If you wake up and don't want to smile, If it takes just a little while.
Open your eyes and look at the day,
You'll see things in a different way.
Don't stop, thinking about tomorrow,
Don't stop, it'll soon be here,
It'll be, better than before,
Yesterday's gone, yesterday's gone.
Don't you look back,
Don't you look back.1
Everyone sees what they want to see. Some are distracted by things trivial and
inconsequential. Many are simply uneducated, lacking the knowledge to perceive
various aspects of the big picture, others too busy with earning a living and caring
for a family to spare a moment for more than a little mindless relaxation. Finally
there are the skeptics and the cynics.
The big picture is alarming to those who believe that human nature is basically
unchanged for centuries. As a consequence, we believe the natural proclivities,
motivations and actions that created various conflicts and crises will reoccur
unless the center can be made to hold against the basic side of human nature, an
innate centrifugal force.
The apple cart is upset, but that only means applesauce is on the menu, along with
the lemonade flavored Kool-Aid, from the spoiled lemons.
Peace in our time 2 seems more elusive than ever. The surrender of the Sudetenland might as
well as happened in a George Lucas empire far, far away, rather than in Europe 75 years ago.
Neville Chamberlain is not the name of a new rock and roll band.
History disappears, swept away by the modern era of the internet, as if nothing existed prior –
because there isn’t a You Tube video. 3
1
Don't Stop was written during the recording of the Rumours album in 1976 around the time that John and Christine McVie were breaking up. It
was one of the classic breaking up songs
PM Neville Chamberlain arrived back in the UK today, holding an agreement signed by Adolf Hitler which stated the German leader's desire
never to go to war with Britain again. …Adolf Hitler did not keep to the promises he made to Neville Chamberlain in September 1938.
http://news.bbc.co.uk/onthisday/hi/dates/stories/september/30/newsid_3115000/3115476.stm
3
A rare exception is this footage of Neville Chamberlain on his return to England. http://www.youtube.com/watch?v=FO725Hbzfls
2
Most, people suffer from some form of solipsism to one extent or another. Existentialism is not
a common or dominant trait in human behavior. The world exists only as we perceive it, and
does not exist beyond the ambit of that knowledge.
The stock market also has its own form of solipsism, seeing valuation based on current
perceptions as well as what is “selected” as the relevant knowledge.
Market perceptions are sometimes quite homogenous, sometimes quite divergent. The recent
consensus favored growth over value, particularly deriding slow growth and stable dividends.
There was supposed to be a continuing flood of investment capital to growth, as investors
choose to weight an uncertain future optimistically, looking forward to continued/resumed
economic progress, as opposed to placing the current situation in the context of history. While
there was a near uniform consensus that growth would outperform, the quintessential “value”
stocks - utilities have outperformed by a wide margin year to date. Not even close to the margin
of error: the D.J. Utilities were plus 7.2% versus the Industrials down 1.9 and the Transports up
0.1%.
This “miss” raises the issue of whether this is a “timing error” or something more substantial,
reflecting a change in the underlying economic trends? Fundamental analysts are currently
engaged in a debate about valuation, as if the economy is irrelevant.
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The debates about the appropriate measures and the current level of price earnings ratio are the
result of challenges to quantitative analysis by the newly confident. I’m inclined to accept the
Schiller position 4, because no matter what anyone says – it is never different this time.
4
An excellent starting point is the CAPE, or cyclically adjusted price-earnings ratio, developed by 2013 Nobel laureate Robert
Shiller of Yale. http://finance.fortune.cnn.com/2014/03/26/why-a-mean-reversion-would-be-mean-to-the-stock-market/
A little like the argument about how many angels can dance on the head of a pin, missing the
point for most investors. “What difference does it make?” The actual question is not whether
there will be a reversion to the mean, but rather how and when it will occur.
It is easy to look back just five years for a little sobriety. In late 2008 and early 2009, when risk
was perceived by many to be so great as to be incalculable, an investor could basically throw a
dart and make a successful purchase, because almost everything was at bargain basement prices.
