ࡱ > N w bjbj:: - P P o + 8 U T , P = : w T l x , , , , , , , // 1 R , ^ T , x i , x x x x , x , x x : % , % YU-v x % * , 0 , % #2 x #2 % x % * : Strategy Thoughts July 2013 Dont rely on central banks or even TINA! Introduction Over the last month many markets have suffered their most dramatic setbacks of the year. Severe falls have been seen in precious metals and selected emerging markets, bonds have also fallen sharply as yields have spiked and developed equity markets have also corrected. Amazingly these more turbulent times have been greeted with a high degree of calm, a complacent desire to buy the dips and an almost religious belief that all is well in equity markets because 1) the Federal reserve wont allow anything bad to happen, and 2) equities have to be bought because there is no alternative (TINA). All of this alarms me greatly. In many cases the recent falls are merely continuations of bear markets that began after the recovery from the GFC lows of 2008/9 with some dating back to 2010 while others rolled over in 2011 or 2012. Of increasing concern is the fact that recent weakness has increased the number of markets that have now rolled over into bear market territory. When fewer and fewer markets remain in clear bull trends the overall health of the investment world declines and the basis for any hope about those few remaining bull markets becomes increasingly fragile. This is where I see the world now, no doubt there will be bounces as each sell off for a while is seen as an opportunity to buy the dips or to get in on a healthy correction but more and more markets have now joined the slide down the slope of hope. I remain as cautious now as I have been since 2007. In this months Strategy Thoughts I review the idiocy of the belief in TINA being a reason to buy equities and look back at a similar attitude, and its subsequent failure, from fourteen years ago. I look at the misplaced faith in central bankers that is currently so prevalent and other lessons that have been forgotten through the recent equity bull market, and I also review a few old and some new bear markets. Finally I will include a summary of my views as to both the cyclical and secular positions of a selection of asset classes. Dont trust TINA One of the primary planks that so many bullish commentators are basing their optimism upon, particularly over the US stock market, is that there is no alternative (TINA). With bonds falling and yields still historically low they offer little attraction, with commodities seemingly locked in a bear market they too have lost their appeal and even the so called safe haven of the last decade, gold and to some extent silver, have been collapsing. With that backdrop for the assets that had been working and the prospect of earning nothing, or next to nothing, for cash on deposit then the yield on stocks and the, until recently, rising stock market appear to offer the only chance of generating the return that investors require. Superficially this seems to make sense and can, for a while, become self-fulfilling. However, what all those investors that have jumped out of poor performing bond funds and into previously rising equity markets have missed is the very important fact that, just because a particular return is required it does not have to be available and if it is then it certainly does not have to be sustainable. As I have listened to and read about the driving force for equities being TINA I was struck with a powerful sense of dj vu. The last time I could remember hearing the argument that equities had to rise because there simply was no other alternative was in the very late nineties. Undoubtedly the poster child of the nineties bull market was the internet and the NASDAQ but the broader market rose too. In fact the S&P 500 was rising throughout that entire decade at an annualised rate of about 17%. At that same time the Baby Boomer generation was realising that they had to think about taking care of their retirement. Most had saved very little and when the y sat down with a financial adviser and laid out what they had saved, what they could save and when and what income they wanted to retire on they quickly realised that they needed a spectacular return from their current and future savings. When they looked at bonds and cash they saw that they would never get where they needed to be but the stock market appeared to give just what they needed, a return that would double an investment every four years or so. It seemed obvious to so many that there simply was no alternative. As a result the boomers poured massive amounts into equity investments. This undoubtedly sustained the markets rise for a little longer than it otherwise would have lasted, but ultimately the price was paid when the markets suffered their most severe bear market in decades. Just because a particular return was required it was certainly not sustainable a little over a decade ago, similarly now, just because it seems so hard to find anything that will give a positive return it does not mean that one should put everything into the only asset that is still rising. At times merely preserving capital, not generating a return, is the best one can hope for and it actually increases ones relative wealth. An investor who merely marked time in low or zero yielding cash through the GFC was far better off in an absolute sense, and even more so in a relative sense, than those that had chased returns. The same was true through the 2000 to 2003 bear market. Through such periods, or cyclical bear markets, there does not have to be an alternative and the mere fact that TINA is being so readily