Tuesday, March 28, 2017

Book Review: Mind, Money & Markets

Most books in the financial genre tend to be, quite frankly, boring.  Books on the subject of stock market speculation are prime culprits of this tendency toward the tedious.  Every now and then, though, a book appears which breaks out of this mold and is truly as entertaining as it is educational.  Such is the case with Dave Harder and Dr. Janice Dorn’s recent book, Mind, Money & Markets.

The fruit of their collaboration is a useful guide for investors, traders, and business people and is rich in examples of how psychology influences markets.  Dr. Dorn is imminently qualified to address this subject as she is a Board certified psychiatrist as well as a long-time investor and investment writer.  Mr. Harder also brings long experience as an investment adviser and is currently vice president and portfolio manager with Canada’s largest financial firm.  The decades of experience between them provides the reader with a far deeper insight into investor psychology than is available in most works on the subject.


I personally found Mind, Money & Markets to be an engaging and insightful read.  At over 400 pages, there’s a lot of info to digest but the writing is smooth and the chapters seemed to fly by.  The book is richly illuminated with many colorful charts and illustrations and is lively with many accounts of how psychology influenced the financial market debacles from the distant pass to the present. 

Chapter 6 affords the reader with an in-depth discussion of market trends and momentum and is alone worth the price of the book.  There are also chapters dealing with the cycle of investor emotions, emotional management, identifying market tops and bottoms, and portfolio management.  Chapter 28 entitled, “It Is Time for a Revolutionary Change in Portfolio Management”, is also worth the price of admission.  


I heartily commend Mind, Money & Markets as a worthy addition to every trader/investor’s library.  The book is available from Amazon.com or click here.

Saturday, March 25, 2017

What Obamacare’s failure means for America

The first legislative setback of the Trump Administration is being celebrated by many, but not by middle class taxpayers and business owners.  A Republican-led Congress last week failed to generate the consensus required to overturn key provisions of the Affordable Care Act (ACA).  In a frank admission of defeat, House Speaker Paul Ryan declared that Obamacare would remain "the law of the land." 

The stock market wasn't too thrilled about it, either, although there wasn't a concerted selling effort on the part of the bears.  The major indices were down for the week, but the tech sector continued to show resilience with semiconductors in the leadership position.  There was a suggestion in the press last week that the stock market "couldn't care less" about Obamacare, and perhaps that's true.  But there's one thing that will be seriously impacted by the lack of Obamacare reform and that's the middle class economy.

Performing a postmortem of a failed political reform effort is seldom a gratifying task, but in this case there are a couple of things that need to be addressed.  From the start, the mainstream press tried to control the debate by constantly reminding everyone of the 24 million Americans who stood to lose coverage should Obamacare be repealed.  Never mind that is only about eight percent of the entire U.S. population, hence an extreme minority.  In a representative-style democracy such as ours, public policy is supposed to benefit the majority -- not the minority at the expense of the majority. 

What too many pundits have failed to consider in their treatment of the Obamacare debate is that the legislation which mandates health insurance for Americans is at root a personal liberty issue.  It's not about providing free (or cheap) coverage for the needy or the underinsured.  The main issue, which seemed to escape most commentators, is that Obamacare is a form of redistributive economics: socialism in its essence.  Obamacare represents the government putting the proverbial gun to the individual's head and saying, "You will buy health care whether you need it or not...or else!" 

I found it shocking that Obamacare was passed in the first place with little of the impassioned protest among individuals which characterized the first attempt at establishing socialized medicine in America (in 1993).  Even more surprising was the limp-wristed effort with which the current Congress failed to address the underlying problem with Obamacare, viz. the individual mandate.  An easy solution to the Obamacare reform debate would have been to simply eliminate the individual mandate and leave everything else intact.  This would have highlighted the single biggest problem with the legislation while avoiding direct confrontation from those who insisted that Obamacare not be entirely repealed.

Aside from personal liberty considerations, the other main consequence of leaving Obamacare intact is that it does nothing to alleviate the problems faced by individuals and small business owners who are forced to shoulder the burden of expensive healthcare coverage or else pay a hefty penalty.  One of the big reasons why the current economic recovery since 2009 has been the slowest on record is because of the exorbitant tax and regulatory burden imposed by Washington in the wake of the credit collapse.  Rather than remit taxes, the tried-and-true palliative for getting out of recession, the Washington establishment did the exact opposite.  No wonder then that Middle America has struggled to restore its financial condition ever since the housing bust laid waste to it some 10 years ago.  

