The Bubble Run Dream and Danger Mike Swanson (06/19/2016) ...the stock market bubble bull missed out on gold and the mining stocks

Transcription

1 The Bubble Run Dream and Danger Mike Swanson (06/19/2016) This is a chart of the CAPE ratio for the S&P 500 going back to before The CAPE ratio is the 10 year annualized P/E ratio for the S&P 500 adjusted for inflation. It shows that the stock market is overvalued and has only gotten to a higher valuation level three times before where it is now. Those times were in 2007, 2000, and I have talked about this ratio many times in the past and how to use it to also look for countries that are at cheap valuation levels. Russia and Greece for instance have historically low CAPE ratios. I haven t really talked about it in awhile, but I want to bring it up today, because a lot of stock market bubble bulls would get angry at me when I have used it to warn of the risks in the stock market. Their argument is that valuations do not matter and that one giant stock market bubble run will come just like it did in They...the stock market bubble bull missed out on gold and the mining stocks STAGE ANALYSIS OF KEY MARKETS S&P 500 Long-term: Stage Four Bear Market Short-term: Drifting Summer Top Let People Buy At High Prices They Love to Buy At Gold Long-term: Stage Two Bull Market Begins Short-term: Not much of a gold stock pause happening yet. DBA ETF Long-term: Stage Two Begins Short-term: DBA reaches escape velocity

2 say that this is not a great timing indicator. I agree with that in the sense that it does not predict what will happen in the next twelve months, but it is very useful for seeing if a market is cheap from an investment stand point or not and so can be used to help you understand the big picture. But bubble bulls do not want to think about market cycles or valuations in any meaningful way, because they want to always think that the stock market will go up for them. There are all sorts of stock market bubble bulls and so there are all sorts of motivations for their need to believe that the market will always go up. Some of them are investment advisors that manage other people s money and fear that if they sell out and reduce risks and the market were to keep going up without them then their clients would get angry and go somewhere else. And this is a really real fear and a legitimate one. So it s easier for the investment advisor to simply rationalize holding forever and look for any argument to justify it and for arguments that dismiss any talk of an overvalued stock market. Other bubble bulls frankly are simply lazy. Instead of researching stocks and finding new ideas they rather just watch TV and hear CNBC people tell them that the stock market will go up or read experts who tell them what they want to hear. But there is a new theme that is getting popular with these stock market bubble bulls who are looking for one more big bubble run in the stock market that I want to talk about. That theme is that money is going to come out of overseas stock markets from around the world as the European markets fall or China falls or things get bad. They believe people all over the world will then pile into the US stock market as a safe haven and will be willing to pay any price to do so. They believe that such people will create one final bubble run that will enable stock market small fries not making any money now to finally make some money. There are two problems with this idea. First of all there is absolutely no evidence for this. In fact the facts say the opposite. The European markets have been weakening the past few months and of course China has been in a horrible bear market for a year now and instead of putting money into the US stock market these foreign investors have been taking money out of it! According to an article in the Wall Street Journal this week: Foreigners are selling U.S. equities at a record pace, and that s calling into question one of the key supports for the yearslong bull market in stocks. 2

3 3 Overseas investors sold $128 billion worth of U.S. equities in the past 12 months, suggesting they re losing their taste for American shares, according to Deutsche Bank chief international economist Torsten Slok. What are they doing? For one thing they are simply piling into US Treasury bonds instead of overvalued US stocks with lackluster earnings for safety and, because they are going up! The article continues: At the same time, they re piling into U.S. corporate bonds and other fixed-income assets in a bid to get yields that are higher than the negative rates in Europe and Japan, he said. Even the market for U.S. Treasurys saw record foreign demand at auctions last week. Many on Wall Street have argued that falling yields around the world would push investors out of safe investments and into riskier stocks, supporting the current rally. But the sale of U.S. equities calls that theory into question. It is something of a criticism of lackluster U.S. economic growth and inflation that has steadily remained below the Fed s 2% annual target, Mr. Slok said. Instead, foreign investors are choosing safe investments and the promise of steady coupons. And of course Chinese investors have been piling into gold and starting to get into other commodities. It s isn t small fry Ameritraders that have been piling into gold and mining stocks, but huge investors like George Soros and people in China. So the stock market bubble bull is wrong again and this is why the person who has been sitting there for the past two years fully invested in the US stock market is making no money. Their hope and dream is that a bubble bull run in the stock market will start and change that situation, but it won t. However, they may be right in the notion that a bubble run is coming and if it does it won t be a dream come true, but a horrible danger for everyone. But they do not care, because they do not care about the country as a whole. All they care about is the possibility of getting paper rich by doing no work in another bubble even if the following bull burst ruins everything. They do not care about what it could mean to their children or grandchildren. They are simply addicted to holding stocks. Over the past 20 years we have indeed seen several bubble runs and two cyclical stock market bull markets. So it s easy for people to think another bubble run can come. The problem is that such a parabolic bubble rally if it happens won t be in the US stock market, but in something else. Bubbles don t just happen in stocks. Yes in 1999 we saw an internet stock bubble, but in the bull market after that there wasn t another big bubble run like that when the market topped out in There was a bubble during that bull market, but it happened in real estate prices across the country and not in the stock market.