utilised to rationalise piling into an equity bull market that is now more than four years old should be a warning sign in itself. Are the Fed really in control Perhaps the most alarmingly complacent commentary I have heard over the last month, while markets were falling and then attempting to rally, was that there was no need to worry about the question of whether the Federal Reserve were going to taper their bond buying or not. This fear was supposedly what triggered the falls after Bernanke seemed to make clear that there would be some degree of tapering. Then, again supposedly, the subsequent recoveries were as a result of calming words to the contrary, that is that the Fed will be there as long as they are needed. Commentator after commentator has seemingly implied that the Fed have such a tight control over the stock market and the economy that there is no need for anyone to worry. If any taper is done too soon then dont worry they will be right back in buying before any real damage can be done. They will make sure that things are just right, not too hot and not too cold, a perfect Goldilocks environment! It may be comforting and soothing to believe such nonsense but sadly even recent market history should make it abundantly clear to any investor that no such control exists. Twelve months ago I wrote the following; The current HOPE, and the hope that was so present until the very end of the decline in markets associated with the GFC four years ago, that central bankers would conjure up a solution is very reminiscent of the hope that was placed in the so called Plunge Protection Team that was formed in the wake of the 1987 crash by Ronald Reagan or as Time Magazine in February 1999 put it The Committee to Save the World with a cover photo of Larry Summers, Alan Greenspan and Robert Rubin. These titans of finance, economics and business were supposed to stop any sort of financial meltdown, three years later world markets had suffered their worst collapse in more than a quarter of a century, the tech bubble had burst and the NASDAQ had fallen 80%. Undoubtedly a plunge had occurred but there did not seem to be too much protection. Yet still the media talks about the almost mythical powers of this group to prevent a severe market decline, particularly as they also have the supposed Bernanke put and everything at his disposal to rely upon as well. Prior to the Dotcom bust in the early 2000s and then the GFC there was a general belief that Wall Street couldnt have a severe decline because The Federal Reserve wouldnt let it. The naivet of this attitude is obvious now, after two of the worst declines in history, yet still so many cling to this hope. However, the naivet should have also been obvious in the late nineties. A decade earlier there was a similar widespread belief, and hope, that the Japanese market could never suffer a severe decline, because the almighty Ministry of Finance wouldnt let it happen. It is hard to believe that after witnessing in real time the devastation of the Japanese market from 1989 to now, and the two massive bear markets of the last twelve years, investors still do believe and hope that somehow someone is going to prevent a severe fall. As long as that hope persists, and makes headlines, a bottom has not been seen, irrespective of valuations or economics! It is certainly the case that no bottom has been seen yet and it should be of increasing concern that the HOPE, or belief, in central bankers ability to keep things just right remains so high. Whenever the next bear market bottom arrives dont expect central bankers to be the ones being thanked for having softened the fall. Any belief in their abilities will have long been evaporated and rather than being thanked they will more likely be being blamed. A currency bear market Last month I discussed the weakness that had been seen in the Australian dollar. Since then, as with so many other assets, there has been further weakness. It is worth reviewing just how expectations have changed toward the Aussie over the last few important reversals it has experienced. In late 2008, having fallen precipitously expectations had become very bleak indeed for the Aussie as this Brisbane Times headline from October 20th 2008 illustrated; Aussie dollar tipped to slump further The article quoted forecasts that the AUD/USD exchange rate in the first quarter of 2009 would fall to 62 cents, or even 59 from one bank economist. At the time the currency was at 69 cents. Just a few months earlier, in May of 2008 the article reported that many of the same economists were forecasting parity with the US dollar. The Aussie dollar did fall after that article appeared, for one more week. It then embarked upon an incredible bull market that took it all the way up to 1.10 US$ in late July 2011, by which time some economists were dangerously referring to a permanently high plateau for the Aussie dollar and all were ratcheting their forecasts higher. What followed was a plateau, or at least a trading range between 94 cents and $1.10, but it has not proved permanent. Back in April, with the Aussie dollar trading around $1.05 one major Australian bank was forecasting for it to correct slightly to $1.01 by the end of this year, and then 96 cents by 2014 and 94 cents in eighteen months time. Over the next two months the currency fell all the way to where it was supposed to be in a year and a half, the natural result was that the bank cut there forecast, all the way to 94 cents in September this year and 93 cents by year end, still higher than the level it had already fallen to. When the current Aussie bear market ends