Gold’s silent comeback and the middle class rebound

The middle class has been stuck in a rut – psychologically if not economically – for years, and they’re not afraid to admit it.  Last year’s upset victory for Donald Trump in the U.S. presidential race was a manifest token of middle class angst.  Opinion polls have shown that many of the anxieties expressed by the middle class last year are still a concern for them this year.  In other words, not much has changed since a year ago.  There are some strong indications that the middle class outlook will change for the better in the coming months, however, as we’ll discuss in this commentary.

Ask the typical middle class wage earner if they think they’re economic prospects will improve in the year ahead, however, and you’ll likely receive a cynical response.  If there was any doubt that Middle America’s economic prospects haven’t improved much since last year, the following graph will lay them to rest.  Shown here is the Middle Class Index (M.C.I.), a share price composite of several leading companies that cater to a largely middle class customer base.  The components of this index include JC Penny (JCP), Ford (F), Dollar General (DG), Wendy’s (WEN), Wal-Mart (WMT), and Kroger (KR). 

If the above graph is any indication of middle class consumption patterns, then middle income Americans haven’t exactly set the world on fire with their spending.  The implication of the M.C.I. is that while middle class spending has certainly increased over the last several years, it has essentially flat-lined on a 3-year basis.  While there is admittedly a danger in reading too much into such a simplified overview of middle class spending, it’s likely not far from the truth to assume that middle class Americans aren’t making much progress.  At least, that’s how they feel based on the trend of the Middle Class Index.

So the question is, “Will the economic prospects ever improve for the middle class?”  While many would respond with a bleak “Never!” there is actually a good indication that the year ahead will witness some solid improvement.  Consider the next chart exhibit, which highlights the prospects for the upper middle class (i.e. individuals who earn in excess of $75K/year).  The Upper Middle Class Index shown here is a stock price average of several companies which cater mainly to the upper middle, including Target (TGT), Starbucks (SBUX), BMW (BMWYY), Apple (AAPL), and Ruth’s Chris (RUTH).

What this graph suggests is that, in contrast to the middle class, upper middle class consumers have increased their spending over the last year.  In just the last few months alone the Upper Middle Class Index has trended decisively higher as luxury spending among upper middle and upper income consumers has been buoyant.  The message of this indicator is that the upper middle class is in much better shape than the middle class.

There is another takeaway from our discussion of the Upper Middle Class Index, however.  Historically, economic improvement following a major downturn like the last recession proceeds from the highest economic classes to the lowest.  It’s much like a freight train when it starts rolling from a standstill; the engine moves first, then the cars closest to the engines, and so on until at last the final cars begin moving forward.  The upper class is always the first to benefit from an increase in credit and money supply, then the upper middle, then the middle, and finally the lower class.  Like a train, economic momentum takes time to build up but when it finally becomes established it tends to be self-sustaining. 

The fact that the Upper Middle Class Index is increasing is a positive indication for the middle class, for it suggests that the increased spending patterns of the upper class of recent years have finally spilled over into the upper middle class.  Eventually the middle class will eventually follow the lead of the upper middle, as is always the case. 

One sign that the U.S. economy may be on the cusp of truly breaking out is found in the graph illustrating the rate of change in M2 money velocity.  This is one way of measuring the demand for money.  Money demand, as measured by the ratio of M2 money stock to nominal GDP, has been extremely high by historical standards for the last several years.  In fact, the demand for cash has been extraordinary since the 2008 crash, as investors have feared a recurrence of the crisis years.  The inverse of this measure is the velocity of M2 money (nominal GDP divided by M2).  Velocity remains near multi-decade lows in reflection of the public’s massive demand for cash; however, it shows signs that it may be reversing. 

The following graph, courtesy of the St. Loius Fed (https://fred.stlouisfed.org), shows the year-over-year change in M2 money stock.  As you can see, it’s trending gradually higher and is close to entering positive territory for the first time since Q1 2010, when the combined impact of Federal Reserve and U.S. government stimulus was at its highest following the Great Recession.  This is also a sign that the perennial problem of low inflation is gradually reversing as inflation slowly, almost imperceptibly, makes its return.

Another indication that things are about to improve for the middle class is, perhaps surprisingly, the price of gold.  Gold serves two primary functions in today’s economy.  The first is as a reflection of how much fear exists among investors as it pertains to the future outlook.  The gold price is basically one way of gauging how much confidence stakeholders (producers, consumers, and investors) have in the future prospects for business. 

