Newsletter #12, 2010 – Market in uptrend from Tuesday December 7th, 2010

Today we have the current gloomy topics that we will dive into:

  • Optimism reaches new highs – Not a sign of an ending bear market
  • Spain will soon be needing a bailout as well
  • In the US, as I have stated so often that everybody probably have heard me screaming wolf for several months now, the situation is not any better
  • We know what the Fed has been doing lately, but it is more interesting to see what they are actually saying
  • Copper as a stock market indicator
  • “Don’t touch my junk” – How US initiatives for increased safety leads to more death

We are now back into a confirmed uptrend in the market. Note however that the daily, weekly and monthly full stochastics are now all overbought and topping. This could mean that we can get a little fall in prices within the new uptrend or that the uptrend could end quickly.

Collective psychology of market participants moves markets, not news. Last Friday’s market action proved that.

The economy looks bad as ever. Today’s market environment reminds me of late 2007, when the market made new highs right into the face of the biggest credit crisis in history.

Optimism reaches new highs – Not a sign of an ending bear market

At least a dozen articles have appeared in recent weeks claiming that there is “too much doom and gloom,” so the contrary play here is to be bullish. We saw the same kind of arguments in early 2008. The only way to resolve this issue is to keep track of actual measures of sentiment, and here are the key ones: The 30-day the Daily Sentiment Index (DSI) of S&P traders rose to 87.3% bulls last month, that is the highest rating since June 2007 (which was the all-time high). Other sentiment indexes like the American Association of Individual Investors survey and the Investors Intelligence survey also show the highest rating of bulls for November since 2007. Mutual fund managers are also bullish; their percentage of assets in cash is only 3.6%, which is just 0.2%-points from the all-time record low set in July. Previous extreme readings occurred in 2000 and 2007. Even in the minor setback of the early 1990s, mutual fund managers got worried enough to get up to double-digit percentages of cash. But now they are more optimistic than ever.

According to Elliott Wave the Dow Industrial Average has only a 2.7% annual dividend yield, lower than it was in 1929! The S&P’s yield is only 2.1%. In the past century of stock market history, the only peaks at which the dividend yield indicated more optimism were those of 2000 and 2007. These previous readings gave us what commentators call the “lost decade,” the worst ten-year return for the S&P ever. Some people think the stock market’s poor ten-year return is a reason to be bullish. But the sentiment figures show that the majority is still historically optimistic, which is not the way bear markets end!

Investors Intelligence also reported that 619 stocks registered weekly buying climaxes for the week ending November 12. The only time it has been higher over the last six years was during the high in April this year. As I have mentioned earlier, buying climaxes is a sign of stocks shifting from strong to weaker hands. It is a sign of distribution, and usually happens near to significant tops. A buying climax happens when a stock makes a 52-week high and then closes the week down.

On the contrary people are very bearish on the USD. The total net hedge fund bets against a USD rise recently surpassed the earlier extremes reached in 2007-2009. The DSI from came in at just 3% USD bulls. And it seems that everybody now is negative to the USD.

The biggest near-term risk for financial markets is the continued popular (and ultimately political) outrage in Ireland and the rest of Europe about implementing austerity measures solely to prop up a hopelessly rotten banking system.”

Spain will soon be needing a bailout as well

The situation in Europe has developed as expected. And I see it as almost a certainty that Spain will need to be bailed out as well. Right now the situation in Europe, due to the lack of flexibility in the monetary system is actually worse than in the US. We all know how bad the situation is in Greece and Ireland, but let’s take a quick look at some of the other Eurozone countries. Nadeem Walayat had a good article in the Market Oracle Newsletter on November 26th (

The Portuguese yield is at 6%. A bailout of Portugal at an estimated Euro 40-80 billion is imminent for an uncompetitive economy carrying a rising debt to GDP ratio at 83%. Spain’s yield has now crossed above the 5% bailout rate to 5.2%, which suggests that the market is pricing in a bailout for Spain, which is not surprising given the exposure of Spanish banks to Portuguese debts, official debt is put at 64% of GDP but this does not fully take into accounts Spanish bank’s bad debts that as with Ireland could easily send Spain’s debt to GDP to well over 100%. Italy’s yield has trended higher to 4.58% putting Italy firmly in the queue for a debt crisis blowout given that public debt is already at 120% of GDP. Belgium’s yield rose to 4%, which illustrates an elevated risk as a consequence of the failure of the political parties to form a new government and public debt is already at 100% of GDP. The German yield is for comparison at 2.92%.

