The Great Hedge Fund De-Levering Event

Friday, August 5th, 2011

by David Goldman, Inner Workings

Today’s (August 4) 400-point plunge in the Dow was driven by capital calls on hedge funds, whose ballooning assets constitute the last big bubble in world markets. The surge in hedge fund assets to $2 trillion at last count created a levered market sector vulnerable to investor withdrawals and hair-trigger sell decisions.

Stocks are stupid cheap. A utility paying a dividend yield of over 5% is a no-brainer trade against a 10-year Treasury yielding 2.45%, especially when the utility dividend is taxed at a top 15% rate and the Treasury is taxed at ordinary income tax rates. Narrow corporate bond yields indicate a very low level of risk associated with these earnings. We have never had a market crash of this magnitude in the past without a collapse of the corporate bond market. That alone tells us that something very different is at work. No-one can fund a retirement at 2.45%. The problem is that the people who need retirement income are in no position to buy equities, and the investors with the liquidity to buy equities face massive redemptions.

On fundamentals, the stock plunge makes no sense. We’ve never had this kind of market bloodshed with a corporate earnings above 7% (and well above 8% on a forward-based bottom-up estimate), and the monetary authorities ready to provide unlimited liquidity to the market. Corporate earnings are solid–we aren’t talking about the phony financials’ earnings of 2006 or dot.coms with burn rates of 2000. The problem is one of market segmentation.

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Tags: Burn Rates, Corporate Bond Market, Corporate Bond Yields, Corporate Earnings, David Goldman, Dividend Yield, Dot Coms, Fund Assets, Hair Trigger, Hedge Fund, Income Tax Rates, Inner Workings, Market Crash, Market Sector, Market Segmentation, Monetary Authorities, Point Plunge, Redemptions, Retirement Income, Stock Plunge
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S&P 500 – the “soldiers are deserting,” says Richard Russell

Friday, May 20th, 2011

Where breadth goes, the market usually follows,” goes an old market saying. Breadth indicators are useful tools to assess the inner workings of the market’s rallies or corrections, and are used to identify strength or weakness behind market moves, i.e. to assess how the bulls and the bears are exerting themselves.

Let’s consider one measure of stock market “internals”: The number of NYSE stocks trading above their respective 50-day moving averages has declined to 55% from more than 75% at the end of April (see top section of chart below). In order to be bullish about the secondary or intermediate trend, one would expect the majority of stocks to trade comfortable above the 50-day line. Although the indicator is back above 50 after a dip below this level a few days ago, the outlook for the intermediate trend has weakened over the past few weeks, but it is premature to cry “wolf”.

For a primary uptrend to be in place, the bulk of the index constituents also need to trade above their 200-day averages. The number at the moment is 76% – somewhat down from its early April high of 83%, but nevertheless still firmly in bullish territory.

Source: StockCharts.com

Richard Russell, 86-year old author of the Dow Theory Letters commented as follows on the deteriorating market breadth: “This is a bearish picture. The ‘soldiers’ are deserting even while the ‘generals’ continue to march forward. In a war, this would be a prelude to disaster. In the stock market, it may be the same.”

Tags: Bears, Bulls, Dow Theory Letters, Few Days, Generals, index constituents, Inner Workings, Intermediate Trend, Market Breadth, Market Internals, Market Moves, Moving Averages, Nyse Stocks, Prelude To Disaster, Rallies, Richard Russell, Stock Market, Stocks Trading, Uptrend, useful tools
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The Canada Bubble?

Friday, March 18th, 2011

Jason Kirby with Erica Alini of Macleans report on The Canada Bubble:

Bob Haber and David Madani are foreigners who have spent a lot of time studying Canada. Haber, an American, was chief investment officer at fund giant Fidelity Canada for 12 years and tracked Canadian stocks from his base in Boston. Meanwhile, Madani, a New Zealander, spent a decade with the Bank of Canada as a forecaster and policy analyst. Both are outsiders with an acute understanding of the inner workings of the Canadian economy. That is where the similarity ends.

