Thoughts from the Frontline: Bubbles, Bubbles Everywhere

By John Mauldin

The difference between genius and stupidity is that genius has its limits.
– Albert Einstein

Genius is a rising stock market.
– John Kenneth Galbraith

Any plan conceived in moderation must fail when circumstances are set in extremes.
– Prince Metternich

You can almost feel it in the fall air (unless you are in the Southern Hemisphere). The froth and foam on markets of all shapes and sizes all over the world. It is an exhilarating feeling, and the pundits who populate the media outlets are bubbling over with it. There is nothing like a rising market to help lift our mood. Unless of course, as Prof. Kindleberger famously cautioned (see below), we are not participating in that rising market. Then we feel like losers. But what if the rising market is … a bubble? Are we smart enough to ride and then step aside before it bursts? Research says we all think that we are, yet we rarely demonstrate the actual ability.

This week we'll think about bubbles. Specifically, we'll have a look at part of the chapter on bubbles from my latest book, Code Red, which we launched last week. At the end of the letter, for your amusement, is a link to a short video of what you might hear if Jack Nicholson were playing the part of Ben Bernanke (or Janet Yellen?) on the witness stand, defending the extreme measures of central banks. A bit of a spoof, in good fun, but there is just enough there to make you wonder what if … and then smile. Economics can be so much fun if we let it.

I decided to use this part of the book when numerous references to bubbles popped into my inbox this week. When these bubbles finally burst, let no one exclaim that they were black swans, unforeseen events. Maybe because we have borne witness to so many crashes and bear markets in the past few decades, we have gotten better at discerning familiar patterns in the froth, reminiscent of past painful episodes.
Let me offer you three such bubble alerts that came my way today. The first is from my friend Doug Kass, who wrote:

I will address the issue of a stock market bubble next week, but here is a tease and fascinating piece of data: Since 1990, the P/E multiple of the S&P 500 has appreciated by about 2% a year; in 2013, the S&P's P/E has increased by 18%!

Then, from Jolly Olde London, comes one Toby Nangle, of Threadneedle Investments (you gotta love that name), who found the following chart, created a few years ago at the Bank of England. At least when Mervyn King was there they knew what they were doing. In looking at the chart, pay attention to the red line, which depicts real asset prices. As in they know they are creating a bubble in asset prices and are very aware of how it ends and proceed full speed ahead anyway. Damn those pesky torpedoes.

Toby remarks:

This is the only chart that I’ve found that outlines how an instigator of QE believes QE’s end will impact asset prices. The Bank of England published it in Q3 2011, and it tells the story of their expectation that while QE was in operation there would be a massive rise in real asset prices, but that this would dissipate and unwind over time, starting at the point at which the asset purchases were complete.

Oh, dear gods. Really? I can see my friends Nouriel Roubini or Marc Faber doing that chart, but the Bank of England? Really?!?

Then, continuing with our puckish thoughts, we look at stock market total margin debt (courtesy of those always puckish blokes at the Motley Fool). They wonder if, possibly, maybe, conceivably, perchance this is a warning sign?



And we won’t even go into the long list of stocks that are selling for large multiples, not of earnings but of SALES. As in dotcom-era valuations.

We make the case in Code Red that central banks are inflating bubbles everywhere, and that even though bubbles are unpredictable almost by definition, there are ways to benefit from them. So, without further ado, let’s look at what co-author Jonathan Tepper and I have to say about bubbles in Chapter 9.

To continue reading this article from Thoughts from the Frontline – a free weekly publication by John Mauldin, renowned financial expert, best-selling author, and Chairman of Mauldin Economics – please click here.

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Weekly Futures Recap with Mike Seery

We’ve asked our trading partner Michael Seery to give our readers a weekly recap of the Futures market. He has been Senior Analyst for close to 15 years and has extensive knowledge of all of the commodity and option markets.

Michael frequently appears on multiple business networks including Bloomberg news, Fox Business, CNBC Worldwide, CNN Business, and Bloomberg TV. He is also a guest on First Business, which is a national and internationally syndicated business show.

Crude oil futures continued their downward trend finishing lower by $1.75 a barrel in the December contract closing last Friday at 97.80 and going out this Friday at 94.50 a barrel hitting a 4 month low. Crude oil prices have declined in the last 4 consecutive trading days as the next major resistance is at 91 and I have been recommending a short position in this market for quite some time and I do think prices are headed lower as there is a global supply glut of crude oil with slowing demand and rising inventories. This is the 1st time I can remember in many years where the stock market & crude oil prices are going in opposite directions which tells me the stock market is starting to benefit from lower gas prices as the unemployment rate still remains relatively high keeping demand low.