4 4 Of course when that real estate bubble collapsed like the internet bubble did in 1999 it was a total disaster for the stock market, the economy, and even the entire country as a whole. During that bull market there also was a huge bubble run in oil prices that was part of an overall bull market in commodities that started in Gold, silver, and mining stocks went up during those years, but they did not have a climatic parabolic bubble run. Oil prices though did. The price of oil went up for a few months like internet stocks did from November 1999 to March of Bubble runs tend to just last 3-6 months in a climatic straight up parabolic move. Bubble runs have been frequent in the past 20 years, because they have been fueled by super low interest rates and money printing central banking policies, but only one of them was in the stock market. Another bubble run took place in silver prices in 2011 when they more than doubled in just a few months. That bubble run was associated with a bull market in gold and mining stocks. However while the silver prices doubled in those months mining stocks hardly went up at all. David Skarica, Jordan Roy-Byrne, and myself all made note of this at the time and remarked on how it was a huge warning sign of some sort of top being made in the precious metals arena. None of us thought gold and mining stocks were going to fall as far or for as long as they did, but we all saw 2011 as a scary time to invest in mining stocks, because of what silver was doing. You see when a bubble run happens it is usually just focused on one thing and not the entire stock market at all, but just one segment of the financial world. But they do often follow with devastating bear market and are a warning of misguided Federal Reserve policies and just economic instability overall.

5 5 So right now there is absolutely no evidence of a bubble run coming in the US stock market. However, I am watching very closely now for a potential bubble run to appear in the global government bond market. We are seeing the lowest interest rates in all of human history. People are buying government bonds with negative yields on them. So people are buying bonds from the government and paying the government to buy them. Why? Well when you buy bonds and interest rates fall they go up in value. When rates go up the bonds go down. So the buyers of these bonds are simply betting that the bonds will go up more and interest rates will turn even more negative. German and Japanese bonds now have negative yields. I pointed out how insane this was too to months ago, but the bonds have continued to go up anyway. So the buyers of the bonds back a few months ago have been right on their bets. It makes no economic sense, just as buying internet stocks as an investment made no rational sense from a valuation standpoint in 1999, but made sense from a pure momentum trading standpoint. Until the momentum ends. At the end of last year I also pointed out how a huge bubble had formed in the junk bond market around the end of 2012 that helped make the stock market go up. What happened is that corporate America took advantage of the low rates to borrow money in order to buy back their shares. Some of these companies bought back more shares than they even made in income for several years in a row and have totally destroyed their balance sheets. Over the course of the year there has been huge insider selling in many of these stocks and these are the type of stocks I am short and

6 6 looking to for short sell candidates. I got a few ideas later in this update. Now the junk bond market appears to have topped out back in If you want a reason for why the stock market has not gone anywhere for over a year this is one of the reasons along with high valuations and falling earnings. Junk bonds go up in value when interest rates fall so a real bear market in junk bonds would be devastating for most stocks, because it would mean rising costs to finance their debts. However, although junk bonds appear to have topped out two years ago government bonds have not. The second chart on this page is of the 30-year US Treasury bond. It has been in a bull market now since the early 1980 s and just made a new high last week. The chart below is of the yield for the 30-year US treasury. You can see that it closed last week at 2.43%. So you can lend money to the government at 2.43% for 30- years. Who in the world would want to do that? Well someone who thinks that the bonds will keep going up and that they can profit that way or someone who feels like they must take money out of riskier assets and put them into something they know they will at least get paid on.