If you want to see just how the middle class business economy is doing right now, take a look at the following graph.  It combines the stock prices of some of the leading U.S. publicly traded companies which cater primarily to the average American.  As you can see, it's hardly a picture of health and prosperity. 


Had Congress signaled its sympathy with middle class struggles by remitting the Obamacare taxes, there would almost certainly have been a strong consumer spending boom in its wake.  Lowering taxes always has a stimulative effect, and there's no better way to facilitate economic health than to make it easier for individuals and businesses to spend more of their hard-earned dollars into the economy than by letting them keep more of it.  Failure to lift the burden imposed by Obamacare means that the millstone remains tied firmly around the necks of millions of Americans.  It also means the economy won't be returning to a vigorous state anytime soon.

The failure of the Obamacare reform attempt also paves the way for the continued dominance of financial engineering in steering the economy.  Congress let slip an opportunity to regain the control over the economy that it surrendered to Wall Street and the Federal Reserve in the wake of the credit crash.  Instead of economic healing via fiscal stimulus and tax remittance, the economy will for now continue to be dominated by financial sector and central bank policy.  Any economic improvement from here will likely be due to the trickle-down effect of a rising stock market.  The direct stimulating effect of Congressional tax policy would have been far preferable.  

While the tone of this article might be construed as fatalistic, by no means should it be assumed that the die is cast.  There's still a chance, however remote, that the Congress will come to its senses in time to at least address some aspects of tax reform before the 2018 mid-term election.  By failing to seriously address one of the leading issues facing the middle class economy, however, Congress has telegraphed the message that it lacks sympathy with the majority of U.S. taxpayers.    An overnight change in this attitude would seem unlikely.

Tuesday, March 14, 2017

What’s preventing the Dow from exploding?

The stock market has once again entered a period of consolidation as investors wait for the results of the most important legislative decision of the year.  The fight to repeal and replace Obamacare has taken the spotlight as Congress debates the passage of legislation that would eliminate its most burdensome aspects for businesses and individual taxpayers alike.

Internally, the NYSE broad market has been unsettled for the last several days after a period of relative calm in the months following the U.S. presidential election.  There have been more than 40 stocks making new 52-week lows on a daily basis since last week.  This makes almost two weeks that the number of daily new lows has exceeded 40, which reflects an increase in internal selling pressure.  Most of that selling pressure is coming from consumer/retail stocks, bond funds and, increasingly, energy stocks. 

The extremity of internal selling pressure isn’t yet great enough to cause any major concerns about the strength of the stock market’s intermediate-term uptrend.  If the new lows don’t soon diminish, however, it could eventually cause problems for the interim trend as internal weakness spreads from the above mentioned sectors to the broader market.

Following is a graph of the daily cumulative NYSE new highs-new lows.  It’s telling that for the first time since the Nov. 9 election, the highs-lows have stalled out.  And while the trend is still technically up for the highs-lows, that trend could be broken if the new lows continue to expand in the next couple of weeks.


It’s clear that the honeymoon phase of President Trump’s election is over as investors aren’t giving a free ride to the stock market until he delivers on some of his campaign promises.  The most critical of these promises concerns the proposed overhaul of the Patient Protection and Affordable Care Act (a.k.a. Obamacare).  The mainstream news media are in full swing right now with negative stories which undermine the Congress’ effort at eliminating the onerous taxes surrounding Obamacare.  The tantalizing prospect of having the bill’s individual and employer mandates (which forces individuals to purchase health care or else pay a steep penalty) repealed is one big reason why the middle class turned out in droves to elect Trump. 

Now it’s time for the Republican-controlled Congress to “spit or get off the pot” as the saying goes.  Congress has an excellent chance to relieve a massive tax burden on individuals and small business owners by approving the proposed repeal of the Obamacare mandates.  Unfortunately, there is now a concerted effort underway within Congress designed at undermining the proposed overhaul.  It can’t be emphasized enough that the repeal of the Obamacare taxes would be of tremendous benefit for the economy by relieving the stress created by years of burdensome taxation.  That pent-up energy would likely express itself through a massive rally in the Dow and major averages, which have been tethered by the uncertainty surrounding the Obamacare reform debate in Congress. 

