"Wall of worry" still intact

Investor psychology is sufficiently muted to where we don’t have to worry about “irrational exuberance” or excessive greed.

The AAII bull-bear ratio is very close to an optimal reading since there has been an abundance of bearish investors lately and a surprising dearth of bulls.  That’s positive from a contrarian standpoint and is constructive for keeping the stock market’s “wall of worry” intact. [Excerpted from the Apr. 29 issue of Momentum Strategies Report]

Is there really inflation?

The inflation vs. deflation debate rages on with enough evidence for both sides to make a case.  In recent months it would appear that inflation has taken the upper hand, at least on the surface.  Below the surface, however, deflationary undercurrents abound.

On this subject I received the following email: “There is huge inflation in stocks and bonds but that's ‘good inflation.’  There is inflation in everything in one’s life: food, cars, health care, college, energy...one cannot look at inflation from a monthly CPI/PPI perspective.

“Go back 10 yrs-20 yrs-30 yrs etc., and take any item – like a house that was 70K; now it is $350K.  Same deal with everything from gas to groceries to the shrinking quantities in boxes from soap to cereals.

“In the ‘60s and ‘70s stock deals were done in the millions, now it’s in the billions.  And every few months now prices are going up in the supermarket.”

All of these are salient points but one fact remains: with record levels of central bank liquidity, corporate cash and bank reserves, why is there no inflation in the classical sense (i.e. rising interest rates and spiraling wages)?  In fact just the opposite is true: interest rates are at record lows and wages are stagnant.  Moreover, the rate of change in consumer price increases is miniscule compared to what it would be in a truly hyper-inflationary environment of the kind we witnessed in the 1970s.

Much of the debate therefore hinges on how the term “deflation” is defined.  When we consider the monumental attempt among central banks at re-inflating the global economy we can see that it has taken non-stop and record levels of pump priming to merely achieve economic stasis.  True economic inflation is still a long way off.

High frequency trading and market manipulation

High frequency trading (HFT) is becoming increasingly common on Wall Street.  It has fast become the most dominant force behind stock price movement and has been the catalyst for at least two major sell-offs in recent years.  As such, it’s coming under close scrutiny as being a potentially destabilizing force in dire need of control.   

Analyst Bert Dohmen of Dohmen Capital Research (www.dohmencapital.com) has made an interesting observation concerning high frequency trading:

“Since May 6, 2011, HFT (high-frequency trading) operations have no longer acted to knock the market down, even on a daily basis.  On that day, the DJI tumbled almost 1,000 points in less than an hour.  The regulators at first blamed it on a ‘fat finger,’ that is, some clerk with a fat finger pressing the wrong key on a computer.  That excuse was laughable.”

Dohmen further observed that more information revealed that HFTs had played a big role.  He contends that since then, U.S. securities regulators have been artfully dodging the subject of HFT regulation whenever it’s brought up.

“For the sake of discussion,” writes Dohmen, “let us assume that the regulators were approached by the Fed to put the situation to good use.  If HFT can be used to knock the DJI down 1,000 points, it could be used to make the market rise a similar amount.  Of course, it would have to be done gradually in order not to cause any suspicions.  So a deal could have been made with the HFT industry to either cooperate or be regulated out of business.  ‘Cooperation’ would mean that HFT will let their algorithms work only to the upside, not the downside.  How else can we explain the strange behavior of the markets?”

It would certainly explain a lot.

The helping hand of deflation

One of investors’ biggest fears over the Fed’s monetary stimulus (QE3) is that it will cause runaway inflation.  While there are reasons for believing this fear could come to pass in the years following the upcoming 120-year cycle bottom in late 2014, the evidence suggests that inflation is not a concern in the 1-2 years ahead.

It’s remarkable just how quickly those fears over inflation getting out of hand can change into fears over deflation.  Just in the last few weeks we’ve seen substantial declines in commodity prices, from corn to oil to gold, and economic forecasters have changed their tune from inflation to deflation.  The reason for this is because the 120-year Kress cycle is in its final deflationary phase and is defeating the central banks’ strongest attempts at creating inflation. 

Take for instance the featured editorial in the latest issue of Barron’s.  Randall Forsyth’s column, entitled “A Deflationary Wave,” says it all.  Forsyth described the recent commodities rout as being part of a “global deflationary wave” that has yet to run its course.  While I agree with this statement from a longer-term (1-2 year) standpoint, the technical indicators suggest a bottom is nigh at hand for this mini-deflationary wave in the near term. 

