Category: contrary indicators

Is new ETF to track ETF industry another sign of an ETF bubble?

Burton Malkiel, early influence (along with Eugene Fama) on Vanguard founder and indexing pioneer John Bogle, has been hired to join the investment committee of the Tosoro ETF Industry Index.  This index guides the ETF Industry Exposure & Financial Services ETF (TETF) recently unveiled on June 26th.

Adding irony to the launch, there appear to be flaws with index construction, not uncommon for ETFs.  The companies in Tier A, which make up 50% of the index and have “direct financial impact” from the ETF industry, are equal-weighted.  That means BlackRock (BLK), with a $71 bil market cap, has the same weight (6.25%) as Wisdom Tree Investments (WETF) with a $1.43 bil market cap.

One dirty little secret of the ETF industry is that there is no such thing as a “passive” index.  Otherwise, why the need to hire an investment committee to decide components and weightings?  The timing of a new ETF is another matter, and almost always a backward look on performance and forward look on what will entice investors.  These are not impartial decisions made by machines, but value judgements made by humans.  Value, as any Austrian economist knows, is always subjective.

Predictions for 2017

Those who have knowledge don’t predict. Those who predict don’t have knowledge.” ~ Lao Tzu, 6th century BC poet and father of Taoism

It appears Lao Tzu anticipated the accuracy of our 2016 predictions twenty seven centuries ago.  While we got a few right (rebound in gold mining and Brazilian stocks, the demise of Valeant Pharmaceuticals, and 50/50 chance Trump would be the next president), we got plenty wrong, most notably a 25% bear market in stocks.

Bloodied, but unbowed, here is our short list for 2017:

1) The Trump honeymoon is short-lived, doomed by absurdly high expectations, faulty economics and political expediency.

– positives: Sanctions against Russia end as the Cold War thaws.  Regulations are cut, especially in the energy sector.  U.S. corporate tax rate is cut to 25%, bringing it more in line globally.

– negatives: Obamacare is not repealed, but instead replaced with a watered down version, dubbed “Trump Care.”  The debt ceiling is raised in March and federal spending continues to grow unchecked, even adjusted for inflation and population growth.  Trade tensions increase.  Common Core is not repealed.

2) Global economy officially enters recession.  China, the Euro Zone and U.S. all join the fray.

3) Global backlash against the political establishment continues.  Populist parties do especially well in Europe.  French, German and Italian bonds suffer.  Heading into 2018, a breakup of the EU looks like a serious possibility.

4) Most global equity markets enter bear market territory.  The S&P 500 ends the year down over 20% (below 1800).

– worst performers: financials (global banks, investment banks, auto finance, bond insurers), REITs (retail and office), technology, industrials, Chinese financials

– best performers: discount retailing (Wal-Mart, Dollar Tree), food-related, fertilizer, genomic sequencing (Illumina), cancer drugs (Bristol Myers)

5) Inflation begins to become a concern.  Gold and gold mining stocks do very well.

6) U.S. dollar peaks, losing ground to the Swiss franc, euro, British pound and Japanese yen.

7) China cracks widen.  Bonds extend losses.  Equities fall over 20%.  Yuan experiences at least one official devaluation, even though the Chinese sell over $200 billion in U.S. Treasuries to shore up their currency.  Trump cries fowl, labeling China a “currency manipulator.”

8) Official U.S. deficit for fiscal year ended 6/30/17 exceeds $600 billion.  Talk of future trillion dollar deficits becomes more commonplace.

9) Active investing makes a comeback.  BlackRock is a notable underperformer.

10) Global free market reforms are a mixed bag.  Brazil makes progress, India regresses.

Venture capital and IPO markets open full tap

Venture capitalists raised $17.5 billion in Q2, the most since the tech bubble top in 2000 according to a survey by PricewaterhouseCoopers and the National Venture Capital Association.  This was 30% higher than Q1.

There were 34 initial public offerings (IPOs) in June, the highest June total since 2000.  The biotechnology space is white hot.  Nearly 30% of the 109 IPOs year-to-date were biotech outfits, easily outpacing the 12% in 2000.  Reminiscent of the dot-com craze 15 years ago when the quality of IPOs fell off a table, more biotech companies are coming public at an earlier stage of development.  Aeglea BioTherapeutics, for example, is seeking to raise $86 million even though its primary drug hasn’t started early-stage trials.  According to Mark Arbeter, 78% of companies going public the past 6 months are losing money, exceeded the peak in 2000.  Big first day moves are another reminder of the tech bubble.  On June 29, Seres Therapeutics popped 186%.  Just last week, cybersecurity firm Rapid7 popped 52% on its debut while cancer drug developer ProNai Therapeutics soared 81%.



