Tag Archives: bearish

Technically Speaking: 5 Reasons To Be Bullish (or Not) On Stocks

Just recently, Tom Lee, head of Fundstrat Global Advisors, published a list of 5-bullish signs for the stock investors which he says you should “ignore at your own peril.” As he notes:

“In short, these signals are saying the S&P 500 is set up for a monster 2H rally. We are not ignoring the negative signal of a plunge in interest rates, nor saying that a full-blown trade war is negative for the World. But, we believe the trifecta of strong US corporates, positive White House (towards biz) and dovish Fed, are major supports for the US equity market.”

His view is that the short-term disruption of the market over “trade” issues is an opportunity for investors to increase equity exposure.

Over the last few weeks, we had discussed the excessive deviation to the market above the 200-dma, which suggested that a reversal of that extension was probable. The question now is whether Tom’s view is correct?

Are the markets set up for “monster second-half rally,” or is this just the continuation of the topping process that began last year.

While these are certainly reasons to be “hopeful” that stocks will continue to rise into the future, “hope”has rarely been a fruitful investment strategy longer term. Therefore, let’s analyze each of the arguments from both perspectives to eliminate “confirmation bias.” 

Economic Growth To Improve

No matter where you look as of late, economic growth has been pretty dismal. However, there is always hope for improvement that could support a recovery in asset prices.

“Still, many analysts remain optimistic that the U.S. economy can continue expanding even if growth slows down. The Citigroup Economic Surprise Index for the U.S., which measures broadly whether data points are meeting expectations, has risen sharply in recent weeks.” – WSJ

After a recent slate of feeble economic data points, the improvement should come as no real surprise. The quarterly, or annual comparisons, can certainly show some improvement. However, it should be noted the improvement is still within the context of a very negative environment, or rather, the data is just “less negative,” rather than “positive.” 

This can be seen more clearly in our economic composite index, which is a broad measure of the U.S. economy including both the service and manufacturing sectors.

The problem for the bullish case is that 10-years into the current advance, there is little lifting power for monetary policy at this juncture. Yes, lower rates from the Fed could indeed provide a short-term bump to markets based solely on momentum. However, the ability to pull-forward accelerated rates of consumption to increase economic growth is much less likely. Most likely, the short-term increase in “less negative” data will turn lower as we move further into the year.

Volatility Signals A Bottom?

Volatility, as measured by the volatility index, spiked up recently. For the bulls, the spike in volatility has been a “siren’s song,” to “buy the f***ing dip.” This has been a winning strategy for investors over the last 10-years.

Is this time different? Take a look at the chart below. The volatility index is inverted for clarity purposes. The red vertical dashed line is when the monthly sell signal was issued, suggesting a reduction in equity risk in portfolios. The blue vertical dashed line is when the volatility index bottomed with extreme complacency and volatility begin a regime of trending higher.

The change in the trend of the volatility, trending lower to trending higher, is a hallmark of previous bull market peaks. 

While the market is short-term oversold, combined with a surge in the VIX, the market will likely bounce short-term.  However, with volatility now trending higher, that rally could be short-lived if a larger corrective cycle is beginning to take hold.

Earnings Not That Bad

“For Q2 2019 (with 77% of the companies in the S&P 500 reporting actual results), 76% of S&P 500 companies have reported a positive EPS surprise and 59% of companies have reported a positive revenue surprise.” – FactSet

On an operating basis, corporate earnings are providing the bulls boost of optimism, as hopefully, the “trade war” impact is limited. Earnings are strong, so prices should be higher.

Here’s the problem with that analysis.

As shown, for 76% of companies to beat estimates, those estimates had to be dramatically lowered. More importantly, as shown in the chart below, if we look at corporate profits for all companies, a more dire picture emerges. (The chart below strips out the profits from the Federal Reserves balance sheet.)

Despite a near 300% increase in the financial markets over the last decade, corporate profits haven’t grown since 2011. Importantly, corporate profits, have turned lower in the first quarter and that slide is continuing into the second. I have compared corporate profits, less Federal Reserve, to the Wilshire 5000 for a more comparative index.

