April 2012

The QE3 Myth

The prospect of a runaway printing press at the Federal Reserve has been the overwhelming factor driving risk assets in 2012.? Being the sober, cautious guy that you all know me to be, I did not join the party. I tell people this is because if I lose all my money I am too old to start over again as an entry level trader at Morgan Stanley.

There is the additional complication that they probably wouldn?t touch me with a ten foot poll anyway. I never was much of an organization man, and in any case the firm has changed beyond all recognition from the small, white shoed, private partnership I knew during the early 1980?s.

Not that I am a party pooper. In fact, I believe that the prospect of further quantitative easing is a complete. The LTRO, Europe?s own quantitative easing, also known as QE3 through the backdoor, with a foreign accent and without a green card, never made over to the US. It poured into European sovereign debt instead, then yielding 8% to 15% for investment grade paper. On my advice, the Chinese government lapped it up.

You can see this clear as day by looking at the chart below prepared by the Federal Reserve of St. Louis, which tabulates a broad, adjusted monetary base. It has been flat as a pancake since QE2 ended on June 30, 2011. That is the day the $75 billion a month in government bond buying abruptly ended. It also was the day that the meteoric assent by the broader money supply came to a screeching halt.

The implications of this for the stock market are not good. It means that the entire rally in global equities from the October lows has been faith based. As I never tire of telling my guests at my strategy luncheons, faith based actions are religions, not investment strategies, and the church down the street can do a far better job at this than I can. Take away that faith, turn traders back into the mercenary agnostics that they really are, and all of a sudden stocks look very expensive.

Listeners to my biweekly strategy webinars already know that we have a 4% GDP stock market and a 2% GDP economy. We also have PE multiple for stocks expanding just when analysis are chopping forecasts as fast as they can. Outside of Apple and Google, who is really going to announce a blowout Q1, 2012, with China and Europe in a race to see who can get into recession the fastest, the source of 50% of S&P 500 earnings?

Now that I have had my say, I?m taking the rest of the afternoon off. There is a major storm approaching the US west coast and with luck, I can surf some 50 foot waves at the nearby Mavericks, dodging jagged rocks along the way. Like I said, I was always a sober, cautious guy.

America?s Demographic Time Bomb

Diary

You can never underestimate the importance of demographics in shaping long term investment trends, so I thought I?d pass on these two highly instructive maps.

The first shows a map of the world drawn in terms of the population of children, while the second illustrates the globe in terms of its 100 year olds. Notice that China and India dominate the children?s map. Kids turn into consumers in 20 years, stay healthy for a long time, and power economic growth. The US, Japan, and Europe shrink to a fraction of their actual size on the children?s map, so economic growth is in a long term secular downtrend there.

There is more bad news for the developed world on the centenarian?s map, which show these countries ballooning in size to grotesque, unnatural proportions. This means higher social security and medical costs, plunging productivity, and falling GDP growth.

The bottom line is that you want to own equities and local currencies of emerging market countries, and avoid developed countries like the plague. This is why we saw tenfold returns from SOME emerging markets (EEM) over the past ten, and why there is an irresistible force pushing their currencies upward (CYB). Use any major melt downs this year to increase your exposure to emerging markets, as I will.

Would You Rather Own Them?

Or Them?

April 11, 2012 - Quote of the Day

Quote of the Day

?The Bernanke put is still there, but it is far more out of the money that it was a few days ago,? said Doug Kass of hedge fund Seabreeze Partners.

Trade Alert - (PHM) April 10, 2012

Trade Alert

As a potentially profitable opportunity presents itself, John will send you an alert with specific trade information as to what should be bought, when to buy it, and at what price. Read more

Trade Alert - (IWM) April 10, 2012

Trade Alert

As a potentially profitable opportunity presents itself, John will send you an alert with specific trade information as to what should be bought, when to buy it, and at what price. Read more

Looking for Shorting Opportunities Among the Homebuilders

Newsletter

As we continue flirting with a final top in equities for the year, I am stepping up my search for the best ways to participate on the downside. At the very top of the list are the homebuilders, one of the top performing sectors since the October, 2011 bottom. The performance of individual names has been absolutely blistering, with Pulte Homes (PHM) clocking a 245% move to the upside, beating the (SPX) by 210%.