“The message seems to be,” writes Forsyth, “that there are limits to central banks’ ability to keep boosting commodities, which are barometers of the real economy.  And the rocky performance of stocks doesn’t inspire confidence that they can keep the bull market running indefinitely.”  Again, this statement may be true in the longer term, but the evidence strongly suggests the Fed’s efforts will prove sufficient to boost equities in the near term.

Besides providing the market with a much needed correction, another thing the commodities sell-off succeeded in doing was relieving the retail economy of some of the excesses from QE3.   The recent drop in oil, food and base metals prices will, in the words of one economist, “give consumers more spending power and let central bankers keep at their game longer.”   In other words, the mini-deflationary wave that Forsyth wrote about will actually prove beneficial for both consumers and investors as long as the Fed is going hard and heavy with its $85 billion-a-month asset purchases.  

Goldman Sachs reverses short-term gold position

Previously we’ve discussed the historical accuracy of investment bank Goldman Sachs when it comes to making commodity price predictions, particularly oil and gold.  Goldman made a high profile bearish call on gold a few weeks ago, a prediction which proved to be spot on.  On Tuesday, Goldman reversed its bearish gold stance in the short term.  That’s potentially good news for the gold market, at least in the near term.

According to CNBC, the firm’s commodities research team said the decline in gold was “more rapid than it expected,” and it exited the trade with a potential gain of 10.4 percent, below its original target price of $1,450. 

Goldman had previously forecast that gold would close out 2013 at $1,450 per ounce, then take a hit in 2014 with a predicted close of $1,270.  Within days of that call, gold fell almost 16 percent to a low of $1,321 an ounce.  As CNBC pointed out, “While the bailout of Cyprus did not send gold higher, reports that Cyprus would sell gold to cover its shortfall sent the metal tumbling, as traders bet other European countries might also sell gold to raise cash.”

Goldman said the surprisingly rapid decline was probably accelerated by breaks in “well-flagged technical support levels.”  With the investment bank no longer on the short side of gold, the yellow metal has another reason for establishing a low in the coming days and weeks.

It pays to follow winners

It’s being called the forecast of the year.  Goldman Sachs last week cut its gold-price view two days ahead of the start of the biggest decline for the commodity in three decades.  “So how did the investment bank manage to foresee a rout that others, including hedge-fund billionaire John Paulson, missed?” asked financial reporter Barbara Kollmeyer.  

The answer is simple: by the unsurpassed expertise of Goldman’s metals research team.  Say what you will about the sometimes scandalous history of the investment bank, there’s no denying its intermediate-term calls on gold and oil have been among the most accurate of any research department on Wall Street in recent years.

“You had a whole group of observations that should have created a substantial rally in gold prices, but they didn’t,” Jeffrey Currie, the head of Goldman’s global commodities research team told Bloomberg  in an interview a day prior.  “The fact that gold did not rally on Cyprus amid the bad U.S. data that occurred in that time period created the conviction we needed.”

The week after Cyprus announced a levy on bank deposits that shocked the investment world, gold rose 0.3%. On April 10, Goldman cut its 2013 forecast to $1,545 an ounce from $1,610 and its 2014 forecasts to $1,350 from $1,490. In February, Goldman slashed its 2013 forecast to $1,550.  Goldman made a further move on Tuesday, in the wake of the huge gold slump, to cut its short-term gold call to $1,400, and said it likes natural gas as a better safe haven.  

For the past five years, Goldman’s highest conviction trades involve being long gold and short natural gas.  Now that both trend have reversed, the firm says it now recommends that its clients short gold and go long natural gas.  Below is a graph from a recent Goldman Sachs gold analysis which supports the bank’s bearish view on the yellow metal.

In the February 26 report I made the following observation regarding Goldman’s gold call:

“You may be wondering why Goldman Sachs’ latest report on gold is considered newsworthy.  While big financial institutions release forecasts on gold and commodities on a regular basis, Goldman Sachs has a long-standing reputation for accuracy in its forecasts which far exceeds the industry standard.  To put it in colloquial terms, when Goldman speaks investors should listen.”

This was based on years of observation that Goldman’s commodity predictions tend to be spot on.  If you’re an outsider to the gold industry (most of us are), it’s always a good idea to follow close in the footsteps of those insiders who have a proven track record of choosing the correct investment path.  Goldman Sachs is one such path leader and its latest gold market victory has once again solidified its reputation as one institution whose pronouncements shouldn’t be ignored.

