Posts tagged ‘volatility index’
The Central Bank Dog Ate My Homework
It’s been a painful four years for the bears, including Peter Schiff, Nouriel Roubini, John Mauldin, Jimmy Rogers, and let’s not forget David Rosenberg, among others. Rosenberg was recently on CNBC attempting to clarify his evolving bearish view by explaining how central banks around the globe have eaten his forecasting homework. In other words, Ben Bernanke is getting blamed for launching the stock market into the stratosphere thanks to his quantitative easing magic. According to Rosenberg, and the other world-enders, death and destruction would have prevailed without all the money printing.
In reality, the S&P 500 has climbed over +140% and is setting all-time record highs since the market bottomed in early 2009. Despite the large volume of erroneous predictions by Rosenberg and his bear buddies, that development has not slowed the pace of false forecasts. When you’re wrong, one could simply admit defeat, or one could get creative like Rosenberg and bend the truth. As you can tell from my David Rosenberg article from 2010 (Rams Butting Heads), he has been bearish for years calling for outcomes like a double-dip recession; a return to 11% unemployment; and a collapse in the market. So far, none of those predictions have come to fruition (in fact the S&P is up about +40% from that period, if you include dividends). After being incorrect for so long, Rosenberg has switched his mantra to be bullish on pullbacks on selective dividend-paying stocks. When pushed whether he has turned bullish, here’s what Rosenberg had to say,
“So it’s not about is somebody bearish or is somebody bullish or whether you’re agnostic, it’s really about understanding what the principle driver of this market is…it’s the mother of all liquidity-driven rallies that I’ve seen in my lifetime, and it’s continuing.”
Rosenberg isn’t the only bear blaming central banks for the unexpected rise in equity markets. As mentioned previously, fear and panic have virtually disappeared, but these emotions have matured into skepticism. Record profits, cash balances, and attractive valuations are dismissed as artificial byproducts of a Fed’s monetary Ponzi Scheme. The fact that Japan and other central banks are following Ben Bernanke’s money printing lead only serves to add more fuel to the bears’ proverbial fire.
Speculative bubbles are not easy to identify before-the-fact, however they typically involve a combination of excessive valuations and/or massive amounts of leverage. In hindsight we experienced these dynamics in the technology collapse of the late-1990s (tech companies traded at over 100x’s earnings) and the leverage-induced housing crisis of the mid-2000s ($100s of billions used to speculate on subprime mortgages and real estate).
I’m OK with the argument that there are trillions of dollars being used for speculative buying, but if I understand correctly, the trillions of dollars in global liquidity being injected by central banks across the world is not being used to buy securities in the stock market? Rather, all the artificial, pending-bubble discussions should migrate to the bond market…not the stock market. All credit markets, to some degree, are tied to the trillions of Treasuries and mortgage-backed securities purchased by central banks, yet many pundits (i.e., see El-Erian & Bill Gross) choose to focus on claims of speculative buying in stocks, and not bonds.
While bears point to the Shiller 10 Price-Earnings ratio as evidence of a richly priced stock market, more objective measurements through FactSet (below 10-year average) and Wall Street Journal indicate a forward P/E of around 14. A reasonable figure if you consider the multiples were twice as high in 2000, and interest rates are at a generational low (see also Shiller P/E critique).
The news hasn’t been great, volatility measurements (i.e., VIX) have been signaling complacency, and every man, woman, and child has been waiting for a “pullback” – myself included. The pace of the upward advance we have experienced over the last six months is not sustainable, but when we finally get a price retreat, do not listen to the bears like Rosenberg. Their credibility has been shot, ever since the central bank dog ate their homework.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients hold positions in certain exchange traded funds (ETFs) , but at the time of publishing SCM had no direct position in any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC Contact page.
The Fund Flows Paradox
How is it that the stock market has more than doubled over the last three years, when investors have been dumping stocks like they are going out of style? If you don’t believe me, and you think jovial investors are jacking stocks higher, then please explain to me why billions of dollars are hemorrhaging out of equity funds on a monthly basis over the last five years (see Fund Flow data chart below)?
Source: Calafia Beach Pundit
If by small chance you buy my argument that skeptical investors continue to doubt the sustainability of the three-year doubling in the stock market, then why is the Volatility Index (VIX) trading like investors are sunbathing at the beach while licking lollipops? For those not keeping score on the VIX (see also The VIX and the Rule of 16), typically a reading below 20 is interpreted as investor overconfidence and/or complacency. On the flip side, readings above 20 usually indicate pessimism or fear.
As you can see from the chart below, we have spent a good portion of the last few years on both sides of the 20 mph VIX speed limit, and currently at a reading of about 17, investors have slowed down to enjoy the scenery.
Source: Yahoo! Finance
So with massive selling and a cheery reading on the VIX, how can these bipolar data-points be reconciled? Therein lies the “Fund Flows Paradox.”
Take Me Out to the Ballgame
If you equate equity investors to fans at a baseball stadium, the fund flow data clearly shows investors are tired of losing money and have been leaving the game in droves. Instead of staying at the equity baseball stadium, those fatigued stock investors have decided to head over to the adjacent bond arena. The equity stadium will never completely be empty because financial markets always have speculative traders. In baseball terms you can think of these short-term traders as the emotionally volatile die-hard fanatics, who will stick around regardless of whether the home team wins or loses.