expect to see fairly bleak forecasts and targets below where the currency has already fallen to. Only then is it likely that expectations will have been smashed to such an extent that a new bull market can start. The potential for surprise or disappointment on the Aussie still seems to be strongly favouring the risk of disappointment. Gold Last November I highlighted the danger in gold given the still high expectations for the metal and the publicity surrounding a new book forecasting a price of $10,000. At the time gold was trading around $1700. Two months later, in January of this year, I noted in a brief comment titled Gold versus the market that the correlation between the price of gold and the US stock market had, over the prior year, been remarkably close, but that given the bout of weakness that gold had suffered the two prices were diverging. I wrote; Whether this divergence is set to simply grow over the coming months, or whether gold is presaging a reversal in the market only time will tell. But it will be fascinating to follow. Well, it has been fascinating to follow and for a while the divergence did grow as gold continued to fall while the market continued to rise. However, since late May the two have once again started moving together. As I was studying the most recent dramatic decline in the price of gold I was struck by a similarity to another fallen darling of investors and another bear market that I have been tracking for about a year; the bear market in Apple. EMBED Excel.Chart.8 \s The chart above shows the last fourteen months price action in both Apple and the gold exchange traded fund GLD. There is more than a passing similarity and it is particularly noteworthy that the sharpest falls in GLD have been quickly followed by falls in Apple. Obviously there is no similarity in the underlying investments and there can be no cause and effect at play here. What this does highlight, once again, is just what drives markets, and that is the collective social mood of investors. Both gold and Apple held very special places in the hearts of investors as their prices soared. In the end the fundamentals were not driving either investment, both were being driven upward by the herd instinct of those clamouring to get involved. Now the reverse is playing out as their respective bear markets unwind and I continue to anticipate further downside in both. Naturally there will be bounces along the way but attitudes to both have only moved slightly since their respective bear markets began. Incredibly golds recent decline is still being described as a healthy correction, this despite the fact that the metal has been falling for two years now and has lost more than a third of its value. Attitudes to Apple have also changed only slightly. The stock has fallen 46% since its peak last year but still the average analyst has a Buy rating on it, the average price target is nearly 40% higher than where the stock is currently trading and in the latest poll of most respected companies Apple may have slipped but it still lies third. When one thinks about just how much wealth has been wiped out in Apple alone it is remarkable that it is still thought of so constructively and kindly. At the stocks bear market trough the reverse will almost certainly be the case. More characteristics of bear markets A couple of years ago I wrote at some length about commentators, analysts and economists tendency to underestimate the magnitude of a move, be it a bull market or a bear market, most of the time. However, towards the very end of a move their tendency switches from being that of underestimation to overestimation. Unfortunately it seems the majority only finally fully commit to a move when that move is in its dying days. They shift from questioning the magnitude and durability of a move to embracing and then extravagantly extrapolating that move. This behaviour has been seen in each of the cyclical bull and bear markets that have been seen in the developed world indices over the last fifteen years. At the peak in 2000 extrapolations as to how far the markets could rise were rampant, the following bear market was initially seen as a healthy correction and the magnitude of the potential fall was consistently underestimated until right at the end when, with the IMF talking about stagnation, the bleak prospects for equities was obvious to all. The same kinds of shifts in expectations were seen in the bull market of 2003 to 2007 and then throughout the GFC. The same underestimation, until capitulation plays its part, can be seen in the moves discussed above. The targets for the Aussie dollar through its decline during the GFC were always above where it actually was until right at the currencys trough, and then the subsequent rise was always viewed cautiously, until the permanently high plateau was reached. Now the underestimation is in full swing. The gold market has also seen the same extrapolation extremes at the bottom fourteen years ago when central banks were dumping their holdings to more recently when different central banks were piling in and targets were through the stratosphere. None of this tells us how long any bear market will last, and there are now a growing number of them to monitor, but it does shed some light on the kind of news and sentiment backdrop one could expect to see at any bear market bottom. Perhaps the most obvious and consistent theme seen in all those market moves discussed this month has been that at low points the consensus forecast has been for prices to go much lower, whether it is a currency, a commodity, an individual share or a market as a whole. Given