More than this, gold is also a measure of future inflation expectations.  When the economy was still quite fragile between the years 2009 and 2011, investors placed a high premium on gold ownership as reflected in runaway gold prices.  When it became clear in late 2011, however, that the U.S. recovery was gaining traction, gold lost much of its luster as a safe haven and it became less desirable for investors to commit the bulk of their investment capital to it.  Risk assets instead became more attractive, undermining the demand for gold.

Since last year, however, gold has embarked on a “silent comeback,” effectively ending a four-year bear market.  (See the SPDR Gold Shares ETF chart below for illustration.)  It has been consolidating its gains in recent months as it prepares to continue its long-term rebound.  The going has been slow for the most part, mainly because inflation has been slow to return and equities continue to steal some of the yellow metal’s thunder.  If the M2 velocity chart shown above is any indication, however, then inflation should slowly increase in the coming years.  This would certainly brighten gold’s longer-term prospects and make gold ownership more attractive to the average investor once again.  A moderate amount of inflation, besides boosting gold’s lure, would also help the middle class to recover even more.

In the final analysis, a full-fledged middle class economic revival has been talked about and anticipated for years, and its failure to arrive has been frustrating.  Its manifestation is long overdue, however, and while it has been slow in coming the indicators discussed here bode well for the middle class in the months ahead.  History shows that sustained improvement in the upper middle class always eventually spills over to the next level down, which is good news for Middle America in 2018.

MSR Performance Review

Following is the 2014-2017 weekly performance of the MSR total stock/ETF portfolio based on all buy/sell trading recommendations in the Momentum Strategies Report. The performance graph pictured here was updated as of Aug. 7, 2017.

Recommendations made in the Momentum Strategies Report are based on a combination of technical analysis, fundamental analysis, relative strength analysis and investor sentiment analysis.  Recommendations are only made in what are deemed to be high-probability, low-risk, low-volatility trading opportunities. 

All trades are initiated once a “buy” signal is confirmed by the price line of the stock or ETF in relation to its 15-day moving average, along with other pertinent technical confirmation (e.g. relative strength, internal momentum, etc.).  Conservative stop-loss recommendations are given and continually updated with each trading position.  The average length of the trades made in MSR is approximately two months, but can sometimes be longer. 

MSR rarely recommends short selling (only in confirmed bear markets) and prefers a 100% cash position whenever faced with a dearth of potential high-probability buy candidates.

In the vast majority of cases, there are only 1-2 stocks/ETFs in the model portfolio at any given time.  Rarely are more than three positions recommended at one time.  This allows us to concentrate all our attention on a few positions without being distracted by having to worry about multiple positions.  This also limits draw downs.  Most recommended positions involve low-volatility, actively traded NYSE stocks and ETFs.

The preceding graphs reflect only entry and exit signals, not profit-taking advice.

[Note: Performance graph is updated each Friday based on change in portfolio value from previous Friday.]

Prepare for a 30-year bull market

Heading into 2017, Wall Street was excited by the prospect of a U.S. president who sympathized completely with business.  His promised tax and healthcare reforms were widely cheered by investors in the wake of his election.  Yet the Congress has so far failed to deliver on those promises and investors are no longer giving the Trump administration a free pass based on the assumption that tax breaks are on the way.

This loss of enthusiasm is reflected in the long periods of dullness the market has experienced since March.  While the bull market leg which began with the November election remains intact, the market has proceeded in a halting fashion and has gradually lost some of its erstwhile momentum.  The following graph illustrates this principle. 

Along these lines, a number of Wall Street economists have expressed the belief that if Trump’s promised reforms fail to materialize, the stock market’s current valuation precludes a continuation of the bull market.  There are a number of reasons why this statement is likely false, however, not the least of which is that the market doesn’t need a political excuse to rally.  Indeed, if that were the case then China’s equity market, in view of the country’s Communist government, would forever be stuck in neutral.  The pace of innovation and productivity in countries with a market-driven economy is consistently high enough to always provide some justification for higher valuations and stock prices, regardless of the political climate.