You do not need to engage in any sophisticated financial analysis to see how expensive this group is. Spend a day visiting open houses put on by the big companies, like Pulte Homes (PHM), KB Homes (KBH), Ryland Group (RYL), Toll Brothers (TOL), and Lennar (LEN), as I did yesterday. Then scan the real estate pages of your hometown newspaper with a calculator in hand. You will quickly find that new homes are selling for double the cost of existing homes on a dollar per square foot basis.

This is a lot to pay for that black granite kitchen counter, built in vacuum system, flashy gas barbeque in the back yard, and solar panels on the roof. You may also notice that the homes are shoehorned so tightly on to their plots that you will become too familiar with the intimate details of the lives of your prospective neighbors. In fact, new homes are trading at the biggest premium over used in history.

I am loathe to bet against those lucky ones selling to the 1%, or anyone who earns close to them, whose wealth and spending power are expanding exponentially as I write this. That knocks out Lennar (LEN) and Toll Brothers (TOL). I am very happy to short stocks of companies saddled with selling on an increasingly impoverished 99%.

That trains my sites over to Pulte Homes (PHM) and KB Homes (KBH), the old Kaufman & Broad. (KBH) has already fallen 38% off of a poor earnings report. At least Eli Broad had the decency to give away most of his money after selling out at the market top. The Los Angeles art world is all the richer for it. That leaves Pulte (PHM) as the next overripe piece of fruit to fall.

I know that many of you have been getting calls from real estate brokers insisting that the bottom is in and prices are on their way up. I get the same calls from stock brokers too. Here are the reasons for you to let those calls go straight to voicemail.

There is still a huge demographic headwind, as 80 million baby boomers
try to sell houses to 65 million Gen Xer?s, who earn half as much money. Don?t plan on selling your home to your kids, especially if they are still living rent free in the basement. There are six million homes currently late on their payments, in default, or in foreclosure, and an additional shadow inventory of 15 million units. Access to credit is still severely impaired to everyone, except, you guessed it, the 1%.

Fannie Mae and Freddie Mac, which supply 95% of all the home mortgages in the US, are still in receivership, and are in desperate need of $100 billion in new capital each. Good luck getting that out of Washington, which is likely to be gridlocked for at least another five years, and maybe more.

The home mortgage deduction is a big target in any revamp of the tax system, which would immediately yield $250 billion in new revenues for the government. How do you think that will impact home process?

There are undeniable signs of life in best prime markets, where the pent up demand can be substantial. Here in the San Francisco Bay area you are seeing bidding wars for anything that is commuting distance from Apple, Google, and Facebook, or the rest of the booming tech world. Real estate is more local now than it ever has been.

The best case scenario for home prices is that we continue bumping along a bottom for as long as ten more years, when the demographic picture shifts from a huge headwind to a major tailwind. The worst case is that this is just another bear market rally and that we have another 20% on the downside.

Show me the Rally

Yes, But Does It Have Solar?

Testimonial

Testimonials

I just wanted to thank you for some great trades. Thanks to you, I was profitable on the (IWM) put trade and it certainly looks like the Apple credit spread will return a nice profit (the profit you defined). Your wisdom in the market has been a godsend to my portfolio and my family. You stand apart from the field in your expertise in the markets.
Thank you, Thank you, Thank you!!

John
Pottsgrove, Pennsylvania

Payroll Bombshell Give Market Technicians Heart Attack

Newsletter

I am sitting here on Easter weekend sifting through pages and pages from the various technical programs I follow warning that the roof is about to cave in on the stock market. Friday?s nonfarm payroll bombshell was dropped right at a key, make or break level for the S&P 500 and the Dow Average. Hold here, and we grind to a marginal new high in weeks. Fail, and it is all over this year but for the crying.

The action in the futures market immediately after the release of the dismal numbers showed that the outcome of this contest has already been decided. S&P 500 futures gapped down from plus 4 points to down 15 points in minutes. The Dow saw a net swing of a gut churning 170 points. Ten year Treasury yields gapped down from 2.22% to 2.08%. The safe haven dollar soared against the euro. It was all, yet again, another harsh lesson on why you don?t take big positions before monthly nonfarm payroll figures, and why you should never listen to the ?experts?.

I couldn?t be more amused watching analysts? reactions to the figures on TV, who had been forecast as high as 250,000 and noticeably blanched when the flash hit the screen. In fact, this is one of the biggest head fakes that I have seen in sometime. The Thursday weekly jobless claims hit a four year low only the day before, pointing followers to the exact opposite direction. So did Canadian job gains, which hit a 30 year high for the month. Extrapolate that to the US and we should have seen of blistering gain of 750,000, not the feeble 120,000 we got.