In October of 2008 I wrote in my newsletter:
“If there 100 signals of major market bottom, we’re witnessing 90.” … “Maintain your plan and
adjust your allocation. You should be moving from a tactical allocation that was heavy on cash,
CD’s and other short term investments. Traditionally you would buy equities, but in the current
environment you can buy almost anything.” “At the end of it all-it doesn’t matter why the
market decides to go up, just that it goes up.”
This is clearly not the case today as the debate is about how many signs of a major market top
are present. Is the PE ratio is 21 or 24?, When are interest rates are going to rise? Can GDP
growth ever achieve “escape velocity” instead of limping along at 2.0% plus or minus 0.5
percent?
Overvaluation is not uniform, or uniformly extreme; there are targets left on the dartboard, but a
better aim is needed. While a major correction is inevitable, timing is impossible. So, be alert
for signals of market tops.
At times, it is as important as to where and when a top occurs, as opposed to the size of the top.
That “market tops take place after significant advances” is a truism. The advance thus far easily
qualifies as “significant”, the top pattern is so small as to be almost imperceptible, although a
moving average crossover could easily occur.
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No one can say how much farther the current phase of the secular bull market will extend, or
how long it will last. Investor psychology rules when markets untie from the moorings of
historical valuations. At these times, markets are susceptible to any one of many extraneous
factors, rising or falling on a perceived nuance in an official’s speech.
Or a ground war in a distant land?
Chairwoman’s Yellen was doing her best Yoda imitation in her first speech. 5 Let reality intrude,
the idea that the FRB will begin raising interest rates leaving the New York Reserve Bank
holding a $4,000,000,000,000 6 balance sheet is ludicrous. Of course, they will never tell us that,
they can create static analysis to paper over this legitimate concern. 7 Sure the principal can
decline, say a mere $500 billion dollars, and the interest costs may rise another “tolerable”
amount. (1% of 4 trillion dollars is a mere $40 billion per year in increased, compounding
interest costs).
5
“Difficult to see. Always in motion is the future..”
http://www.frbsf.org/our-district/press/presidents-speeches/williams-speeches/2014/march/inside-monetary-policy/The-FederalReserve-Inside-Monetary-Policy.pdf also figure 2
6
7
http://www.frbsf.org/economic-research/publications/economic-letter/2014/march/federal-reserve-interest-rate-risk-stress-test/
So, while we may have modest interest rate certainty; that nothing will be done that might rock
the boat, internationally the era of Fracas Americana is a time of international instability.
The confrontation in the Ukraine may be a defining moment for the future of the entire World,
both economically and diplomatically. While many believe these are minor matters far away,
history has repeatedly proven otherwise. If, (once), the Russians invade Ukraine, a country with
a strategic pact with the US as a quid pro quo for surrendering the third largest nuclear arsenal in
the world, the wild eyed optimists may sober up. A ground war in Europe on the borders of
NATO is something that many thought we would never see again.
Collapse of the Soviet Union
http://users.erols.com/mwhite28/ussrfall.htm
And then there are other active conflicts.
These conflicts are asymmetrical and on different battlefields, but are very real conflict. We are
currently engaged in a worldwide cyber war as technology has expanded in vital security
functions and industries.
Hard to tell if we are winning or losing this war, other than that the government has been
promiscuous with access to important data, enabling Private Manning and Edward Snowden to
compromise just about everything in the National and Military security apparatus by the crudest
of data thefts.
So back to the markets, what does this mean?
The ideal entry point for the “secular bull” market is already a modest intermediate bear market
in percentage terms away, around 1600 on the S&P 500. There are higher entry points, with the
short term level around 1770. There is also a middle ground around the round number of 1700.
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Of course, investments require funding, so a modest overweight to cash and liquid assets is a
tactical move in response to uncertainty. A healthy cash balance penalizes performance until an
opportunity arises, and then the costs of liquidity often become trivial in comparison.
Tops and bottoms usually occur over many months. There are numerous portents, omens almost.