Writing nearly 200 years ago, Alexis de Tocqueville observed that in America no matter how much the tax burden increased, American ingenuity and resourcefulness always found a way to counteract its malignant effect.  He stated:

“It is certain that despotism ruins individuals by preventing them from producing wealth, much more than by depriving them of the wealth they have produced; it dries up the source of riches, whilst it usually respects acquired property.  Freedom, on the contrary, engenders far more benefits than it destroys; and the nations which are favored by free institutions invariably find that their resources increase even more rapidly than their taxes.”  [Democracy in America]

Tocqueville understood that America is unique among the nations in that its people and commercial spirit are strong enough to countervail even the most strenuous attempts by politicians at slowing commercial progress.   This principle is as true today as it was then, perhaps even more so.

While many analysts are concerned by currently high market valuation indicators, the reality is that valuations can climb considerably higher before the market is in imminent danger of a bear market.  The S&P 500 P/E ratio may be high at 26.13 by historical standards, it’s still a ways from those high levels in the late 1990’s/early 2000’s which preceded the death of the powerful ‘90’s bull market.  Moreover, price/earnings alone isn’t a reliable measure of how undervalued or overvalued a market is.  One must also take into account the investor sentiment backdrop, levels of participation among retail investors, and other technical and monetary policy factors when forming a final determination as to whether or not the market is truly “overvalued.” 

To illustrate how important it is to consider investor sentiment along with valuation, I reprint here the words of William Jiler, who wrote investment books in the 1960s.  Using International Business Machines (IBM) as an example, he wrote:

“How could [an investor] anticipate that IBM would sell as low as 12 times its annual profit in the late Nineteen Forties and at 60 times earnings in the late Fifties?  Obviously, ‘investor confidence’ went up sharply in the Fifties.  And obviously, the psychology of the market – that is, the sum of the attitudes of all potential buyers and sellers – is a crucial factor for determining prices.”  [How Charts Can Help You in the Stock Market]

The main consideration for stocks going forward is the level of participation among individual investors.  With investor sentiment still neutral and few small investors actively trading, the bull market still has plenty of room to run.  The informed investors who are keeping the bull market alive need someone to sell to when it finally comes time for them to unload their holdings.  That someone is the uninformed public which by and large has been afraid of owning stocks since the 2008 credit crash.  Until they rediscover the “joys of investing” the 8-year-old bull market will continue to age, all the while maintaining its vigor. 

History teaches that following a major financial crisis, a bull market lasting from around 20 to 30 years normally follows.  Such was the case following the Great Crash and Depression of the 1930s, the economic and political turmoil of the early 1970s, and in other eras in U.S. market history.  The last crisis in 2008-09 witnessed the birth of a new secular bull market which is already eight years old.  A generation is around 20-30 years, which partly explains why bull market typically last so long until the next great crash; it takes that long for the generation that experienced the last crisis to be replaced by an entirely new one which doesn’t remember it.  It’s only when the new generation has come of age that the mistakes which led to the previous crisis are repeated and the cycle begins anew.

Given that the current generation is still, nearly 10 years later, still averse to stocks to a large extent, the secular bull market has probably another 10-20 years to run before encountering the problems which always prove fatal to it.  I’m referring of course to the dangers of over-participation and excess enthusiasm.  Those dangers are nowhere in sight today.  We can therefore assume that the long-term bull market still has many more years to run before eventually reaching its terminus.   

Is the market all-knowing?

“The tape tells all” is a Wall Street bromide we’re all familiar with.  It neatly summarizes the belief that the major averages discount everything pertaining to the business outlook.  It’s also a basic tenet of Dow Theory.

Writing a century ago, Richard Wyckoff was one of the very first market pundits to put this belief in writing.  “The tape tells the news minutes, hours and days before the news tickers or newspapers and before it can become current gossip,” he wrote.  “Everything from a foreign war to the passing of a dividend; from a Supreme Court decision to the ravages of the boll-weevil is reflected primarily upon the tape.”

This sentiment was also eloquently summarized by author Robert Rhea over 80 years ago.  Writing in his classic book, The Dow Theory, Rhea observed:

“The fluctuations of the daily closing prices of the Dow-Jones rail and industrial averages afford a composite index of all the hopes, disappointments, and knowledge of everyone who knows anything of financial matters, and for that reason the effects of coming events (excluding acts of God) are always properly anticipated in their movement.  The averages quickly appraise such calamities as fire and earthquakes.”

The late Joe Granville took this a step further by suggesting that the stock market represents the sum total of a nation’s intelligence across many different fields.  He maintained that the market knows virtually everything worth knowing about the short-to-intermediate-term outlook.