Latest fad: buy the dip

Now that the S&P 500 has had all of a 3.4% correction, rationalizations for dip buying are coming out of the woodwork.  E.g., the latest headline from Yahoo Finance: “Fear not. The VIX is flashing a buy sign.”  Seriously?

VIX - 140805


There are better indicators of bullishness:

Rydex bear fund assets


“Spikes in the VIX tend to indicate heightened investor fear,” said Ari Wald, head of technical analysis at Oppenheimer. “From a contrarian standpoint we use that as ‘buy’ signals, and the numbers agree.”

We wholeheartedly disagree.  Investment professionals have adopted the Orwellian logic that up is down, black is white, stimulus is sustainable, and bravado is fear.  The true contrarian position is to raise cash, get short, and fasten the seat belt.

Addendum: Recent quotes from some of our favorite talking heads:

This is not a weak economy, it’s a pleasantly strong economy.  This is a nicely strengthening economy.  This is a very well demeanored economy.  It’s not an excited one.  It’s one that’s doing quietly better…  Let’s all be calm and not be panicked at this point.  I turned from being quite bullish of stocks to being neutral early last week and I have to tell you, I never thought we’d see the market fall several hundred Dow points in the course of three or four days.  I got very lucky, and I’m going to turn back to being bullish again.

~ Dennis Gartman, as appeared on CNBC, August 4, 2014

Tony Dwyer


Where are the ominous headlines?

Biotech Index - 140413


The momentum stock bubble burst last week, with highflying stocks showing significant declines from their February/March highs:

  • brokerage stocks: -10.8% (high set on March 20)
  • housing stocks: -9.4% (February 27)
  • Internet stocks: -17.1% (March 4)
  • biotechnology stocks: -21.1% (February 25)
  • Tesla Motors: -20.0% (March 4)
  • Netflix: -28.2% (March 4)
  • Twitter: -45.4% (December 26)
  • 3D Systems: -50.1% (January 3)

Yet a brief scanning of the financial headlines shows little concern:

  • – “Stocks fall as volume rises, but here’s why not to worry”
  • The Wall Street Journal – “Stock-Market Jitters Put Investors at Ease; Recent Turbulence Is Seen as a Healthy Sign”
  • CNBC – “Last week’s big selloff ‘probably over': Pro”
  • – “Don’t let these stock market gyrations scare you; It’s likely that we’ve seen the end of recent declines”

The common theme among pundits is that the momentum bust is isolated, contained, healthy, and even predictable.  CNBC quoted Jonathan Golub, chief U.S. market strategist at RBC Capital:

“I think the selloff is probably over.  If you look at the economically sensitive stuff in the market, it’s not really selling off. It’s tech. It’s bio-tech [which makes up about 10 percent of the market.]  The other 85 to 90 percent is in perfectly fine shape.

This weekend Barron’s patted itself on the back for predicting the tech bust several months ago:

In November, when pundits began to natter about a stock market bubble, we pointed out in a prescient cover story that it was a tech bubble, not a market bubble.  Our advice has paid off handsomely.

Barron’s quoted perma-bull Jim Paulsen, chief investment strategist at Wells Capital Management:

My guess here is that we’re having a valuation adjustment in one small part of the market, in the highflying momentum stocks that got ahead of themselves and are now correcting.  I think this is more of a buying opportunity.

The article concluded:

All this suggests that despite some ominous headlines, the stock market’s health is still good. [emphasis added]

Where are the ominous headlines?  We don’t see any.  We see complacency as far as the eye can see with the assuredness that the momentum stock bust is “contained.”  We heard these same words in April, 2000 after the dot-com bust and March, 2007 after the subprime bust… early warning signs that were overwhelmingly ignored.



Barbarians at the trough

“Activist investors” have become momentum chasers, another example of how far the market has untethered from reality.  Is Time magazine tempting the investment gods with this cover?