When I recommended this trade a couple weeks ago it had excellent chart structure risking around $500 on the trade and this one continues to move lower so continue to place your stop at the 10 day high if you took my advice because I do think prices are headed under $90 a barrel within the next couple of weeks especially if the U.S dollar continues to move higher as it’s done in the last 2 trading sessions. Many of the commodity markets continue to move lower with crude oil acting as the leader as the characteristics in many commodities at this time is an oversupply which is pressuring prices currently but economies around the world are starting to improve & it will put a floor on prices, however crude oil in my opinion is headed sharply lower. TREND: LOWER –CHART STRUCTURE: EXCELLENT

The silver market finished unchanged today after hitting a 5 week high earlier in the week then selling off $1.00 in yesterday’s trade to settle today around 21.80 an ounce. The Federal Reserve will continue its bond buying for the foreseeable future therefore which is bullish silver in my opinion but what happened in yesterday’s trade was buy the rumor and sell the fact as I think prices are still headed higher. I have been recommending a long position in many previous blogs and I do think that silver will retest the summer highs of $25 dollars and head towards $30 an ounce possibly by Christmas time. Silver is trading above its 20 and 100 day moving average signaling that the trend is getting stronger and with stronger economies around the world coupled with a weak U.S dollar silver gains may have just begun as I still think prices are cheap. Remember silver prices are down about 35% from their 52 week highs so there is room to run on the upside especially if the dollar drops another 300-500 points which is what the Federal Reserve is trying to accomplish and they are doing an excellent job I just wish they were as good at building websites as they are at printing money. TREND: HIGHER –CHART STRUCTURE: EXCELLENT

Coffee futures for the December contract continue to slump in New York right near a 5 year low as prices had been down 14 consecutive trading days currently at 105.55 a pound up 15 points in a lack luster trade today as prices look to break 100 and the next couple of weeks as supplies around the world are huge. The huge world production and harvest continuing in Vietnam pressuring prices as nobody has interest in buying coffee at this point and there is a real possibility of prices dropping to the 90 – 100 level and if prices do get down to the 90 level in my opinion I would start to be a buyer as eventually this market will turn around and all the bad news is already reflected in the price but it still looks weak at this time. Coffee is trading way below its 20 and 100 day moving average down over 400 points for the week continuing to be one of the best bear markets around. TREND: LOWER –CHART STRUCTURE: EXCELLENT

Here's some additional calls from Mike including sugar, cotton, wheat, soybeans and orange juice.
 

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What NOT to Do When Investing in Miners

By Eric Angeli, Investment Executive, Sprott Global Resource Investments

 

Precious metals miners are the most volatile stocks on earth. They're so volatile that investors often forget that underneath those whipsawing stock prices lie real businesses. But even many of those who consider themselves old pros in natural resource investing tend to get one thing wrong. Eric Angeli, an investment executive with Sprott Global Resources and protégé of legendary resource broker Rick Rule, explains how not to fall into the "top down" trap…



If the past two years have taught us anything, it's that trying to predict short term moves in the gold price can be a road to ruin. Parsing the umpteen countervailing forces that combine to set the price of gold is tough. And it's even tougher when you consider that oftentimes, market moving news, such as a central bank trade, isn't reported until after the fact.

In my years spent evaluating natural resource companies as a broker and analyst, I’ve found that there are two ways to successfully invest in precious metals equities. Doing it right can bolster the strength of your portfolio, not to mention your own confidence in your holdings.

Method #1—Top-Down Approach

 

You may have heard this method referred to as “Directional Investing.”
A directional investor decides that gold prices will increase in the long run. That's the starting point of his thesis. He then proceeds to find the companies that will be successful if his prediction comes true. He looks for companies with leverage to the gold price.

If an investor can get the timing right, this can be a lucrative strategy. There is an obvious caveat, though: for this strategy to work, precious metals prices must rise.

In my role as a broker, I deal with both companies and investors all day long. I can tell you that most speculators involved with gold equities use this top down approach.

That's why the number one question I’ve heard over the last three months has been, “Why isn’t gold moving up?” To directional investors, the answer to this question is paramount.

This mindset leads to the herd mentality and, frankly, gives us our best bull markets.
I prefer method #2.

Method #2—Fundamental Approach

 

Fundamental investors ignore prognostications about where gold prices might move next. We eliminate gold price movements as the crux of our investment decisions, which removes a lot of the guesswork from our portfolios. For a fundamental investor, gold prices are still a piece of the puzzle, but they are not the only driver.

Fundamental investors want to know: which company has a promising deposit in a relatively safe jurisdiction? Which has a tight share structure? This “bottom up” method, however, does require a lot more homework.
Fundamental investing is all about identifying the difference between a stock’s intrinsic value and the price at which it is trading at in the open market.

While I do believe in higher gold prices eventually, and inevitably, I know that short-term movements in the price of gold are beyond my control. I instead prefer to position my clients for success in the current environment. Instead of focusing on when the gold price will move, which we can never know, we focus on picking quality companies.

Why Hasn’t the Top-Down Approach Been Working?

