Traders buy the dip as Trumphoria begins to fade

There were two headlines about bearish sentiment on CNBC and Yahoo Finance this week that were classic.  CNBC claimed the fear gauge was “breaking out.”  Yet the VIX still shows plenty of bullishness (62nd percentile 10-year reading).  I pay little attention to the VIX: it’s mostly noise.  Far more important are the VIX futures 3 months and out.  The 3-month VIX closed the week at a 95th bullishness percentile.


Earlier in the week, this Yahoo Finance headline read: “By one measure, investors have almost never been this nervous about stocks.”  Reading the fine print, their methodology is flawed, even admitting that the cost of downside protection is cheap.  Delusional!


Buy-the-dip is so ingrained by 8 years of bull market behavior, hardly anyone sees any downside.  The crowd is rationalizing their behavior with talk of “fear” and “cash on the sidelines.”  All nonsense, of course.  This week assets in Rydex MMF dropped 13% to an all-time low $457 mil.


This all took place while the averages were breaking down with financials leading the way (XLF -2.63%).  On Fast Money at Thursday’s close, the fast monkeys were all foaming at the mouth to buy bank stocks!

Market timers remain all-in.  The NAAIM Exposure Index jumped 19% to 86.7%.  Among assets in Rydex bull and bear funds, just 7.6% are positioned for the downside, weighted for leverage.


I realize we shouldn’t get overly infatuated with market timing, but this “what, me worry?” behavior struck me as noteworthy.  So far, at least, this is very different from the breaks in August 2015 and January 2016 in which Rydex MMF balances and 3-month VIX futures spiked.

The bear crying wolf

A perennially bearish hedge fund manager with an Austrian economics bent recently appeared as a guest on the Tom Woods Show.  Tom Woods opened the discussion with:

What do you say to somebody who says, “The trouble with you Austrian-influenced financial guys is that you’re always bearish, so of course you’re going to be right when things go wrong.  Why should I listen to you now?”

Great question.  Are we Austrians eventually right, but always early?  Is this one “big, fat, ugly bubble” that, when it bursts, will vindicate all of us?  Are we just flat wrong?  Is Austrian Business Cycle Theory (ABCT) out of touch with reality?  Or are we stopped clocks, right twice a day, but miss out on a lot of opportunities the rest of the time?

For the full article by Kevin Duffy, see here.

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.





1.  fear of irrational Fed easing doing irreparable harm to a rational short selling strategy

A central banker fesses up (almost)

William White, the Swiss-based chairman of the OECD’s review committee and former chief economist of the Bank for International Settlements (the central banker’s central bank), recently made some frank statements about future debt defaults from Davos, reported here by Ambrose Evans-Pritchard.  We parsed his comments and responded with a few of our own:

“The situation is worse than it was in 2007. Our macroeconomic ammunition to fight downturns is essentially all used up,” said William White.

Their ammo is used up.  That may be a good thing since all the central bankers can do with their interventions is cause mischief.  That won’t prevent them from trying.

“Debts have continued to build up over the last eight years and they have reached such levels in every part of the world that they have become a potent cause for mischief,” he said.

“It will become obvious in the next recession that many of these debts will never be serviced or repaid, and this will be uncomfortable for a lot of people who think they own assets that are worth something,” he told The Telegraph on the eve of the World Economic Forum in Davos.

All enabled by Central Bankers Gone Wild.  Since 2007 the Fed’s balance sheet quintupled.  The rest of the world’s central bankers followed suit.  The debt followed: cause and effect.

 “The only question is whether we are able to look reality in the eye and face what is coming in an orderly fashion, or whether it will be disorderly. Debt jubilees have been going on for 5,000 years, as far back as the Sumerians.”

It will be disorderly and there is nothing the central bankers can do to stop it.  Year-to-date action in financial markets has been very orderly.  That will change.

The next task awaiting the global authorities is how to manage debt write-offs – and therefore a massive reordering of winners and losers in society – without setting off a political storm.

No!!!  The next task should be to shut down the entire central banking operation.  I guess we’re going to have to endure even more pain as the central banks compound their mistakes… once again.

