Daily Capitalist: As regular Daily Capitalist readers know, I have been observing a topping process for the U.S. stock market for a few months now. Last fall, near the market bottom in late September, I suggested that despite their
out-performance in the prior months, tax-free municipal bonds looked pretty attractive. That piece was titled Gold on Hold; The New Play May Be in Muni Bonds. Indeed, various muni bond investments have done fine, and on a year-on-year basis have decisively outperformed the average stock. Only if you compare stocks right near last year’s lows to munis at what were already elevated prices (lower yields) can you find modest total return outperformance of stocks over munis.
The reason I’m posting tonight is that while markets may be setting up for an oversold rally given they have dropped rather rapidly and the ECB could announce a new LTRO and send stocks soaring within a few hours from now, two matters are making me more bearish earlier than I expected to be. One is the disaster in the economically- and inflation-sensitive metals, especially the non-gold metals. Platinum (NYSEARCA:PPLT) and palladium (NYSEARCA:PALL) have miserable charts, copper is looking weak, and silver’s chart is methodically eliminating any chance of a valid inverse head and shoulders bottom (for the technicians amongst you).
The other reason is the financial disaster du jour, surprisingly not out of a second-tier (or third-tier) company such as Dexia, but out of the august JPMorgan Chase.
Added to the growing problems in the eurozone, it is no surprise that the financial markets suddenly look starved for liquidity. We’re certainly not “there” yet in the U.S., but matters are looking more and more recessionary. My wintertime bullish call on gold was poorly timed, and long ago I took small losses on most purchases I made back then. That which I continue to own represents insurance, and as in the aftermath of the 2008 experience, I am looking to add to my metals holdings if the metals continue to take the path of least resistance and trend yet lower. Speculative interest in gold is near rock-bottom, but coming off of last year’s frenzied top, when I did describe $1900/ounce as a sell point last August, a sharp new spike downward as in 2008 would be no surprise. (Matching 2008′s 30% peak-trough drop in gold would put the price well below $1400/ounce.) This is what happens to inflation hedges when people, traders, institutions, etc. run short of dollars. It has always been an open question as to which way the leverage in the precious metals market went. Right now it may be that the longs are over-leveraged and are being forced to liquidate. Who wants to catch falling knives? Not many of us.
Meanwhile, I have not been posting much due to travel, so I’m not sure exactly what I’ve been discussing with Jeff in emails and what has made its way onto the blog. I do believe that last fall I described keeping about 1/3 of my long-term zero coupon Treasury bonds as insurance, having sold the rest of what was a large and successful bet last spring and summer that I blogged for numerous times since then. Both for profit potential and for hedging purposes, I have been buying and trading the long Treasury vehicles (NYSEARCA:TLT) and the Vanguard ETF (NYSEARCA:EDV). TLT owns 20-30 year par Treasury bonds and pays interest monthly. EDV owns zero coupon long-term Treasury bonds and also manages to pay income back to trust holders quarterly. People who have my point of view that regardless of short-term movements, we could be looking at another move to yet lower lows in Treasury yields may want to examine either these funds, or the alternative of direct ownership of Treasurys (par bonds or my preference of zero coupon bonds, especially in tax-deferred accounts).
All this is consistent with a theme I discussed in one of my early blogs, from Land of the Setting Sun(January 2009), which began:
We are Japan.
(Though with nukes and military bases in about 92 countries)
Barack Obama made it more or less official today: trillion dollar deficits are here to stay.
“Potentially we’ve got trillion-dollar deficits for years to come, even with the economic recovery we are working on.”
The dead hand of government will provide tax cuts, either by printing money or borrowing from the savers of the US and the globe, to “stimulate” something by someone…
and which ended as follows:
As with Japan, giant deficits are bipartisan policy. Massive wealth transfers to the undeserving corporate losers are also bipartisan and Fed policy. This is the zombification of America just as much as Japan did with its big banks in the 1990s. It is worse here and now for at least two reasons. One reason is that at least Japan could point to its culture and find a reason to support the zombie companies. Our zeitgeist was supposed to be ‘agin that. The second reason is that we lectured Japan contemporaneously not to create zombies, and we were probably correct: but how hard it is for the doctor to diagnose and treat himself!