UK – Whilst not part of the Eurozone has seen its 10-year yields continue to trend higher to 3.45%. The lower UK yield despite Britain’s huge debt mountain illustrates the flexibility afforded by being OUTSIDE the euro-zone as it allows Britain to continue to stealth default on its debts by means of printing money induced high inflation that the Eurozone countries cannot do individually I.e. the UK government prints money that it loans to the bankrupt banks at 0.5% to buy UK government bonds at 3.45%, hence why the yields are lower than the likes of Spain and Italy, which acts as a safety valve preventing outright bankruptcy but the price paid is in high inflation, with the doctored official inflation measure of CPI is at 3.2%, the more recognized RPI at 4.5% and real inflation at 6%. (All data is updated as of December 7th.)

This looks to be the outcome of the current and coming bailouts:

  • Greece – Bust requiring bailed Euro 110 bailout
  • Ireland – Bust requiring Euro 85 billion Bailed out
  • Portugal – Pending an imminent bailout of approx Euro 40-80 billion
  • Belgium – Pending bailout of approx Euro 50 billion.
  • Spain – Pending bailout of approx Euro 400 to 500 billion.
  • Italy – Pending bailout approx Euro 1 trillion+.

Does not look very good for the EUR. Expect a lot of political turmoil and more riots as governments are forced to make painful budget cuts to try to better balance their budgets.

In the US, as I have stated so often that everybody probably have heard me screaming wolf for several months now, the situation is not any better

The data is a little old, but nothing has improved since then. On September 16, the US Census Bureau reported that 43.6 million Americans – including 20% of its children were living in poverty in 2009, the largest number since the Census Bureau began recording poverty a half century ago.

Unemployment is rising despite the largest monetary stimulus package the world has ever seen. Which has lead to an enormous budget deficit and humongous debt levels close to USD 14 trillion. The budget deficit and the mounting debt is the biggest problem that the US faces right now, and if something is not done shortly the country is for sure going the way of Greece, or the Roman Empire more than a few centuries ago.

The best Obama’s deficit commission could come up with was USD 3.9 trillion in savings over the next 10 years. An average USD 390 billion per year, which equals just 11% of the 2010 budget. The budget deficit for the 2010 budget is estimated at USD 1.2 trillion(!) so we are a very long way of getting close to anything that resembles a balanced budget. Their revenue projections assumed we would have no recessions for the next 10 years. Very unlikely! And not unexpected, the plan couldn’t get the required 14 out of 18 members to sign on for the plan to be formally recommended to Congress.

Remember: Only 67% of this budget is paid for by revenue. The other 33% is debt! To get an understanding of how far the US is from ever balancing its budgets you can zero out unemployment, food stamps, Medicaid and all other welfare programs… and that’s only 24%. Assume they accommodate the demands to “keep government’s hands off my Medicare,” Social Security, and that the Pentagon is untouchable… and that immediately puts 51% of all spending off-limits. The US has a BIG challenge ahead in the years to come.

But they have at least started with some very promising initiatives, that will save the US government a whole lot of money going forward. Here is a little piece from Agora that makes you wonder what kind of time/impact budget the politicians are working on: President Obama wants to freeze federal salaries for the next two years. Republicans are carping that they suggested the same thing months ago. Neither side is acknowledging a couple of basic facts… This sudden onset of fiscal prudence comes only after the number of federal workers earning more than USD 150,000 a year grew tenfold in just five years. A two-year pay freeze would save the massive amount of USD 60 billion across the next 10 years. Considering the national debt is growing USD 4 billion a day, this is good for about 15 days of savings. This is what it’s come to: Democrats and Republicans fighting over who gets credit for proposing something that will tide over Uncle Sam for 15 whole days. If it ever gets enacted. Which it probably won’t.

