The Long View - Q&A
This is a followup to my last post: The Long View - http://caps.fool.com/Blogs/ViewPost.aspx?bpid=314202. In the comments section, there were two very good observations / questions by crystlz and mymini with some comprehensive responses by me.
I felt that these two conversations were detailed and pertinent enough to warrant their own post. Please read the original post first, so that you understand the context below: The Long View - http://caps.fool.com/Blogs/ViewPost.aspx?bpid=314202
From where I live in the midwest it is really hard to buy the recovery and post recovery talk that is being sent our way. Here tax revenues are still shrinking while tax rates are rising and unemployment is very high. I must say that this latest move by the USD has taken me by surprise and reminded me how much the world economy is connected to our own.
From where I live in the midwest it is really hard to buy the recovery and post recovery talk that is being sent our way. Here tax revenues are still shrinking while tax rates are rising and unemployment is very high.
I definitely agree.
Yep, and this Dollar bounce was not unexpected either. Many of us have been watching and calling for it. The question is now, what does it signify? Is it the start of a major multi-year dollar rally (some think so), or is it a bounce that lasts a few months (I am in this camp).
I think the Dollar Carry trade is about to unwind a bit. And I think this bounce was more or less engineered. The QE fund pool is almost dried up, and the demand from foreign governements during the last bond auctions was severely anemic. So the Fed needs a good "deflation scare" to get a second round of Quantitative Easing authorized.
And the purpose of this next round of QE will be to keep the government running, not to prop up the stock market. Like you observe above, tax revenues are down, yet the national debt ceiling is being *raised*. Government is *growing* in the face of shrinking revenues. And the only way to accomplish this is through defecit spending. And if foreign governments won't buy our debt to allow our government to run, then we have to buy our own debt (via debt monetization courtesy of the Fed, of course). It is the only way to keep the government running, other than slashing services. And the chance of that happening in an election year? Approximately 0.0%.
This is why the outcome was never going to be deflationary. As long as there is Fed, debt monentization will always be the preferred expedient action.
But just because the outcome is inflationary, it does not mean that assets will rise. I hemorrhage a lot when I read economic commentary because nobody tries to understand the complexity of the macroeconomic situation. And since 2000, we have seen first hand how little the ramifcations of monetary policy decisions are made not only by the public, but even by those who are making them. I still hear a lot of "dollar down = stocks up" or "inflation means stocks will rise".
Inflation "helps" (used *very* loosely) stocks rise ... until it doesn't. Stocks can fall in an inflationary environment, because the economic fundamentals are weak, and the inflation starts to exascerbate the weakness, not hide it. This happened in the 1970s. And it is called stagflation.
When stocks fall again due to poor fundamentals, people will say this is proof of deflation. I mean after all, if assets fall, it's deflationary right? Not if you want to understand cause and effect and not if you want to understand what the macroeconomic ramfications are. Mislabelling the next downturn as deflationary is exactly the misperception that the Fed wants so that it can be more aggressive with QE and similar policies (ramp up inflation while everybody is focused on "deflation" -- which is actually a deflation scare). Hell, they even said they were buying more mortage back securities today! (monetizing debt is directly inflationary). It believes that it is helping to solve the problem, but in actuality it is reinforcing it.
Peter Schiff had a great bit on his video blog (which kdakota always does a great job of reposting) regarding the PPI interpretation and extrapolation. Check out this post: http://caps.fool.com/Blogs/ViewPost.aspx?bpid=312473 and watch from 3:05 to 5:15. It is easy to see how this argument has ramifications for lower stock prices within an inflationary environmentThe comparison between now and the 1970s has a lot of compelling aspects: high inflationary environment, poor fundamentals, and falling asset prices. The only difference now is that the structural imbalances are a lot worse. Which means that the monetary inflation is going to reinforce the problems much more than they did in the 1970s.
A valid question would be "well once the Fed realizes (supposing they do) that it is a positive term in the feedback loop, not a negative one, won't they just stop inflating?".
The first answer is: no. And the first clue is the yield curve. Nobody but the Fed is buying our long term debt. The only reason why the government is running at the moment is because the Fed is funding the Treasury, it isn't getting money from foreign governments (well it is, but in much smaller proportion). And the National Debt ceiling is being *raised*. The Fed needs to inflate to get the government running.