Americans are looking at disordered finances, economic stagnation, and political discord rising from the above. The people are dispirited and see the rot in the body politic. The October bank bailout, supported with excessive force by no good reason and/or changing rationales by the Establishment, was a defining moment. Massive wealth transfers have gone and continue to go to the worst-run giant companies in America. All this in a world of domestic peace, good harvests, abundant raw materials, a hard-working labor force, a general culture of honesty and fair dealing among the people at large (excepting the higher levels of government and many businesses), and unchallenged world dominance. Thisshould be among the best of times.
We deserve better than it looks like we are going to get.
I see no reason to change that basic view. For stock bulls, let’s go back arbitrarily to the first week of January, 2009. Pictures of Depression-era soup/bread lines were on the covers of leading newsweeklies. Thus stock buyers were depressed. The SPDR S&P 500 ETF (NYSEARCA:SPY) was around $89. The SPDR Gold Trust (NYSEARCA:GLD) was around $84. SPY is now around $136 and GLD is around $155. So even adding in a few years of dividends, gold – which was no longer depressed by Jan. 2009 has outperformed an extraordinarily depressed stock market.
Now, this does not say anything about future relative performance. What it suggests, though, is that the entirety of the stock market move has been an artifact of inflation. After all, both the price of oil (NYSEARCA:USO) and the price of silver (NYSEARCA:SLV) have gone up much more than either gold or stocks in the same time frame.
This point recalls Keynes’ famous post-WW I admonition that the process of price inflation, beginning with monetary inflation, is so insidious that the public simply cannot divine cause and effect.
The Fed is nearing the end of its third round of post-Lehman monetary easing. As a percentage of the amount of the assets on the Fed’s balance sheet at the start of Operation Twist and associated money-printing actions last fall, this easing program was the least vigorous of the three. No surprise, then, that bonds have begun to outperform stocks and that deflationary (price, not central bank) forces are gaining ground.
I have studied the Japanese experience with ZIRP, and blogged a little about it. There is little doubt in my mind that there is much more potential for interest rates in the United States to go lower; see this post to understand why. The world is experiencing its lowest aggregate interest rates in history. We are knee-deep in Extremistan quicksand. For Star Trek fans, we are in a sort of financial Mutara Nebula. Because interest rates are so low all along the yield spectrum, I urge investors to take a long-term view of their assets. At the same time, an objective view of the complicated problems in important parts of the global economy that are going on while the price of money resides at multi-century/all time lows should (IMHO) remind people that Japan didn’t know it was “going Japanese” until it actually happened. They had no idea that four years after they went to ZIRP, their 10-year govvie would yield 0.5% and their 30-year would yield 1.0%. (Note that right now the U.S. is also in its fourth year of ZIRP.) The Japanese had no idea that stocks would continue to rise only to crater.
Could the same happen here, with yet another stock collapse coming seemingly out of the blue, as occurred in Japan since their bubble burst in 1989?
My guess is that due to America’s greater propensity for inflation plus numerous other economic and demographic advantages we have over Japan, that the answer is “No”– at least in nominal terms. Ultimately, I don’t doubt that holders of high quality U.S. stocks will do “OK”, if not better. But since history is a series of timeless moments, I close with the fear that we are seeing a three-peat series, and that the waning year on year momentum this year is showing vs. last year may portend an even worse financial performance in the months ahead than occurred last year.
And last year was harrowing enough.
Plus there’s a presidential election coming along. As in 2008…
Speaking of presidents, the U.S. had a president with a middle name that was just an initial that lacked a period after it. He might have said that if you can’t stand the heat, don’t be in risk assets. I think people need to be prepared for an unusually wide range of possible outcomes in the upcoming months and even years.
Related: S&P 500 Index (INDEXSP:.INX), Direxion Daily Small Cap Bear 3X Shares (NYSEARCA:TZA).
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