So while sentiment gauges like the VIX, or sentiment surveys conducted by AAII (American Association of Individual Investors) may be temporarily flashing contrarian bearish signals, one should be cognizant that these data points do not include the petrified opinions of investors who have raced out of the stadium. Eventually when the home team’s winning streak is long enough, investors will return back to the stadium from the bond arena. While there is no sign of individual investors coming back to the stock game anytime soon, in the meantime patient and disciplined investors have had plenty of opportunities to take advantage of. With massive numbers of individual investors and sellers sitting on the sidelines, the markets require relatively little buying to push prices higher.
Over the last few years, not only have equity valuations been broadly reasonable, volatility spikes during the last few summers have also created amplified opportunities. With the wall of worries currently blanketing traditional and new media headlines (i.e., European crisis, U.S. election uncertainty, unsustainable and slowing profits, pending tax cut expirations, Mideast turmoil, etc.) there is no sense of urgency to pile back in to the equity markets.
The doubling in stock prices have occurred on low volumes, largely on the backs of a smaller institutional investor base, not to mention high frequency traders and speculators. While sentiment surveys may currently provide some insight into short-term equity trader attitudes, don’t let these volatile and unreliable data cloud the true underlying pessimism of the masses who have left the stock stadium in large numbers. Trillions of dollars remain on the sidelines as potential fuel for future equity appreciation, once confidence returns.
Opinions are interesting, but actions speak louder than words. Spend more time looking at the actions of the fund flow data, rather than the opinions of various short-term sentiment surveys or short-term options trader statistics. Adjusting your focus to investor actions and behavior will provide a truer gauge of overall investor sentiment and assist you in solving the “Fund Flows Paradox.”
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients own certain exchange traded funds, but at the time of publishing SCM had no direct position in VXX, or any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC “Contact” page.
Bears Hibernate During Melt-Up
Source: Photobucket
Here we are 719 days from the market bottom of March 2009, and the S&P 500 has more than doubled from its index low value of 666 to 1343 today. Noticeably absent during the meteoric rise have been the hibernating bears, like economist Nouriel Roubini (aka “Dr. Doom”) or Peter Schiff (see Emperor Schiff Has No Clothes), who blanketed the airwaves in 2008-2009 when financial markets were spiraling downwards out of control. The mere fact that I am writing about this subject may be reason enough to expect a 5-10% correction, but with a +100% upward move in stock prices I am willing to put superstition aside and admire the egg on the face of the perma-bears.
Shape of Recovery
After it became clear that the world was not coming to an end, in late 2009 and throughout 2010, the discussion switched from the likelihood of a “Great Depression” to a debate over the shape of the alphabet letter economic recovery. Was the upturn going to be an L-shaped, V-shaped, square root-shaped, or what Roubini expected – a U-shaped (or bathtub-shaped) recovery? You be the judge — does six consecutive quarters of GDP expansion with unemployment declining look like a bathtub recovery to you?
Chart Source: Yahoo Finance
This picture above looks more like a “V” to me, and the recently reported Institute for Supply Management’s (ISM) manufacturing index figure of 60.8 in January (the highest reading in seven years) lends credence to a stronger resurgence in the economy. Apparently the PIMCO bear brothers, Mohamed El-Erian and Bill Gross, are upwardly adjusting their view of a “New Normal” environment as well. Just recently, the firm raised its 2011 GDP forecast by 40-50% to a growth rate of 3-3.5% in 2011.
The Bears’ Logic
Bears continually explain away the market melt-up as a phenomenon caused by excessive and artificial liquidity creation (i.e., QE2 money printing, and 0% interest rate policy) Bernanke has provided the economy. Similar logic could be used to describe the excessive and artificial debt creation generated by individuals, corporations, and governments during the 2008-2009 meltdown. Now that leveraged positions are beginning to unwind (banks recapitalizing, consumers increasing savings rate, state and government austerity and tax measures, etc.), the bears still offer little credit to these improving trends.
Are we likely to experience another +100% upward move in stock prices in the broader indexes over the next two years? Unlikely. Our structural government debt and deficits, coupled with elevated unemployment and fiercer foreign competition are all factors creating economic headwinds. Moreover, inflation is starting to heat up and a Federal Funds rate policy cannot stay at 0% forever.
The Shapes of Rebounds
To put the two-year equity market recovery in historical perspective, the Financial Times published a 75-year study which showed the current market resurgence (solid red line) only trailing the post-Great Depression rebound of 1935-1938.
Source: Financial Times
Although we are absolutely not out of the economic woods and contrarian sentiment indicators (i.e., Volatility Index and Put-Call ratio) are screaming for a pullback, the foundation of a sustainable global recovery has firmed despite the persisting chaos occurring in the Middle East. Fourth quarter 2010 corporate profits (and revenues) once again exceeded expectations, valuations remain attractive, and floods of itchy retail cash still remain on the sidelines just waiting to jump in and chase the upward march in equity prices. Although the trajectory of stock prices over the next two years is unlikely to look like the last two years, there is still room for optimism (as I outlined last year in Genesis of Cheap Stocks). The low-hanging equity fruit has been picked over the last few years, and I’m certain that bears like Roubini, Schiff, El-Erian, Gross, et.al. will eventually come out of hibernation. For those investors not fully invested, I believe it would be wise to wait for the inevitable growls of the bears to resurface, so you can take further advantage of attractive market opportunities.
Click Here for More on the PIMCO Downhill Marathon Machine
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients own certain exchange traded funds, but at the time of publishing SCM had no direct position in any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC “Contact” page.
Investing Caffeine 
