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posted on 13 December 2015

Will Santa Visit Broad And Wall?

by Lance Roberts, StreetTalk Live

Real Investment Report 12 December 2015

"Gimbal's Manager: 'Ok people - tomorrow morning, 10 A.M., Santa's coming to town!'

Buddy: 'Santa! Oh, my god! Santa here? I know him! I know him!'" - Elf

It is hard to believe that Christmas is just TWO Friday's away and the volatility over the past week has put a bit of a damper on holiday cheer. However, hopes remain high that "Santa will soon come to Wall Street."

Of course, that reminds me that I have not done any shopping as of yet. (With four kids and a phenomenal wife, I should be able to make up any slack in the retail sales figures.)

But I digress. Despite the hopes of a stronger economy and earnings environment at the beginning of this year, those hopes failed to come to fruition. However, even as earnings and corporate profits have deteriorated, along with many of the underlying economic data points, the market has made NO gains for the year. The good news? There has been no inflation to chip away at the purchasing value of cash.


In early November, I discussed the need for many hedge and mutual funds, which were lagging their respective benchmarks, to play catch up. The chart below shows the S&P 500 as compared to the Morning Star Hedge Fund index. You can see the underperformance of funds this summer and the resulting performance chase to date.


In that missive, I laid out the expectation (dashed blue line) of a market decline back to support which would facilitate the year-end advance.

"With the markets currently oversold on a very short-term basis, the current probability is a rally into the 'Thanksgiving' holiday next week and potentially into the first week of December. As opposed to my rudimentary projections, the push higher will likely be a 'choppy' advance rather than a straight line.

In early December, I would expect the markets to once again pull back from an overbought condition as mutual funds distribute capital gains, dividends, and interest for the year. Such a pullback would once again reset the market for the traditional 'Santa Claus' rally as fund managers 'window dress' portfolios for their end-of-year reporting."

Here is the updated version of that chart which shows the markets playing out very closely to that previous projection.


As we now approach the end of mutual fund distributions, the market should be able to gain some traction through the end of the year as fund managers put positions back on their books for year-end reporting.

This suggestion of a year-end rally also aligns with the markets in 2011 which also experienced a sharp summer decline and a very warm winter which allowed for stronger economic activity. (via Market Anthropology)

"The SPX analog that we mentioned a few weeks back, continues to hold congruence with the closing weeks of 2011. With the SPX achieving a lower low in Wednesday's session, the comparative window for the much heralded Santa Rally would open tomorrow.

Considering the timing with next weeks Fed meeting and greater clarity with posture and policy, a bullish outcome over the near-term would certainly not be out of the question in equities."


However, while the seasonal tendencies suggest that such will be the case, there is no guarantee. With economic remaining weak and the Federal Reserve on the verge of tightening monetary policy further, while the global economy struggles with a deflationary backdrop, there is a rising possibility that "Santa fails to visit Broad and Wall."

5 Charts Suggest Markets On The Naughty List

While I do suspect that the markets will likely end positively by year-end, it is 2016-2017 that is becomes more worrisome.

From a statistical standpoint, the odds of both a recessionary environment and negative market returns rise substantially over the next two years as shown in the charts below.


2016 has the lowest average positive return of all years, with 2017 posting the most negative average rate of return. However, both 2016 and 2017 have posted negative return years more than 40% of the time. Considering that most negative return years coincide with a recessionary environment, 2017 is tied for the second most recessions of the ten-year cycle.

Okay, you can breathe easy, right? Statistics say no recession likely until 2017. As I stated previously in "The Coming Market Meltup and 2016 Recession:"

"There are plenty of reasons that that the market could lapse into a far bigger correction sooner than the historical evidence would otherwise suggest. Such an event would not be the first time that an "anomaly" in the data has occurred.

The inherent problem with most analysis is that it assumes everything remains status quo. The reality is that some unexpected exogenous shock is likely to come along that causes a more severe reversion as current extensions become more extreme. "

The following 5 charts suggest a rather substantial possibility that something could "break" within the markets sooner, rather than later.

1. World GDP Is Contracting. According to the IMF's most recent report, world gross domestic product contracted by 4.9% in 2015. The only other time that world GDP has contracted to such a degree was in 1980, starting year of the IMF database, when it fell by 5.9%. The U.S. experienced a recession at that time as well as in 2001 and 2009 which also coincided with global economic declines. Despite many beliefs to the contrary, the U.S. is not an island that can withstand the drag of a global recession.


2. Junk Bond Warning. As David Keohane points out in this past week's FT article:

"Late stages of every credit cycle, by definition, are built on a theory as to why this time is different. This type of attitude was prevalent going into 2015, when credit markets largely dismissed the oil sector distress, choosing to believe that this was an isolated issue and will stay that way. Historical evidence pointed to the contrary, where no earlier precedents existed of the largest sector being in distress and the rest of the market remaining firm. Today, two out of three sectors in US HY have more than 10% of debt trading at distressed levels."


3. Institutions Are Selling. According to BofA, institutions continue to offload equities to retail clients. This is typical of a late stage market cycle as "smart money" harvests their gains while telling their "retail clients" to "just buy and hold for the long term." (Just a question to ponder - "if they don't buy and hold, why exactly is it good for you?")


