months. The extent to which that was caused by an excess of supply or by a slowdown in demand has big implications for where prices will head next. People wishing for a big rebound may not want to read farther.
Goldman Sachs released an intriguing analysis on Wednesday that shows what many already suspected: The big culprit in the oil crash has been an abundance of oil flooding the market
. A massive supply shock in the second half of last year accounted for most of the decline. In December and January, slowing demand contributed to the continued sell-off.
At this point so much oil has already been stored up that companies are running out of places to put in all. Just consider the words of Goldman Sachs executive Gary Cohn…
“I think the oil market is trying to figure out an equilibrium price. The danger here, as we try and find an equilibrium price, at some point we may end up in a situation where storage capacity
gets very, very limited. We may have too much physical oil for the available storage in certain locations. And it may be a locational issue.”
“And you may just see lots of oil in certain locations around the world where oil will have to price to such a cheap discount vis-a-vis the forward price that you make second tier, and third tier and fourth tier storage
[…] “You could see the price fall relatively quickly to make that storage work in the market.”
Read more at http://investmentwatchblog.com/look-it-should-be-obvious-to-anyone-with-even-a-basic-knowledge-of-economics-that-the-stage-is-being-set-for-a-massive-financial-meltdown/#oaQGYRovK5jAetB4.99
Long only, deep value, contrarian, long-term horizon
Why I Am Hedging My Portfolio With UVXY
Feb. 23, 2015 9:05 PM ET |
Disclosure: The author is long UVXY. (More...)
- The stock market is hovering near all time highs.
- The current bull market at 6 years is approaching the historical average.
- The VIX Index has not closed a month over 30 in more than 3 years.
I usually stay away from investments that do not have tangible asset backing, but I have made an exception in the case of the Pro Shares Ultra VIX Short Term ETF (NYSEARCA:UVXY).
Perfect Portfolio Insurance
What exactly is UVXY? According to its prospectus on the Pro Shares website, it seeks daily investment results that correspond to 2x the daily performance of the S&P 500 VIX Short-Term Futures Index.
What this basically means is that this ETF rises and falls with the level of the VIX, which is more commonly referred to as "The Fear Index." With general market levels at all time highs, there is not much fear permeating today's business landscape. However, as market historians have learned time and again, fear is one of the most powerful human emotions, and can skyrocket at a moment's notice. Let's look at some of the possible reasons why the VIX could increase dramatically in the near future.
The VIX Is Below Its 20-Year Averages
Take a look at the following 20 year chart for the VIX:
^VIX data by YCharts
As you can see, the VIX hasn't closed a month above 30 since November of 2011, over 3 years ago. The VIX has risen to 30 or above on 10 different occasions throughout the past two decades, leaving us with an average of one spike above 30 every two years. The longest time the VIX remained below 30 was 3/31/03-9/30/08, a period of 5.5 years. Although this was a long wait, the VIX jumped all the way to its 20 year high of over 65 shortly thereafter.
An era of low fear can only exist for so long in the volatile world of the stock market. This current run of low VIX readings is the second longest of the past two decades, and the longer that it continues, the higher the probability of a spike, based on historic averages.
The Current Bull Market Is Almost 6 Years Old
As a student of the stock market, I am fascinated by the bull and bear trends that are the fabric of investing. Although hindsight is always 20/20 in the stock market, the current trend is approaching the historical average bull market length. The longer that the market keeps running, the harder the inevitable fall will become.
Since the 1950s, there have been 9 bear markets, which are defined as a drop in the S&P 500 by 20% or more from its high point. That leaves us with roughly one bear market every 6.5 years. The current bull market began in March 2009, which makes it almost 6 years old. The longer that this bull market runs past its historical average, the higher the likelihood that it will sell off and become a bear market.
Current Statistics Indicate An Overvalued Market
I'd love to say that I can predict exactly when the correction will happen, but I know that is a fool's errand. I just know that the longer a trend continues in the stock market, the more people believe it to be true, which is ultimately when the sentiment changes.
Robert Shiller, a renowned economist, created the Cyclically Adjusted Price-Earnings (CAPE) ratio in an effort to create a gauge of how expensive the current market is. It is tallied by dividing price by the 10 year moving average of earnings, adjusted for inflation. Check out the following historical CAPE chart for the S&P 500:
S&P 500 Cyclically Adjusted Price-Earnings Ratio data by YCharts
As you can see, we are currently at the same level that we were at during the peak of the 2008 market, and just under the level of the infamous 1929 crescendo. This does not mean that a crash is imminent, but it does mean that we are entering dangerous waters.
