Crack-Up Booms and Black Swans

By: Bob Hoye | Thu, Jan 29, 2015
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The following is part of Pivotal Events that was published for our subscribers January 22, 2015.


 

Signs of The Times

"Small Business Optimism Index Increased in December, Highest Since 2006"

- NFIB, January 13.

"Why So Many Big Bankruptcies?"

- The Bond Buyer, January 14.

It was reported that 2014 recorded the largest par value for defaults on data back to 2009. That was for municipalities and counties.

"There is still hope for the Fed - in preventing a deflationary spiral."

- INO Trading, January 15.

"U.S. equity markets can now lay claim to being 'not just a cyclical, but in fact is a new secular bull market'."

- National Post, January 17.

"Chinese Stocks Hit By Margin Crackdown"

- Bloomberg, January 19.



Credit Markets

Generally, moves in credit markets lead moves in stock markets. To add emphasis, at a turn to adversity credit markets lead changes in rates administered by the Fed. This is because the senior central bank has never had any control over spreads and the yield curve.

Credit spreads reversed, on schedule, in June and have been heading towards adversity. After correcting, widening resumed a couple of weeks ago and is at new "wides" for the move.

We have been out of spread products since June.

In 2007 and in 2000, widening was accompanied by the equivalent turn in the yield curve. This time around, there has been a gap with the curve still flattening with the boom. Typically, this can run for some 12 to 16 months and then reverse. January is Month 13 on the count.

Volatility in the trend has arrived and we are watching for the reversal.

There is a form of research out there that focuses on the supposed intentions of the Fed and the abilities of corporate management. The above paragraphs say that this view seems removed from reality and is often surprised. It is worth adding that the Fed itself, as well as top corporate management, are often surprised by cyclical change.

Tuesday's "Special" on long-dated treasuries noted speculation has become excessive, which we call "ending action". We have been "in" the long bond since January 2014 and it is time to begin taking money off the table.

At one time the saying was that "gentlemen buy bonds and clip coupons" and as of now it is that "only fools buy bonds". The appropriate adjudication of governments buying bonds will be left to our readers. Of course all the way through has been the observation that "Real men trade the long bond". The ten-year note is for wusses.

These days coupons are hardly worth clipping.

It is very disappointing that the Bank of Canada lowered the administered rate. This is inflationary folly (currency depreciation) that will not improve the economy. It transfers wealth from the average taxpayer to the state and to capable speculators. It has been on for decades and the Swiss may be stepping away from the scam.

For decades these pages have been recommending that the Bank of Canada be wound up and replaced with a currency board. This would keep the Canadian dollar pegged at par with the US dollar. It is rather silly to have a bunch of academics experimenting with impractical theories that rest upon the utter nonsense of a national economy. Especially one that rests upon a political border that's some 4500 miles long that in no way separates the two economies. The US economy is almost ten times bigger than that of Canada's.

Interventionist economists in Canada can move to the States and compete for status there. Or remain armchair quarterbacks at home.


Stock Markets

Our theme remains that Exuberance and Divergences usually seen at cyclical peaks in the stock market have been accomplished. Alerts from sharp increases in Volatility have also been recorded. Corrections have been moderate. The Resolution to the excesses of a financial mania is usually dramatic and is waiting in the wings.

We are patient of time, while central bankers become more frantic in keeping the bubble inflated. Some of the technical excesses have not been seen since 2000 and others since 1987. And then there is the bond bubble which is the biggest and most reckless in all of financial history.

Beyond speculative excesses, the path to Resolution is again being provided by the credit markets. As noted above spreads have been widening since June but the flattening curve is still a positive.

In the meantime, unusually weak commodity prices have been likely to have some respite. This could be brief but it could be positive for the overall stock market.

The NYSE Comp (NYA) continues in its Rounding Top pattern as seen in 2007 and in 2000. A weak start to the year seems in pattern and this rally is testing the 50 and 200-Day moving averages. The key level is at 10800. Above this is possible but resistance at December's 11000 seems formidable.

The European STOXX is in a similar Rounding Top pattern with a weak start to the year. However fairly rapid depreciation in the euro has prompted similar appreciation in the stock index. The shot of financial asset inflation has forced the index above its two key moving averages. It is uncertain how far it may go.