 

You might say: because the price of gold hasn’t gone up! That's true, but there’s more to the story.
Until quite recently, gold has continued to rise, though not at the same clip we enjoyed after 2008. The problem is that miners' operating costs rose faster than the price of gold. Investors didn't expect that.
Nor did they factor in other cost increases. Sure, the value of a deposit rises every day the gold price rises. But did oil prices jump at the same time, making trucking the goods out more expensive? Did your laborers start demanding high wages? Did energy costs increase? Did the federal government demand a bigger slice of the pie?

Top down investors can stop trying to figure out why they haven’t been correct over the last several years. They were correct on the gold price, but they ignored underlying cost factors.

The Top 7 Things to Look For

This is where the Fundamental Approach shines. All of your investments should fulfill a few key checkpoints:

1. Look for companies where management owns a large percentage of the stock. A vested interest at a higher share price is even better.
2. Look for a tight capital structure. A bloated outstanding share count is a red flag. As is a history of management carelessly diluting away shareholder interest by issuing new stock.
3. Look for a thrifty management team. A good company should spend their capital on projects, not swanky new offices.
4. The company's mine should remain profitable even if gold drops to $1,000 per ounce. It could happen.
5. Look for companies with enough cash to finance their current drill program, expansion plans, feasibility study, or construction phase. This year in particular, companies are having a very difficult time finding financing. Those who have adequate cash are diamonds in the rough.
6. Know which countries support mining. A tier-one asset under the control of a wildly corrupt government isn't really a tier-one asset. You don't want to get caught in the middle of a government dangling final permits above managements’ heads.
7. Know the geological potential of the exploration area. A four-million-ounce gold deposit is swell, but what if your company discovers not just one gold mine, but an entire new gold district? How will you factor in that upside?

Don't Let Fear Make You Miss Out

 

Mining companies have a fiduciary responsibility to make their shareholders money, so they can’t help but paint a rosy picture for potential investors. That's why you need to have a disciplined and impartial eye. Most companies are not worthy of your hard earned capital.

Having an advisor you trust, or access to technical expertise, is crucial. Ideally you should have both. The most educated investor always has the edge.

I'll conclude with this: the markets have not been kind to the miners recently. But selling a stock just because it dropped in value is an emotional decision. Seeing red on your computer screen is painful, but it is not relevant. What is relevant is what you do with that capital going forward. Don't let emotion cloud your judgment.
 
On the other hand, if you’re waiting for the gold price to move higher before you sell, then you’re a speculator masquerading as an investor, and you may as well buy a ticket to Vegas.

My boss and mentor, Rick Rule, recently said, “Bear markets are the authors of bull markets.” When these markets do start moving, if you’re not positioned with the highest quality tier one companies, you could miss out on one of the biggest bull market moves of your investing life.

Eric Angeli is an investment executive at Sprott Global Resources. 

Read Eric's, and other experts', pertinent investment advice every day in the free e letter, Casey Daily Dispatch. Click here to sign up now.



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Stock Market Trend – Eye Opening Information

My Stock market trend analysis is likely different from what you think is about to unfold. Keep an open mind as this is just showing you both sides of the coin from a technical stand point. Remember, the market likes to trend in the direction which causes the most investor pain.

Since the stock market bottom in 2009 equities has been rising which is great, but this train could be setting up to do the unthinkable. What do I mean? Well, let’s take a look at the two possible outcomes.

The Bear Market Trend & Investor Negative Credit 

 

The S&P500 has been forming a large broadening formation over the last 13 years. The recent run to new highs and record amounts of money being borrowed to buy stocks on margin has me skeptical about prices continuing higher.

Take a look at the chart below which I found on the ZeroHedge website last week. This chart shows the SP500 index relative to positive and negative investor credit balances. As you can see we are starting to reach some extreme leverage again on the stock market. I do feel we are close to a strong correction or possible bear market, but we must remember that a correction may be all we get. It does not take much for this type of borrowed money to be washed clean and removed. A simple 2-6 week correction will do this and then stocks will be free to continue higher.

Monthly Bearish Trend Outlook

 

Below you can see the simple logical move that should occur next for stocks based on the average bull market lasts four years (it has been four years) and the fact the negative credit is so high again.

Also, poor earnings continue to be released for many individual names across all sectors of the market. While corporate profits may be holding up or growing in some of the big name stocks, revenues are not. This means the big guys are simply laying off workers and cutting costs still.

Overall the stock market is entering its strongest period of the year. So things could get choppy here with strong up and down days until Jan. After that stocks could start to top out and eventually confirm a down trend. Keep in mind, major market tops are a process. They take 6-12 months to form so do not think this is a simple short trade. The market will be choppy until a confirmed down trend is in place.