Writing in September 2004, just after a devastating series of Florida hurricanes, Granville observed: “When the stock market turns down it is warning of trouble ahead.  It doesn’t matter what the trouble turns out to be…For a look at the future it was only necessary to follow the market instead of hurricane reports.”  In view of the vulnerable state of the market prior to the major hurricanes of 2005 and 2012 (Katrina and Sand), perhaps Granville was on to something.

Not all investors believe that Mr. Market reflects the sum of all wisdom as it pertains to the future outlook, however.  Proponents of Random Walk Theory in particular dismiss this notion with scorn.  But are they right to reject this proposition?

Experience has shown that Granville’s proposition is essentially correct, if overly simplistic.  To assume that the market always declines at the first scent of trouble would be the height of folly.  The collective wisdom of informed investors does tend to trace out its foresight in the charts, but it isn’t always blatantly obvious at first and sometimes is evident only in retrospect.  The market action of the year 2007 is instructive.  Consider that beginning in February that year the market commenced a series of volatility plunges as insiders first began to manifest their advance knowledge of the coming credit storm.

In between, and immediately after, the market plunges in February and August ’07, however, the S&P made new highs.  This was either a consequence of the recoil rallies going too far, or was the result of manipulation to disguise insider selling.  The lesson here is that while Mr. Market will usually provide advance warning signals for trouble on the horizon you must often pay close attention to discern those signals, for it isn’t always obvious. 

If the tape does indeed tell all, what is it telling us now?  The major indices and the NYSE breadth indicators have been in good shape for most of the year.  By the same token, cumulative trading volume has been subdued because of diminished participation among individual traders as passive ETF investing has gained popularity.  The major averages have been buoyant, but not lively, in recent months.  This has been reflected in the economic news for most of the year, and there have been no crisis events to speak of.  The market, in short, has been dull and listless in reflection of the lack of bad news news.  You could even say that the market has predicted the lethargic U.S. political/economic scene of recent months by its own lack of excitement. 

If the tape indeed tells all (and I believe it does), then it’s telling us that there are currently no major worries among informed investors and insiders about anything that might torpedo the U.S. ship of state and disturb the country’s equanimity.  Developments of this magnitude take time to develop and the traces of these dangers always eventually manifest in the stock market long before making an announcement anywhere else. 

This is not to say that the market will necessarily continue to experience smooth sailing for the balance of the year, as short-term volatility tends to be erratic and isn’t always predictable.  But the tape doesn’t suggest anything calamitous on the horizon, contrary to the warnings of the perpetual alarmists.  The secular bull market which began in 2009 is still very much intact with lots of room to run before entering those tumultuous shoals which always mark the end of the line.  By the time that point has arrived, however, the tape will have long since whispered the danger to those who bother to listen.  

The silent economic boom

[Note: I was recently interviewed by Kenneth Ameduri who hosts the Crush The Street internet show.  In it I discuss my take on gold, stocks, Trump, the economy and Bitcoin.  The interview can be found here: https://crushthestreet.com/videos/live-interviews/economic-bubble-burst-trumps-watch-clif-droke-interview]

Though many Americans aren’t feeling it, the economy is quietly gathering forward momentum.  With consumers gaining in confidence and real estate heating up on both the commercial and residential levels, the U.S. economy is much stronger than it may seem at first glance.

One reflection of the strengthening economy is the equity market, which is in the eighth year of a bull market since the bottom of the credit crash.  The bromide, “As goes the stock market, so goes the economy,” is something that hardly needs explaining, yet so many investors lose sight of this cogent fact that it bears repeating.  Rising corporate profits and efficiencies in recent years have contributed in large part to the economic improvement. 

Another reflection of the recovery can be seen in our in-house New Economy Index (NEI), which combines the stock prices of the leading U.S. retail and business service stocks.  The graph below shows that NEI continues to hit all-time highs on almost a weekly basis and as such is reflecting a strong consumer retail economy.

With so many indicators pointing to a strong economy, why then are so many Americans acting as if recession is imminent?  That’s the question we’ll address here.

Ed Hyman is one of the most respected, and accurate, economists.  As Barron’s recent observed, he has been voted Wall Street’s top economist for 36 of the past 41 years in Institutional Investor’s annual poll.

In an interview conducted by Barron’s editor Randall Forsyth, Hyman said he sees cities around the U.S. “booming,” including smaller ones away from the megalopolises on the coasts. His conclusion is that this will benefit Main Street more than Wall Street.

