Is market timing overrated?

Markets are hopelessly complex, yet many try to make them black and white.  “The stock market is a house of cards.”  “You can’t time the market.”  These become excuses to either put all your eggs in the macro basket or none at all.

What is more important, market timing, a sound economic framework, or getting the business right?  The success of Warren Buffett shows the value of the last.  Here is an example: Sanderson Farms, a poultry producer from Mississippi.  What does the chicken business have to do with business, credit, and market cycles?  Some, but not as much as, say, Goldman Sachs.  People eat chicken in good times and bad.  There are plenty of other factors that influence their business such as grain prices, bird flu epidemics, and export markets (the industry tends to take the brunt of trade tensions).  Since 12/31/97 SAFM has plodded along, growing revenue from $500 million to $2.9 billion today (10.4% CAGR).  Over that time, total return to investors was 13.8%/year.  Had an investor timed the market perfectly, selling at the top of the tech bubble in 2000, buying at the low in 2002, selling at the credit bubble high in 2007, and buying again at the low in 2009, his total return would have been reduced to 10.5%/year.

Timing is not everything… market timing, that is.

That said, the macro environment is as dangerous as any we’ve experienced.  But some companies will be fragile (banks, for example) while others will be robust, such as the poultry business.

Caterpillar is no butterfly

If Caterpillar offers a window into the global economy, the view isn’t pretty.  Year-over-year revenue growth by geography/segment:

North America:

  • Construction -3.5%
  • Energy & transport -15.7%
  • Mining -7.4%

Latin America:

  • Construction -46.8%
  • Energy & transport -6.6%
  • Mining -5.6%

EAME:

  • Construction -18.0%
  • Energy & transport -4.7%
  • Mining -20.1%

Asia/Pacific:

  • Construction -30.5%
  • Energy & transport -17.3%
  • Mining -12.2%

Takeaways:

  • Mining revenues down over 60% from the peak.  Declines are coming from depressed levels.
  • North America E&T (shale boom) was a bright spot, now a negative.
  • North America Construction was a bright spot, now negative.
  • Construction around the world is plunging (-29.4% excl. North America).

CEO Doug Oberhelman was interviewed on CNBC yesterday and asked if he regretted buying back stock at $100/share (traded at 79.76 at previous day’s close).  His response:

When you do a buyback at an industrial company like us, we have a lot of cash on our balance sheet.  Our balance sheet is strong, our debt-to-cap ratio is as strong as it’s been in decades, and having cash just sit on the balance sheet doesn’t do anybody any good.

[…] Caterpillar’s a 90-year old company and I am convinced at some point, probably not in the too distant future, those $100 shares will look cheap.  They’ll certainly look cheap today and you look at this as a long-term basis.

Oberhelman apparently sees no need to batten down the hatches even though he’s in the mother of all storms (and we’re just getting started).  In fact, he just hiked the dividend 10% in June and now wants to ramp up buybacks!  Keep in mind, Oberhelman never saw this storm coming.  On November 15, 2010, just months from the top of the commodity bubble, he paid $8.6 billion for Bucyrus International, which he called “a strong statement about our belief in the bright future of the mining industry.”  The company’s press release announcing the deal read:

The acquisition is based on Caterpillar’s key strategic imperative to expand its leadership in the mining equipment industry, and positions Caterpillar to capitalize on the robust long-term outlook for commodities driven by the trend of rapid growth in emerging markets which are improving infrastructure, rapidly developing urban areas and industrializing their economies.

Caterpillar is the ultimate canary in the global economy coalmine.  As their 2nd quarter confirmed, the canary is stone cold dead.  Yet eerily, hardly anyone is talking about it.  Fittingly, CEO Oberhelman is still at the helm.

Generals charge ahead while soldiers in full retreat

Friday was a remarkable day for students of the market’s internal strength, aka “market breadth.”  The Nasdaq 100 (NDX), powered by a 16% surge in Google, was up 1.45% even though declining stocks outnumbered advancing stocks by 50.  This has never happened on a day the NDX gained over 1%, not even close.  According to Jason Goepfert of SentimenTrader, breadth was negative only three other times in history.  One of those days was March 23, 2000 – right at the top of the Nasdaq bubble!