U.S. retail economy slipping

A couple of weeks ago we examined the New Economy Index (NEI) and noticed some weakness.  The index provides us with a real-time picture of the overall health of the U.S. retail/consumer economy.  NEI was verging on a sell signal but had not quite broken the uptrend.  While the interim uptrend still hasn’t been broken, it’s now one step closer to breaking after the latest update to the index.

You’ll notice that as of April 19 the index has violated both its 12-week and 20-week moving averages.  This doesn’t technically qualify as a break of the uptrend that has been intact for the past few years, but if NEI violates the nearest pivotal low we’ll have our first economic “sell” signal since spring 2010 (see dashed line in chart below).

The implication behind the recent weakness in the NEI is that the U.S. retail economy is slipping.  This can be seen in the stock price performance of leading business shipper FedEx (FDX), which is a component of the NEI.  FedEx is an important business indicator, and a sliding stock price for FDX suggests demand is diminishing.

Gold and deflation

“The price of gold tends to follow the underlying trend in the more volatile CRB raw industrials index. So gold’s two-day free-fall of $203 per ounce to $1,360 is unsettling if investors see it as a harbinger of a widespread plunge in commodity prices resulting from a much weaker global economy. I don’t see it that way. Nevertheless, gold’s precipitous descent only one week after the Bank of Japan announced a massive QE program suggests that investors are losing their confidence in the power of central banks to stimulate economic growth. As a result, gold bugs may no longer be convinced that inflation will heat up, notwithstanding the monetary excesses of the central banks.”  [Ed Yardeni, 4/15/13]

A global market crisis in the making

A client writes: “In my opinion the U.S. stock market looks better than the markets in Europe.  As a German, I follow our market closely.  Please look at some charts from market leaders in Germany:

“As you know, Germany is a export-driven economy, so looking these charts the world economy seems to be rolling over and more trouble potentially lies ahead.”

My response: The rest of the world does look quite “toppy” from a stock market perspective.  China, India and Russia look very weak and so do many of the European countries.   Germany's DAX index is down 8% in the last month and looks very top heavy from a longer-term chart perspective.  Many individual stock charts from Germany look ominous.  

My best guess is that economic and financial market weakness in Asia, Europe and Latin America will eventually find its way to the U.S, just as the bear market and commodities crash of mid-1998 started with Asia, Russia and Latin America.   There are many parallels between '98 and today's market.

Gold: technicals vs. fundamentals

Gold’s recent crash also serves as a case in point of what happens when investors fall in love with a fundamental story and ignore the market’s technical picture. 

Speaking of gold’s sell-off, Thomas Vitiello, partner at Aurum Options Strategies, told CNBC: “What happens is the fundamentals are there and it’s not responding the way you would think it would, so you have to look at that.” 

The above statement is typical of those who embrace an asset’s fundamentals without taking into consideration price pattern and internal factors.  Vitiello added, “You can’t buck the trend, but right here, how could you be bullish?” 

This statement is reflective of the confusion that faces a fundamental investor after the price of his investment has crashed.  He sees that the fundamental picture hasn’t changed, yet prices keep dropping.  This serves to illustrate that in the near term the market is driven primarily by technicals, not fundamentals.  [Excerpted from the 4/16/13 issue of Gold & Silver Stock Report, available at www.clifdroke.com]

War with Asia and the 24-year cycle

Lately North Korea has been causing quite a stir with the obstreperous military threats of its leader, Kim Jong Un, against the U.S. and South Korea.  North Korea’s threats can be ascribed to the singular frustration arising from the country’s worsening economic condition.  

The country's frustration, moreover, is reflected in the declining fortunes of its neighbors and trading partners – South Korea, Russia and China. 

Notice, for instance, that China’s stock market has been locked up in a bear market since 2011.  The long-term weekly chart for the iShares China 25 ETF (FXI) reflects a pattern of declining tops for China stocks that has been intact since the peak in late 2010.  Historically, periods of social unrest – which usually lead to war – are gestated in a period of economic stagnation.  Economic stagnation is normally preceded by equity market weakness.  The stock market trends for China, India and South Korea suggest a period of Asian regional economic stagnation has either begun or is soon forthcoming. 

The flagging equities trend in the Asia region also suggests the sociopolitical climate is ripe for revolutionary fervor of the type we saw in Egypt and some of the Arab countries a couple of years ago.  The declining trend for Egypt’s stock market (below) began well before the so-called “Arab Spring” revolutions commenced in 2011.  Most expressions of violence, whether military or of the people, are born during periods of economic stagnation near the bottom of a major down cycle.   