Monthly BULLISH Trend Outlook

 

This scenario is the least likely one floating around market participant’s minds. It just does not seem possible with the global issues trying to be resolved. With the Federal Reserve continuing to print tens of billions of dollars each month inflating the stocks market this bullish scenario has some legs to stand on and makes for the perfect “Wall of Worry” for stocks to climb.

The U.S. dollar is likely to continue falling in the long run, but I do not think it will collapse. Instead, it will likely grind lower and trade almost in a sideways pattern for years to come.

Major Stock Market Trend Conclusion:

 

In summary, I remain bullish with the trend, but once price and the technical indicators confirm a down trend I will happily jump ships and take advantage of lower prices.

Remember, this is big picture stuff using Monthly and quarterly charts. So these plays will take some time to unfold and within these larger moves are many shorter term opportunities that we will be trading regardless of which direction the market is trending. 

As active traders and investors we will profit either way.

Get My Reports Free at The Gold & Oil Guy.com

Chris Vermeulen


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Nobel Prize Winner: Bubbles Don’t Exist

By Doug French

No wonder investors don't take economists seriously. Or if they do, they shouldn't. Since Richard Nixon interrupted Hoss and Little Joe on a Sunday night in August 1971, it's been one boom and bust after another. But don't tell that to the latest Nobel Prize co-winner, Eugene Fama, the founder of the efficient-market hypothesis.


The efficient market hypothesis asserts that financial markets are "informationally efficient," claiming one cannot consistently achieve returns in excess of average market returns on a risk adjusted basis.

"Fama's research at the end of the 1960s and the beginning of the 1970s showed how incredibly difficult it is to beat the market, and how incredibly difficult it is to predict how share prices will develop in a day's or a week's time," said Peter Englund, secretary of the committee that awards the Nobel Prize in Economic Sciences. "That shows that there is no point for the common person to get involved in share analysis. It's much better to invest in a broadly composed portfolio of shares."

Fama is not just a Nobel laureate. He also co-authored the textbook, The Theory of Finance, with another Nobel winner, Merton H. Miller. He won the 2005 Deutsche Bank Prize in Financial Economics as well as the 2008 Morgan Stanley-American Finance Association Award. He is seriously a big deal in the economics world.

So if Fama has it right, investors should just throw in the towel, shove their money into index funds, and blissfully wait until they need the money. Before you do that, read what Fama had to say about the 2008 financial crisis.

The New Yorker's John Cassidy asked Fama how he thought the efficient-market hypothesis had held up during the recent financial crisis. The new Nobel laureate responded:

"I think it did quite well in this episode. Prices started to decline in advance of when people recognized that it was a recession and then continued to decline. There was nothing unusual about that. That was exactly what you would expect if markets were efficient."

When Cassidy mentioned the credit bubble that led to the housing bubble and ultimate bust, the famed professor said:

"I don't even know what that means. People who get credit have to get it from somewhere. Does a credit bubble mean that people save too much during that period? I don't know what a credit bubble means. I don't even know what a bubble means. These words have become popular. I don't think they have any meaning."

No matter the facts, Fama has his story and he's sticking to it.

"I think most bubbles are 20/20 hindsight," Fama told Cassidy. When asked to clarify whether he thought bubbles could exist, Fama answered, "They have to be predictable phenomena."

The rest of us, who lived through the tech and real estate booms while Fama was locked in his ivory tower, know that in a boom people go crazy. There's a reason the other term for bubble is mania. According to Webster's, "mania" is defined in an individual as an "excitement of psychotic proportions manifested by mental and physical hyperactivity, disorganization of behavior, and elevation of mood."

Financial bubbles have occurred for centuries. In January 1637, the price of the common Witte Croonen tulip bulb rose 26 times, only to crash to 1/20^th of its peak price a week later.

Eighty years later in France, John Law flooded the French economy with paper money and shares of the Mississippi Company. The public went wild for stock in a company that had no real assets. The shares rose twentyfold in a year, only to crash. Law, a hero in the boom, was run out of France in disgrace.

At the same time across the channel, the British public bid up South Sea Company shares from ₤300 to ₤1,000 in a matter of weeks. Even the brilliant Sir Isaac Newton was caught up in the frenzy. He got in early and sold early. But he then jumped back in near the top and went broke in the crash.

In the modern era, booms and busts are too numerous to count: Japanese stocks and property, real estate (multiple times), stocks, commodities, stocks again, farmland (multiple times), and art are just a few. Yet the newest co-Nobelist denies the existence of booms and busts and advises you to put your money in index funds and hope for the best.
However, investor returns have not been the best. The last complete calendar decade for stocks ending in 2009 was the worst in history. The Wall Street Journal reported, "Since the end of 1999, stocks traded on the New York Stock Exchange have lost an average of 0.5% a year thanks to the twin bear markets this decade."

When you adjust that for inflation, the results were even worse, with the S&P 500 losing an average of 3.3% per year.

