"Cook, Cook, drink your tea.
But save some in the pot for me.
We'll watch the tea leaves in our cup
When our drink is all sipped up.
Happiness or fortune great,
What will our future be?" - From the book, "Afternoon Tea at Pittock Mansion" by R.Z. Berry
Traders spend hours trying to gain an edge over the market and most of it is like looking at tea leaves to dissect and expectation about future market movements. With the decimation of some of the most prolific momentum stocks in the past few weeks I thought it would be a good to take a look at some market indicators to see what they are telling us if anything. Now some of this may be relatively technical in nature but that is all part of the education process so bear with me and see if you can make sense of my tea leaves.
First off I took a look at the S&P 500 and while it recently made a new high of 1897.28 on April 4th, it subsequently rolled over. It did bounce but does not look like it has the momentum to regain its previous high particularly when you look at the Relative Strength Index which is showing short term weakness. Also given that the Federal Reserve continues to slash its support in $10 billion monthly increments, the catalyst for the market to move higher seems to be gone. Whether it will actually die or consolidate at this level is still open to debate but on the surface it does not look like it will take out the highs in the coming weeks and in fact may even test the 200 day moving average around 1,800 first.
Looking at the fear gauges of Gold and the VIX it still looks like the market is complacent. The VIX is a barometer of market fear as it measures the number of put options to call options in a given market. More put options (an option that bets that the market will fall) shows more concern for future market direction. A VIX of less than 15 shows complacency while a VIX of over 50 points to high risk. Right now the VIX is 14 so there is little in the way of panic. Also while the price of gold seems to have stabilized it is still not showing signs of a full blown recovery in the price. So by both of these measures the market is not expecting a huge draw down but it is at these times of complacency that the Black Swan appears.
I always follow copper closely as that is a good barometer of global industry and while it has taken a beating in the past few months it is actually showing some signs of strength. While this strength is very short term in nature and therefore cannot be considered as showing signs of strong global economic growth a recovery has to start somewhere. So with stock markets looking weak it is always interesting to see a divergence in this commodity from the market movements. More strength in this price might point to a recover in global trade and that would portend to a stronger economic platform on which markets could base a recovery.
Crude oil recently made a new 52 week high of $104 a barrel and this has had a huge impact on the price of gasoline. While this price strength can be attributed to stronger demand and therefore stronger economic growth, the impact of this spike in gasoline prices is not encouraging as a sudden spike in inflation would quickly derail any form of recovery. Consumers are still too cash strapped to handle and extended spike in this price but fortunately the price has quickly fallen to just over $100 a barrel. I would like to see this below $95 a barrel to ensure that there is not a significant impact to economic growth.
A friend of mine showed me some research on interest rate movements since the 70s. The study was done to see the impact of rising interest rates on the market returns but what I found most interesting about the study was that from 1970 to 2007 interest rates rose every 5 years or so. Since 2007 however there really has not been a significant tightening in interest rates and so this recovery is really long in the tooth. The basic premise is that interest rates have to rise soon but looking at the overall data of low inflation, high unemployment and continued significant (although slowing) stimulus I would expect interest rates to remain low for an extended period. While this may be good for the market a quick look at Japan shows that even with low interest rates particularly when those are low for an extended period of time there is no guarantee of a continued burgeoning market. In fact the length of time between raising rates is signalling problems rather than good times so more of the same will have more and more of a negative impact as the magnitude of the problem is truly understood.
Now I could go on with more indicators but the above is a good barometer that the market is really in a quandary right now. There are no clear signals that point to continued strength or to a total collapse and so I would not be surprised to see the market drift along aimlessly until a new catalyst is found. What that catalyst is I cannot fathom a guess but I would not think it a time to be overly optimistic and in this type of market caution is often your best friend.
Friday, April 25, 2014
Friday, April 18, 2014
Is Volatility Risk?
"Traders can cause short-term volatility. in the long run, the market must revert to a sensible price/earnings multiple." - Ben Stein
"Never think that lack of variability is stability. Don't confuse lack of volatility with stability, ever." - Nassim Taleb
"We are facing extreme volatility." - Carlos Ghosn
Modern society has determined that it has the tools to smooth out volatility. We can witness these efforts at work in government, central banks, medicine, work and even at home. The question is whether all of this effort to alleviate day to day variability is beneficial or is this massive effort really the cause of all the pain?