What the stock market indices for the major Asian countries tell us is that the region is ripe for a militant uprising of the type we’re now seeing in North Korea.  With the 24-year cycle of war due to bottom in late 2014 it should not surprise us to see a potential outbreak of war as we head closer to this fateful time frame.

Thoughts on gold and silver

A reader writes: “I have some thoughts regarding precious metals and would like your opinion on them: 

1) All gold and silver have done is trade sideways for two years.  In gold’s case it has been sideways for two years in August.

2) The news in gold is very bearish as one hears that Soros and other hedged funds have bailed out.  Which is typical if they don't make money they leave the asset.

3) If gold and silver break down from these critical support levels one needs to see acceleration in price right now if you look at the move down it is taking much more time than the move up.

4) If you are right about a problem in the world coming [in 2014], gold and silver should start moving up soon in a trending fashion without people talking about it.”

My reply: On the first thought I would point out that while both gold’s price is essentially unchanged from two years ago, the pattern in gold has been one of declining tops and bottoms, which by definition is that of a downward trend.  The declining trend is even more pronounced for silver. Thus we must continue to assume that bear market conditions hold sway over the precious metals instead of giving the metals the benefit of the doubt.  A trend reversal requires definite technical indications, including an upward turn of the 15-day and 30-day moving averages.  Gold and silver continue to be held captive below both these critical trend lines, meaning the short-term trend is still down.  Remember: a new bull market begins with the short-term trend.

The second point is that while it's true that most hedge fund traders are momentum traders who follow the prevailing market winds, this alone can't be used as a contrarian indicator for gold and silver.  When billions of dollars are pouring into a given market direction (namely down), the downward momentum this generates can be self-sustaining for many weeks and months before eventually become exhausted.  There's a reason why Soros and his peers are billionaires.

On the fourth and final point I would say that gold should certainly begin to move up once the insiders with access to key information on geopolitical and financial affairs see trouble on the horizon.  That such trouble isn't forthcoming yet is proven not only be gold's failure to rally in a sustained fashion, but also by the relentless advance in risk assets such as equities.  It will likely take a major shift in the prevailing economic and/or geopolitical winds to catalyze a revival of gold's fortunes.  Such a shift is expected in 2014 as we approach the final bottom of the 120-year Kress cycle.

One thing I still believe is that investors are still prone to run to gold as a safe haven when headlines are troublesome, as we saw in the last couple of weeks.  We have good reason for believing, therefore, that the next gold trend change will most likely be catalyzed by the market's perception of a shift in the political and/or economic winds from good to bad.  

The Great Rotation becomes the Great Panic

One of the themes for this year so far has been the so-called “Great Rotation” out of bonds and into stocks.  While this has been true for the most part, there are signs that investors haven’t completely lost their skittishness and haven’t yet fully embraced the bull market.  This can be seen in the recent performance of the Treasury Bond ETF (TLT). 

Note the conspicuous spike in the TLT price line from last week.  This is indicative of the rush into Treasuries that occurred with North Korea’s threatened nuclear strike.  Gold also experienced a rally last week during the tension.  What this tells us is that investors are still quick to run to the safe havens over the slightest provocation – however distant the threat may be.  But it’s equally telling that while investors may have temporarily panicked into Treasuries, they didn’t completely run away from stocks.  

Now that the threat of a military episode involving North Korea is perceived as unlikely, investors were just as quick to rush headlong into equities, sending the major indices to new highs.  This volatile behavior is reflective of the latest AAII investor sentiment poll which showed a huge spike in the number of bears and a substantial drop in the bulls.

Why Bernanke can't stop deflation

While there are many risks to the current ultra loose money policy, consumer price inflation isn’t one of them.  Inflation remains persistently low despite the best efforts of central banks to increase it.

The Consumer Price Index (CPI) among the G7 economies was only 1.6%, year over year, during February.  It was even lower at 1.4% excluding food and energy, according to economist Ed Yardeni.  Meanwhile Producer Price Index (PPI) inflation rates are close to zero, Yardeni points out.  In the euro zone, the CPI inflation rate is just 1.7%, and 1.4% excluding food and energy.  Japan continues to experience deflation despite continuous efforts at reversing it through monetary easing. 

“In the Brave New World (BNW),” writes Yardeni, “pumping more liquidity into financial markets won’t stop consumer price deflation, but it will inflate asset prices, a.k.a. asset bubbles. Central bankers like Ben Bernanke at the Fed and Haruhiko Kuroda at the BOJ are still using models based on the 1930s. They are clueless about the BNW.”  Yardeni believes this is why central bankers are so committed to doing whatever it takes to avert deflation. They fail to realize that productivity-led deflation should be welcomed as the best way to boost the purchasing power of consumers, thereby increasing government tax revenues. 