The slide in corporate profits suggests weaker asset prices in the future as the economy, and ultimately corporate profits, continue to slow.

Sentiment Is Bearish

As Tom Lee noted in his “plea” for investors to “buy equities,” investor sentiment, very short-term is indeed negative. As shown in the chart below, the spread between bullish and bearish investors (according to AAII) is currently at -26. This is indeed a pretty bearish tilt and does suggest a short-term bottom is likely.

While that statement is true, it is a VERY short-term indicator more useful for trading rather than investing.

However, on a longer-term basis, we see that investor confidence is just about as bullish as it can get with investors outlook for stock price increases over the next 12-months near the highest levels on record.

The same is true when we look at the Commitment of Traders (COT) report which shows that speculators are just about as long as they can be in the markets.

While short-term the market could indeed rally over the next couple of weeks, investor sentiment suggests that the topping process for the markets is set to continue for a while longer.

The Fed Is Cutting Rates

Another one of Tom Lee’s points is that when the Fed cuts rates, it has previously led to a positive return over the next 6-months.

That is a true statement.

The problem is that Tom Lee isn’t going to tell you to “sell” in 6-months. There will find another reason to tell you to be bullish. This is the problem with the mainstream media, the market is “always a buy” in order to keep you buying the “products” Wall Street is selling.

For investors, the outcome of the Fed cutting rates is not a function of stronger economic growth, but a response to weaker growth, declining profitability, and lower asset prices. As I wrote last week:

“This suggests that the Fed’s ability to stem the decline of the next recession, or offset a financial shock to the economy from falling asset prices, may be much more limited than the Fed, and most investors, currently believe.

The Fed has a long history of making policy mistakes which has led to negative outcomes, crisis, bear markets, and recessions.”

It is becomingly increasingly clear from a variety of inputs that deflationary pressures are mounting in the economy. Recent declines in manufacturing, and production reports, along with the collapse in commodity prices, all suggest that something is amiss in the production side of the economy.

The Fed is going to cut rates further. Unfortunately, those rate cuts are not going to lead to higher asset prices.

What Should You Do Next

With the current bull market already up more than 300% of the 2009 lows, valuations elevated, and signs of economic weakness on the rise, investors should be questioning the potential “reward” for accelerating “risk” exposure currently. \

Ultimately, stocks are not magical pieces of paper that provide double-digit returns, every single year, over long-term time frames. Just five periods in history account for almost all the returns of the markets over the last 120 years. The other periods wiped out a bulk of the previous advance.

Too often it is forgotten during that “thrill of the chase” that stocks are ownership units of businesses. While that seems banal, future equity returns are simply a function of the value you pay today for a share of future profits.

The chart below shows that rolling 20-year real total returns from current valuation levels have been substantially less optimistic. 

What is important for investors is to understand each argument and its relation to longer-term investment periods. In the short-term, Tom’s view may well be validated as current momentum and bullish “biases” persist in the markets.

However, for longer-term investors, it is worth considering the historical outcomes of the dynamics behind the financial markets currently. The is a huge difference between a short-term bullish prediction and longer-term bearish dynamics.

As Howard Ruff once stated:

“It wasn’t raining when Noah built the ark.”

Has The Fed Done It? No More Recessions?

“Wow!”

That is all I could utter as my brain spun listening to an interview with Chamrath Palihapitiya on CNBC last week.

“I don’t see a world in which we have any form of meaningful contraction nor any form of meaningful expansion. We have completely taken away the toolkit of how normal economies should work when we started with QE. I mean, the odds that there’s a recession anymore in any Western country of the world is almost next to impossible now, save a complete financial externality that we can’t forecast.”

It is a fascinating comment particularly at a time where the Federal Reserve has tried, unsuccessfully, to normalize monetary policy by raising interest rates and reducing their balance sheet.  However, an almost immediate upheaval in the economy, not to mention reprisal from the Trump Administration, brought those efforts to a halt just a scant few months after they began.

