Holding Support at S&P 1300

Stocks Weighed in 2011 By European Banking Crisis

Dow Down 200, S&P Loses 22

Stocks Begin Day Deep in Red

S&P was down as much as 20 points, but just 17 right now. Dow was down 180. Trading is choppy, however. Volume must be poor.

Make That Down 20

Stocks Go Negative

After S&P futures were up 15 points, stocks turn red.

S&P Futures Collapse Another 20 Points

True Market Mayhem!

The S&P 500 is down about 38 points. The Dow has been down around 300 points thus far, but is showing a minor bounce at the moment.

Charles Hugh Smith: From Here, a Dead Cat Bounce

This is what I've been expecting. Wall Street is determined to rally stocks despite the atrocious economic news in the past three months.


Submitted by Charles Hugh Smith from Of Two Minds
The Turning Point
Some technical analysts are calling for a major rally from here, but the massive injections of financial insulin don't seem to be reviving the sagging global economy.
The stock market and economy are both at a turning point. Analyst Martin Armstrong's Economic Confidence Model (tm) set the turn date as June 13/14, 2011.

In the stock market, a number of technical analysts are issuing strong buys based on the negative sentiment of so-called "dumb money"--small investors--and the number of stocks below their 50-day moving averages.

Others such as Armstrong are predicting that Greece has no alternative to default and the Euro is untenable as "one size does not fit all."

It is rare to find a market where the technical evidence is so compelling for a strong rally yet the fundamental basis for such a rally so lacking. Exactly where do Bulls think the growth and rising profits are going to come from?

The answer for the past few years has been massive Federal Reserve/Federal intervention and stimulus, and a weakening U.S. dollar that boosted overseas profits via the legerdemaine of currency devaluation.

But three years of these policies have accomplished nothing but load the taxpayer with staggering amounts of debt: none of the causes of the 2008 implosion have been fixed or even addressed. As Armstrong notes, the massive interventions did not shorten the crisis, they have prolonged it.

This reality has filtered down to the political swamp, and now the politicos are hesitant to bet their own futures on additional trillions in stimulus and quantitative easing. For the first time in memory, the Federal Reserve is on the defensive. Simply put, its policies have failed to accomplish anything except prop up a rotten, insolvent banking sector that needs to be declared bankrupt and swept into the dustbin of history.

As I have noted here before, the next round of QE (quantitative easing) will fail to inflate the stock market regardless of its size or tricks. The fact that QE3 is needed will spook everyone who understands that it is a last-ditch effort to keep the Status Quo financialization from imploding, and since QE2's sugar-high was so brief, others will be spooked by the possibility that the next high will be even shorter.

This is the dreaded Diabetes Financial Syndrome--the Fed is pouring ever larger amounts of financial insulin into the system, but the financial "body" no longer responds to this insulin. The financial system then goes into toxic shock and implodes.

Let's look at two charts for context. Here is the S&P 500 from 1965 to 2011. Hmm, are there any aberrations visible here, any gigantic spikes of speculative frenzy? Just because these spikes of speculative, financialized frenzy have been normalized doesn't mean they are no longer speculative, financialized frenzies.



Has the economy really been healed? If not, then what is the basis of the market's spectacular rebound since 2009? We all know the answer: $6 trillion in Federal financial insulin and another $2 trillion in Federal Reserve insulin. The entire rally, in other words, is an artifact of Central bank/State intervention.

Courtesy of dshort.com, here is an inflation-adjusted chart of the S&P 500. This chart clearly illustrates that unprecedented Central State stimulus and intervention/manipulation have juiced the market higher than previous post-crash highs.


But the whole financial-insulin project is looking a bit long in tooth compared to previous post-crash markets. In the long run, perhaps we can attribute this extension of the euphoric high of "recovery" to the Fed's QE2, which pumped half a trillion dollars into stocks in a matter of months.

Short of the Fed simply buying trillions of dollars in stocks outright, then it looks like this "recovery" rally is about to have a Wiley E. Coyote moment, as it has raced off the solid ground provided by the Fed's QE2 injections and is now poised in thin air.

Of course the market could rally from here, but it's hard to see on what basis other than a technical dead-cat bounce. The Fed could announce another round of intervention, and that would certainly give the comatose body a jolt. But for how long?

If it does respond to gravity, then we might want to re-visit the definition of "dumb money:" small investors have been pulling money out of the stock market all during the QE2 insulin-rush rally while the "smart money" has been piling in, blubbering piously about the key tenet of their religious faith, "don't fight the Fed."

So which do you think is all-powerful, smart money--the Fed or gravity? We're about to find out.

Market Sentiment: Choppy Going Up, Hard and Fast Going Down

When I see this candlestick pattern (see description next paragraph), I take it as a reading of market sentiment. The S&P 500 is now back to flat for the day. The Dow is lagging behind and is still positive; since the Dow was up much higher in percentage terms, this is not surprising.


Notice on this chart that the uptrend was choppy and sloppy going up, but hard and fast going down. This tells me that traders are uneasy taking a long position, but quick to liquidate and/or short when the market turns. Note on the left the frequency of red, downward candles and long wicks in an uptrend. Note also on the right the lack of green candles and the rapidity of the downward move.

S&P 500 Turns Red

Stocks Fall Through the Floor

Once prices fell through support, the bottom fell out. Stocks are really getting plastered now! Amazing, given the strength of the mid-day rally today. The S&P got back to flat, but stocks have since fallen back to the equivalent of a 200-point drop for the Dow.

I really expected the market to rally and sustain it. This is why I must relentlessly work hard to maintain control over my biases and trade what the market and the charts say instead of what my bias or opinion is.