This decade, stocks have been on a tear—as have bonds, farmland, and art. At first glance, it's nonsensical that the price of virtually everything is rising. But when you remember that the Federal Reserve's cheap money has flooded Wall Street but hasn't come close to Main Street, it becomes clear. The money has to go somewhere.

If Fama were correct, there would be no legendary investors like Doug Casey or Rick Rule. There would be no opportunities for ten-baggers and twenty-baggers in resource stocks.

Fama is like the economist in the old joke who sees a hundred-dollar bill on the ground but doesn't pick it up. "Why didn't you pick it up?" a friend asks. The economist replies, "It's impossible—a hundred-dollar bill would have already been picked up by now."

Of course savvy investors know there are hundred-dollar bills to be picked up in the market. With tax-selling season upon us, now is the time to be shopping for bargains.

Doug's friend Rick Rule often says, "You can either be a contrarian or a victim." Taking Fama's advice will make you a victim. The path to wealth is to run against the herd, not with it.

Learn how to be a contrarian… how to make handsome gains from the best precious metals, energy, and technology stocks… how to find investment opportunities even in the most unlikely places… how to recognize profitable trends before they start. Read all this and more in our free daily e-letter, the Casey Daily Dispatch —  click here to get it now.



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Thoughts from the Frontline: A Code Red World

By John Mauldin

I wasn't the only person coming out with a book this week (much more on that at the end of the letter). Alan Greenspan hit the street with The Map and the Territory. Greenspan left Bernanke and Yellen a map, all right, but in many ways the Fed (along with central banks worldwide) proceeded to throw the map away and march off into totally unexplored territory. Under pressure since the Great Recession hit in 2007, they abandoned traditional monetary policy principles in favor of a new direction: print, buy, and hope that growth will follow. If aggressive asset purchases fail to promote growth, Chairman Bernanke and his disciples (soon to be Janet Yellen and the boys) respond by upping the pace. That was appropriate in 2008 and 2009 and maybe even in 2010, but not today.

Consider the Taylor Rule, for example – a key metric used to project the appropriate federal funds rate based on changes in growth, inflation, other economic activity, and expectations around those variables. At the worst point of the 2007-2009 financial crisis, with the target federal funds rate already set at the 0.00% – 0.25% range, the Taylor Rule suggested that the appropriate target rate was about -6%. To achieve a negative rate was the whole point of QE; and while a central bank cannot achieve a negative interest-rate target through traditional open-market operations, it can print and buy large amounts of assets on the open market – and the Fed proceeded to do so. By contrast, the Taylor Rule is now projecting an appropriate target interest rate around 2%, but the Fed is goes on pursuing a QE-adjusted rate of around -5%.



Also, growth in NYSE margin debt is showing the kind of rapid acceleration that often signals a drawdown in the S&P 500. Are we there yet? Maybe not, as the level of investor complacency is just so (insert your favorite expletive) high.



The potential for bubbles building atop the monetary largesse being poured into our collective glasses is growing. As an example, the "high-yield" bond market is now huge. A study by Russell, a consultancy, estimated its total size at $1.7 trillion. These are supposed to be bonds, the sort of thing that produces safe income for retirees, yet almost half of all the corporate bonds rated by Standard & Poor's are once again classed as speculative, a polite term for junk.

Central Bankers Gone Wild

But there is a resounding call for even more rounds of monetary spirits coming from emerging-market central banks and from local participants, as well. And the new bartender promises to be even more liberal with her libations. This week my friend David Zervos sent out a love letter to Janet Yellen, professing an undying love for the prospect of a Yellen-led Fed and quoting a song from the "Rocky Horror Picture Show," whose refrain was "Dammit, Janet, I love you." In his unrequited passion I find an unsettling analysis, if he is even close to the mark. Let's drop in on his enthusiastic note:

I am truly looking forward to 4 years of "salty" Janet Yellen at the helm of the Fed. And it's not just the prolonged stream of Jello shots that's on tap. The most exciting part about having Janet in the seat is her inherent mistrust of market prices and her belief in irrational behaviour processes. There is nothing more valuable to the investment community than a central banker who discounts the value of market expectations. In many ways the extra-dovish surprise in September was a prelude of so much more of what's to come.

I can imagine a day in 2016 when the unemployment rate is still well above Janet's NAIRU estimate and the headline inflation rate is above 4 percent. Of course the Fed "models" will still show a big output gap and lots of slack, so Janet will be talking down inflation risks. Markets will be getting nervous about Fed credibility, but her two-year-ahead projection of inflation will have a 2 handle, or who knows, maybe even a 1 handle. Hence, even with house prices up another 10 percent and spoos well above 2100, the "model" will call for continued accommodation!! Bond markets may crack, but Janet will stay the course. BEAUTIFUL!