Last December, Haber’s new book, Go Canada: The Coming Boom in the Toronto Stock Market and How to Profit From It, hit bookstores. Haber, who now runs his own investment firm in Boston and manages a series of Go Canada funds for Toronto-based Canoe Financial, has emerged as one of the most enthusiastic proponents of Canadian investments at a time when the world can’t seem to get enough of us. With Canada’s strong economy and wealth of resources, Haber predicts the S&P/TSX Composite Index could double to 30,000 points within 10 years. “Global growth and all the free money out there are coming together and investors are realizing the best place in the G7 for them to put their money is Canada,” he says. “Things are in gear for Canada to really outperform.”

Madani’s outlook couldn’t be more different, though it tends to get drowned out amid the Canuck euphoria. Last fall, he joined Capital Economics, a prominent U.K. investment research firm, to cover the Canadian market from Toronto. He says the boom in commodities is due for a reversal. More importantly, Canada’s red-hot housing market has soared into the danger zone. By his estimates, house prices are set to plunge at least 25 per cent, and will drag the economy down with them. “Housing has gotten crazy, it’s a bubble,” he says. “These things always have an unhappy ending, and Canada is not going to be any different.”

So there you have it. Canada is either primed to be a world beater, or we’re about to go down the tubes. There’s arguably never been a time when forecasters have been so divided in their views of Canada’s economy. That’s partly due to the seemingly Herculean way we shrugged off the global recession while almost every other developed nation tanked and continues to struggle—a feat that can’t help but arouse a bit of too-good-to-be-true anxiety.

But the division of opinion has to do mostly with the two particular engines that have driven our success—resources and real estate. Both are cyclical. Prices rise and fall as supply and demand shift. Only that’s no longer seen to be the case in Canada. Never mind that some experts now say the surge in commodities exceeds anything we’ve seen in two centuries, or that by many measures the housing market sits at multi-decade highs. Those who see good times ahead are convinced the phenomenal gains reflect a fundamental shift in the global economy. In short, it requires one to ascribe to the four most dangerous words in the world of investing: this time it’s different.

As it is, the love-in for all things Canadian is in full swing. In January, giant U.S. retailer Target announced plans to take over hundreds of Zellers stores in 2013, its first expansion beyond America’s borders. The company expects big things from shoppers here; Target believes its new Canadian stores will help drive annual revenue, now around US$67 billion, to more than US$100 billion over the next few years. And Target is just one of many big name U.S. retailers, including J.Crew, Kohl’s and Marshalls, banking that Canada’s prosperity can make up for sagging sales on their home turf.

Canada is also the toast of international think tanks and world leaders. They praise our sound financial system, which seemingly avoided the traps that engulfed other nations’ banks. Conservative legislators in America and Britain sing the virtues of our relatively sound government finances. Like a cherry on top, the Economist magazine once again just selected Vancouver as the world’s most livable city, with Toronto and Calgary also making it into the top five.

You can read the rest of this long article by clicking here. So is this time different? Is Canada going to coast right through the next decade unscathed? Of course not. I have already referred to a Canadian bubble back in October 2009 when I stated another bubble sooner than you think. It was a very wise senior pension fund manager who opened my eyes to the one bubble that escaped me because I live in Canada and never thought that a major bubble is brewing right in our own backyard.

Tags: Alini, Bank Of Canada, BMO, Canada Funds, Canadian, Canadian Economy, Canadian Investments, Canadian Market, Canadian Stocks, Canoe Financial, Chief Investment Officer, Commodities, Composite Index, Danger Zone, Emerging Markets, Fidelity Canada, Free Money, Global Growth, Go Canada, Infrastructure, Inner Workings, Investment Firm, Madani, New Zealander, oil, Policy Analyst, Toronto Stock Market
Posted in Canadian Market, Commodities, Credit Markets, Energy & Natural Resources, Infrastructure, Markets, Oil and Gas, Outlook | Comments Off

Matt Taibbi on the Rise, Fall and Rescue of Wall Street

Monday, February 21st, 2011

Matt Taibbi discusses his book “Griftopia: Bubble Machines, Vampire Squids, and the Long Con That Is Breaking America“, the stunning rise, fall and rescue of Wall Street in the bubble-and-bailout era and the inner workings of politics and finance in America.