The inception is often seen in one or more major sectors seemingly rotating out of the leadership,
and/or extraordinary froth is a few specific sectors, 3D printing and biotechnology, as well as
popular stocks that attract excessive media attention and offer the opportunity for program and
high frequency trading because of volume, price, spreads and multiple derivatives. When these
stocks start to underperform the broad market, a warning yellow light begins to flash. You may
not own Tesla Motors, Inc. (TSLA, $212.23, 04/04/14), Netflix, Inc. (NFLX, $337.31, 04/04/14),
Facebook, Inc. (FB, $56.75, 04/04/14), and Twitter, Inc. (TWTR, $43.14, 04/04/14), their biotech brethren, or their ilk, but these are the real canaries in the coal mine.
There is often diffuse technical deterioration in individual charts, some start to look strange,
because the negative implications are too terrible to be considered plausible. Often a chart
breaks down and then reverses and make modest new highs, before failing again. This pattern
can repeat for months, we saw that in the last modest correction. This time the rallies seem to be
falling at lower levels. Chevron Corporation (CVX, $118.80, 04/04/14) and International
Business Machines Corporation (IBM, $191.77, 04/04/14) are good charts to watch.
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Also there is the typically a surge in new issues, sometimes centered on a “concept” as opposed
to profitability, the many Software as a service (SAAS) offerings are a good example. Another
is the surge in the sale of companies and properties acquired during “distress” as the various
Business Development Companies, hedge funds, etc. are monetizing their holdings.
The signs of tops are ephemeral, appearing and disappearing as the process builds, until all the
“suckers” are in, on borrowed money, in my experience.
http://www.fool.com/investing/general/2014/03/07/ominous-sign-as-margin-debt-continues-torise.aspx Once the greatest fool has made their purchases, the game of musical chairs stops and
the seating is removed, fast!
Despite the multitude of concerns it is important to note the contrary outcome of the first quarter
as interest rate sectors led the market. The utility index chart is a classic bullish configuration of
major significance. Along with the configuration of the long bond price chart, it seems unlikely
that the course is set to reverse.
The technical signs and internals of the market all suggest extreme caution, if not outright flight
from the more extended sectors. On the other hand, a 4, 5 or 6% yield should eventually result in
better outcomes, particularly in a flat or down trending market.
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Since both the Utility and Real Estate Indexes have emerged from bullish configurations these
are areas to consider.
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These are only guideposts, individual shares have very different patterns; one might look to
accumulate the fertilizer shares on minor pullbacks, versus more significant retracements in
some high flyers.
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One strategy is to run toward trouble, because the bottoms of 2008-2009 can occur elsewhere, in
varying markets. The obvious disaster de jour is in the emerging/developing markets that have
significantly underperformed, as their economies are undergoing considerable strain. No
xenophobia or jingoism here, the failures of Bear Sterns, Lehman Brothers, General Motors,
Fannie and Freddie are pretty good examples of bad economic stewardship, and make the other
matters trivial in size, by comparison. At the height of that debacle, prices were at levels that
may never been seen again.
While it is counterintuitive in the extreme, buying world income, especially higher yield
countries, this is one asset sector that should be considered.
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The equities from these markets offer far more risk, but also far greater return. So high quality
equities in damaged markets are also a specific asset class to accumulate. Might be a good time
to consider reentering Brazil, perhaps with the big banks, like Ita (ITUB, $15.22, 04/04/14) and
Banco Bradesco S.A. (BBD, $14.14, 04/04/14), or the big food company, BRF S.A. (BRFS,
$20.51, 04/04/14), as well as CHINA. (see charts below)
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There are some big patterns in major markets. The tumblers are falling into place. We may soon
discover another “new normal” as the lock turns and the doors open.
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A few G-d forbid orders are also appropriate; you just never know when the ball will land on
your numbers. At these rare and unpredictable junctures, when the markets basically suffer a
nervous breakdown, a Lernerism is apt: “When everything is cheap, buy the best.”
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Disclosures:
Views expressed are the current opinion of the author, but not necessarily those of Raymond James &
Associates. The author’s opinions are subject to change without notice.
Information contained in this report was received from sources believed to be reliable, but accuracy is not
guaranteed. Past performance is not indicative of future results. Investing always involves risk and you may
incur a profit or loss. No investment strategy can guarantee success.