The second answer is: it doesn't matter. Because once the inflation is detectable in general prices, the massive monetary inflation will have already done vast amounts of damage. And because of the inertia in the economy, we will be feeling the aftermath of that inflation for a very long time.
Things you own go down in value, the things you need to consume cost more. Sounds like stagflation to me.
Sorry for the ramble. I tend to do that (a lot). But let me tie it back in with the Dollar, which was your original observation.
The Dollar and equities are far more positively correlated than they are negatively correlated. And I lay out the case in my Dollar post ( Thoughts on the US Dollar, Analysis of the USDX Long Term, Follow up on the Gold Blog ) where the weak dollar eventually hurts the stock market. Since, like I am saying above, the outcome was always going to be massively inflationary ever since Quantitative Easing was announced, the long term direction of the stock market was sealed: USD-SPX-Correlation_since_1990.png
I would like to make an intelligent decision based upon many different forms of analysis as I plan to make some very large financial decisions soon.
I would like your comment regarding the following link and analysis. Thank you...
"Finally, the monthly chart looks very bullish for the long term (months to years). I say that primarily because the PMO has turned up from a deeply oversold reading and has passed up through its 10-EMA. This is about as bullish a picture as you are likely to see on a monthly chart. Keep in mind that this doesn't override the medium-term or short-term picture. If you study the chart carefully, you will see that quite violent price swings can occur without causing the monthly PMO to change direction. Nevertheless, the overriding message is that the long-term direction of the market is most likely to be up. "
This is an open-ended question (perhaps not outright, but the implications certainly are) so I am giving you fair warning that this response will ramble :)
Before I delve into the specifics of the analysis in the link, (which is a long term bullish interpretation) let me address the implied question you are asking, which is:
Why am I showing such a bearish outcome for the future? Couldn't it be bullish?
And the answer is: absolutely, it is possible that the outcome is in fact bullish. No analysis, and no analyst for that matter, is *ever* 100% correct. I fully admit that I am not. I used to write a blurb about this in every post, and then I eventually just started linking to it: binve's rant regarding being "right". Please read this, it is important. You as the reader have to view every analysis with skepticism. *Especially* of those that are trying to outright convince you of something.
However, I am not. Please review the first section of my post:
Why Should You Listen to Me? ..... You shouldn't.
I am not going to sit here and make some argument about why I am the finest macroeconomic mind around, nor am I going to try to convince and dazzle you with my charting prowess.
I am an analyst. I make observations. I examine the macroeconomic landscape and I draw conclusions.
I lay my observations out for you to follow.
So you read them and you agree with them, or you read them and you disagree, or you ignore them altogether. It is immaterial to me. Because the point of this post is not to convince you of anything. The point of this post is to share information and observations. I will draw and share my conclusions, and I offer them to you if you are interested in reading them. But your conclusions are up to you.
I am resaying all of this because of what you wrote: "I would like to make an intelligent decision based upon many different forms of analysis as I plan to make some very large financial decisions soon." You may already know and think what I am about to say, so please do not take this the wrong way. But I am going to say it anyways just to be on the safe side: You will *never* read any analysis that is "completely right", not only because it is impossible, but because the relationship between you and your money is a personal one. Only you know your own risk tolerance, only you know your own timeframe, etc.. So while this advice may not be needed for you specifically, I am saying it for anybody else who reads this.
Okay, that out of the way, lets get to specifics:
Even I don't put a 100% chance on the scenario I describe in this post. I am an engineer. I deal with probabilities, and conservative analysis. From a structural standpoint, you have to design for load cases. Load cases are determined from the design environment, but are also determined probabilistically based on past data. You might have an extremely high transient load case, but its chance of occurrence is 1 in 1000000000. But its impact if it does occur: catastrophic. So you must design for these cases. Then there are other load cases where the damage might be high but not catastrophic. You might used a 3-sigma environment for these.
My point is, as thermal analyst and structural analyst, I must be a good engineering risk manager. As a stock market analyst and investor, I view my role in *exactly* the same way. What are the possible outcomes? What are their likelihood and impacts? What are their overall risk profiles?
This is why I go to the trouble of all of this fundamental analysis from the macroeconomic perspective. I am trying to assess the likelihood for economic recovery vs. economic catastrophe. This is why determining what is real GDP growth vs. what is due to government intervention is critical. This is why money supply policy and growth is critical. This is why understanding sentiment and social mood is critical. etc.
My assessment would go something like this (keep in mind, this is just one analysts take):
1) The bottom was in on March 9, 2009 and this is the start of a multi-year bull market.