Janet will not be bogged down by pesky worries about bubbles or misplaced expectations about inflation. She has a job to do – FILL THE OUTPUT GAP! And if a few asset price jumps or some temporary increases in inflation expectations arise, so be it. For her, these are natural occurrences in "irrational" markets, and they are simply not relevant for "rational" monetary policy makers equipped with the latest saltwater optimal control models.

The antidote to such a boundless love of stimulus is of course Joan McCullough, with her own salty prose:

And the more I see of the destruction of our growth potential … the more convinced I am that it's gonna' backfire in spades. Do I still think that we remain good-to-go into year end? At the moment, sporadic envelope testing notwithstanding, the answer is yes. But I have to repeat myself: The data has stunk for a long time and continues to worsen. And the anecdotes confirming this are yours for the askin'. The only question remaining is for how long we can continue to bet the ranch on wildly incontinent monetary policy while deliberately opting to ignore the ongoing disintegration of our economic fabric?"

And thus we come to the heart of this week's letter, which is the introduction of my just-released new book, Code Red. It is my own take (along with co-author Jonathan Tepper) on the problems that have grown out of an unrelenting assault on monetary norms by central banks around the world.

To continue reading this article from Thoughts from the Frontline – a free weekly publication by John Mauldin, renowned financial expert, best-selling author, and Chairman of Mauldin Economics – please click here.

© 2013 Mauldin Economics. All Rights Reserved.






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The Great American Wall Of Worry – U.S. Stock Market

Traders and investors all around the world are having trouble climbing over the wall of worry/fear with the US stock market, and rightly so. There is a lot of things taking place and unfolding that carry a high level of uncertainty. Let’s face it, who wants to invest money into the market when it’s hard to come by (high unemployment, banks are still extremely tight with their money, companies are nowhere near wanting to hiring new staff).

The hard pill to swallow is the fact that the stock market loves to rise when uncertainty is high. It’s almost doing it just to drive investor’s nuts who sold out near market bottom or recent correction. You must overcome the urge to short the market when the economy looks so bearish in the years ahead, and continue to trade with the trend.....Read the entire story and view the charts.



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Precious Metals: Gold, Silver and Miners Are Trapped

The precious metal market has been stuck in a strong down trend since 2012. But the recent chart, volume and technical analysis is starting to show some signs that a bottom may have already taken place.

This report focused on the weekly and monthly charts which allow us to see the bigger picture of where the precious metals sector stands in terms of its trend. Let’s take a look at a few charts below for a quick overview, but if you want more interesting ...... Click here to Read More.

Earnings Growth to Ramp Up? Call Me a Skeptic

By Sheraz Mian

Stocks have performed impressively this year and have largely been able to hold on to the gains despite monetary and fiscal uncertainties and the less than inspiring economic and earnings pictures. In a price-earnings framework for the market, most of the gains this year have resulted from investors’ willingness to pay a higher multiple for pretty much the same, or even lower, earnings.

Reasonable people can disagree over the extent of the Fed’s role in the market’s upward push, but few would argue that the Bernanke Fed’s easy money policy has been a key, if not the only, driver of this trend. If nothing else, the Fed policy of deliberately low interest rates pushed investors into riskier assets, including stocks.

But with the Fed getting ready to institute changes to its policy, investors will need to go back to fundamentals to keep pushing stocks higher.

We don’t know when the Fed will start ‘Tapering’ its bond purchases, but we do know that they want to get out of the QE business in the "not too distant" future. What this means for investors is that they will need to pay a lot more attention to corporate earnings fundamentals than has been the case thus far.

The overall level of corporate earnings remains quite high. In fact, aggregate earnings for the S&P 500 reached an all-time record in 2013 Q2 and are expected to be not far from that level in the ongoing Q3 earnings season as well. There hasn’t been much earnings growth lately, but investors are banking on material growth resumption from Q4 onwards. This hope is reflected in current consensus expectations for 2013 Q4 and full year 2014.

I remain skeptical of current consensus earnings expectations and would like to share the basis for my skepticism with you. The goal is to convince you that current earnings expectations remain vulnerable to significant downward revisions.

Negative estimate revisions haven't mattered much over the last few quarters as the Fed's generous liquidity supply helped lift all boats. But if the Fed is going to be less of a supporting actor going forward, then it's reasonable to expect investors to start paying more attention to fundamentals. It is in this context that the coming period of negative revisions could potentially result in the market giving back some, if not all, of its recent gains.

This discussion is particularly timely as we are in the midst of the 2013 Q3 earnings season that will help shape consensus estimates for Q4 and beyond. In the following sections, I will give you an update on the Q3 earnings season and critically review consensus expectations for Q4 and beyond.

The Q3 Scorecard

 

As of Monday, October 21st, we have Q3 results from 109 companies in the S&P 500 that combined account for 31.6% of the index’s total market capitalization. Total earnings for these 109 companies are up +7.5% year over and 63.3% of companies beat earnings expectations with a median surprise of +2.1%. Total revenues are up +2.1%, with 45.9% of the companies beating top line expectations and median revenue surprising by +0.02%.