As we all know volatility is a movement around a so called norm or trend. In stocks volatility is seen as large movements in the price of the stock either up or down away from the trend line of mean. In most cases people ignore the large upward move as that more often than not is a benefit so beneficial movements (even though they are volatile) are considered good and are ignored. The same can be said for the economy, accelerating economic growth is considered acceptable but as with stocks excessive acceleration is worrisome and in most cases is met with a central banker that tries to slow the growth to a more "normal" level.
Most people consider volatility associated with their paycheck as bad but some of us (normally the entrepreneur) loves this volatility as it offers the opportunity to make a lot more money. Vaccines are constantly being created and worked on to protect the world against disease and cleaning agents try to eradicate germs. Governments that are rouge are taken out and replaced with more conservative middle of the road ideals and mothers and fathers around the world try to protect their kids from bully's and nurture them in a way completely different from the real world.
The problem with all of this is that we evolve through volatility. Germs become stronger to fight back against the newest drug, they evolve into ever more powerful aliens that kill more people in hospitals than in motor car accidents. Puppet governments fall apart in time as given complete power they ultimately fail through lack of attention to detail and a sense of self-entitlement. Take Mugabe and Saddam Husein as two people placed into power by the United States to maintain the peace. There are obviously more examples of people placed in power by countries other than the United States but these are two readily available examples. Our DNA advances by learning from previous generations and fixing those weaknesses (only the strong survive).
Central governments are continually tinkering with the markets to create a "normal" environment so that in the end no-one knows what "normal" really is. What we do know is that these efforts to placate the markets has always ended in more bloodshed than if the markets were left to their own devices. Furthermore each time the market collapses the reserve bankers step in to try to "repair" the problem by adding liquidity or artificially moving interest rates which causes another problem elsewhere.
Now before you think I am advocating the complete removal of all government bodies and to live like John Lennon says we should in his song Imagine, I am not. There is a place for authorities to monitor certain situations and prevent a complete collapse caused by crowd hysterics or to provide law and order but outside of that framework the markets need to be left to handle themselves. Consider if Greenspan had not provided support for the Internet bubble. Meddling to save the market created the low interest rate environment which caused the housing bubble which has now lead to the largest experiment known to man. What would the real implications have been to let the technology bubble burst? The collapse of the banking system in 2007 was far more serious than the original problem and now that we have propped up that mess with $4 trillion no-one can even fathom a guess at the problems this will cause.
On a separate note, my friend John Cox is advocating a larger government body to repair the broken political system that is California. While on the surface this idea appears to be madness, in effect what he is offering is more volatility at the local level to ensure less trouble at the top thereby actually repairing the problem caused by too much power in the hands of too few people. This type of system is working admirably in other parts of the globe (Switzerland to name one) and could be what we need but moving the mindset of the average citizen will be a monumental task so if possible given him your support.
In conclusion, small, regular amounts of volatility is the ingredient that alleviates massive economic and political turmoil. Trying to end small uncomfortable problems associated with volatility causes greater global imbalances and will result in greater problems. Until we can accept this and change the way that problems are dealt with, the future will continue to be filled with large economic shocks to society at regular intervals. It is inevitable and unavoidable and as this idea is imbedded in most political parties around the globe (China included) the only thing we can do is prepare for large scale shocks in the future.
"Never think that lack of variability is stability. Don't confuse lack of volatility with stability, ever." - Nassim Taleb
"We are facing extreme volatility." - Carlos Ghosn
Modern society has determined that it has the tools to smooth out volatility. We can witness these efforts at work in government, central banks, medicine, work and even at home. The question is whether all of this effort to alleviate day to day variability is beneficial or is this massive effort really the cause of all the pain?