Odds of occurrence: very low.
Impact: high (being severely short a strong bull market would be detrimental to your portfolio)
Overall Risk Assessment: medium-low
2) Drift higher into the middle of next year and then start heading down
Odds of occurrence: medium-low
Impact: medium-low (I build enough cushion into my positions that I can afford to have them go against me up to a point)
Overall Risk Assessment: medium-low
3) Trade sideways / rangebound for the next several years into what amounts to be a Cycle-Degree X-Wave
Odds of occurrence: medium
Impact: low (If we are range bound for years, there will be opportunities to exit shorts and to go long to play the range)
Overall Risk Assessment: medium-low
4) The count I show in this post plays out (Primary 3-4-5 down)
Odds of occurrence: medium-high
Impact: very high
Overall Risk Assessment: high
So, for myself, when I look at all of the scenarios, it is clear to me that scenario 4 is the clear one to hedge against.
However, like I have said repeatedly, no outcome is guaranteed. I will always maintain some cash margin to either hedge my positions if the trade really starts going against me, or if a scenario I had not thought of begins to play out.
So why don't I show all 4 scenarios? Why don't I do charts for the cases I don't think are as likely?
As an analyst and, more importantly, as an investor I have to make decisions. To be sure, there are more possibilities than just the 4 that I list. Maybe there are 100. Do I then divide my time, attention, and resources among all these possibilities? No.
I have to pick a "preferred count", one that I think is most likey, and trade that one until it is proven to be wrong. I will adjust my hedging strategy if the positions goes against me.
But at the end of the day, the whole point of all this analysis and information gathering is to make a decision.
In fact, I personally find it extremely distracting, confusing, and generally not helpful to look at a chart or a count that has several different options on it. I like my charts to be clean and concise. They tell one story, the one that I think is most likely. This way there are clear ways to tell when that analysis gets invalidated.
There is no right or wrong in this regards. I am just relaying my opinion.
Now, onto the link you provided: http://blogs.stockcharts.com/chartwatchers/2009/12/analysis-of-three-time-frames.html
.... Wow, I have so many problems with this. And they all stem from the fact that they are doing long term analysis with arithmetic charts. And I have a *huge* problem with that.
Please read this post: Why Arithmetic Stock Charts Are Worthless - http://caps.fool.com/Blogs/ViewPost.aspx?bpid=290893. Read all of the comments in the post, especially the conversation between myself and Tastylunch
There is an exception to this general statement, and it is the crux of AdirondackFund's analysis. He has done a lot of work with Gann, and arithmetic charts are critical to this analysis. Because there is a *very* specific way you must set up your templates to make them work. And when you do, very specific angle relationships show up that otherwise won't.
But that is not what the analysis in your link shows. It is just looking at some long period of time on an arithmetic chart with no special format, and per my reasoning in my link above, I argue that it is invalid. Does it mean I am right? No. It just means I have an opinion, but what I do is share that basis for my opinion. Your job is then to read my reasoning, see if it makes sense to you, and then decide if you will use it.
As a point of comparison, I took their 3rd chart, the 20 year one, an examined using a log scale. And you can see, it paints a very different picture:
So, in short, I vehemently disagree with the trendline analysis in your link.
Regarding the PMO, which is similar to the MACD. Yes, there is a monthly positive cross, just like there is an MACD positive cross. But just because there is an indicator cross *does not* mean that new trend will continue. Indicators can stop mid-range and reverse. If there is a positive cross *AND* the price surpasses major price resistance, then that is a different story. So if the $SPX moved to say 1200-1250, then I would reevaluate my scenario. But right now, it is simply an indicator that is signaling bullish potential. That's all.
In fact, I make similar observations in the post above regarding the MACD (where I call the possible MACD crossover fakeouts):
I would like to leave you with one last thought:
I approach my analysis from my own viewpoint. Everybody has a different viewpoint. Two analysts can look at the exact same economic data, and analyze it with the same exact analysis methods and could come to two completely different conclusions:
Regarding Economic Debates and Opinions: The Fallacy of "Purely Objective" Analysis - http://caps.fool.com/Blogs/ViewPost.aspx?bpid=305849
So what I am saying is that when you look at mine or anybody else's analysis, look at the reasoning behind that analysis instead of the just the results. In fact, I would tend to give more weight to the reasoning behind the analysis than to any conclusions.