Year-to-date, the Wilshire 5000 (a measure of market capitalization of 5000 companies) has added $751 billion in market cap, a 3.5% gain.  By our measure, 10 companies have accounted for $471 billion, or 63% of those gains.  The top 5 have a combined market cap of $1.489 trillion – 6.6% of the Wilshire 5000 – and accounted for 52% of the ytd gains.

  • Apple: $113 billion, +18.4% ytd
  • Google: $107 billion, +31.8%
  • Amazon.com: $81 billion, +55.6%
  • Facebook: $48 billion, +21.7%
  • Gilead Sciences: $38 billion, +25.9%
  • Netflix: $29 billion, +135.2%
  • Celgene: $18 billion, +20.3%
  • Biogen: $15 billion, +19.2%
  • Regeneron Pharmaceuticals: $15 billion, +34.5%
  • Tesla Motors: $7 billion, +23.5%

Further, biotechnology stocks make up 3% of the S&P 500 by market cap yet account for 15% of the year’s gains.  Meanwhile, the Dow Jones Transportation and Utility Averages are 12.5% and 11.9% below their 52 week highs respectively, even though the Dow Jones Industrials Average is within 1.4% of an all-time high.

As legendary market watcher Bob Farrell warned, narrowing leadership is typical of the late stages of a bull market.  This phenomenon is even more pronounced during the blowoff stage of a financial bubble.  We call this the “casino effect.”  Gamblers, addicted to winning over a long period, refuse to leave the casino even though several tables are coming up snake eyes.  Instead they gravitate to the diminishing number of winning tables.  Regarding the stock market, this is a classic sign of denial.  The losing tables are in essence early warning signs, stocks succumbing to deteriorating economic fundamentals.  Yet speculators ignore the red lights and fail to connect the increasingly obvious dots.  At the end the investing crowd feels it is in control and their favorite stocks are immune to macro factors.

Apple is a good example.  In Q1, China revenue grew 71% and accounted for 29% of the total.  At what point do the troubles in China affect Apple, the beloved stock of retail investors and the biggest weighting in index funds?  We could get some clues this Tuesday after the close when they report Q2 earnings.

 

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:

  • MarketWatch.com – “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”
  • MarketWatch.com – “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?

 

 

Peak profits, stock prices?

Recently a respected colleague said our strategy was rational but markets, and the world for that matter, were highly irrational.  After participating in financial markets for the last 25 years I thought my experiences allowed me to see it all-wrong!  So after reflecting on our irrational state of affairs the logical side compiled some of the glaring data sets signifying a massive market top. 

First, a chart created by John Hussman (www.hussmanfunds.com) indicates how much excess we’ve witnessed in corporate profitability vs GDP lately.  Keep in mind his data includes financials which to this day remain a subsidized black box.  (Click on image to enlarge).New Picture (1)

Of course this hasn’t stopped wall street from expecting further net margin expansion:

 

Profit margin growth

Before Wall Street follows Congress out the door for the holidays maybe they should scrutinize this:

profits vs labor

To derive this unprecedented profit picture both consumers and government went on a spending binge.  US national debt, through 5 years of record deficits, added almost $7.7 trillion to our balance sheet-can you say malinvestment?personal savings govt deficits profits

 

Now, if we remove the creators of financial alchemy we notice the real economy topped many quarters ago. 

 

Nonfinl corp profits

So if you care to break away from CNBS and look at the graphs above rational behavior would suggest profit taking and or short exposure.  In fact, it was just 7 years ago that many of these same signals were sent to the market yet we were labeled as the boys crying wolf.  If your timing is perfect the crowd labels you a genius but too early, a chump. 

 

 

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 www.sentimentrader.com 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 SentimenTrader.com 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”

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