Bullish investor sentiment continues to set records

Doug Wakefield of Best Minds Inc. just made the following insightful comment about unprecedented levels of investor optimism:

One of my sources is where Jason Goepfert pulls together several dozen indicators on an ongoing basis.  All year he would rarely make a comment that would signal a “bull” or “bear” indicator that would go on his general list of “bulls” and “bears” worthy of notice. In fact, as of the Sept 18th “no taper yet” announcement, there were only 4 indicators that had made the list for the year (both bulls and bears for stocks).

However, since that time, the pace and number has picked up to the point that where there have been 13 bear posts since Sept 18th against only one bull post.  All of these a major indicators are very rare, or highest ever.

One of my favorites for a full blown mania, is a recently reported figure of 21 dollars in double long NASDAQ funds at Rydex for every 1 dollar in double inverse NASDAQ funds. Of course, another record.

Below are several snippets from the daily emails of over the past five weeks:

Oct 31

  • Active investment managers have added to their exposure to stocks and are now carrying among their heaviest loads in 7 years.
  • As an update to Wednesday’s report, the Rydex Total Index Bull / Bear Ratio hit 5.0 as of that day’s close.  It is now equivalent to the levels seen at the past three market corrections.
  • According to Lipper, investors have contributed a net $41 billion to equity mutual and exchange traded funds over the past three weeks.  Going back to 2002, that exceeds the prior 3-week record inflow by more than 17%.

Nov 4

  • Safety-seeking behavior among traders in a popular mutual fund family (Rydex Funds) has just dropped to a 12-year low.

Nov 5

  • Trading in penny stocks, the Wild West of the stock market, jumped higher in October, more than 50% above September’s levels.

Nov 6

  • The spread between Smart Money and Dumb Money has reached a troubling extreme.  The last three times we saw such a divergence, stocks peaked quickly.
  • Traders and investors appear to be very comfortable trading individual stocks as opposed to “safer” exchange-traded funds.  The Liquidity Premium, particularly for the Nasdaq 100, has reached the 2nd-most-extreme level since 2002.  It was only higher in mid-August 2012 and nearly this extreme in early March 2011, both preceding corrections.  Stocks usually do quite a bit better when investors aren’t quite so complacent in their trading activity.

Nov 7

  • Speculative activity has increased sharply, particularly when looking at indicators focused on the tech-heavy Nasdaq 100 index.

Nov 8

  • Buying climaxes among stocks in the S&P 500 have added up to more than 125 during the past three weeks, one of the highest totals in 20 years.
  • We touched on speculators’ positions in the Nasdaq 100 futures on Thursday, and the latest data from the Commitments of Traders report confirmed that they got even more net long this week, to a new all-time record degree.
  • According to Bloomberg data, the skew on options for the S&P 500 tracking fund, SPY, has dropped to its lowest level since at least 2005, the earliest for which data is available.  While there are many possible structural reasons for this involving arcane options trading strategies, the knee-jerk interpretation is that traders have decided to pay up greatly for call options, betting on a further market rally.  This has a consistent history of being a contrary indicator, which would suggest that this is market-negative.

Nov 15

  • This is the 3rd time since 1997 that the S&P rose at least 0.4% to a 52-week high but with less than 2/3 of stocks rising on the day for three days in a row.  The others were 10/6/97, 3/23/00 and 11/22/05, all preceding short-term corrections.  Historically, it marked market peaks in 1950, 1955, 1959, 1968, 1975 and 1980, with an overall return over the next three weeks that averaged -1.0% with 41% of days showing a positive return.

Nov 19

  • The SKEW Index from the Chicago Board Options Exchange jumped to 137 on Monday, which is one of the highest readings in history.  It suggests an approximately 12% probability of a “black swan” event – a rapid, 2-standard-deviation market move – within 30 days.

Dec 2

  • Investment managers have never been this exposed to the stock market, this aggressively (at least since 2006).
  • We looked at a moving average of the Options Speculation Index on November 19th, and it was nearing all-time highs.  The weekly reading last week jumped to 131%, tied for the 2nd-highest level of speculation among options traders in 13 years.
  • The latest Commitments of Traders report shows that speculators have been pushing short-side bets on precious metals.  Total speculator positions in gold, silver, copper, platinum and palladium are nearing decade-long lows, second only to several weeks in late June and early July.

Dec 3

  • Traders in the Rydex family of mutual funds have moved to a new level of speculation in the major index funds.  With $5.30 riding on bullish funds for every $1.00 in bearish funds, they’ve never been more exposed.