Hyman has a rather old-fashioned, yet highly effective, method of gathering data from which to make his forecasts.  His team of researchers simply contact companies such as employment agencies, truckers, car dealerships and home builders and ask, “How’s business?”  A rating scale of zero to 100 is used by respondents to describe business conditions and from this tally Mr. Hyman is able to get a good read on what’s happening in the economy. 

According to Barron’s, Hyman’s surveys were trending higher well ahead of last year’s election.  “At that time,”  quoting the Barron’s article, “his model was forecasting real growth in gross domestic product of about 1.5%, although not as ‘uplifting’ as the recent ‘soft data,’ such as confidence surveys, indicate.  Now, the model points to 3% growth, bolstered by indicators such as tight credit spreads and high consumer net worth, which accords with what he calls a ‘scientific method.’”

Ad Ed travels around the country, he’s finding that “every place is booming,” he told Barron’s.  “Every major city, Chicago, Minneapolis, Kansas City, they’re doing great.”  Smaller cities are also outperforming, he says.

Hyman also reports that “millennials are coming on like locusts,” as they emerge from years of living in their parents’ basements.  “They’re getting jobs and apartments,” he told Barron’s.  “Millennials’ employment is growing at 3% while everything else is growing 1%.”

Hyman also pointed out that many observers have undervaued the extent to which central banks around the globe “are still flooding the system every week” with liquidity, with the Bank of England and the ECB having purchased more than two trillion euros’ ($2.14 trillion) worth of bonds in less than three years.  Meanwhile the BOJ and the Federal Reserve, along with the ECB, hold $13 trillion in assets, which has lowered interest rates around the globe.  This, he says, explains how the Fed funds rate at just 0.80% while U.S. companies are doing so well.

If Hyman’s macro optimism is to be believed – and our indicators strongly suggest he is right – then 2017 may prove to be the year that the U.S. economy finally takes off and leaves investors with no doubts as to its latent strength and momentum. 

Crush The Street Interview

I was recently interviewed by Kenneth Ameduri who hosts the Crush The Street internet show.  In it I discuss my take on gold, stocks, Trump, the economy and Bitcoin.  The interview can be found here:

https://crushthestreet.com/videos/live-interviews/economic-bubble-burst-trumps-watch-clif-droke-interview

The bull market and Donald Trump's death knell

In the minds of many investors, the election victory of Donald J. Trump to the United States Presidency was nothing short of a miracle.  Following his shocking victory, expectations were high that Trump would, with the help of Congress, fulfill his promises of tax reform and infrastructure spending.  The lifting of the heavy penalties associated with Obamacare was another hope that investors cherished.  Many hailed his victory by declaring that it was “morning in America” again.  But after only six months since the election, Trump's presidency has hit a potentially fatal obstacle and he now faces the growing possibility of impeachment. 

By now the particulars of the political onslaught against President Trump are well known and there is no need to recount it.  Impeachment in the wake of recent developments has become an increasing likelihood, and it is said that even the Trump White House is preparing for it.    It now appears that the president will be investigated by a Congressional inquiry with the possibility of eventually being replaced by his vice president.  The powers-that-be, it seems, have decided they've seen enough of Trump's muscular leadership and controversial America-first plans. 

How did America come full circle so quickly?  What started as a widespread hope that a president who fully understood the needs of commerce and would do everything in his power to further America's economic future now faces an ignominious ending.   Can this be chalked up to voter's remorse or the volatile temper of the American voter?  Or is it simply a case of Trump's ideological opponents taking an aggressive approach to derail his ambitious reform plans? 

A more likely answer is that Trump's election was a fluke and that it was never intended that a man of such convictions could ever be allowed to lead today's left-leaning society.  There are a few basic principles which can be addressed here.  One is that the leader of a free country is generally a reflection of the people he represents.  Is it credible to assume that today's average American favors the type of free-enterprise capitalism championed by Trump?  America's shift to the left of the political spectrum has become pronounced in the last two decades and the long-term trend is conducive to more socialist activism, not less, in government.  France has only recently been reminded of that and the U.S. is now being faced with that lesson. 

If anything, Trump's election victory was an aberration – a counter-trend rally in financial market terms.  It was born of deep frustration among middle class voters.  After the painful experiences of the Great Recession and years of stagnation, Main Street America was in a rebellious mood.  Donald Trump represented a radical departure from Washington-as-usual and, unlike the other candidates, he addressed middle class concerns in the most vigorous terms.  Voting for Trump was essentially an act of defiance, a way of rejecting the Establishment which professed concern for the plight of the middle class but did nothing to help it.