Mr. White said Europe’s creditors are likely to face some of the biggest haircuts. European banks have already admitted to $1 trillion of non-performing loans: they are heavily exposed to emerging markets and are almost certainly rolling over further bad debts that have never been disclosed.

We agree.  Deutsche Bank is this cycle’s Lehman Brothers.  We are heavily short.

The European banking system may have to be recapitalized on a scale yet unimagined, and new “bail-in” rules mean that any deposit holder above the guarantee of €100,000 will have to help pay for it.

Get ready.  The euro zone is headed down the bailouts-for-banks path.

The warnings have special resonance since Mr. White was one of the very few voices in the central banking fraternity who stated loudly and clearly between 2005 and 2008 that Western finance was riding for a fall, and that the global economy was susceptible to a violent crisis.

What a telling quote!  Correct, these guys do not see around corners.  Nearly all of them failed to anticipate the 2008 meltdown.  Even when the subprime cracks appeared, nearly all thought the cancer was contained.  It wasn’t just 2008.  Interventionist economists missed the 1929 crash and 1970s inflation, failed to identify the 1989 Japan bubble and 2000 tech bubble, and thought the Soviet economy was exemplary before it collapsed in the late 1980s.

Mr. White said stimulus from quantitative easing and zero rates by the big central banks after the Lehman crisis leaked out across east Asia and emerging markets, stoking credit bubbles and a surge in dollar borrowing that was hard to control in a world of free capital flows.

The result is that these countries have now been drawn into the morass as well. Combined public and private debt has surged to all-time highs to 185pc of GDP in emerging markets and to 265pc of GDP in the OECD club, both up by 35 percentage points since the top of the last credit cycle in 2007.

“Emerging markets were part of the solution after the Lehman crisis. Now they are part of the problem too,” Mr. White said.

Spot on.  My jaw is on the floor.  I can’t believe any central banker would admit how much they screwed things up by trying to prop up the financial system in 2008.

Mr. White said QE and easy money policies by the US Federal Reserve and its peers have had the effect of bringing spending forward from the future in what is known as “inter-temporal smoothing”. It becomes a toxic addiction over time and ultimately loses traction. In the end, the future catches up with you. “By definition, this means you cannot spend the money tomorrow,” he said.

True statement.  There is a reason people defer spending: so they can invest today and have more in the future.  Central bank suppressing of interest rates breaks the regulator on this behavior, encouraging more spending today.  People are under the illusion that they can have their cake and eat it, too.  Unfortunately, there are no free lunches in economics.

A reflex of “asymmetry” began when the Fed injected too much stimulus to prevent a purge after the 1987 crash. The authorities have since allowed each boom to run its course – thinking they could safely clean up later – while responding to each shock with alacrity. The BIS critique is that this has led to a perpetual easing bias, with interest rates falling ever further below their “Wicksellian natural rate” with each credit cycle.

This is central-banker-speak for “moral hazard.”  Thank you very much Alan Greenspan for inventing the “Plunge Protection Team.”  Also, thanks to Robert Rubin, nicknamed “Mr. Bailout” (for good reason).

“Responding to each shock with alacrity?”  This is an understatement.  With each crisis the response has been exponentially greater.  The 2008 variant saw global central bank balance sheets probably go up 3-4 times and interest rates taken to zero for 8 years!

 The error was compounded in the 1990s when China and eastern Europe suddenly joined the global economy, flooding the world with cheap exports in a “positive supply shock”. Falling prices of manufactured goods masked the rampant asset inflation that was building up. “Policy makers were seduced into inaction by a set of comforting beliefs, all of which we now see were false. They believed that if inflation was under control, all was well,” he said.

This is a muddled statement, but revealing.  China joined the world economy in the 1990s, an unmitigated positive.  And yes, this extra supply masked underlying inflation.  But who caused that inflation?  Central bankers, of course.  Were they “seduced into inaction?”  Well, not exactly.  They were doing what they normally do: suppressing interests below the market level.  They should have gone to inaction: let interest rates rise to their natural level.  The revealing part of this statement is that central bankers are always fighting the bogeyman of deflation.  This is dangerous and what always give them an excuse to meddle.  Btw, if we’re going into debt defaults and asset declines, central bankers will have plenty of excuses to “fight deflation.”