The Bank of Japan recently voted to flood its economy with freshly printed yen in an effort to reverse the country’s 20-year deflationary trend.  BOJ Governor Kuroda has previously said that he would do "whatever it takes" to drive growth in Japan.  The central bank underscored its commitment to fighting deflation by announcing that it would also buy riskier assets such as ETFs and REITs.  The move toward an even looser monetary policy by BOJ, while decreasing the value of the yen, is also expected to decrease the prices of its manufactured goods sold abroad.  That would be a boon for U.S. consumers but Japan’s move could also hurt U.S. exports. 

Japan’s latest move illustrates how deflation isn’t actually stopped by central bank intervention – it’s merely exported.  Moreover, the CPI trend for G7 economies shows that try as they may, central bankers are simply unable to reverse the deflationary impact of the 120-year mega cycle which is in its final “hard down” phase through late 2014.  

As the crisis in Cyprus recently reminded us, don’t underestimate the long-term Kress cycle.  Also, don’t overestimate the ability of central bankers to inflate their way out of deflation.

Clif Droke interview with SmartStox Radio

I was recently interviewed with Rob Graham of SmartStox Radio.  You can listen to it at the following link:

www.smartstox.com/analysts/clif_droke

We talked about the outlook for equities, gold, the Fed and the U.S. economy.  Special thanks to Mr. Graham for the interview.

U.S. retail economy is slipping

Should we fear a spring economic slowdown?  Not just yet, but if a key economic index keeps falling then we very well could be in a mini-recession before summer. 

Our New Economy Index (NEI) measures the overall strength of the U.S. retail economy in real time.  It’s an average of the most sensitive consumer retail and business services stocks and is updated on a weekly basis.  When viewed in conjunction with its 12-week and 20-week moving averages, NEI provides an excellent picture of the short- and intermediate-term health of the U.S. retail economy.  It has flashed only one signal of weakness in the retail economy in the last four years – a brief one in the spring of 2010.  For the better part of the last four years, NEI has given the all-clear sign for the U.S. economy but is in danger of giving another sell signal if recent trends persist. 

Here’s what the NEI looks like as of its latest update on April 5. 

As you can see, the index remains above the 12-week (red line) and 20-week (black line) moving averages but has made a series of lower highs and lows for the last few weeks.  The recent pattern of conspicuously lower peaks is the most ominous I’ve seen the NEI look since 2007 before the last recession began.  While it’s not too late for NEI to reverse its recent decline and keep the interim uptrend intact, the pattern over the last few weeks is troubling and could well be a harbinger of worse things to come.

Note also that the NEI trend closed slightly below the important 20-week moving average last week.  While this alone doesn’t qualify as a “sell” signal, it does imply weakness in the retail economy.  With the first quarter earnings season now underway it will be interesting to see how the sales trends of leading retail companies stack up to Q4 2012 sales.  This will give us a clearer picture of what we can expect for the retail economy this spring.

Does the merger dearth mean death for the bull market?

After a spate of merger activity in 2011 and 2012, the value of mergers in the first quarter of 2013 fell precipitously.  Global merger activity in March was about $100 billion according to Bloomberg, on track for the lowest monthly total since July 2009. 

Investors are concerned that U.S. government spending cuts from the recent sequester, along with leadership changes in China and chronic sovereign debt troubles in Europe are to blame.  The feeling is that these factors are “weighing on executive confidence and inhibiting deals,” according to Mark Shafir, co-head of global M&A at Citigroup.

Some investors also worry what the recent dearth of mergers means for the overall health of the bull market for equities.  It’s true that bull markets are historically characterized by healthy levels of merger activity and that diminished M&A levels often correspond with bear markets.  But the relationship is more complex than that.  Corporate cash is still at record levels – more than $4 trillion – which is atypical for a major long-term market top.  The mantra at tops is “cash is trash” and at bottoms “cash is king.” 

Rising stock prices always stimulates merger activity, and as long as equity prices remain near historic highs we can expect to see more M&A activity before long.  Rising share prices also make it easier for companies to pay for takeovers with stock instead of cash, as Steve Baronoff, chairman of global M&A at Bank of America observes.  He further notes that cash-rich private equity firms are on the lookout for $10 billion-plus takeover targets. 

More to the point, bull markets are often engineered to facilitate corporate mergers among key industries.  And this one probably won’t end until we see an explosion of M&S deals of the type that normally accompany exhausted market trends.