Indeed, Trump's election was tantamount to a full-scale middle class revolt.  As with all revolutions, however, this one appears destined to end at the point of origin with no net progress to show for it.  (A revolution, after all, consists in making a full circle according to a literal rendering of the word.)  Since his election victory was against the primary trend toward socialism, Trump's eventual replacement as president will almost certainly be in line with the status quo, and the middle class will once again be ignored.

Incidentally, the word revolution has more than one application here.  The long-term economic Kress cycle which bottomed around the year 2014 was described by the late cyclist Samuel J. Kress as the “Revolutionary Cycle.”  This observation was based on the cycle's tendency to usher in a new socioeconomic order when it bottoms (e.g. the transition of the U.S. from an agrarian to an industrial economy in the late 19th century).  Before his death, Kress forecast that the next bottom of the 120-year cycle around 2014 would witness the final transition from free-market capitalism in the U.S. to a much more aggressive socialist government.  His prediction proved prescient when one considers that the Affordable Care Act (a.k.a. Obamacare) was the first major legislative inroad to full-blown socialism since the New Deal of the 1930s. 

The revolutionary aspect of the long-term Kress cycle – which also answers to the Kondratieff wave, or K-wave – provides the context for the mass discontent we’ve seen develop in the U.S. and other countries in recent years.  From Occupy Wall Street to Arab Spring to Brexit, discontent has been widespread in the wake of the 2007-2012 economic malaise.  Students of behavioral finance are aware of the connection between financial market collapse and mass psychology.  After a major shock in the financial market/economy, it usually takes several years for the resulting psychological impact to fully disappear.  This is why revolutions are common occurrences in the years following such a shock, not during the actual shock itself.  Humans are reactive by nature and it takes them a while, in the aggregate, to psychologically process an economic shock, hence the delayed reaction to the economic event in question.

The mentality behind the above mentioned revolutions also resulted in Donald Trump’s presidential victory.  But since this revolutionary episode was against the grain of the prevailing political wind, its lifespan will likely be brief.  Many European countries are already rethinking their political reactions against the European Union.  Now America will soon be forced to decide whether it truly wants to commit to the path it chose last November. 

Free market capitalism can survive only when a country’s citizens are fiercely committed to preserving personal liberty and self-initiative.  It requires a healthy, but respectful, disdain of government interference and a reliance on one’s own ingenuity to thrive.  If the Obamacare debate was any indication, America lacks the internal strength and will to survive as a free-market economy.  For this reason and others, socialism will eventually reassert its sway in the U.S. once the wave of revolutionary fervor subsides.

Returning to the subject at hand, how would a Trump impeachment affect the markets?  Will the secular bull market in stocks continue if Trump were removed from office?  What about the potential impact on the price of gold?  A successful Donald Trump presidency replete with tax and Obamacare reform would not have been good for the price of gold.  Gold is primarily a barometer of investor fear and uncertainty.  Tax reform would almost certainly have benefited both corporate profits and the economy, and a booming economy isn’t normally conducive for a vibrant gold market (the exception being a war-time economy).  However, the uncertainty generated by an investigation and subsequent impeachment hearings would likely serve to buoy the gold price to some degree.  The greater the uncertainty surrounding the outcome of Trump’s trial by fire, the more likely gold will benefit.

As for equities, the secular bull market which began in 2009 for the S&P 500 is still alive and will likely remain intact even if Trump is impeached.  The stock market hasn’t been as vibrant in the last couple of years due to a variety of technical and fundamental factors, including the uncertainties surrounding the U.S. political outlook.  Yet throughout the ups and downs of the last two years, there has been one constant: the lack of interest among retail investors.  Americans by and large lost their appetite for equities several years ago and it shows little sign of returning to normal in the immediate future.  This factor alone will ensure the bull’s longer-term survival throughout the short-term uncertainties, for no major bull market can end until the informed “smart money” investors unload their holding on uninformed participants (“dumb money”).  The big money investors have to have someone to sell to as they can’t very well unload their stocks amongst themselves.  So until we see the return of equity mania, we can be assured of the bull’s continuance notwithstanding its reduced vigor. 

What will finally break the market's lethargy?