Btw, a similar mistake was made in the mid to late 1920s when the Fed tried to “stabilize the price level.”  With electrification, new inventions and productivity gains, consumer prices should have gone down.  However, the Fed would not tolerate the dreaded “deflation” so they printed money.  Consumer prices were strangely (and unnaturally) flat during the second half of the 1920s.  In retrospect, most of the Fed’s inflation went into asset prices, blowing a great bubble.  This didn’t end well, if my recollection of history is correct.

 In retrospect, central banks should have let the benign deflation of this (temporary) phase of globalisation run its course. By stoking debt bubbles, they have instead incubated what may prove to be a more malign variant, a classic 1930s-style “Fisherite” debt-deflation.

Correct.  I doubt they’ve learned the lesson.

Mr. White said the Fed is now in a horrible quandary as it tries to extract itself from QE and right the ship again. “It is a debt trap. Things are so bad that there is no right answer. If they raise rates it’ll be nasty. If they don’t raise rates, it just makes matters worse,” he said.

Checkmate.  The best they can do is shut down the operation and do something productive, like work as greeters for Wal-Mart.

 There is no easy way out of this tangle. But Mr. White said it would be a good start for governments to stop depending on central banks to do their dirty work. They should return to fiscal primacy – call it Keynesian, if you wish – and launch an investment blitz on infrastructure that pays for itself through higher growth.

Bad idea!!!  More government “stimulus” can only make matters worse. If Mr. White is so concerned about high debt levels, why is he encouraging even more government debt?

 “It was always dangerous to rely on central banks to sort out a solvency problem when all they can do is tackle liquidity problems. It is a recipe for disorder, and now we are hitting the limit,” he said.

No, all they can do is wreak havoc.

Predictions for 2016

“It’s OK to forecast the end of the world, but don’t ever give a date.” ~ Burton S. Blumert, 1929-2009


With that sage advice as a caveat, our thoughts on how 2016 might play out:

1) Global economy will be in full blown recession by the end of the year.  China leads the way, but the Euro Zone and U.S. not far behind.

2) Global equity bubble bursts, with the S&P 500 down over 25%.

– Worst performers: financials (global banks, auto finance, asset managers like BlackRock), technology (including highflying “FANGs”), REITs (especially those with exposure to shopping malls and NYC real estate), health care (heavily leveraged serial acquirers like Valeant, pharma companies with dubious patent protection, health insurers gaming Medicare), Chinese financials and real estate-related

– Best performers: Wal-Mart, food-related, fertilizer, defensive/consumer staples stocks in beaten down markets like Brazil

3) Euro zone bonds decline (yields rise), reflecting too much debt and too weak economies to service that debt.  German, Italian, French, Spanish bonds all decline.

4) U.S. dollar peaks

– Japanese yen surprise winner as speculative carry trades unwind; Swiss franc reemerges as safe haven – Gold holds up well and gold mining stocks outperform as costs decline (but sticking to high quality companies and royalty companies that control their owns destinies and don’t depend on rising gold prices); platinum and silver also do relatively well

5) A Republican wins the 2016 election as Dem experiment of last 8 years is discredited (50-50 chance it’s Trump).

6) Optimism and dip buying remain intact; Jim Cramer still working for CNBC; no more than 1 or 2 short selling hedge funds are launched.  Denial is still the order of the day.

7) Fed raises rates no more than 2 more times, then does an about-face.  The world’s central bankers begin to lose credibility and swagger (though still early in the process – no “Wizard of Oz moment” yet).  (Yellen & Co. may not even raise at all.)

8) Biggest winners in 2016: short sellers (though they are still treated by the mainstream financial press like pariahs).

Happy New Year, everyone!

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%


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


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


  • 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%
  • $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%.



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