Bull markets rarely end on a dearth of merger activity; rather they tend to terminate in a climate of heightened deal making.  The recent downturn in M&A activity is likely therefore a temporary anomaly rather than the start of a new bear market.  

A bubble in dividend stocks?

Since the start of the financial market recovery four years ago, dividend-paying stocks have been in high demand.  As the recovery gained traction in 2010, big dividend payers were especially sought after by investors and were given preference over growth stocks and tech shares, which have historically been the big leaders in bull markets. 

Income hungry investors became disillusioned with low-yield Treasuries and instead turned their attention to companies with higher than average dividend yields.  A multitude of books and articles on dividend investing in the last couple of years have only increased investors’ appetites for such stocks. 

It was somewhat surprising to learn that the securities of longtime steady dividend payers in the S&P 500 have outpaced the price gains in the S&P index itself.  According to Alexandra Scaggs, writing in the April 1 issue of Barron’s, while stocks haven’t actually recovered from the financial-crisis lows on an inflation-adjusted basis, “dividend payouts from the S&P 500 have more than kept pace.” 

According to research from Howard Silverblatt, senior index analyst with S&P Dow Jones Indices, dividends grew 14% from 2007 through the end of 2012, outpacing inflation.  Moreover, dividend-paying stocks have also seen worthwhile gains in share price, as Scaggs points out.  The so-called Dividend Aristocrats have made a 144% recovery from their financial crisis lows.

So what does it all mean?  While it would be tempting to jump to the conclusion that there is a “bubble” in dividend stock investing, I wouldn’t go this far.  Demand for dividend payers is reaching a level that suggests they’re close to the point of diminishing returns, however.  As more and more investors jump onto the dividend bandwagon, ignoring technically stronger market segments in the process, the stodgy dividend payers will surely be unable to continue meeting investors’ heightened expectations. 

If anything, history tells us that when the pendulum swings too far in one segment of the market, a reversal of the trend can’t be far away.  Overlooked market sectors will undoubtedly get their just due before this recovery is over and it will likely come at the expense of the big dividend-payers.

The rich are leveraging up

There’s a saying about high-net-worth individuals: they’re always the first to snap their wallets shut in a recession and the last to start spending in a recovery.  But when the rich finally start spending again they spare no expense! 

Witness the rebound in consumer spending in the U.S. since the 2009 rebound.  While earnings and discretionary spending among the middle class has shown only modest gains, spending among the “upper crust” has been nothing short of robust.  According to Mark Jordahl, president of U.S. Bank Wealth Management, high-net-worth individuals are not only spending fast and furiously, their also taking on leverage.  Jordahl told Barron’s  that his lending business is up 66% on a year-over-year basis. 

The increased borrowing among the wealthy is not a function of need, but of perceived opportunity.  The rich are taking on leverage because they see investment return opportunities at historically low rates of interest.  They’re feeling more risk averse than they were just a couple of years ago and more money is coming out of safe haven investments (like bonds and gold) and flowing into risk assets (like stocks). 

Spending patterns by upper-income earners remain buoyant thanks to strong stock prices and rising home prices, as well as dividends and bonuses distributed in late 2012 (rather than in 2013 to avoid higher taxes).  Kipplinger Finance points out that consumers at the upper end of the wealth spectrum pack an outsize punch in the economy, with those in the top 20% of income accounting for roughly 40% of spending. 

So what does it mean when the rich come out to play?  While it’s still too early to worry about the implication of increased leveraged among upper-income investors, the trend toward increased debt is certainly troubling and will eventually lead to increased volatility down the line. 

For now, let’s enjoy the economy’s strong showing courtesy of the upper 20%! 

MSR quarterly performance review

At the end of each quarter I publish a complete record of all individual stock and ETF trading recommendations made in the Momentum Strategies Report newsletter.  This report allows subscribers to track the accuracy of the trading methods used by MSR.

Unlike many investment advisories, I believe in maintaining a small and manageable trading portfolio in order to maximize returns while minimizing risks.  You may have noticed that most investment newsletters maintain portfolios consisting of several – perhaps even dozens – of stocks at any one time.  Besides being cumbersome to track and expensive to maintain, it’s usually counterproductive.  Keeping a small number of technically and fundamentally sound trading positions – perhaps as few as one or two at a time – is far simpler and can be just as rewarding.