4. International And Emerging Market Divergence. As I stated above, there is currently a belief that the U.S. can remain isolated from the rest of the world. Given the global interconnectedness of the world today, there is little ability for the U.S. to permanently diverge from the rest of the world. As shown below, historically when international and emerging markets have declined, the U.S. has been soon to follow.


5. Combined Monthly Sell Signals. Lost in the day-to-day volatility of market action, is the longer term look at the underlying TREND of price action. Much like driving a car at full speed, assuming you don't crash along the way, the car will continue to "coast" for some distance even after the tank runs dry. The same is true for the market. When investors are "exuberant" about the markets, they can keep prices elevated longer than underlying fundamentals and logic would dictate. However, like a "car running out of gas," the momentum of the market begins to substantially slow until its inevitable conclusion of the advance. If we look at various measures of price action on a MONTHLY basis, we can clearly see warnings that have only previously existed at major market peaks. While this does not mean the markets will immediately crash, historically it has suggested that investors were much better served by becoming more risk adverse.


Whether or not a recession begins in 2016 or 2017 is largely irrelevant. The reason is that by the time the BEA backward adjusts their data, and the National Bureau of Economic Research declares the start of the recession, it will be far too late react.

What is clear, is the "risk" of being overly exposed to the market currently far outweighs the potential reward. This is why understanding the difference between "possibilities" and "probabilities" is critically important going forward.

Is it "possible" the markets could advance further over the next 12-24 months. Absolutely.

However, the "probabilities" are mounting that such will not be the case and the resulting negative outcome to investors' portfolios will be more than most expect. This is the inherent risk/reward dynamic that all investors face, the difference is whether or not you do something with the information at hand.

In the meantime, Wall Street has some great stocks for you to buy.

No! Low Oil Prices Are Not A Boon

I have pointed out many times in the past, and discussed on the radio show, that falling energy prices WAS NOT good for the economy or the markets.

Here is the latest mis-statement by the media in this regard which was published by Martin Wolf in the FT:

"(A) $40 fall in the price of oil represents a shift of roughly $1.3 trillion (close to 2 per cent of world gross output) from producers to consumers annually. This is significant. Since, on balance, consumers are also more likely to spend quickly than producers, this should generate a modest boost to world demand."

On the surface, this sounds correct.

If someone spends less at the gas pump, then they have more to spend somewhere else, right?


In order to have MORE to spend, you must have MORE income. Let me use a simple example to explain my point.

  • John has $100 to spend each week.

  • John normally spends $20 a week on gasoline and $80 on other living needs.

  • This week John only spent $10 on gasoline, spent $80 on living and bought took his wife to dinner with the remaining $10.

(See, he just spent his "extra" $10 at the restaurant on his wife. I will address the problem of taking a spouse to a $10 dinner in a future missive on the "5-reasons for divorce.")

  • From a personal standpoint - John had an "extra" $10 to spend elsewhere in the economy.

  • From an economic standpoint, which is most important, John still only spent $100.

The gas station where John fills up lost $10 in revenue. The restaurant gained $10. The net economic effect of shifting spending in the economy is zero.

Furthermore, the issue with Mr. Wolf's view is the negative impact to production. In any economy, it is "production" that creates the "jobs" which provides the "incomes" for "consumers" to "spend."

The negative impact of a $1.3 trillion decline in output to producers is increased job losses, reduced economic activity and capital expenditures, and lower output. The negative ramifications to the production side of the equation outweigh the positive shift to consumers.

As Doug Kass recently pointed out:

"We see this in the weakness in certain regional manufacturing data (e.g., the Dallas Fed's manufacturing index), in the rig count contraction, in the jobs market (e.g., job count and wages) in energy dependent states, in stagnating housing activity, in a plunge in energy-related capital spending, in a weakening high-yield market, and in a (likely) meaningful subtraction ($5/share to $7/share) in 2015 S&P forecasts.

We have yet to see the benefit of lower oil prices in retail spending or in automobile industry sales.

If lower oil and gas prices are anticipated to catalyze domestic economic growth, why is the yield on the 10 year U.S. note still around 1.75%?

The entirety of the Sell Side on Wall Street as well as the Buy Side keep telling us low oil price is good for the economy (and by abstraction earnings and the stock market). BUT the market rips every time market blips up (the last two days), and sells off when the price of oil goes down.

The lesson: Watch what they do, not what they say!"

Lastly, and most importantly for investors, here is the ongoing meme from Wall Street as to why you should "stay invested" despite the fact they are dumping stock like crazy:

"If you extract the energy sector, earnings are still very positive for the year."

Here is the problem with that argument.

When oil crashes to $40/bbl and the bullish argument of profitability is under attack, it is suggested you strip out the "bad" so that everything else looks "good."

But when oil was at $110/bbl, analysts weren't suggesting that you consider marginalizing surging corporate profitability because of surging oil prices. Such would have significantly reduced forward estimates and increased valuations. Neither of those is good for suckering, uh I mean, providing expert and unbiased investment advice to clientele.

Something to think about.

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