Another tell tale sign of a roaring bull market is high speculation on margin. This chart shows an eerie correlation between stock prices and margin levels:
Source: Business Insider
As the famous Mark Twain quote goes, "history doesn't repeat itself, but it does rhyme." As stock prices keep increasing, people become more confident, and overextend themselves. It is a reality of the stock market today. Unless we are truly entering a fairy tale era of high margin speculation and never ending growth, this trend has to reverse itself eventually.
The Federal Reserve has officially ended its unprecedented QE program, which has been the largest economic stimulus in world history. This is important because it is now only a matter of time before the Fed raises interest rates. It will be fascinating to see how the financial markets react to the inevitable rate hike. This will negatively impact earnings for thousands of companies that rely on borrowed money. When this happens, volatility will spike.
From a macro perspective, it is a harsh reality that there is a tremendous amount of uncertainty in the world today. With Greece teetering on the edge of default and ISIS being in the news almost daily, there is high potential for a negative trigger sometime in the near future. Unfortunately, subprime lending is making a comeback and student loan debt is burdening an entire generation, causing first time home buyer rates to drop to 30 year lows. As the student loan generation ages, they will have less disposable income to spend, and thus will impact the revenues of many companies.
All of these are potential catalysts that could trigger a long overdue negative reaction in the stock markets.
Why Choose A Leveraged Fund?
The reason I chose a leveraged ETF like UVXY rather than a standard futures ETF like the iPath S&P 500 VIX Short Term Futures ETF (NYSEARCA:VXX) is simple: a strong conviction that the facts mentioned above will contribute to a market volatility higher than current levels in the near future. UVXY attempts to return 2x the VIX's performance for that particular day. This means that when a spike in volatility occurs, UVXY will significantly outperform VXX, which only attempts to achieve 1x the VIX performance.
Although UVXY will decline more than VXX in a low volatility market, the increased profit potential outweighs that drawback in my opinion.
There is one dominant risk concerning this strategy: the structure of UVXY itself. UVXY is a leveraged futures ETF, which means that it suffers exponential decay when in a period of contango. Contango is when the futures price is more expensive than the current spot price. Unfortunately, in a low volatility market like the present one, UVXY is in contango the majority of the time.
Accordingly, the risk of holding UVXY for a long period of time should be obvious. It WILL lose money if the market keeps up its slow ascent and fear fails to materialize. However, history shows us that record high stock prices and low volatility cannot go on indefinitely.
It is of utmost importance to exit a position in UVXY as soon as the VIX spikes in a significant way. Why is this? Because fear is a much stronger emotion than greed, but lasts for a much shorter time, which makes the spikes that much more pronounced. Accordingly, fear can vanish in an instant, so huge gains in a vehicle like UVXY can vanish in the blink of an eye.
Although the near future in stocks may continue to be bright, I believe that preparing for the worst is always a good strategy. As a holder of equities, I am hoping that the stock market continues its upward trend, but I will be prepared if it does not.
I consider the decay of UVXY the monthly premium that I pay in order to hold insurance in the case of disaster. If any of the aforementioned negative triggers materialize, UVXY should increase in value, which will then allow me to add to my long positions at lower prices.
As Warren Buffett is famously quoted: "Only when the tide goes out do you realize who's been swimming naked." All I know is that when the wave of fear hits, at least I'll have my bathing suit on.
Friday, February 20, 2015
10 RT - Daily news by RT / 10min // keep unread // hide // preview
Also saved in OneNote
The magazine doesn’t provide any detail, other than saying that ECB is working on plans for Greece’s possible exit from the euro. On Friday, the Eurogroup is holding an extraordinary meeting in Brussels to agree on a loan extension for Greece.
A lack of progress in talks between the new leftist government in Greece, that promised to end austerity, and the troika of international creditors have increased worries that Athens could exit the eurozone and possibly cause a ‘domino effect’, with Portugal, Spain and Italy following suit.
"The Greeks have acted like elephants in a China shop," Guenther Oettinger, German EU Commissioner was cited as saying on Friday by the New York Times. "Now they slowly realize what the real numbers are. But they have already done quite a bit to sap the confidence of their European partners."
On Thursday, Germany’s Finance Ministry rejected Greece’s request for an extension to its expiring bailout agreement. Greece’s Syriza government asked for a six-month loan extension for more time to renegotiate its €316 billion debt.
At a meeting of eurozone officials on Thursday, German Finance Minister Wolfgang Schauble called the Greek proposal a “Trojan horse, intending to get bridge financing, and in substance putting an end to the current program,” the New York Times reports.
— The Economist (@TheEconomist) February 20, 2015
Greece’s current bailout loan was agreed by the previous Greek government in 2012, totals €240 billion. The conditions of the bailout program, which include cuts in government spending, higher taxes are extremely unpopular in Greece.
If the EU and Greece fail to reach an agreement Friday, according to a European Union official talking to Bloomberg, this would mean another round of talks on Sunday or Monday.