So while politicians focus on the little things, lets look at what matters, the big picture. I still believe it is very likely, and the most recent development indicates to me that is becoming more likely for each month that we will see a double dip in the global economy. What the trigger will be, Europe, the US, China or whatever else, I have no idea. But if you take a moment to look behind the GDP numbers of the US is reveals a situation a little different from what the headline figure should indicate.

GDP growth comes mainly from changes in sales and inventory. There has been a massive inventory buildup in the US over the last few quarters. Companies are just as optimistic about the future as investors. In Q3 we saw the largest increase in production relative to orders in the last 20 years. This has been the reason for the large increase in GDP growth lately as well. But if the consumption does not increase as expected this will have a significant negative impact on the economy. We have seen the biggest ever stimulus to the economy after a recession but the weakest ever rebound. Inventory build up needs to be more than USD 110 billion, which it was in Q3 to have a positive contribution to GDP growth according to Albert Edwards, strategist with SocGen. The ISM on the other hand points to a fall in inventories over the coming quarters. So unless sales picks up from the current level it is very likely that we can see negative GDP growth again soon.

And we have already gotten a “double dip” in the housing market. New home sales took a dive in October. Prices are weak everywhere and falling in some areas.

We know what the Fed has been doing lately, but it is more interesting to see what they are actually saying

It is always great to listen to Ben Bernanke. Not because he has so much too say, but because whenever he says something with any conviction you can be sure that the opposite happens. We have mentioned some of this earlier but here is a short recap of his success at forecasting market events. And remember this is supposedly one of the most powerful people in the world and he also has access to the most data for analytical work of probably anyone. Here is a short list of his earlier statements:

  • On July 1, 2005, Bernanke stated with great confidence that the U.S. was not experiencing a housing bubble, saying: ”I think what is more likely is that house prices will slow, maybe stabilize, might slow consumption spending a bit.”
  • He was on a roll that month (July 2005). Here is from an interview with CNBC. “Tell me, what is the worst case scenario if in fact we were to see prices come down substantially across the country?” Bernanke goes on to answer: “Well, I guess, I don’t buy you premises, it is a pretty unlikely possibility, we have never had a decline in house prices on a nation wide basis.
  • In November 2005, he talked about derivatives, saying, ”With respect to their safety, derivatives, for the most part, are traded among very sophisticated financial institutions and individuals who have considerable incentive to understand them and to use them properly.” He also said, ”The Federal Reserve’s responsibility is to make sure that the institutions it regulates have good systems and good procedures for ensuring that their derivatives portfolios are well managed and do not create excessive risk in their institutions.”
  • And a couple months after that (now in February 2006), back on housing again, he said, ”Our expectation is that the decline in activity or the slowing in activity will be moderate, that house prices will probably continue to rise.”
  • “We see no serious broad spillover to banks or thrift institutions from the problems in the subprime market.” (May 2007)
  • “The Federal Reserve is not currently forecasting a recession.” (January 2008, a month after the recession began.)
  • And in February of 2008, he said, ”I expect there will be some failures of smaller banks.” Bear Stearns collapsed just a couple weeks later…
  • He also told the world in July 2008 that Fannie and Freddie were ”adequately capitalized” and ”in no danger of failing.”
  • “Currently, we don’t think [the unemployment rate] will get to 10%.” (May 2009, now it is at 9.8%).
  • “The economy… appears to be on track to continue to expand through this year and next,” Fed chief Ben Bernanke told Congress on June 9th, 2010.

Sorry for including so many, I just wanted you to be convinced that this is not just an unlucky coincidence that he misses on his predictions. Now, this brings us to this weekends interview on 60 minutes were Ben said that because the Fed is acting the risk is pretty low for deflation now. He added that he is 100% certain of his ability to control inflation, and that housing is already weak and it can’t get much weaker.