Following is the MSR Trading Portfolio recommendations for Q1 as of Mar. 31, 2013:

1/8: Bought Pulte Group (PHM) @18.99

1/10: Bought PowerShares S&P 500 High Quality Portfolio ETF (SPHQ) @ 16.22

1/19: Took some profit in PHM @ 20.49

2/4: Bought Marathon Oil (MRO) @ 33.97

2/8: Sold remainder of PHM @ 19.47

2/19: Sold MRO @ 35.75

2/25: Sold SPHQ @ 16.56

3/5: Bought Bristol Myers Squibb (BMY) @ 37.50

3/10: Bought PowerShares S&P 500 High Quality Portfolio ETF (SPHQ) @ 17.08

3/15: Took some profit in BMY @ 39.00

The first quarter of 2013 was a profitable one for us as you can see.  It must be pointed out that bull markets are far more forgiving than bear markets when it comes to making trading and investment decisions, however.  Timing isn’t as crucial for buying stocks as it is for selling short.  Moreover, the volatility factor is always less in a bull market which makes it less likely that a conservative stop loss discipline (which MSR always employs) will be “whipsawed.”  

The trading methodology employed by MSR is based mainly on technical factors including price pattern, internal momentum, technical market condition and relative strength.  Other factors including earnings estimates for individual companies, relative volatility, etc. are also part of the selection process.  Price-related considerations are always paramount as long experience proves.

One of the challenges that every strategies faces is how to sidestep market declines.  This is simple enough if you employ a conservative stop-loss strategy on all your trading decisions.  Amazingly, few strategists seem to have mastered this relatively simple art.  Worse, all too many are inclined to tempt fate by going heavily short at the first sign of weakness.  Unless your timing is nearly perfect, even a correctly bearish posture in a bear market doesn’t always produce profits (just ask George Soros re: the 2008 credit crisis).  Experience teaches that it’s best to maintain a heavy cash position during market downturns rather than leveraging up on bearish trades.  As the venerable Bob Prechter has said, “There’s nothing wrong with cash.  It gives you time to think.” 

MSR employs a strategy that automatically puts us into an all-cash position during periods of market weakness.  Only during fierce bear markets when the market’s internal path of least resistance is strongly to the downside do we employ short selling, and selectively at that.  Investment advisories that do otherwise are more likely to lose money than preserve it. 

If you are a serious trader or investor looking for a safe, reliable approach to market timing you may want to subscribe to the Momentum Strategies Report.  As the long-term record clearly shows, our technical discipline allows us to profit during bull markets with minimum volatility while our drawdown/volatility factor is much lower during bear markets than the industry average.

Subscribe to the Momentum Strategies Report now and receive as my compliments to you the 2013 Forecast issue. 

In addition to that you’ll also receive the MSR newsletter emailed to you each Monday, Wednesday and Friday.  MSR provides reliable forecasts and analysis of U.S. and global markets based on internal momentum, cyclical and technical factors.  Low-risk stock and ETF recommendations are also made based on my proprietary system of selection.  Specific entry and exit instructions are also given for each recommendation.

Bonus: Subscribe to MSR today and receive a free PDF copy of my latest book, “2014: America’s Date With Destiny.”  Don’t miss what the Kress cycles have in store for the coming years! 

[For the complete 2013 Kress cycle forecast for the U.S. stock market and the latest newsletters, subscribe to the Momentum Strategies Report at the link below.]

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Your guide for 2013,

Clif Droke 

Fed can’t completely stop the Kress cycle

Try as it may, the Federal Reserve can’t seem to patch all the holes in the leaky inner tube that is the U.S. economy.  While Fed chief Bernanke is credited for pumping up the deflated tire since 2009, each time he succeeds in patching one hole another leak takes its place. 

While all eyes are on the soaring U.S. stock market and rebounding housing market, few commentators have drawn attention to the remarkable weakness in the commodities market.  Consider that in the last 1-2 years bear markets of varying magnitudes have overtaken the markets for “softs” including coffee, sugar and cocoa.  More recently grains prices have taken a tumble.  Corn prices are in free-fall and wheat prices are also in steep decline.  The price of corn crashed recently when a USDA report revealed much higher corn supplies than the market anticipated.   

To make matters worse, deflation has again reared its ugly head in Europe as Cyprus became the latest victim of the European sovereign-debt crisis.  The revival of the deflationary scare in Cyprus has had a spillover effect on several countries and has resulted in falling stock prices across the euro zone.  Greece’s stock market has retraced more than half its gains since August while Spain and Italy’s equity markets have also recently stumbled.  The declining value of the euro currency meanwhile suggests that Europe’s troubles are far from over.