A repeal of the individual and employer mandates would also likely result in a hiring spree by small business and would give the stock market the euphoric burst of investor confidence needed to achieve heights undreamed of by even the most optimistic bulls.  This in turn would stimulate even more business activity due to the stimulative effect of America’s financially-driven economy.  

It’s sobering to think that how the rest of 2017 turns out for investors and wage earners alike might very well rest in the hands of Congress even as we speak.  All we can do now is pray for the best outcome and hope the Congress is able to deliver what would be the most extraordinary gift that Washington could possibly give the American taxpayers.   

Thursday, February 23, 2017

Another bubble? Bring it on!

Anytime the Dow makes a new high you can be reasonably assured of hearing the B-word bounced around in the media.  Memories of the last bubble are still vivid and painful enough to trigger flashbacks of the bubble’s collapse.  It’s only natural then that investors fear a return of irrational exuberance.  Despite these fears, the evidence of a newly formed bubble is surprisingly lacking, as we’ll uncover here.

Asset manager Jeremy Grantham famously defined a bubble as any asset whose price has moved at least two standard deviations above its longer-term statistical mean, or norm.  This definition is too rigid, however, and can sometimes be misapplied to see bubbles where none actually exist.  Markets can sometimes exceed the 2 standard deviation rule in non-bubble environments, as when the utilities sector last year experienced a 3 standard deviation event. 

This definition also is overly reliant on statistics and is lacking in the psychology department.  Investor psychology, after all, is a primary driving force of the pricing mechanism in all free markets.  What Grantham’s 2 standard deviation event rule fails to consider is that if a market experiences a record-breaking and sustained run-up, it can sometimes occur without widespread participation by small traders and investors.  And without large scale participation among retail traders the psychology of a bubble is lacking, i.e. there is no bubble.

The latest rally in the major stock market averages has once again fueled talk of a mania for equities in the popular press.  As discussed in previous commentaries, though, there is as yet no evidence of widespread direct participation in the equity market by small investors.  Much of the movement behind the rally to new highs is courtesy of institutional activity, with the public participating only indirectly via retirement savings funds.  Nowhere to be seen is the incessant preoccupation with day trading, swing trading and stock picking which were symptoms of the last two bubbles. 

One explanation for this startling lack of bubble psychology despite the all-time highs in stock prices is the K-wave.  Readers of this commentary should be familiar with this most basic of all long-term economic cycles, which answers roughly to the 60-year equity market cycle.  The K-wave deflationary descent bottomed in 2014 based on the Kress cycle count.  K-waves are often divided into four sections or “seasons” with each section being assigned a season of the year (e.g. winter, spring, summer, fall).  The following graph was devised many years ago by P.Q. Wall and does an admirable job of describing the K-wave seasons.
                                                                                                                            

If we assume that K-wave winter season ended in 2014, we’re now in the early phase of K-wave spring.  Early spring can easily be confused with winter due to the occasional freeze or snow storm that sometimes happens during the transition period between the two seasons.  But as the season progresses the signs of new life and warmth that always accompany spring gradually become more evident.  In that same vein, the last couple of years might easily have been confused with winter due to periodic outbursts of deflation in the global economy.  Yet we’re starting to see unmistakable signs that K-wave spring has truly sprung, even in the weakest performing foreign markets. 

To take one example, China’s stock market is starting to show renewed signs of life after being in a bear market the last two years.  China has also recently begun trying to increase its economic growth by providnig plenty of credit.  As Dr. Ed Yardeni has observed, “During January, total ‘social financing’ rose by a record $542.3 billion.  That’s not on a y/y basis, but rather on a m/m basis!  On a y/y basis, social financing totaled $2.7 trillion over the past 12 months through January.  Bank loans, which are included in social financing, rose $335.7 billion during January m/m and $1.8 trillion over the past 12 months.”

The emerging markets have experienced a similar rebound along with several euro zone markets.  As the U.S. leads the rest of the world out of global recession, there can be no denying that the K-wave is beginning to work its spring-time magic.

The aggressive policy stance by China’s central bank has led to worries that China’s real estate and stock markets may soon experience another bubble.  This in turn has added to fears that the U.S. will soon experience another bubble event in the stock market.  This need not concern us, however, since painful memories of the credit crisis are still strong enough among central bankers to prevent a bubble from forming, let alone get out of control.  Even China’s last taste of an equity market bubble ended prematurely when frightened policy makers quickly tightened money and credit in fear of the consequences. 