To most individual traders, there is no bigger buzz kill than a narrow trading range.  It takes the wind out of the sails of breakout and momentum traders, and even expert stock pickers have a tough time finding the stocks which are bucking the sideways trend.

Wall Street would much rather see a lively bull market when stocks are roaring and participation is widespread among all classes of investors.  But sometimes even a trading range-type market is good enough for the Street , provided stock prices are near all-time highs.  For even when prices are making no headway, the aggregate yield on stocks pays enough in dividends to make the lack of action worthwhile. 

There are indeed enough listed companies which pay a high enough dividend to make buying and holding in a lackadaisical stock market an attractive proposition.  This is one reason for the torpor which currently infuses not only the financial market, but the rest of the country as well.  Why worry when you can sit back and live off the interest?  Widespread lethargy breeds a range-bound stock market, but it also contributes to a sluggish economy.  As we'll discuss here, there is a reason for the public's lethargy and within that reason lies the solution to the problem. 

If you needed proof of the trading range-induced complacency out there right now, the public's response to the U.S. airstrike on Syria is a good example.  While there was a modicum of shock and anger, the response to the military action was mostly lethargic.  Even the stock market seemed unimpressed enough to rally, which underscores the extent of the public's complacency. 

Even Congress is infected with the conservation bug.  Even as President Trump touts his ambitious plan to cut taxes, the U.S. House majority leader is pouring water all over that plan by saying Congress will balance any proposed tax cuts by finding ways to increase revenues (read more taxes, but in different areas).  Thus the old "paying Peter by robbing Paul" syndrome has infused America's elected leaders, who seem to afraid to risk anything like general prosperity.

One certainly can't fault the President for trying to break the lethargy that has dominated the economy in the last two years.  His attempt at lifting the huge burdens imposed on the middle class by reforming Obamacare were spurned by Congress.  His latest move appears  aimed at stimulating the economy via military conflagration, a tried-and-true (short-term) economic palliative to be sure.

The subdued mood of the market can only be understood in terms of the long-term economic cycle, or K-wave.  This cycle is divided into four "seasons" of economic activity over a period encompassing roughly 60 years.  Each season approximates to 15 years.  The winter season of the cycle was between 2000-2014/15, with the last 60-year cycle bottoming at the end of 2014.  We're now in the early stages of K-wave spring, which should last until about 2029/30. 

So if economic spring has sprung, what is keeping the economy from flourishing?  The answer to that is best seen in a timely analogy.  Even as the Northern hemisphere experiences the early phase of spring in April, there are still lingering signs of the previous winter.  While most days are fairly warm, temperatures can still be sometimes chilly and even winter-like.  It takes a while for a new season to fully establish itself while the vestiges of the preceding season gradually fade away.  In like manner, it will probably take a few years for K-wave spring to become established -- especially given the severity of the K-wave winter season a few years ago. 

The question everyone is concerned with is what will it take to finally break the psychological shackles which have held back profligate spending and retail-level investing?  The answer to that question can be found in the previous paragraph: the immutable laws of the economic K-wave will eventually lay the foundation for a fundamental change in mass psychology. 

At some point in the current K-wave spring season the zeitgeist of contraction and fiscal restraint will give way to expansion and liberality.  Until then, expect to see occasional flare-ups of the winter mentality that predominated in the last decade.  These flare-ups should become more and more infrequent, however, as the K-wave spring season gradually warms the blood and increases the animal spirits. 

When K-wave spring finally hits full bloom, it will bring many economic benefits.  There will be a few signs to watch for to let us know that spring has fully arrived.  First and foremost, watch for higher yields on U.S. Treasury bonds.  There is no surer sign that the long-term economic cycle is accelerating than rising bond yields. 

As the new K-wave upward phase progresses we'll also see increasing real estate activity as prospective home buyers and commercial builders alike look to lock in still-attractive mortgage rates before they get too high.  As real estate timer Robert Campbell addressed in his latest newsletter (www.RealEstateTiming.com), U.S. home prices have broken out of a two-year doldrums phase and are rising at their fastest pace since 2014.  The momentum of real estate activity is on the upswing. 

Finally, look for speculative interest in both stocks and commodities to increase on a large scale.  Risk aversion is a lingering symptom of the contractionist psychology of the K-wave winter season.  When K-wave spring blooms in full, however, investment activity will pick up as participants shed their anxieties and trade them in for a more optimistic outlook.  

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.

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.

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.   

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.    

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.