this, it is unlikely that the lows have even come close to being seen in most stock markets, commodities or in the Australian dollar. Was that a crash in emerging markets? The chart to the left shows the performance of the SPDR S&P BRIC 40 exchange traded fund. It aims to track the performance of the underlying BRIC 40 index made up of forty leading companies in Brazil, Russia, India and China. The very recent plunge can be seen on the far right hand side. From the peak on the 22nd May to the most recent low on the 24th June the fall was just over 20% with over half that fall coming in just four trading sessions. Perhaps more importantly is the fact that the index has now fallen almost 25% since its peak in January and 33% since the post GFC high recorded in April 2011. Investors in this ETF have endured many bull and bear markets over more than the last six years but on balance have made no money. A very similar picture is seen in the broader ishares MSCI emerging markets exchange traded fund shown to the left. The falls in most of these emerging markets over the last few weeks have been dramatic, but given what was endured in these same indices five years ago it is probably a stretch to call it a crash. Nonetheless, no one should complacently believe that all is well in their equity portfolio with this increase in volatility, particularly given its downside bias of late. The bear market in long dated treasuries In the August edition of Strategy thoughts last year I wrote the following; For a very long time I have proclaimed the virtues of long dated US treasury bonds, and anticipated that yields would go lower than virtually any economist was forecasting. I also didnt expect long dated yields to rise until the consensus view had given up on looking for higher rates and accepted low rates for a very long time. In June I wrote; Until the fear of deflation and ever lower yields becomes widely embraced and discussed it is likely that further surprises on the downside in yields, not a sudden reversal to the upside, are in prospect. At the time ten year treasuries were yielding a little over 1.7%, over the next eight weeks yields plunged, briefly falling below 1.4%. As a result there has been an interesting shift in investor expectations and attitude. Two days ago Bloomberg ran the following story; Treasury Bears Submit To Fed As Bond Optimism At High Jay Mueller, who manages $3 billion of bonds forWells CapitalManagement in Milwaukee, resisted buying Treasuries for four months, anticipating theFederal Reservewould drop its pledge to keepinterest rateat a record low through late 2014. No more. With the economy growing at a 1.5 percent annual pace, the odds of a recession have risen to 60 percent, making 1 percent yields on 10-year notes a possibility, he said. Wells Capitals parent,Wells Fargo & Co., boosted its Treasury holdings 32 percent to $11.5 billion in May alone, according to the latest data compiled by Bloomberg. Were in a low-rate environment for a long time, longer than I had thought, Mueller said in a July 26 interview at Bloomberg headquarters inNew York. Im finally throwing in the towel. So are Pioneer Investment Management Inc., Pacific Investment Management Co., Federated Investors Inc., Northern Trust Global Investments and Columbia Management Investment Advisers LLC. They are adding to holdings of Treasuries as economic growth cools. Of the 20 firms that own the most Treasuries, 16 bought moreU.S. government debt during their most-recent reporting periods, Bloomberg data show. If treasury yields continue to rise, as they have over the last three weeks, and spreads start to widen junk bond returns will start to struggle. With the benefit of eleven months of hindsight it is fascinating, and instructive to see just how attitudes had changed back then, how many towels had been metaphorically thrown in and how much long dated treasury yields have risen since then. The chart below shows the movement of the ten year US Treasury yield over the last twelve months; The all-time low in yields was recorded in the last days of July last year, since then yields have risen a massive 91% at their very recent high. It is highly likely that the low last year marked the end of the more than three decade long secular bull market in bonds. With that as a back drop there is both good news and bad news for investors. The good news is that yields are likely to become more attractive over coming years, the bad news is that one doesnt want to be investing in long dated bonds as they will continually be being marked down in price. Naturally this is the reverse of the environment that we have all enjoyed for so long. As I noted last year in the extract above, it is also likely that high yield bonds will suffer more as spreads rise. I continue to believe that very high quality, relatively short dated fixed income, along with cash deposits, remain the most appropriate investments for investors with a focus on absolute return and capital preservation rather than a relative return against a benchmark that may fall sharply. I also continue to favour the US dollar in the potentially much more challenging period ahead. Another bear market? Without garnering substantial media headlines yet another commodity, lumber, has plunged in price over the last three months and was down 30% at its recent low as can be seen in the chart below. Interestingly, in January of this year there was talk of a new super cycle in wood products prices driven by a resurgent US housing market and the expectations were for new highs in 2013 and record all-time highs in 2014. Given the crack that has now been