Now let’s assume for a minute, though, that a bubble was allowed to form in the U.S. equity market this year.  Would this be such a bad thing?  Considering that the biggest advances in technological progress and development, to say nothing of widespread prosperity, have occurred during bubbles it’s easy to answer that question in the negative.  While the naysayers focus on the negative aspects of a bubble’s implosion they neglect to mention that even after the inevitable popping, society is still immeasurably better off than before the bubble began.  Indeed, a bubble might be just what is needed to put the U.S. economy back on the right track for vigorous growth.   

It should be added that when it comes to economic policy, it’s always best to err on the side of too much growth than on too much austerity.  The events in Europe of recent years serve as a stark reminder of this fact.  Thus whenever fears of a bubble are discussed, it would do policy makers well to consider that the benefits of a loose monetary policy always outweigh that of a tight one. 

Probably the biggest argument used by the bubblemongers right now is the chart of the NASDAQ 100 Index (NDX).  This chart can easily be used to justify the fear of an incipient bubble, yet the investor psychology and mass participation factors are curiously missing right now. 


Before we arrive at the bubble stage, we should see increased interest bordering on obsession among small investors as the stock market becomes a primary focus among the masses.  As this hasn’t yet happened, the inescapable conclusion is that the long-term bull market hasn’t reached bubble proportions yet and therefore has a ways to go before expiring.    

Tuesday, February 14, 2017

The bull market no one believes in

The stock market continues to make new highs, yet none of the signs which accompany a market bubble are evident.  Investors are asking, “When will the Dow finally correct?”  By “correct” they mean “decline.”  However, a market correction doesn’t always entail a decline for the major averages and can sometimes take the form of a lateral consolidation or trading range.  That appears to be the case for the 2-month period from December through early February when the Dow and S&P made little headway.

In fact, in January the Dow Jones Industrial Average (DJI) recorded its tightest trading range of only 1.1% in over 100 years.  This continues a prolonged sideways pattern in the Dow and other averages since mid-December when the post-election rally reached a plateau.  The question everyone was asking was whether this plateau was merely a temporary “pause that refreshes” in an ongoing rally or the end of the rally and the prelude to another market setback.  The Dow provided the answer to that with the last week’s breakout above the top of the trading range ceiling.  It has rallied each day since, putatively on the hopes generated by President Trump’s forthcoming tax-related announcement.


While the bull market in equities continues, a surprising number of investors are either mistrustful of the rally or outright bearish.  According to a recent article in BBC News, there are a growing number of wealthy and politically liberal U.S. citizens who are doing things in the wake of Donald Trump’s election that were commonly seen by politically conservative citizens during the Obama years.  That is, they are buying guns, becoming survivalists, and preparing for an impending catastrophe related to the Trump presidency, the article reported. 

It was also reported that a number of wealthy Americans are preparing for what they believe is the apocalypse.  According to Business Insider, some have purchased underground bunkers while other wealthy individuals are planning to emigrate to New Zealand.  “Saying you’re ‘buying a house in New Zealand’ is kind of a wink, wink, say no more,” said Steve Huffman, CEO of the Reddit web site.  “Once you’ve done the Masonic handshake, they’ll be, like, ‘Oh, you know, I have a broker who sells old ICBM silos, and they’re nuclear hardened, and they kind of look like they would be interesting to live in.” 

The common denominator in these accounts is fear among the upper class.  The dread of an uncertain future which was pervasive among America’s middle class for much of the last eight years has now been transferred to the upper class.  While it might be premature to ascribe this to the recent rush back into gold, bond funds and other safe-haven investments, it would seem that there is just enough uncertainty among the upper crust to account for the lack of movement in the major stock market indices since December. 

Tight, narrow trading ranges in the major indices are launching pads for major moves in either direction.  In the context of a bull market, they typically represent rest and consolidation before the next move higher.  The odds technically favored this outcome, yet a substantial number of investors still don’t believe in the strength of the bull market.  This is reflected in the manifestations of fear among the upper class mentioned above, as well as in the path the market rally is taking. 

There is talk among some observers that the market is undergoing a “melt-up”.  This is an erroneous application of that term.  A classic melt-up is characterized by a runaway, almost straight-up and sustained market rally on high volume with widespread participation.  The trajectory of the major indices since November can hardly be described as “melting up.”  Rather, the market’s path has been measured and well-ordered, as the daily chart of the NYSE Composite Index (NYA) attests. 