As we all know volatility is a movement around a so called norm or trend. In stocks volatility is seen as large movements in the price of the stock either up or down away from the trend line of mean. In most cases people ignore the large upward move as that more often than not is a benefit so beneficial movements (even though they are volatile) are considered good and are ignored. The same can be said for the economy, accelerating economic growth is considered acceptable but as with stocks excessive acceleration is worrisome and in most cases is met with a central banker that tries to slow the growth to a more "normal" level.
Most people consider volatility associated with their paycheck as bad but some of us (normally the entrepreneur) loves this volatility as it offers the opportunity to make a lot more money. Vaccines are constantly being created and worked on to protect the world against disease and cleaning agents try to eradicate germs. Governments that are rouge are taken out and replaced with more conservative middle of the road ideals and mothers and fathers around the world try to protect their kids from bully's and nurture them in a way completely different from the real world.
The problem with all of this is that we evolve through volatility. Germs become stronger to fight back against the newest drug, they evolve into ever more powerful aliens that kill more people in hospitals than in motor car accidents. Puppet governments fall apart in time as given complete power they ultimately fail through lack of attention to detail and a sense of self-entitlement. Take Mugabe and Saddam Husein as two people placed into power by the United States to maintain the peace. There are obviously more examples of people placed in power by countries other than the United States but these are two readily available examples. Our DNA advances by learning from previous generations and fixing those weaknesses (only the strong survive).
Central governments are continually tinkering with the markets to create a "normal" environment so that in the end no-one knows what "normal" really is. What we do know is that these efforts to placate the markets has always ended in more bloodshed than if the markets were left to their own devices. Furthermore each time the market collapses the reserve bankers step in to try to "repair" the problem by adding liquidity or artificially moving interest rates which causes another problem elsewhere.
Now before you think I am advocating the complete removal of all government bodies and to live like John Lennon says we should in his song Imagine, I am not. There is a place for authorities to monitor certain situations and prevent a complete collapse caused by crowd hysterics or to provide law and order but outside of that framework the markets need to be left to handle themselves. Consider if Greenspan had not provided support for the Internet bubble. Meddling to save the market created the low interest rate environment which caused the housing bubble which has now lead to the largest experiment known to man. What would the real implications have been to let the technology bubble burst? The collapse of the banking system in 2007 was far more serious than the original problem and now that we have propped up that mess with $4 trillion no-one can even fathom a guess at the problems this will cause.
On a separate note, my friend John Cox is advocating a larger government body to repair the broken political system that is California. While on the surface this idea appears to be madness, in effect what he is offering is more volatility at the local level to ensure less trouble at the top thereby actually repairing the problem caused by too much power in the hands of too few people. This type of system is working admirably in other parts of the globe (Switzerland to name one) and could be what we need but moving the mindset of the average citizen will be a monumental task so if possible given him your support.
In conclusion, small, regular amounts of volatility is the ingredient that alleviates massive economic and political turmoil. Trying to end small uncomfortable problems associated with volatility causes greater global imbalances and will result in greater problems. Until we can accept this and change the way that problems are dealt with, the future will continue to be filled with large economic shocks to society at regular intervals. It is inevitable and unavoidable and as this idea is imbedded in most political parties around the globe (China included) the only thing we can do is prepare for large scale shocks in the future.
Friday, April 4, 2014
The Elephant and the Bicycle
"China is like an elephant riding a bicycle. If it slows down, it could fall off, and then the earth might quake." - James Kynge's book China Shakes the World
After 30 years of economic growth of more than 8% a year it appears that China has finally reached the end of the road. During the 30 years of expansion there were a few bumps in the road but nothing like the Great Recession. Like most investors that get used to an extended bull market the Chinese government did what it always had done and that was to support their economy. They had the resources and so they sprang into action running a massive deficit, pushing interest rates down to extremely low levels and injecting large quantities of debt. The idea, as with all stimulus packages, was to weather the storm from the West and ramp up in preparation for the coming global expansion. When that global expansion took hold they could mop up the excess liquidity and stimulus and profit from the continued economic growth of 8%.
Unfortunately 8 years later the world still has not recovered and the stimulus has created bubbles and excesses all over China making it look like economic growth in China may finally stall bringing the elephant off the bicycle. Should this happen the repercussions will be felt across the globe as China is now the world's second largest economy, it has massive foreign reserves invested in all the developed nations and has grown itself into a hugely important consumer and industrial market.