seen in lumber prices it appears that those extravagant extrapolations should have been a hint that a reversal may have been imminent. Of perhaps greater concern, particularly to the US, is that the lumber market may be telling investors more about where housing and housing starts may be headed rather than the other way around, as the following headline from Moneynews.com hints. Lumber Market Says Next Housing Top in Sight The article pointed out; More ways to share... Mixx Stumbled LinkedIn Vine Buzzflash Reddit Delicious Newstrust Technocrati HYPERLINK "http://twitter.com/share"Tweet HYPERLINK "javascript:void(0);"inShare0 Supply chains offer valuable insights into the state of the market. For example, many analysts believe Apple has a new product coming later this year because their contractors in China are hiring. This idea allows investors to identify industry trends that could help generate profits.Right now, lumber futures have entered a bear market and that could be warning of a downturn in home building.Orders for lumber are placed before homes are built. When orders for lumber or any commodity fall, prices generally slump for that commodity. Since March, lumber prices have fallen by 25 percent. A decline of 20 percent is often used to define a bear market. Lumber price peaks and troughs have led trend reversals in the stocks of homebuilders in the past. Home building stocks have been among the leaders in this bull market, but the fundamentals are no longer pointing to gains in this sector. It would certainly be a disappointment to the currently fairly sanguine bulls on the US market and economy if housing starts and housing prices were to roll over into another bear market as lumber prices are currently hinting. Conclusion For several months I have been concluding that little has changed to change my views, this continues to be the case although I do find it interesting that despite the action of the last few weeks my views continue to be very much in the minority. Perversely perhaps this heartens me, it would certainly be a concern if my views had somehow become the broad consensus. Preservation of capital through holding cash deposits and very high quality fixed income instruments of short maturity continues to be my favoured strategy along with some exposure to US dollars. Avoid chasing yield or potential returns in equities or commodities. Kevin Armstrong 2nd July 2013 Disclaimer The information presented in Kevin Armstrongs Strategy Thoughts is provided for informational purposes only and is not to be considered as an offer or a solicitation to buy or sell particular securities. Information should not be interpreted as investment or personal investment advice or as an endorsement of individual securities. Always consult a financial adviser before making any investment decisions. The research herein does not have regard to specific investment objectives, financial situation and the particular needs of any specific individual who may read Kevin Armstrongs Strategy Thoughts. The information is believed to be-but not guaranteed-to be accurate. Past performance is never a guarantee of future performance. Kevin Armstrongs Strategy Thoughts nor its author accepts no responsibility for any losses or damages resulting from decisions made from or because of information within this publication. Investing and trading securities is always risky so you should do your own research before buying or selling securities. Appendix Summary of selected asset secular and cyclical positions AssetCyclial positionSecular positionCommentsFixed incomeBear marketVery early stages of a secular bear marketthe low in yields seen last year marked the end of the secular bull market in bondsDeveloped market equitiesA cyclical bear market may have begun in May 2013 for those last holdouts. Others such as France saw a cyclical peak in 2011 The secular bull market ended in 2000 amid unprecedented hype, expectation and valuation.At the 2007 lows valuations were not consistent with a secular turn. Look for even lower valuations at the next cyclical troughEmerging equity marketsA rolling series of cyclical peaks have been seen from late 2009 to May 2013Many markets saw a secular trough in either 2002/3 or 2007A far from homogeneous groupGoldThe secular peak was seen in 2011Valuation measures cannot be used for gold therefore secular shifts can only be identified by historic long term sentiment extremesOil$147 in 2008 likely marked the high extreme as did the low of $30 later that same yearBroad Commodity IndexThe 2008 peak was likely a major secular peak comparable to 1980, 1951, 1920, 1864 and 1815Bear markets and consolidation dominate the history of commodities. Secular bull markets tend to be short livedAustralian dollarA cyclical peak was recorded in 2011Secular and cyclical moves are harder to distinguish in currenciesUS dollarA cyclical trough was recorded in the first half of 2011Chinese equitiesA cyclical bear market has been in force since the second half of 2009The extreme peak in 2007 was likely a secular peakUS Real estateA cyclical peak may be imminentA secular peak was seen in 2006 ahead of the GFCDespite seven years of correction it is unlikely that the final secular lows have been seen A final observation on the value of waiting for a secular low to become overweight any asset class goes to the octogenarian market letter writer Richard Russell who last week wrote; Investing in the stock market is not the ideal method of getting rich. No, but there is one exception -- you wait for a primary bear market to hit bottom. 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