Is Something Really Bad Going To Happen Soon?
Jul. 9, 2015 6:45 PM ET
Summary
- Six years and four months into one of the most impressive rallies we have ever witnessed. Can it last?
- Many warning signs are flashing-red around us. Can investors afford to ignore them?
- Debt markets already seem out of steam. Will equity markets follow through?
- While this article is by no means a "doom and gloom"prediction, I believe that the "bad wolf" will eventually show up.
Will it? Can it? I strongly doubt it.
Let me start by saying loud and clear: I have no idea when the rally in equity markets will end.
I'm not a prophet and I don't like making predictions that try pointing out both direction and timing. Nevertheless, I know that it will end and I dare say that after 6 years and four months of almost-non-stop rise - we're way closer to the end (of the rally) than to the beginning.
When it comes to the debt markets, investors are now reciting (almost?) unanimously that long durations are bad, that yields are way too low and that the reward doesn't compensate for the risk. I believe that the exact same clear-sound voice is going to be heard in regard to equities, soon enough.
It may take time and, as we all know, timing is everything! Yet, it's worthwhile hitting the gong again and you are better off to get yourself ready (in advance) for the future than adjust yourself (retroactively) to the present.
While trying to avoid being perceived as "The boy who cried wolf" - the wolf will eventually show up. My philosophy has always been: Better safe than sorry.
Sitting on the sidelines, waiting for the right moment is nothing to be ashamed of.
Nobody ever lost what he could have gained.
This article takes a closer look at the most "immediate suspects"; the five main factors that any investor should take into consideration.
But before doing so it I must make it clear: Greece isn't one of those factors. True, this tiny economy is making a lot of noise and it's the Greek-ongoing-saga that everyone tend to blame for not allowing the markets to keep marching higher. Well, I'm sorry to be the one ruining the ("blaming") party but Greece, in-spite of its gorgeous islands and ancient history, is insignificant when it comes to the capital markets. A tiny economy, accounting for not much more than 1% of the entire European economy - and this, folks, is no reason to get in or out of the markets.
I'll allow each investor to make his own interpretation to these warning signs but ignoring those signs might turn to be a big mistake. With no further delay, here are the factors that any investor should take into consideration right here, right now:
1. CHINA (FXI, MCHI, GXC). As much as the world overplays Greece, I believe that there's a huge underestimation of China. The world's second -biggest economy (officially) - and the biggest, fastest growing, force de-facto - is in trouble. It's not only the crushing of the stock exchange indices but mainly the weakening demand. Even the most recent bond auction failure is, to the very least, a good reason to raise some concerns.
With both the Shanghai Composite Index and the Shenzhen Component Index tumbling 3-5% on a daily basis over the past few weeks - this is not just "entering into a bear market territory" but a more in-depth situation that can easily get out of control.
2. BONDS (BND, AGG, LQD, HYG, JNK). Some investors tend to ignore the debt markets and solely focus on the equity markets. This is a big mistake; not only that the debt markets are much bigger (size wise) and liquid (volume wise) but they have a much better predictive powers!
Yields are, generally speaking, on the rise since the beginning of this year but one should keep in mind that this is a very tricky and sneaky tool:
- The average yield on a 10-year US treasury note ("UST10Y") during 1912-2015 is 6.32%.
- The highest yield on record for the UST10Y was registered in September 1981 = 15.82% (and no, this is not a typo...)
- The lowest yield on record for the UST10Y was registered in July 2012 = 1.40% (once again, this is not a typo...)
- Even more interesting is the movement since July 2012: After going over the 3% handle at the end of 2013, the UST10Y yield hit 1.64% at the beginning of 2015, near-by the record-low territory.
3. EQUITIES (SPY, QQQ, DIA, IWF, EFA). Let's make it very simple: Six years and four months since the lows (9 March 2009) and after the S&P 500 gained circa 220% (at its peak) - I doubt there are many who believe that we're going to see another ~6.5 years with over 200% gain. It's not only against statistics but it's mostly against reality.
From a valuation point of view, there's not much room for further gains.
On 16 April 2015, Goldman Sachs - (always) one of Wall Street most bullish players - published a model that indicates a 62% probability for a (minimum) 10% correction (from peak to through) in the S&P when valuations are high. Almost three months following the presentation of this projection the probability for a 10% correction is now higher.
There are plenty more signs to take into consideration when looking at equities right now but I may publish a separate article soon to address them all. For now, it's safe to say that it's safe(r) to take profits and stay on the sidelines.
One of the most common arguments when it comes to the stock markets are that they will keep going up because "there's no alternative". Well, folks, not only that there's ALWAYS an investment alternative (to anything, anytime) but it's sufficient to say that avoiding losing money is a good enough alternative.
4. OIL (USO, OIL, UNG). After dropping to ~$44 (per barrel) in early March 2015, oil prices spiked all the way up to circa $64 in early May; that's a huge move in just two-months.
Getting back to the low $50s as I write doesn't only fall into the "entering a bear market" territory, defined as a 20% drop from any point/peak, but it's a direct result of the above-mentioned, especially the weak demand from China.
As one of the most in-use commodities, oil prices are a very good barometer to measure the world economy status.
More than the recent moves, one should ask himself what was the underlying behind for the drop from $115-120 to $40 and has this massive drop been reflected by the equity markets?
You don't need to be an orthodox in order to view the oil price fluctuations as a sign from above - or from the underneath in oil's case… - shouting-out-loud that something is not working properly inside the engine.
5. COPPER (JJC, CUPM, CPER). Similar but not identical to oil - copper prices are the best seismograph for China specifically and for the world development and construction as a whole. It's worthwhile reading the report "Copper price as an economic indicator" as well as the article "Is a global economic recession coming? Copper price say 'yes'".
Falling 50% (!) since the end of January 2015 isn't something to be ignored. Unlike oil, the decline is decisive with technical corrections along the way.
Now, don't get me wrong: I belong to the school of thought that believe that commodities, more than any other asset-class, are hard - perhaps impossible - to predict. Therefore, as much as I give no credit to "doom and gloom" predictions I do the same in regard to positive-prosperous projections. Prices of commodities are a mirror reflection of the world economy and its healthiness. One must admit that the current diagnostics don't seem very encouraging…
Joining the herd isn't necessarily a bad thing to do - and in fact, joining the LONG EQUITY herd since early 2009 proved to be one of the best-ever things an investor could have done.
Nonetheless, every party comes to an end at some point; so will the current one.
When exactly, to what extent and how will it look like - I really don't know and I dare not trying to predict. What I do know that one must always look around, pay attention to warning signs and definitely not assuming that parties last forever.
There may be several ways to interpret any warning sign but ignoring it is definitely not one of those!
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