Dec 4

  • Assets in equity mutual funds and ETFs have now eclipsed assets lingering in safe money markets by a ratio of 3.7-to-1, a three-decade record.
  • The Rydex bull / bear ratio mentioned in Tuesday’s report climbed even further on Tuesday, now with another new all-time high reading of 5.5.  In the Nasdaq 100, there is now nearly $21 invested in the leveraged long fund for every $1 in the leveraged inverse fund.

“Unprecedented” levels of bullishness is an understatement.

Investors Intelligence poll shows most bullishness since 1987

The granddaddy of sentiment indicators is the weekly Investors Intelligence poll which grades investment newsletters as bullish, bearish or neutral.  Latest reading: 57.1% bulls vs. 14.3% bears.  The ratio of bulls/bears, at 3.99, is the highest since early 1987.  Prior to the ’87 Crash the ratio peaked at 3.48 on August 14, 1987 (less than 1% off the year’s high).  Two months later the S&P 500 had plunged 33%.

"Buy high, sell low"

“Buy high, sell low”

Rydex timers most bullish since 2000 tech bubble

As of the close last Friday, just 9.8% of assets in Rydex bull and bear funds bet on the downside (weighted for leverage).  This is the highest level of bullishness since January 30, 2001.

Greenspan sees no bubble

The Maestro’s crystal ball is the gift that keeps giving.  With an uncanny knack for completely missing most of the major inflections points in financial markets over the past five decades, Greenspan added this gem to his resume in a FOX Business News interview yesterday:

“There are a lot of things that can go wrong, but to say that the market is bubbly and in a position where it could conceivably create a serious problem, I think is overstating it.”

Let’s put this prediction in perspective by filling in some of his resume…

“It’s very rare that you can be as unqualifiedly bullish as you can now.”  ~ Alan Greenspan, The New York Times “Economic Survey”, January 7, 1973

1973 and 1974 turned out to be the worst years for economic growth and the stock market since the Great Depression.  (as noted in Jason Zweig’s commentary in The Intelligent Investor)

On October 2, 1990, then Federal Reserve chairman Greenspan made this prediction:

“At the moment it isn’t raining.  The economy has not yet slipped into a recession.”

It was later revealed that a recession had actually begun three months earlier, in July.

In April 2000 (one month after the NASDAQ peak), Greenspan was asked if rising rates would prick the stock market bubble.  His response:

“That presupposes I know that there is a bubble…  I don’t think we can know there’s a bubble until after the fact.”

From The Age of Turbulence (2007), Greenspan recounted his thoughts on the 2003-2006 housing bubble:

“I would tell audiences that we were facing not a bubble but a froth – lots of small, local bubbles that never grew to a scale that could threaten the health of the overall economy.”

The December 26, 2005 issue of BusinessWeek confirmed his complacency:

“The view of most economists, including Fed Chairman Alan Greenspan, is that a national home-price bust is highly unlikely.”

Greenspan also whistled past the subprime lending grave:

“With these advances in technology, lenders have taken advantage of credit-scoring models and other techniques for efficiently extending credit to a broader spectrum of consumers. . . . As we reflect on the evolution of consumer credit in the United States, we must conclude that innovation and structural change in the financial services industry have been critical in providing expanded access to credit for the vast majority of consumers, including those of limited means. . . . This fact underscores the importance of our roles as policymakers, researchers, bankers and consumer advocates in fostering constructive innovation that is both responsive to market demand and beneficial to consumers.”  ~ Alan Greenspan, from a speech given April 8, 2005

Housing prices peaked in Q1 2006 and by Q4 were in full retreat, yet Greenspan was unconcerned:

“Most of the negatives in housing are probably behind us.  The fourth quarter should be reasonably good, certainly better than the third quarter.”  ~ Alan Greenspan, October 26, 2006

Even as late as Q2 2008 he thought the worst was over:

U.S. financial markets, roiled by the collapse of the subprime-mortgage market, have shown a pronounced turnaround since March. The worst is over for the credit crisis, or will be soon, and there’s now a reduced possibility of a deep recession.  ~ Alan Greenspan, June 13, 2008

The S&P 500 plunged nearly 45% over the ensuing five months.

Alan Greenspan is a stark reminder that central bankers have only one productive use: as contrary indicators.

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