The table below presents the current scorecard for Q3



Note: One sector, Aerospace, has not reported any Q3 results yet. NRPT means ‘no reports’; NM means ‘not meaningful’. 

With results from more than 30% of the S&P 500’s total market capitalization already out, we are seeing the Q3 earnings picture slowly emerge. This is particularly so for the Finance sector, where 51.8% of the sector’s total market cap has already reported. Other sectors with meaningful sample sizes include Transportation (47.3%), Consumer Staples (40.4%), Technology (36.9%) and Medical (25.2%).

Finance has been a steady growth driver for the last many quarters and is diligently playing that role this time around as well despite anemic loan demand, wind-down of the mortgage refi business and weak capital markets activities, particularly on the fixed income side. Outside of Finance, total earnings are up +4.4% for the companies that have reported already.

How do the 2013 Q3 results thus far compare with the last few quarters?

The short answer is that they are no better than what we have seen from this same group of 109 companies in recent quarters. In fact, on a number of counts the results thus far do not compare favorably to either the preceding quarter (2013 Q2), or the 4-qurater average, or both.

Specifically, the earnings and revenue growth rates and revenue beat ratio are tracking lower, while the earnings beat ratio is about in-line



The charts below compare the beat ratios for these 109 companies with what these same companies reported in Q2 and the 4-quarter average (beat ratio is the % of total companies coming ahead of consensus expectations).



The trends we have seen thus far will shift to some extent as the rest of the reporting season unfolds, but not by much. A composite look at the Q3 earnings season, combining the actual results from the 109 companies with estimates for the 391, is for +2.1% earnings growth on +0.8% higher revenues, as the summary table below shows.

 

Earnings growth rate has averaged a little over +3% over the first two quarters of the year and will likely stay at or below that level in Q3 as well. With respect to beat ratios, roughly two-thirds of the companies come ahead of expectations in a typical quarter and the Q3 ratio will likely be in that same vicinity.

The ‘Expectations Management’ Game

 

In the run up to the start of the Q3 earnings season, consensus earnings estimates came down sharply. The primary reason for the estimate cuts – guidance from management teams. Companies guided lower for Q3 while reporting Q2 results, a trend that has remained in place for more than a year now.
The chart below does a good job of showing the evolving Q3 earnings expectations over the last few months.



The Q3 estimate cuts weren’t unusual or peculiar to the quarter, as we have been seeing this trend play out repeatedly for more than a year now. The chart below compares the trends in earnings estimate revisions in the run up to the Q3 and Q2 reporting seasons



These expectations mean that Q3 wouldn't be materially different from what we have become accustomed to seeing quarter after quarter, with roughly two-thirds of the companies beating consensus earnings estimates. This game of under-promise and over-deliver by management teams has been around long enough that it has likely lost most of its value in investors’ eyes.

Beat ratios may not carry as much informational value this time around, but what will be particularly important is company guidance for Q4 and beyond. Guidance is always very important, but it has assumed added significance this time around given the elevated hopes that Q4 represents a material earnings growth ramp up after essentially flat growth over the last many quarters.

Evaluating Expectations for Q4 & Beyond

 

Let's take a look at how consensus earnings expectations for 2013 Q3 compare to what companies earned in the last few quarters and what they are expected to earn in the coming quarters.
The chart below shows the expected Q3 total earnings growth rate for the S&P 500 contrasted with the preceding two and following two quarters. (Please note that the Q3 growth rate is for the composite estimate for the S&P 500, combining the 109 that have reported with the 391 still to come)



The Finance sector has been a big earnings growth driver for some time. Outside of the Finance sector, total earnings growth for the S&P 500 was in the negative in 2013 Q2 and is expected to be no better in Q3. But the high hopes from Q4 and beyond reflect a strong turnaround in growth outside of Finance.
The chart below shows the same data as the one above, but excludes the Finance sector.



What this means is that quarterly earnings growth was +3.4% in the first two quarters of the year, is expected to be 2.1% in Q3, but accelerate to a +9.4% pace in Q4. And not all of the expected Q4 growth is coming from the Finance sector, as the rest of the corporate world is expected to reverse trend and start contributing nicely from Q4 onwards.

The chart below shows the same data, but this time on a trailing 4-quarter basis. The way to read this chart of steadily rising expectations is that total earnings for the S&P 500 are on track to be up +3.8% year over year in the four quarters through Q3, but accelerate to +4.5% in Q4 and +5.6% in 2014 Q1. Consensus expectations are for total earnings growth of +11.8% in calendar year 2014.



The two charts below show earnings for the S&P 500; not EPS, but total earnings. The first chart shows quarterly totals, while the second one presents the same data on a trailing 4-quarter basis. As you can see, the 'level' of total earnings is very high. In fact, quarterly earnings have never been this high - the 2013 Q2 total of $260.3 billion was an all-time quarterly record.