A quick Google search on Chamrath revealed a pretty gruesome story about his tenure as CEO of Social Capital which will likely cease existence soon. However, his commentary was interesting because despite an apparent lack of understanding of how economics works, his thesis is simply that economic cycles are no longer relevant.

This is the quintessential uttering of “this time is different.” 

Economists wanting to get rid of recessions is not a new thing.

Emi Nakamura, this years winners of the John Bates Clark Medal honoring economists under 40, stated in an interview that she:

“…wants to tackle some of her fields’ biggest questions such as the causes of recessions and what policy makers can do to avoid them.”

The problem with Central Bankers, economists, and politicians, intervening to eliminate recessions is that while they may successfully extend the normal business cycle for a while, they are most adept at creating a “boom to bust” cycles.

To be sure the last three business cycles (80’s, 90’s and 2000) were extremely long and supported by a massive shift in financial engineering and credit leveraging cycle. The post-Depression recovery and WWII drove the long economic expansion in the 40’s, and the “space race” supported the 60’s.  You can see the length of the economic recoveries in the chart below. I have also shown you the subsequent percentage market decline when they ended.

Currently, employment and wage growth is fragile, 1-in-4 Americans are on Government subsidies, and the majority of American’s living paycheck-to-paycheck. This is why Central Banks, globally, are aggressively monetizing debt in order to keep growth from stalling out.

Despite a surging stock market and an economy tied for the longest economic expansion in history, it is also is running at the weakest rate of growth with the highest debt levels…since “The Great Depression.”  

Recessions Are An Important Part Of The Cycle

I know, I get it.

If you mention the “R” word, you are a pariah from the mainstream proletariat.

This is because people assume if you talk about a “recession” you mean the end of the world is coming.

The reality is that recessions are just a necessary part of the economic cycle and arguably an crucial one. Recessions remove the “excesses” built up during the expansion and “reset” the table for the next leg of economic growth.

Without “recessions,” the build up of excess continues until something breaks. The outcomes of previous attempts to manipulate the cycles have all had devastating consequences.

In the current cycle, the Fed’s interventions and maintenance of low rates for a decade have allowed fundamentally weak companies to stay in business by taking on cheap debt for unproductive purposes like stock buybacks and dividends. Consumers have used low rates to expand their consumption through debt once again. The Government has piled on debts and increased the deficit to levels normally seen during a recession. Such will only serve to compound the problem of the next recession when it comes.

However, it is the Fed’s mentality of constant growth, with no tolerance for recession, has allowed this situation to inflate rather than allowing the natural order of the economy to perform its Darwinian function of “weeding out the weak.”

The two charts below show both corporate debt as a percentage of economic growth and total system leverage versus the market.

Do you see the issue?

The fact that over the past few decades the system has not been allowed to reset has led to a resultant increase in debt to the point it has impaired the economy to grow. It is more than just a coincidence that the Fed’s “not-so-invisible hand” has left fingerprints on previous financial unravellings.

Given the years of “ultra-accommodative” policies following the financial crisis, the majority of the ability to “pull-forward” consumption appears to have run its course. This is an issue that can’t, and won’t be, fixed by simply issuing more debt which, for last 40 years, has been the preferred remedy of each Administration. In reality, most of the aggregate growth in the economy has been financed by deficit spending, credit creation, and a reduction in savings.

In turn, this surge in debt reduced both productive investments into, and the output from, the economy. As the economy slowed, and wages fell, the consumer was forced to take on more leverage which continued to decrease the savings rate. As a result, of the increased leverage, more of their income was needed to service the debt.

Since most of the government spending programs redistribute income from workers to the unemployed, this, Keynesians argue, increases the welfare of many hurt by the recession. What their models ignore, however, is the reduced productivity that follows a shift of resources from productive investment to redistribution.

All of these issues have weighed on the overall prosperity of the economy and what has obviously gone clearly awry is the inability for the current economists, who maintain our monetary and fiscal policies, to realize what downturns encompass.

