Monday, July 25, 2016

Beware of a Bull Trap?

Chuck Jaffe of MarketWatch reports, Technical analyst: Is this bull market just a bull trap?:
Leo Leydon of Financial Focus Advisory Services in Pembroke, Mass., says the market’s run of good days to record highs could be a “bull trap” that sees latecomers gored when the market takes a step back.

In an interview on “MoneyLife with Chuck Jaffe,” a MarketWatch senior columnist, Leydon expressed concern that much of the current rally has been fueled by the U.K’s Brexit vote to leave the European Union. That flow of funds leaving the British pound for the safer haven of the dollar could reverse itself quickly.

Leydon, a technical analyst who early this year forecast the market’s rebound from a horrible start, noted that the action has the potential to set up a whipsaw.

“[The market] pulled back and broke short-term support — and did it in an ugly fashion — and then flipped it and went positive and broke through the top of resistance,” he explained. “But before I make a major change, I want to see some conviction in the underlying stocks.”

Leydon noted that the market highs have been accompanied by a change in leadership, with stocks that had been lagging now looking much stronger. Still, he lamented that the results reported by companies like Microsoft Corp (MSFT) “are not good, just better than expected.”

If the market can’t develop the broad support to stay at its new highs, Leydon said he fears a bull trap, which is when the market breaks out, fails to hold the new levels “and slams back down to the bottom of the channel.”

That potential — despite liking the market’s rally overall — has Leydon on hold.

“I’m the confident technical analyst who says ‘Wait a minute, things may be changing,’” he said. “So what do you do when things may be changing? Don’t make any dramatic decisions.”

You can listen to the interview at
Michael Taylor, a former Goldman Sachs bond salesman who now writes the finance blog, also wrote an interesting column for The San Antonio Express, Why the record-high stock market may be bad for investors:
It’s silly season in stock market news again. By that I mean the regular “stock market reaches new highs, hooray!” headlines and commentary.

I’ll start by unpacking some reasons why this is silly news and how you can be a much more sophisticated reader of financial news. I admit upfront that you’ll risk being a bore at cocktail parties if you repeat my commentary when people want to discuss how “the market” is doing. Sorry. (Not sorry.) But still, I want you to know these things and feel quietly smug.

I conclude this column with an argument for why a rising stock market overall probably isn’t even good financial news for me, or many of you, if you’re not yet retired.

But first, there’s our bad habit of noting point changes and absolute levels in stock market index values, as if the market index matters much.

In my first year in bond sales in the late 1990s, I used to call each morning upon a junior trader — a Venezuelan named Luisa who worked at the smallest customer of my desk — to give market commentary. I remember the morning I breathlessly mentioned a dramatic move in the Dow, like a 100-point drop. Luisa dryly noted that she didn’t pay much attention to point movements, but rather percent changes in the market.

Ugh, my ears burned with shame. They still do.

Mathematically, she was right. A 100-point drop means a lot if the index value is 2,000 — a 5 percent move! — but very little if the index is 10,000 — a 1 percent move. Meh.

We should all be like Luisa and only pay attention to percent changes, not point moves.

Similarly, noting that numerically pleasing round numbers like Dow 10,000 or Dow 18,000 have been breached for the first time is the financial equivalent of noting that Mercury is in retrograde while Neptune’s tilt should lead us to tread cautiously with emotional matters this week. People do pay attention to these things, but they really shouldn’t. It’s utterly meaningless.

Next, there’s the problem of talking about moves in “the market” when we’re describing just a small sliver of companies.

“The market” as typically described in financial media is the Dow Jones industrial average — a 120-year-old marketing tool of the company that used to own the Wall Street Journal — comprising just 30 large companies in a variety of industries. These are important companies, but a very skewed snapshot of stock market performance.

Even the more-representative S&P 500 Index — another widely used proxy for “the market” — still describes only what 500 large companies in the U.S. have done, excluding an additional 5,000 or so reasonably big companies in this country, not to mention the thousands more located in other countries.

Next, we have the topic of dividends, which account for a significant portion of stock market gains for long-term investors. The dividend yield for S&P 500 stocks — aka how much cash you get paid to just hold the stuff year in and year out — is about 1.9 percent in 2016 and has ranged from 1 percent to 4 percent in recent decades. That means much of the long-term return from investing in stocks happens regardless of whether the prices for stocks even go up or down.

With a 1.9 percent dividend yield, the stock market indexes could flat-line for many years, and you’d still make more current income than you would invested in U.S. Treasury bonds. By this point, I just mean to emphasize that the index’s going up is not the key to making money in stocks in the long run. Which sort of brings me to my final point.

I don’t mean to be a complete Grinch. (Yes I do.) It seems like it should be better for existing stock investors if the market indexes reach new highs rather than new lows, right?

But when I think about it, that’s not quite right either.

I personally should not celebrate high stock prices. It kind of makes the most sense depending on your age and where you are in your investing life.