I wonder how this guy who did not see anything of the big economic events over the last 5 years, and there have been some pretty clear and big ones are going to be able to steer the economy going forward.

I will finally mention that he also said that consumer’s fear of the future is the highest risk we face now, which probably explains why government officials are even close to explaining in plain English how dire the US situation is. If consumers knew how the situation was they would for sure riot and demand “Change.” I wonder what happened to that Change Obama promised the world… Maybe it was a change to the worse he meant? Or maybe Bernanke has Changed? I won’t believe it until I see it. And I don’t expect to see it anytime soon.

I think the only thing that is for certain now is that the Fed has absolutely no control over inflation. I continue to expect deflation driven by a massive stock market fall (when investors finally realizes that earnings growth will not meet expectations), massive debt reduction and a growing elderly population.

Copper as a stock market indicator

Graham Summers has some interesting articles on his website ( every once in a while. Today was one such day ( Copper is often called Dr. Copper as the metal is considered a bell-weather for the world economy due to its close correlation to economic growth (used by many industries, copper typically rallies when the world economy is growing). Indeed, one of the first signs that the market was going to rally rather than fall off a cliff during the Euro Crisis Round 1 in June came from Copper. As the below chart shows, the metal bottomed in June, preceding the stock bottom by almost a month. Since that time, the correlation between stocks and copper has strengthened to the point that today, the two assets are trading together on a near tick-for-tick basis:

With that in mind, today I want to focus on the metal for signs of what’s to come in the markets. The first and most important item to note is that copper is coming up against long-term resistance. A breakout here would indicate the “inflation trade” is prepared to explode higher in a major way.

Is this a sure thing? Not necessarily, copper has actually just formed a rising bearish wedge pattern in the last six months. These patterns tend to be topping patterns, which preclude sharp sell-offs down to the base (in copper’s case 2.80 per pound) when broken. As you can see, copper broke this pattern in early November. This latest rally has brought copper up to test the broken trend-line. A rejection here would likely precede a sharp sell-off back down to USD 3.70 per pound. And if we take out the downward support line (green line above) then we’re going down in a BIG way.

Keep your eyes on the Doctor, he may be flashing a warning signal to stocks.

“Don’t touch my junk” – How US initiatives for increased safety leads to more death

I am sure that you have all heard about the increased security check for flights in and to and from the USA, and maybe even picked up on the “don’t touch my junk” debate. A reader of one of Agora’s newsletters had this to say about the TSA: “Honestly, I would prefer to risk being blown out of the sky. The TSA searches are causing greater loss of useable lifetime than the terrorists ever could. About 800 million people have to arrive ~1h earlier at the airport to wait in lines and now suffer increased humiliation. Human beings only live for 700,000 hours. The TSA is wasting time equivalent to killing over 1,000 people each year.” The increased security measures have also caused more people to drive instead of flying. “Driving is much more dangerous than flying, as you are far more likely to be killed in an automobile accident mile-for-mile than you are in an airplane,” says economist Steven Horwitz of St. Lawrence University. “The result will be that the new TSA procedures will cause more Americans to be killed on the highway.”

I kind of liked this alternative from another reader. “Develop an enclosed booth that passengers step into but, instead of X-raying them, when the door closes, it will detonate any explosive device they have hidden on or in their body. The explosion will be contained within the sealed booth. This would be a win-win for everyone! There would be no more concern about racial profiling. The booth would eliminate long, expensive trials. You’re in the airport and you hear a muffled explosion, followed by an announcement over the PA system, ‘Attention standby passengers, we now have a seat available on flight number…’”

And while we are one the subject of homeland security. If you are still not convinced that the US is corrupted: “According to Congressman Ron Paul, the former Secretary of Homeland Security, Michael Chertoff, is making millions selling the backscatter X-ray scanners to his former agency.” The week after the Christmas day “underbomber” incident, Chertoff was all over TV posing as an “expert,” advocating that more scanners be installed at airports, but never disclosing that his firm consults for the companies that make the scanners.

Until next time,

Eirik W. Moe

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