A closer examination of the numbers offered little solace. The headline unemployment rate fell from 8.3% to 8.2%, but only because there are fewer job seekers. Manufacturing showed the biggest gain, +37,000, followed by food and drinking services, +37,000, professional and business services +31,000, and health care, +26,000. The big hit was taken by retail, -34,000. There are 12.7 million total unemployed, and the broader U-6 unemployment rate dropped from 14.9% to 14.5%.

It looks like the good winter weather bump we saw in February disappeared after possibly pulling as many as 50,000 jobs forward from the spring, generating the great payroll number for the previous month. That explains why the February correction in the market I had been expected never showed.

These unwelcome developments call into question the survival of the entire 35% bull move. It will be very interesting to see how many traders flip to sell every rally mode this week after spending the last six months buying every dip. Watch Apple. It will be key. So will the raft of data releases about the Chinese economy, which will be tricking out every night this week.

I was hoping for a healthy payroll number on Friday to give us a nice two day rally which I could use to reestablish my short positions. At least I covered my yen short, which is also bouncing hard. Now I have to decide if I want to sell into the dip. Welcome to show business.

The Payroll Figures Did Not Come in as Expected

Cross Asset Class Analysis Warned ?RISK OFF? Was Coming

Newsletter

Last week saw a dramatic deterioration in the economic data that has been the foundation of the Great Bull Market of 2012.

First, we read minutes from a Federal Reserve meeting suggesting that QE3 has been put on a back burner. Then the Department of Labor?s Friday nonfarm payroll report poured gasoline on the fire, coming in at 120,000, versus an expected 210,000. Until this week, the best you could say about the data flow was that it was mixed. Now it is decidedly negative.

Whenever we see sea change events like this bunch up over a short time period, I like to show readers my cross asset class review, which I conduct on a daily basis. This discipline is great at showing which securities are trading in line with the rest of the world, and which ones aren?t. And guess what is looking outrageously expensive right now?

The charts show that trouble has in fact brewing for a few months. Asset classes have been rolling over like a line of dominoes. This is the way bull markets always end, and this time should be no different.

The Australian dollar (FXA) saw the weakness coming first, which peaked on April 6.

The Australian stock market (EWA) followed, peaking on February 28.

Copper (CU) warned that trouble was coming, peaking on February 12.

Then Gold (GLD) faded on April 12.

And Silver (SLV) on February 28.

Bonds never bought the ?RISK ON? on scenario. The ten year Treasury ETF (IEF) is down less than three points from its 2011 peak, instead of the 15 points we should have gotten if the economy had truly entered a sustainable stage in the recovery.

Only equities (SPX) didn?t see ?RISK OFF? coming

Because it was all about Apple (AAPL), which added $225 billion in new market capitalization this year. That amounts to creating the third largest company from scratch, right after Exxon (XOM).

The final message of all of these charts is that equities alone have been powering up for months while every other asset class in the world has been dying a slow death. Experience shows that this only ends in tears for equity holders. I?ll let you adjust your own positions accordingly.

Trolling for Short Sale Candidates at Market Tops

Diary

Fear of law suits prevents most analysts from publishing lists of short selling targets. But the GMI Ratings, Inc., a forensic accounting firm, regularly posts lists of public companies they believe may go bankrupt (see http://www.auditintegrity.com ).

Many of their picks reflect the accelerating shift from the old economy to the new economy. With offices in New York and Los Angeles, they look at leverage, market position, debt, and their own proprietary indicators. Another red flag are the legal shenanigans that companies resort to when coming out of a recession, like writing off large amounts of good will.

In the media space, CBS (CBS), Sirius XM Radio (SIRI), and Hertz Global (HTZ) are at risk. In the consumer field, Rite Aid (RAD), Macy?s (M), and Las Vegas Sands (LVS) made the list. Advanced Micro Devices (AMD) is the largest tech company to warrant scrutiny.

Airlines are always a favorite of bankruptcy mavens. The company correctly pegged American Airlines (AMR) as seriously at risk two years ago. Continental (CAL) dodged the executioner by merging with United Airlines. Sprint Nextel (S) tops the list of telecom companies. Better take that portfolio out and give it a good scrubbing.

Looks Like I Hooked a Whopper