The data in this chart reflects current consensus estimates. This shows that consensus is looking for new all-time record quarterly totals in the coming two quarters. The high expected growth rates in Q4 and beyond are more than just easy comparisons, they represent material gains in total earnings.
The record level of current corporate profits is also borne by the very high level of corporate profits as a share of nominal GDP, which has never been this high ever. The chart below, using data from the BEA, of corporate profits as a share of nominal GDP clearly shows this.




Where Will the Growth Come From?


There is some truth to the claim that the current record level of corporate profits, whether in absolute dollar terms or as a share of the GDP, does not mean that earnings have to necessarily come down. But earnings don’t grow forever either as current consensus expectations of double-digit growth next year and beyond seem to imply.

After all, earnings in the aggregate can grow only through two avenues - revenue growth and/or margin expansion.

Revenue growth is strongly correlated with 'nominal' GDP growth. If the growth outlook for the global economy is positive or improving, then it’s reasonable to expect corporate revenues to do better as well. But the global economic growth outlook is at best stable, definitely not improving as the recent estimate cuts by the IMF shows.

The U.S. economic outlook has certainly stabilized and GDP growth in Q4 is expected to be modestly better than Q3’s growth pace. The expectation is for growth to materially improve in 2014, with consensus GDP growth estimates north of +3% for 2014 and even higher the following year. Europe isn’t expected to become an engine of global growth any time soon, but the region’s recession has ended and its vitals appear to be stabilizing. The magic of Abenomics is expected to revitalize Japan, but it’s nothing more than a hope at this stage. In the emerging world, sentiment on China has improved, but India, Brazil, Turkey and other former high flyers appear to be struggling.

All in all, this isn’t a picture to get overly excited about. But with almost 60% of the S&P 500 revenues coming from the domestic market, the expected GDP ramp up next year should have a positive effect on corporate revenues, which are expected to increase by +4.2% in 2004. But in order to reach the expected +11.8% total earnings growth in 2014, we need a fair amount of expansion in net margins to compliment the +4.2% revenue growth.

Can Margins Continue to Expand?

 

The two charts show net margins (total income/total revenues) for the S&P 500, on a quarterly and trailing 4-quarter basis. For both charts, the data through 2013 Q2 represents actual results, while the same for Q3 and beyond represent net margins implied by current consensus estimates for earnings and revenues.



The chart below shows net margins the same data for a longer time span on a calendar year basis – from 2003 through 2014.



As you can see margins have come a long way from the 2009 bottom and by some measures have already peaked out.

Margins follow a cyclical pattern. As the above chart shows, they expand as the economy comes out of a recession and companies use existing resources in labor and capital to drive business. But eventually capacity constraints kick in, forcing companies to spend more for incremental business. Input costs increase and they have hire more employees to produce more products and services. At that stage, margins start to contract again.

We may not be at the contraction stage yet, but given the current record level of margins and how far removed we are from the last cyclical bottom, we probably don’t have lot of room for expansion. The best-case outcome on the margins front will be for stabilization at current levels; meaning that companies are able to hold the line on expenses and keep margins steady. We will need to buy into fairly optimistic assumptions about productivity improvements for current consensus margin expansion expectations to pan out.

So What Gives?

 

What all of this boils down to is that current consensus earnings estimates are high and they need to come down - and come down quite a bit. I don't subscribe to the view held by some stock market bears that earnings growth will turn negative. But I don't buy into the perennial growth story either.

So what's the big deal if estimates for Q4 come down in the coming days and weeks? After all, estimates have been coming down consistently for more than a year and the stock market has not only ignored the earnings downtrend, but actually scaled new heights.

A big reason for investors' disregard of negative estimate revisions has been that they always looked forward to a growth ramp up down the road. In their drive to push stocks to all-time highs in the recent past, investors have been hoping for substantial growth to eventually resume. The starting point of this expected growth ramp-up kept getting delayed quarter after quarter. The hope currently is that Q4 will be the starting point of such growth.

Guidance has overwhelmingly been negative over the last few quarters. But if current Q4 expectations have to hold, then we will need to see a change on the guidance front; we need to see more companies either guide higher or reaffirm current consensus expectations. Anything short of that will result in a replay of the by-now familiar negative estimate revisions trend that we have been seeing in recent quarters.

Will investors delay the hoped for earnings growth recovery again this time or finally realize that the period of double digit earnings growth is perhaps behind us for good? Hard to tell at this stage, but we will find out soon enough. My sense is that markets can buck trends in aggregate earnings for some time, as they have been doing lately. But expecting the trend to continue indefinitely may not be realistic.

220 Stocks To Sell Now

 

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Best,
Sheraz Mian
Sheraz Mian is the Director of Research for Zacks and manages its award-winning Focus List portfolio. 
 
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