There is no assurance the trends mentioned will continue or that the events discussed will occur. The market
value of securities fluctuates and you may incur a profit or a loss. The performance mentioned does not include
transaction costs which would reduce an investor’s return. This material reflects the opinions of Mr. Lerner and
not necessarily those of Raymond James & Associates. Further information on the investments discussed is
available from Mr. Lerner.
Investors should consider this report as only a single factor in making their investment decision.
Investments and strategies mentioned may not be suitable for all investors.
Commodities are generally considered speculative because of the significant potential for investment loss.
Commodities are volatile investments and should only form a small part of a diversified portfolio. There may be
sharp price fluctuations even during periods when prices overall are rising. International investing involves greater
risks including currency fluctuations, differing, financial accounting standards and possible political and economic
instability. These risks are greater in emerging markets.
Links are being provided for information purposes only. Raymond James is not affiliated with and does not endorse,
authorize, or sponsor any of the listed websites or their respective sponsors. Raymond James is not responsible for
the content of any web site or the collection or use of information regarding any web site’s users and/or members.
Companies engaged in business related to a specific sector are subject to fierce competition and their products and
services may be subject to rapid obsolescence. There are additional risks associated with investing in an individual
sector, including limited diversification.
Investments in the energy sector are not suitable for all investors. Further information regarding these investments is
available from your financial advisor.
The price of gold has been subject to dramatic price movements over short periods of time and may be affected by
elements such as currency devaluations or revaluations, economic conditions within an individual country, trade
imbalances, or trade or currency restrictions between countries. As a result, the market prices of securities of
companies mining or processing gold may also be affected.
There is an inverse relationship between interest rate movements and bond prices. Generally, when interest rates
rise, bond prices fall and when interest rates fall, bond prices rise.
Technical Analysis is a method of evaluating securities by analyzing statistics generated by market activity, such as
past prices and volume. Technical analysts do not attempt to measure a security's intrinsic value, but instead use
charts and other tools to identify patterns that can suggest future activity.
Moving Average (MA) is a widely used indicator in technical analysis that helps smooth out price action by filtering
out the “noise” from random price fluctuations. A moving average (MA) is a trend-following or lagging indicator
because it is based on past prices. Moving Averages are commonly used to identify trend direction and to determine
support and resistance levels.
Dividends are not guaranteed and will fluctuate. Price Earnings Ratio (P/E) is the price of the stock divided by its
earnings per share. Gross Domestic Product (GDP) is the annual market value of all goods and services produced
domestically by the US.
The S&P 500 is an unmanaged index of 500 widely held stocks.
The Dow Jones Industrial Average is an unmanaged index of 30 widely held securities.
The Dow Jones Utility Average Index is a price-weighted average of 15 utility stocks traded in the United States.
The MSCI EAFE (Europe, Australia, Far East) index is an unmanaged index that is generally considered
representative of the international stock market. These international securities involve additional risks such as
currency fluctuations, differing financial accounting standards, and possible political and economic instability.
The Dow Jones U.S. Select Real Estate Securities Total Return Index sm (RESI) is comprised of equity real estate
investment trusts (REITs) and real estate operating companies (REOCs) traded in the U.S.
The MSCI Emerging Markets Index is designed to measure equity market performance in global emerging markets.
The Bombay Stock Exchange Sensitive Index (Sensex) is a cap-weighted index of 30 constituent stocks and is
generally considered representative of the Indian stock market.
The Bovespa Index is a total return index (includes the effect of dividends) and is generally considered the main
indicator of the Brazilian stock market's average performance. The index is comprised of the most liquid stocks
traded on the Sao Paulo Stock Exchange.
Germany's DAX Index is the most commonly cited benchmark for measuring the returns posted by stocks on the
Frankfurt Stock Exchange. The index is comprised of the 30 largest and most liquid issues traded on the exchange.
The Nikkei index is an unmanaged index which is representative of the Japanese stock market.
The Dow-China Broad Market Index, which represents 95% of shares traded on the Shanghai and Shenzhen
exchanges, is constructed by combining the Dow-Shanghai and Dow-Shenzhen indexes.
It is not possible to invest directly in an index.