7 I believe that the craziness in bond prices are the fundamental reason why gold prices have begun a new bull market this year. The stats also show that the Chinese have been selling US Treasury bonds. So they obviously are people who are selling bonds and buying gold. But the buying into bonds has been increasing enough that their selling has not mattered. I expect as time goes on more and more people will start to think like they are, even if that moment has not come yet. I am not interested in buying bonds hoping they will go up more, because I am happy with the way I am positioned already, however I am now watching them very closely for the possibility that they will enter a final parabolic bubble run like oil did in 2008 and silver did in There is a possibility that they will spike up crazy and top before this year is over. Giant bull markets often do end in bubble tops and the bond bear market has been going on now for over 30 years and has reached historic dimensions. CNBC people talk like it all makes sense and is fine, but that is what they said about internet stocks in 1999 too. I am watching TLT, which tracks the 20-year Treasury Bond make a new high last week, and wondering if it might not be starting a months long rally that will be a parabolic bubble run. If it happens TLT will go up another 20% in the next days and the 10-year Treasury bond yield will fall to less than a percent. 7

8 I am not predicting this, but keeping my eye on the possibility. TLT is now overbought and should top out and fall. CNBC says the economy is fine so TLT should not keep going up, but if it breaks here and just keeps going up for several weeks a parabolic climatic rally is likely to happen. Parabolic bubble runs mark the end of bull markets. Stock market bubble bulls are mistaken in thinking that all bull markets end that way, but are right to realize that they do happen. It is just they are not looking at the right place for this possibility to occur this year. Of course a parabolic run for bonds would likely be driven by investors not only chasing the trade but running into them for safety after selling stocks. That could be caused by a crash in European banks, turmoil in Japanese and Chinese stock markets, or the American junk bond market. I have been thinking and still do that a scary drop is likely to hit the US stock market after the next earnings season, really most likely sometime after the July Fed meeting and the Facebook earnings date as the latter has marked the end of market rallies or start of weakness in three of the last four earnings periods. Or it could be the simple realization that the Federal Reserve is so scared of causing a stock market crash after what happened last August and this January that they are now incapable of ever raising interest rates again. That was the message last week when the Federal Reserve FOMC statement suggested that an interest rate hike in July was now totally off the table when six weeks ago Janet Yellen suggested that she badly wanted a July hike to have ammo to lower rates in the future. Not only that, but her press conference afterwards and the tone of the Fed statement showed that only one rate hike by the end of the year is possible now. On Thursday morning St. Louis Federal Reserve governor Jim Bullard got on CNBC and said that they now only needed to raise rates ONCE from now till the end of 2018! Not much really happened in the stock market last week, but it has been a remarkable week nonetheless. Just six months ago the Federal Reserve was predicting four rate hikes for 2016 and an economic lift-off that would make it possible. All of this talk is out the window in an about face change in monetary policy all as a result of a little stock market dip in January and falling markets overseas. All of these events this year has provided the backdrop for the new gold bull market and the moves into other soft commodities and ETF s such as DBA, which I own, but a parabolic Treasury bond rally might be next. If it happens it will end in a climatic top that will spark the end of the 30-year bond bull market. It would also cause the Federal Reserve to totally lose control of the bond market and interest rates. It would 8

9 9 mean the end of any successful Fed manipulation. A total disaster in the stock market over the next few years, a falling dollar, and even more explosive gains in gold would be the result. So yes we have to keep our eyes on TLT to see what happens. If we do see a parabolic bubble run in TLT and Treasury bonds I am likely to find a way to make bets against bonds later this year and will let you know if I do and how I do it. Now none of this is anything to be afraid of if you are well diversified. Right now I have no need to change my core positions. In the model rebalancing portfolio I am 20% long each in DBA, GDX, and CEF, which owns both gold and silver and short via SDS and DXD. I am positioned roughly like this in all of my investment accounts too, with some individual stock and ETF positions in my main account around these core positions. I go over my model rebalancing system and how it works and provides for diversification in one of the modules of the Gold Traders Toolkit Course: Gold is in a bull market. Focus on that on the long side. DBA has achieved escape velocity from its 200-day day moving average too and now other commodities are starting to breakout. It looks to me like JO, which is an ETF that tracks coffee, is in a good position now to make a nice big move up next. It has broken through its $20 resistance level and its upper 200-day Bollinger Band to complete a state one basing phase. It is now pausing though with resistance at $22 to provide for an entry point. Once it goes through that though I expect it to just run away. As for the S&P 500 it still remains in a short-term topping formation like it went through last year from May through July and October through December. The risks are now fully to the downside, although I am not sure what it will do this week. Sometimes things are clear on the short-term and other times they are not. We have seen weakness in the