Source: YouTube.com, February 11, 2011 (hat tip: Financial Doom Blog)

Tags: Bailout, Breaking America, Bubble Machines, Doom, Era, Finance America, Hat Tip, Inner Workings, Matt Taibbi, Politics, Squids, Vampire, Wall Street
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Stock Market – Divergence Alert

Monday, December 20th, 2010

I posted an article on Friday, stating that the stock market still had a bullish bias, but that breadth was deteriorating. Breadth indicators are also useful tools to assess the inner workings of the market’s rallies or corrections, and are used to identify strength or weakness behind market moves such as the nascent rally, i.e. to assess how the bulls and the bears are exerting themselves.

Let’s consider a specific measure of stock market “internals”: The number of S&P 500 stocks trading above their respective 50-day moving averages has declined to 80% from 93% in October (see bottom panel of the chart below). In order to be bullish about the secondary trend, one would expect the majority of stocks to be above the 50-day line.

However, the fact that fewer stocks are now above their 50-day moving averages than in October means that a smaller number of stocks are participating in the rally. In the meantime, the S&P 500 has been scaling new highs for the move. This is known as a so-called bearish divergence – a phenomenon investors should be mindful of, especially given the overbullish sentiment levels.

Source: StockCharts.com

The bulk of the index constituents, 86.4%, are trading comfortably above their 200-day averages. As long as this number holds above 50%, a primary bull market remains intact. However, a short-term reaction to clear some of the froth is likely and should be factored into investors’ decision-making.

John Hussman (Hussman Funds) summarized the situation as follows: “In short, it’s not impossible that specific features of the current market could make investors more tolerant of rich valuations, or more careful to demand conservative ones. Regardless, my impression is that a decade from today, investors will view the present time as a relatively undesirable moment to put investment capital at risk.”

Tags: bottom panel, Current Market, Hussman Funds, index constituents, Inner Workings, Investment Capital, John Hussman, market divergence, Market Internals, Moving Averages, New Highs, Present Time, Stock Market, useful tools
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Stock Market Valuation is Stretched on Long-term Basis

Tuesday, March 16th, 2010

With the S&P 500 Index and a number of other benchmark stock market indices flirting with cycle highs, I will be monitoring things very closely over the next few days to see if the market’s overbought condition spells more downside potential than an expected consolidation. Or will the Index surprise us and fly trough the 1,151 area?

In addition to being overbought, the S&P 500 is also now expensively valued on a long-term cyclically adjusted PE (CAPE) basis, according to Robert Shiller, economics professor at Yale and author of, among others, Animal Spirits, Subprime Solution and Irrational Exuberance.

In order not to work with notoriously unreliable forward-looking earnings estimates, I have always preferred using Shiller’s CAPE methodology, or normalised earnings, as they average ten years of earnings. This measure provides a good picture of the market’s value regardless of where we are in the business cycle. I have therefore been updating a CAPE chart for a number of years. On this basis, the multiple has increased to 20.5 since the March low of 13.3, representing an overvaluation of 25.0% when compared to a long-term average of 16.4.

“Where breadth goes, the market usually follows,” goes an old market saying. Breadth indicators are useful tools to assess the inner workings of the market’s rallies or corrections, and are used to identify strength or weakness behind market moves, i.e. to assess how the bulls and the bears are exerting themselves.

One such measure is net new highs, calculated by subtracting the number of new 52-week lows from the number of new 52-week highs (see top pane in the chart below). This indicator often peaks before the price index, as was the case in November. It has also been falling sharply over the past few days. Is this again a precursor to a lower S&P 500 (bottom pane)?

Source: StockCharts.com

I stand by my summary in my Words from the Wise review on Sunday: Although the fat lady has not yet made her appearance to signal the end of the bull cycle, the steepness of the nascent rally, together with resistance in the area of the January highs, could result in stock markets consolidating in order to work off a short-term overbought condition. On the fundamental front, tighter money does not necessarily spell a declining stock market, but turning off the “juice” will certainly remove a tailwind, making earnings growth the key determinant for generating further gains (especially in light of stretched valuations).

Tags: 52 Week Highs, 52 Week Lows, Animal Spirits, Bottom Pane, Breadth, Business Cycle, Earnings Estimates, Economics Professor, Inner Workings, Irrational Exuberance, Market Moves, New 52 Week Highs, New 52 Week Lows, New Highs, Normalised, Price Index, Robert Shiller, Stock Market Indices, Stock Market Valuation, Term Basis
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