The theory is that central bank depreciation will boost stock and bond prices. Eventually commodities will rise and prosperity will encompass the land. Unfortunately, massive expansion of bureaucratic rules, regulations and confiscatory taxation have been impeding business activity that would accompany the post-crash recovery. Rather than reduce barriers to business, central bankers push harder. Credit supply not needed flows into financial instruments.

If speculation in the long bond peaks, will that add extra buying to the US stock market? European investors are enjoying rises in the STOXX as the euro declines. The equity world is enjoying the rise in the NYSE plus the rise in the dollar.

Interventionist economic theories and practices have become a mad passion, with no means of self-criticism or constraint.

We enjoy questions and one recently was about the violence eventually provoking a "Crack- Up Boom". This is a term from Mises and describes the classic rush to commodities and goods in a massive issuance of currency as in the Weimar Inflation.

Over the past 400 years in the senior economy there has been no example of a "Crack-Up Boom". Instead, history records that a long economic expansion culminated in an era of inflation in tangible assets, a speculative collapse and a long credit contraction. Then it repeats and since the advent of publicly-traded equity markets each era of inflation has included financial bubbles. The first was the South Sea Bubble of 1720.

In the senior economy with the senior currency, Crack-Up Booms have been as rare as Black Swans. Severe financial contractions have had similar paths.

A couple of financial indexes have recorded interesting moves, in response to increasing concerns in credit markets.

In December 2006, the Monthly RSI for the banks (BKX) reached a little over 70, then the index rolled over in September - 9 months later. Banks plunged with the crash into March 2009.

This time around, the Monthly RSI reached a little over 70 in March and set a high in late December at 75.61. The slump to 66 last week took out both the 50 and 200-Day moving averages. This was the low set in December and it provided support. The roll-over is 10 months after the momentum high.

Action in Broker-Dealers (XBD) is similar but with the Monthly RSI soaring to 80 on the same dates. The index high was 187 in late December and it has rolled over. The decline found support at 163 which was at the 200-Day ma.


Commodities

Crude oil continues to stabilize, which "pause" could last for a few weeks. Copper's plunge had reached our objective and could, also, stabilize. The extreme low was 2.42 and it has bounced to 2.63. Sideways could run for a week or so.

Cotton enjoyed a rally with our "Rotation" expectation in December 2013 and made it to 97.35 and an overbought in the spring. It slumped to 58.53 in November and bounced to 62.84 in December. Today's 57.61 sets a new low for the move. The bull market high was 219 set with many commodities in 2011.

Withstanding the commodity decline following 2011, lumber rallied from 223 in 2011 to 411 in early 2013. It has since set a sideways wedge. This week it broke to the downside turning the pattern into a bear. As Ross says "Trees don't grow to the sky". Whatever, lumber is essentially a North American market and it does not augur well for the housing industry. The trend is down.

Of technical interest, a similar wedge prevailed from 2010 to 2012 and the resolution was to the upside.

Base metals and agriculturals have been stabilizing, but could resume the downtrend later in the year.


Precious Metals

The Precious Metals sector has been acting well. Gold stocks have been rising relative to the bullion price and silver has been outperforming gold.

The former started in mid-November, was tested in mid-December and at the first of the year rose above the 50-Day ma. This is constructive and it is now up to the 200-Day.

The silver/gold ratio set its low at .129 in mid-December and has recovered to above the 50- Day. This is constructive and has further to go.

Gold stocks (GDXJ) set their low at 21.24 in mid-December and have rallied to 30.74. This is through the 50-Day and as this level represents resistance it could take a rest.

What is impressive is that gold's price in dollars has been rising with rallies in the dollar. We have long thought that this was possible at some point, but in a post-bubble contraction. Stocks and treasuries are booming but there is a sense of deflation in the air. Fascinating while it lasts.

In the meantime gold's real price (relative to commodities) reached a new high for the move. The low was set in June and we have been convinced that that was the start of a cyclical bull market for the price relative to the cost of mining. This will enhance mining profitability as well as valuations for gold deposits.

The bottoming process for gold stocks is setting up a cyclical bull market.


Consumer Sentiment

University of Michigan Consumer Sentiment

 


Link to January 23rd Bob Hoye interview on TalkDigitalNetwork.com: http://talkdigitalnetwork.com/2015/01/lower-bank-of-canada-rate-hammers-loonie

 


 

Bob Hoye

Author: Bob Hoye

Bob Hoye
Institutional Advisors

Bob Hoye

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