Adding to the difficulties in containing the global deflation problem is the threat of an economic contraction in China.  The governor of China’s central bank issued a warning over the country’s high inflation rate of 3.2 percent (as of February).  The People’s Bank of China also released a survey saying that 68 percent of the Chinese households believe that housing prices are “too high.”  The government is widely expected to tighten money supply in an attempt at curbing the housing market again.  This will have an adverse impact on the Chinese economy with possible spillover repercussions for the global economy. 

What’s making it difficult for central bankers to completely contain the deflationary threat is that the fiscal policy of several major nations is at odds with what Bernanke and Draghi are trying to do.  While the Fed and the ECB are committed to ultra-loose money policies, the governments of leading nations in North America and Europe have embraced austerity and/or fiscal tightening.  Such fiscal policies will only serve to counteract much of what the central banks of the U.S. and Europe are trying to accomplish in the way of re-inflating the global economy.  It’s like trying to mix oil and water – it simply won’t work. 

Since lawmakers are stumbling over their own feet in this matter we can expect that at some point – probably later this year – the momentum from the 2009-2013 financial and economic recovery will wane.  When it does, it’s only a matter of time before the downside pressure from the bottoming long-wave deflationary cycle takes over and reverses much of the gains of recent years. 

Governments, it seems, never can learn from the mistakes of the past and are indeed doomed to repeat them.

Art Huprich’s rules of trading

• Commandment #1: “Thou Shall Not Trade Against the Trend.”

• Portfolios heavy with underperforming stocks rarely outperform the stock market!

• There is nothing new on Wall Street. There can’t be because speculation is as old as the hills. Whatever happens in the stock market today has happened before and will happen again, mostly due to human nature.

• Sell when you can, not when you have to.

• Bulls make money, bears make money, and “pigs” get slaughtered.

• We can’t control the stock market. The very best we can do is to try to understand what the stock market is trying to tell us.

• Understanding mass psychology is just as important as understanding fundamentals and economics.

• Learn to take losses quickly, don’t expect to be right all the time, and learn from your mistakes.

• Don’t think you can consistently buy at the bottom or sell at the top. This can rarely be consistently done.

• When trading, remain objective. Don’t have a preconceived idea or prejudice. Said another way, “the great names in Trading all have the same trait: An ability to shift on a dime when the shifting time comes.”

• Any dead fish can go with the flow. Yet, it takes a strong fish to swim against the flow. In other words, what seems “hard” at the time is usually, over time, right.

• Even the best looking chart can fall apart for no apparent reason. Thus, never fall in love with a position but instead remain vigilant in managing risk and expectations. Use volume as a confirming guidepost.

• When trading, if a stock doesn’t perform as expected within a short time period, either close it out or tighten your stop-loss point.

• As long as a stock is acting right and the market is “in-gear,” don’t be in a hurry to take a profit on the whole positions. Scale out instead.

• Never let a profitable trade turn into a loss, and never let an initial trading position turn into a long-term one because it is at a loss.

• Don’t buy a stock simply because it has had a big decline from its high and is now a “better value;” wait for the market to recognize “value” first.

• Don’t average trading losses, meaning don’t put “good” money after “bad.” Adding to a losing position will lead to ruin. Ask the Nobel Laureates of Long-Term Capital Management.

• Human emotion is a big enemy of the average investor and trader. Be patient and unemotional. There are periods where traders don’t need to trade.

• Wishful thinking can be detrimental to your financial wealth.

• Don’t make investment or trading decisions based on tips. Tips are something you leave for good service.

• Where there is smoke, there is fire, or there is never just one cockroach: In other words, bad news is usually not a one-time event, more usually follows.

• Realize that a loss in the stock market is part of the investment process. The key is not letting it turn into a big one as this could devastate a portfolio.

• Said another way, “It’s not the ones that you sell that keep going up that matter. It’s the one that you don’t sell that keeps going down that does.”

• Your odds of success improve when you buy stocks when the technical pattern confirms the fundamental opinion.

• As many participants have come to realize from 1999 to 2010, during which the S&P 500 has made no upside progress, you can lose money even in the “best companies” if your timing is wrong. Yet, if the technical pattern dictates, you can make money on a short-term basis even in stocks that have a “mixed” fundamental opinion.

• To the best of your ability, try to keep your priorities in line. Don’t let the “greed factor” that Wall Street can generate outweigh other just as important areas of your life. Balance the physical, mental, spiritual, relational, and financial needs of life.

• Technical analysis is a windsock, not a crystal ball. It is a skill that improves with experience and study. Always be a student, there is always someone smarter than you!

[Art Huprich is Chief Technical Analyst at Raymond James Financial]