The Keynesian view that “more money in people’s pockets” will drive up consumer spending, with a boost to GDP being the result, is clearly wrong. It has not happened in four decades. What is missed is that things like temporary tax cuts, or one time injections, do not create economic growth but merely reschedules it. The average American may fall for a near-term increase in their take-home pay and any increased consumption in the present will be matched by a decrease later on when the tax cut is revoked.

This is, of course, assuming the balance sheet at home is not broken. As we saw during the period of the “Great Depression” most economists thought that the simple solution was just more stimulus. Work programs, lower interest rates, government spending, etc. did nothing to stem the tide of the depression era.

The problem currently is that the Fed’s actions halted the “balance sheet” deleveraging process keeping consumers indebted and forcing more income to pay off the debt which detracts from their ability to consume. This is the one facet that Keynesian economics does not factor in. More importantly, it also impacts the production side of the equation since no act of saving ever detracts from demand. Consumption delayed, is merely a shift of consumptive ability to other individuals, and even better, money saved is often capital supplied to entrepreneurs and businesses that will use it to expand, and hire new workers.

The continued misuse of capital and continued erroneous monetary policies have instigated not only the recent downturn but actually 40-years of an insidious slow moving infection that has destroyed the American legacy.

Here is the most important point.

“Recessions” should be embraced and utilized to clear the “excesses” that accrue in the economic system during the first half of the economic growth cycle.

Trying to delay the inevitable, only makes the inevitable that much worse in the end.

The “R” Word

Despite hopes to the contrary, the U.S., and the globe, will experience another recession. The only question is the timing.

As I quoted in much more detail in this past weekend’s newsletter, Doug Kass suggests there is plenty of “gasoline” awaiting a spark.

  • Slowing Domestic Economic Growth
  • Slowing Non-U.S. Economic Growth
  • The Earnings Recession
  • The Last Two Times the Fed Ended Its Rate Hike Cycle, a Recession and Bear Market Followed
  • The Strengthening U.S. Dollar
  • Message of the Bond Market
  • Untenable Debt Levels
  • Credit Is Already Weakening
  • The Abundance of Uncertainties
  • Political Uncertainties and Policy Concerns
  • Valuation
  • Positioning Is to the Bullish Extreme
  • Rising Bullish Sentiment (and The Bull Market in Complacency)
  • Non-Conformation of Transports

But herein lies the most important point about recessions, market reversions, and systemic problems.

What Chamrath Palihapitiya said was both correct and naive.

He is naive to believe the Fed has “everything” under control and recessions are a relic of the past. Central Banks globally have engaged in a monetary experiment hereto never before seen in history. Therefore, the outcome of such an experiment is also indeterminable.

Secondly, when Central Banks launched their emergency measures, the global economies were emerging from a financial crisis not at the end of a decade long growth cycle. The efficacy of their programs going forward is highly questionable.

But what Chamrath does have right were his final words, even though he dismisses the probability of occurrence.

“…save a complete financial externality that we can’t forecast.”

Every financial crisis, market upheaval, major correction, recession, etc. all came from one thing – an exogenous event that was not forecast or expected.

This is why bear markets are always vicious, brutal, devastating, and fast. It is the exogenous event, usually credit related, which sucks the liquidity out of the market causing prices to plunge. As prices fall, investors begin to panic sell driving prices lower which forces more selling in the market until, ultimately, sellers are exhausted.

It is the same every time.

While investors insist the markets are currently NOT in a bubble, it would be wise to remember the same belief was held in 1999 and 2007. Throughout history, financial bubbles have only been recognized in hindsight when their existence becomes “apparently obvious” to everyone. Of course, by that point is was far too late to be of any use to investors and the subsequent destruction of invested capital.

This time will not be different. Only the catalyst, magnitude, and duration will be.

My advice to Emi Nakamura would be instead of studying how economists can avoid recessions, focus on the implications, costs, and outcomes of previous attempts and why “recessions” are actually a “healthy thing.”