The real melt-up phase of this bull market hasn’t even started yet.  We’ll know it has arrived when we see runaway stock prices coupled with increased participation among the legion of retail investors still on the sidelines.  Even institutional investors are surprisingly tempered in their usual optimism, as expressed in their collective 2017 forecasts.  Melt-ups have a way of surprisingly even the bulls in how high they carry the market averages before peaking.  For now, though, a combination of fear and cautious optimism holds sway among investors and this alone is enough to argue that the bull market still has legs.

Monday, February 6, 2017

The danger of being bearish in a bull market

One of the biggest contributors to losses for traders in the financial market is the temptation to sell short.  Borrowing shares of a company that are not owned by the seller in the hopes of making a massive profit has shipwrecked more traders than probably any other factor.  With stories abounding of the quick and easy profits to be made in selling stocks which are supposedly on the verge of plummeting, it’s no wonder that the allure of “shorting” is so irresistible to so many. 

Selling short is a simple enough proposition: place a short sale order with your broker for a company whose shares you believe are overvalued or technically “overbought”.  Then just sit back and wait for the profits to start rolling in.  If only it were that easy!  The trouble with selling short is that in most cases the odds are against the short seller.  This is due to a number of factors, some of which we’ll examine here. 

Perhaps the biggest risk for short sellers is the crowded short trade.  A high-profile example of what happens when too many traders pile into a single stock on the short side occurred recently – a cautionary tale if ever there was one.  It involved the loss of one man’s entire fortune due to a misguided attempt at selling short one of the most widely traded U.S.-listed stocks.  It’s a textbook case of what can go wrong when attempting one of the most dangerous of all trading maneuvers. 

According to MarketWatch, Canadian investor F.S. Comeau bet his last $249,000 against Apple Inc. (AAPL) in an attempt to reclaim $2.5 million lost in poor investments.  At the time of the trade, shares were valued around $122, and MarketWatch reported that an increase of just $6 would deplete Comeau’s savings. 

Apple shares screamed higher last week when the tech giant released an impressive Q1 earnings report and Comeau lost substantially.  As of this writing, AAPL shares had risen to a 52-week high of $130.50.


Before Apple released its earnings report, Comeau, who live blogged his reactions while wearing a wolf mask, acknowledged the capacity of investors aware of his short position to fade his trade.  “With 14,000 people watching, you guys could really mess with me,” he said.  When the company released its report his reaction was terse but poignant: “Oh, no.”

YahooFinance described Comeau’s reaction to Apple earnings as follows: [Comeau] kept howling.  And crying.  And throwing his pre-popped, celebratory champagne bottle.  There was a timeless stretch of blank camera stares, and then the sound of dry heaving. With mask still on, he pulled out a trashcan, and vomited more than his life savings.”

This misguided trader can perhaps be excused for his desperation born of inexperience.  What’s inexcusable, though, are the far more experienced trading advisors who gave assurances to their followers that Apple was a prime short-sale candidate despite all the technical and fundamental evidence to the contrary.  This misleading advice undoubtedly led to many hundreds of traders making the same mistake as Comeau. 

More than anything, the Apple experience provides a wonderful cautionary tale for all would-be short sellers.  The lesson here is that in an established bull market it’s best to avoid selling short altogether.  Trading against the prevailing trend is especially dangerous when one considers that short interest can quickly reach critical levels, thus the slightest bit of contrary news can catalyze a massive rally.  Short-covering rallies tend to involve wealth-destroying upside gaps, as the latest Apple stock experience proved.  These gaps are products of the urgency among short sellers to exit the trade.  They frequently represent losses on an unimagined scale.

Since naked short selling involves borrowing, the debt component of this trade ensures that the volatility factor will be greatly magnified vis-à-vis buying outright.  While this can sometimes work to a trader’s advantage in a bear market, it can prove catastrophic in a bull market.  The best policy is to avoid shorting unless a major bear market is underway and downside momentum has been thoroughly established.  Even then, your timing must sometimes be perfect. 

In a bull market the trend is truly your friend, and trading against the grain is usually a fool’s errand.  Best leave that to the men wearing wolf masks.  

Thursday, February 2, 2017

Financial Sense News Hour

I was recently interviewed by Cris Sheridan of the Financial Sense Network (www.financialsense.com).  The interview can be downloaded at the following link:


In it we discuss the possibility that 2017 will witness an extreme "blow-off" in the stock market followed by a major sell-off later in the year.  Special thanks to Cris and everyone at FSN.