Celebrating high stock market prices only makes sense if I’m a seller of stocks, not a buyer. I bought my first stock at age 24. I figure I’ll want to still accumulate more through maybe age 64. Right now, at age 44, I’m right at the hump of my investing life, my midpoint. If I have a chance to accumulate stocks over the next 20 years, shouldn’t I prefer prices to stay low rather than high?

Taking this thought process to the extreme, shouldn’t I prefer a completely flat-lined stock market for the first 39 years of my 40-year investing life, then some kind of rocket-ship price jump, in which the market zooms up by 6,188 percent in the final year, when I’m getting ready to sell in retirement? (FYI, 6,188 percent is the cumulative returns of the S&P 500, including dividends reinvested, over the previous 40 years, from July 1976 to July 2016. Or 10.9 percent annual return, if you prefer.) I recommend verifying this for yourself with an online S&P calculator for any time period.

Meanwhile, the upward climb in prices we celebrate in financial news really isn’t helpful for me, as I accumulate stock at higher and higher prices.

This rising stock market index news is both misleading and not something to particularly celebrate, for most of us.
Bond people have a way to look at things the way most investors don't. They focus on the cold hard facts and don't get carried away by the exuberance of the yipee stock market.

This is why I take the bond market's ominous warning so seriously, it reflects the reality out there that despite the record-setting US stock market, the future is bleak and anemic growth, disinflation and possibly deflation are in the cards.

It also means ultra low rates and the new negative normal are here to stay and investors need to readjust their expectations to prepare for lower and volatile returns ahead (read my comment on CalPERS smearing lipstick on a pig).

The other reason why I like this article is because it demonstrates why a pension system built around 401(k)s, RRSPs or defined-contribution plans is doomed to fail, exposing millions to pension poverty. It's all a matter of luck because even if they invest wisely and stick to a disciplined process, if they have the misfortune of retiring during a bad bear market, they're pretty much screwed and risk outliving their savings.

This is why I firmly believe that a solid pension system is built around large, well-governed defined-benefit plans like we have here in Canada (read my comment on the big CPP clash).

Now, when it comes to the stock market, everyone has an opinion. Some fear we are entering a Cold War-style stock market while others think the economic data is improving (at least that's what Dr. copper is signalling) and the bullish case for global stocks is under-appreciated.

Nobody really knows where the stock market is headed but even FundStrat's Tom Lee, a well-known permabull, is telling his clients it may make sense to fade strength and be prepared to add to weakness in August.

As Zero Hedge points out, to make his case, Lee shows how equity risk is trading below bond risk for the first time since right before markets crashed in August 2015 (click on image):
S&P 500 implied volatility (VIX) has now been lower than Treasury ETF TLT's implied volatility for the month of July (since Brexit)...

As FundStrat's Tom Lee points out in a recent reports, gaps as wide as the current one were followed 68% of the time by S&P 500 Index declines in the next 20 trading days, according to his data... and is clear from above, the last time stocks got this 'relatively' complacent, things went south very fast.
Zero Hedge being Zero Hedge also thinks Verizon just signaled the top of the market:
The last time AOL (bought by Verizon in May 2015) was involved in a mega merger was January 2000, when AOL acquired Time Warner for $182 billion in what was the mega deal of the last tech bubble, creating a $350 billion behemoth... which nearly dragged down both companies a few years later. The timing could not have been more perfect as it marked the tech bubble top...

Will it happen again? (click on image)

Will it happen again? As I've written, I don't see a summer crash but that doesn't mean stocks can't pull back from these levels.

On Friday, Needham Growth Fund Portfolio Manager Chris Retzler said even though markets have recovered nicely following Britain's vote to leave the European Union, investors should be prepared for a pullback.

This isn't necessarily a bad thing. Bloomberg posted an interesting comment stating buying the biggest stock market dips in 2016 returned three times the S&P's YTD returns.

Of course, buying the dips in deeply oversold stocks works well when central banks are pumping massive liquidity in the global financial system and algorithmic, high-frequency traders are having fun buying and selling momentum stocks.

But buying the dips isn't fun when markets are crashing hard and there's nowhere to hide. I vividly remember a phone conversation with Bob Bertram, a former CIO of Ontario Teachers, back in 2008 when he was telling me how he tried buying a few dips but "the market kept going lower and that was a very scary feeling" (trading ultra high beta biotech shares, I know exactly what he meant, when it works out, you're making a killing, but when it goes against you, it really stings a lot!).

When I trade markets, I'm always asking myself the same questions: Are central banks pumping liquidity into the system? Where are rates heading? How is the US economy relative to the global economy? Will the US dollar rise or fall over the next six months? What about the yen and euro? Is China getting ready to devalue again? And most importantly, is global deflation still alive and well and if so, which sectors do I want to trade?