10 past few days that has come AFTER dovish Fed news, which is really bad. However we also have the big BREXIT vote on Thursday that is being talked about non-stop on TV so that could be a sell the news buy the rumor type deal. Whatever the case, the S&P 500 seems to me like it is slowly dropping down to support in the 2000 level over the course of the next few weeks, with the Nasdaq and Russell 2000 falling more on a percentage basis. If it does that I d look for a pause or bounce from there into earnings season after which the real drop begins. I watched CNBC for a few hours last week and Jim Cramer and the Downtown Josh Brown character are both calling for huge rallies and telling people to buy stocks into weakness. Cramer yelled at people to buy Chipolte Thursday night ignoring the fact that insiders are now dumping big time and the stock made a new low. It s a disaster, but stock market small fries love such gamble plays. One thing worth noting is that volume has been light in the market the past few weeks except on Friday in which there was a lot of volume hitting stocks on the sell side. Apple had a lot of selling volume. It s in the charts of note. As for gold stocks they are now so bullish they are even surprising me. I was looking for a pause this month and next in gold stocks and in gold, but the stocks have already made a new high for the year and gold is now flirting with the $1,300 level. If gold were to somehow pullback down to the $1,220 - $1,250 area the gold stocks have acted so strong that GDX would be lucky if it were to fall to the $23-24 area. It is riding up its 50-day moving average and upper 200-day Bollinger Band and is likely to just keep doing this all year. That s what happens during a stairway to heaven style rally in a sector or financial market like we saw gold stocks do in 2009 and the stock market do that year and in So what do you do when the very short-term trend is tricky to call right now? Well I simply use my core ETF positioning strategy so that daily moves don t really matter that much. I also at this point simply look at stocks to go long and bet against by looking at their own individual chart patterns and fundamentals instead of worrying about what everything else is doing. 10

11 So with mining stocks I bought private placements in Meadow Bay (Vancouver: MAY) and IDM Mining (Vancouver: IDM) this year and am looking do that in a few more this summer. I will let you know when I find one. I also am long JO and short several stocks, but most of those I shorted months ago and are well below I bet against them at and I look every week for new ideas. The credit card stocks look like a good sector to bet against right now as they have been among the absolute worst sectors during the entire market rally. AXP has been the best of the bunch since it is in the DOW along with V, but COF, MA, PYPL, SLM, HAWK and SYF are all stocks in the sector displaying weak relative strength against the stock market. I like AXP as a short here with a stop loss above its 200-day moving average of $ AXP has been one of the buyback stocks as the company did $3.4 billion in buybacks in 2015, and over $3.2 billion in the two preceding years. It has not gone as deep into debt as other companies have to do the buybacks, but it is still trading at a nice high historical valuation and now lagging the stock market. Insiders also have liquidated over 44% of their own holdings in the past six months so they seem to think it is a good time to get out. CEO Kenneth Chenault for one sold over $90 million dollars worth of his own shares of AXP last month alone. He is also a director of IBM and a member of the Council for Foreign Relations so he is treated as a corporate god whenever he is on CNBC. I would not continue to hold this stock if I owned it if the CEO is dumping like this. We have already seen what that has meant with stocks like Apple and Dunkin Donuts. Stock buybacks pumped stocks up and provoked stock market small fries into chasing and buying, but the small fries never get out even when the insiders dump even when it s pointed out to them. I don t know why small fries can t sell, but you can t blame insiders for getting out. Anyway here are some charts of note this week on the following pages. 11

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14 14 MODEL REBALANCING ETF PORTFOLIO ALLOCATION The goal of this portfolio is to have five have core positions with no more than 20% invested in each one that together provide an investment allocation with a low intra-portfolio matrix. This makes it so that when one ETF goes down another can go up overtime. Traditionally people do this with using US stocks and Treasury bonds, but in the long-run a mix of more diversified assets can generate superior investment returns and if one day stocks and T-bills go down together then it will be a necessity. To make the strategy work one must also rebalance the positions to maintain the fixed allocation percentages. Rebalancing also boosts returns overtime and lowers the overall volatility of the account. To make this work monthly or weekly rebalancing is best. For more on how this strategy works read my January monthly newsletter from Also see module 7 of my Bear Market Power Pack for several videos and academic papers about this market strategy: Right now my recommended mix of ETF s is the following: 20% - SDS: Ultra Short 2X S&P % - DXD: Ultra Short 2X Dow-30 20% - CEF: Fund that invests in gold and silver 20% - GDX: Fund that invests in mining stocks 20% - DBA: Fund that invests in agriculture commodities. This generates an intra-portfolio correlation of A 50% in TLT and 50% in SPY currently generates a correlation of 0.29.You can use your own ETF s or funds to play with correlations by going to this website: A correlation of 1.00 would mean that everything in a portfolio is trading together. With these positions at this moment I do not expect DBA to go up over the next few weeks. It may be pushed down with the stock market before it breaks out. I have core positions in my trading and investment accounts roughly invested like this. If you want an alternative to DBA you may want to consider SJB, which trades opposite to junk bonds.

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