As with all attempts to stimulate an economy with debt, the economy becomes addicted and unless more is produced exiting is painful. Debt produces excesses as why not risk the farm if it is owned by the bank anyway? It is not your money so keep producing until your line of credit is taken away and then, taking the remaining cash, head onto the next project and leave the mess to the bond holders. This should sound pretty familiar to most of you who follow this blog and certainly China is not alone in this quandary but let's look at some of the metrics pointing to excesses:
1. China has only consumed 65% of the cement it has produced in the past 5 years.
2. Steel production is larger than the next seven largest producers combined.
3. More than 27 billion square feet of new construction is vacant but more than 1.8 billion more is currently under construction.
4. Property prices in large metropolitan areas is almost 40 times the rental cost.
These are just some of the metrics that show the large excesses that their stimulus has created and the problem is that unless there is significant economic growth these problems will be transferred to the banks and we have all witnessed the problems associated with a financial crisis. Furthermore a large part of the globe's economic recovery was based on China and the continued growth of the BRIC nations. These nations continued to expand while the United States continued to print money but, with the reduction in stimulus from the Federal Reserve, the quick money is leaving these markets and showing them to be very vulnerable.
So for the past 30 years China has been seen as an economic miracle and has managed to avoid the kind of hard landings felt in the rest of the world for the simple reason that their economy was based on solid economic growth. This has now changed as they have finally succumbed to the West's economic stimulus models and with it we could witness for the first time the elephant fall off the bicycle and this shock will be felt across the globe.
After 30 years of economic growth of more than 8% a year it appears that China has finally reached the end of the road. During the 30 years of expansion there were a few bumps in the road but nothing like the Great Recession. Like most investors that get used to an extended bull market the Chinese government did what it always had done and that was to support their economy. They had the resources and so they sprang into action running a massive deficit, pushing interest rates down to extremely low levels and injecting large quantities of debt. The idea, as with all stimulus packages, was to weather the storm from the West and ramp up in preparation for the coming global expansion. When that global expansion took hold they could mop up the excess liquidity and stimulus and profit from the continued economic growth of 8%.
Unfortunately 8 years later the world still has not recovered and the stimulus has created bubbles and excesses all over China making it look like economic growth in China may finally stall bringing the elephant off the bicycle. Should this happen the repercussions will be felt across the globe as China is now the world's second largest economy, it has massive foreign reserves invested in all the developed nations and has grown itself into a hugely important consumer and industrial market.
As with all attempts to stimulate an economy with debt, the economy becomes addicted and unless more is produced exiting is painful. Debt produces excesses as why not risk the farm if it is owned by the bank anyway? It is not your money so keep producing until your line of credit is taken away and then, taking the remaining cash, head onto the next project and leave the mess to the bond holders. This should sound pretty familiar to most of you who follow this blog and certainly China is not alone in this quandary but let's look at some of the metrics pointing to excesses:
1. China has only consumed 65% of the cement it has produced in the past 5 years.
2. Steel production is larger than the next seven largest producers combined.
3. More than 27 billion square feet of new construction is vacant but more than 1.8 billion more is currently under construction.
4. Property prices in large metropolitan areas is almost 40 times the rental cost.
These are just some of the metrics that show the large excesses that their stimulus has created and the problem is that unless there is significant economic growth these problems will be transferred to the banks and we have all witnessed the problems associated with a financial crisis. Furthermore a large part of the globe's economic recovery was based on China and the continued growth of the BRIC nations. These nations continued to expand while the United States continued to print money but, with the reduction in stimulus from the Federal Reserve, the quick money is leaving these markets and showing them to be very vulnerable.
So for the past 30 years China has been seen as an economic miracle and has managed to avoid the kind of hard landings felt in the rest of the world for the simple reason that their economy was based on solid economic growth. This has now changed as they have finally succumbed to the West's economic stimulus models and with it we could witness for the first time the elephant fall off the bicycle and this shock will be felt across the globe.
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