When people ask me what is the best way to become a good investor, I tell them you have to read a lot and learn through your mistakes. The same goes with trading, some like buying the dips, others prefer buying breakouts, but unless you've had your head handed to you a few times, you will never learn how to trade properly no matter what 'disciplined' system you're using.

These markets are brutal. They may seem easy as stocks keep posting record highs, but trust me, they are brutal and that's why some of the best hedge funds in the world are struggling. Anyone who tells you these are easy markets is either a flat out liar or a complete and utter fool who is one crash away from getting his or her head handed to them.

But as my good friend Frederic Lecoq always reminds me: "When are markets ever easy?" He's absolutely right, if markets were easy, everyone would be stinking rich buying the dips or buying the breakouts and holding on for the big gains.

Having said this, there are always opportunities in the stock market and I'm seeing it now in individual names like Advanced Micro Devices (AMD), Big Lots (BIG), Dollar General (DG), Dollar tree (DLTR), eBay (EBAY), Sprint (S), Texas Instruments (TXN) and many others making 52-week highs.

The problem is picking the right stocks and even the experts are struggling. As the Financial Times reports, active managers are actively failing:
To an audience of financial advisers who had come to hear the hottest stock tips from the big stars of the fund management industry, it was a startling thing to say: “If somebody asked me to make the argument for active management, I would find it difficult given the statistics.”

The speaker, Dennis Lynch, is stockpicking royalty. The son of the founder of Lynch & Mayer, a pioneering money manager from the 1970s, has his own $3.4bn mutual fund — the Morgan Stanley Institutional Growth fund — which has put money into the likes of Twitter, Netflix and Tesla. It has outperformed the S&P 500 by more than 2 percentage points annually for the past decade, putting him in the top 6 per cent of his peers and accumulating substantial extra profits for his investors.
But active managers, those whose funds must try to beat the market rather than simply track the index, are facing something approaching a crisis.

A majority fail to beat the index over any significant period, and most of those that do ultimately find their outperformance to be fleeting. New competitors are claiming any insight they actually possess can be replicated by a computer. Clients are shifting en masse to index-based funds — active funds have lost $213bn in assets in the year to the end of May, Morningstar says, while passive funds took in $240bn. Profit margins, traditionally among the best in the finance world, are under threat and it seems only a matter of time before there is pressure on managers’ pay. Sporadic lay-offs at some money managers this year may be a harbinger of more to come, say consultants, especially if a newfound willingness to discuss mergers triggers a wave of cost-cutting deals.

The panel at the Morningstar Investment Conference, held in Chicago last month, was titled “Ultimate Stockpickers”, but it began with a challenge to participants to, in effect, justify their existence. Mr Lynch said that perhaps only 15 per cent of active managers are persistent market-beaters.

“The managers that tend to outperform have certain characteristics in common,” he said. “They tend to be longer term in nature, not traders. They are willing to be different to the benchmark. Most importantly, they also tend to have a lot of skin in the game.”
The bulk of active managers are not justifying their fees, especially in emerging markets, and things are about to get a whole lot tougher for them. Standard & Poors thinks passive fund fees could hit zero and Moody's thinks active management will shrink substantially as passives popularity grows.

On that note, let me wrap things up because this comment is long and I'm getting tired.

Below, markets have recovered nicely following Britain's vote to leave the European Union, but investors should be prepared for a potential wave of selling, Needham Growth Fund Portfolio Manager Chris Retzler said Friday.

Second, Jeroen Blokland, a widely followed money manager, finds stocks in the US are too pricey based on a chart comparing the level of the market to the amount of sales generated by the companies within the S&P 500.

Third, J.P. Morgan Private Bank’s Stephen Parker takes a look at what’s been driving the market rally, including the current trend for “safe haven” assets and interest rates.

Fourth, Tom McClellan of the McClellan Market Report discusses the 14-day choppiness index and what it could mean for the market going forward with Dominic Chu.

Fifth, in a recent interview with CNBC's "Fast Money," Cornerstone Macro's Carter Worth described the current chart of crude oil as a "perfect match" to that of the turbulent 2008-2009 period. That leads him to believe the commodity could continue to come under pressure.

"I think we're going lower, and crude looks to my eyes like it's heading back to $40," said Worth. Given my views on the US dollar for the second half of the year, I agree and continue to recommend steering clear of oil (USO), gold (GLD), silver (SLV),  metal and mining (XME), energy (XLE) and emerging markets (EEM).

Lastly, Les Funtleyder, E Squared asset management, and Michael Yee, RBC biotech analyst, discuss trading health care and the future of biotech during the election and CNBC's "Fast Time Halftime Report" traders discuss whether or not its worth buying the biotech bounce.

For many reasons, biotech (IBB and XBI) remains my favorite sector going forward and I bought the big dips on a few smaller biotechs that got clobbered earlier this year and are now coming back strong. The US presidential election didn't factor into my decision. If there's a bull trap, it's not here.

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