Stocks Rise On bin Laden Killing, Fall on Crude Oil Rise

Interesting! I am surprised to see crude oil rise to nearly $115 after sinking to about $110.85. It could be that this is the reason stocks have been weak since the initial reaction to the news of the killing of Osama bin Laden last night, as shown at the far left of the chart.

This price for crude oil will ultimately bring a recession.

Stocks Erase Overnight Losses, Go Positive

I suspected that yesterday's S&P downgrade would be short-lived. It turns out that I was right!

Hussman: Perspective on Recent Market Weakness

from John Hussman of Hussman Funds. I nominate John Hussman to be the next Fed chairman. That monthly chart speaks volumes about where we're at. Even devastating earthquake, tsunamis, Arab world unrest, and catapulting crude oil prices, can't dampen the bubblishness of Wall Street. 

Good analysis and perspective:

The market action of the past two weeks contrasts with the generally uncorrected advance of recent months. The chart below places this pullback in perspective, relative to the "big picture" for the S&P 500, showing monthly bars since 1996. I suppose it's possible for investors to characterize the recent decline as a "panic" if they press their noses directly against their monitors, but in that case, they really do have a short memory. The pullback has been negligible even relative to the action of the past several months, and is indiscernible in the big picture. As of Friday, the market remained in an overvalued, overbought, overbullish, rising-yields syndrome that has typically been cleared much more sharply than anything we saw last week.

We still expect to establish a moderate positive exposure to market fluctuations if we can clear some component of this syndrome, provided that market internals (breadth, leadership, sector uniformity, etc) don't also deteriorate substantially enough to signal a shift to risk aversion among investors. We've already seen meaningful breakdowns in international markets, both within and outside of Asia. Thus far, market internals in the U.S. have maintained intact, though still burdened with a negative syndrome of conditions over the short-to-intermediate term. Even with a more constructive position, we would still expect to maintain a strong line of put option protection in the event of abrupt weakness, but suffice it to say that we don't require a major change in valuation in order to be willing to accept greater market exposure - just enough to clear this syndome without strongly damaging market internals.

In order to clear this syndrome, last week's decline would have required either a meaningful retreat of investor bullishness, or a deeper price decline on the week. That said, the pullback did clear very short term overbought conditions, and we covered some short calls and lowered some put strikes as the market briefly challenged the 1250 level. This maintains a defensive line of index put options for the entire portfolio of Strategic Growth, but leaves us with short calls against only 60% of the portfolio. The change wasn't very observable on Thursday and Friday, because the sharp drop in implied volatilities (to a VIX of 23) created some short-term drag. But even here, any sustained upmove in the market should be far more comfortable than what we've experienced since QE2 triggered the recent speculative run.

It's important to recognize that various indicators used by investors often have implications contrary to what is commonly assumed. For example, the strong ISM Purchasing Managers Index reading above 60 is widely seen as a favorable indication for stocks, yet historically, readings above about 59 have been followed by negative average returns for the S&P 500 over the short- and intermediate-term, and flat returns over a 12-month horizon. Weaker PMI readings are actually preferable, so long as they don't occur within a syndrome of pre-recession signals (rising credit spreads, flattening yield curve, weak employment growth and tepid stock returns).

Meanwhile, a "This time is different" perspective may very well apply to the increasingly extreme policy moves that have been required to produce a surface layer of economic growth, but while this has affected short-term market dynamics to a surprising degree, it doesn't materially change the long-term stream of cash flows that stocks are likely to deliver. So positive short-term returns come at the cost of progressively thinner long-term return prospects.

Our investment orientation is emphatically long-term and full-cycle. Even so, short- and intermediate-term returns do matter, particularly those that have some hope of being retained. Even in richly valued markets, there are often conditions that have been associated with positive average return/risk profiles when you look across numerous subsets of historical data. Those favorable conditions reasonably warrant a moderate exposure to market fluctuations, and we would certainly prefer to observe and respond to those opportunities. Until we do observe them, however, we have aligned ourselves with the expected return/risk profile associated with the current set of market conditions. For now, that profile remains negative.

The events in Japan have had a tragic effect on individual lives, and they are undoubtedly in all of our prayers. With respect to the global economy, there will likely be supply disruptions, and reallocations of trade, but we would expect these to be mainly of a short-term nature. Given that the most strongly affected areas were not heavily urbanized or industrialized, the increased demand for raw materials is also unlikely to be enormous. Instead, it is likely to be modest and spread over a large number of years. Witness the slow pace of reconstruction in the wake of Katrina, and in other places that have been hit by natural disasters in the past. Invariably, such disasters result in rapid destruction but very slow and long-term reconstruction.

The larger economic problem is that this disruption is occurring when there are other economic pressures elsewhere, particularly in Europe. The U.S. has quite a bit of slack capacity, so the prospects for economic growth over a multi-year period seem reasonably good, but the frequency of weak patches is also likely to be higher in the next several years, and it is worth keeping in mind that much of the recovery we've observed - particularly in the credit markets - is a veneer over continuing credit issues.

Nobel economist Joseph Stiglitz tied the issues together nicely in an interview that appeared in Barron's over the weekend. Speaking about Japan, he observed "The sad thing is that they've never fully recovered from the bubble of 1989 bursting. In that sense it should remind the U.S. of what happens if you allow a bubble to get outsized. It's water under the bridge, but Bernanke and Greenspan have to bear some responsibility for that ideology that bubbles don't really exist, and they clearly do. When we went into this financial crisis, the administration said, 'We won't make the mistake of Japan and delay restructuring.' That's exactly what we did. It's mind-boggling that we haven't learned any of the lessons of Japan."

My only disagreement might be that any of this is actually "water under the bridge," because the same basic policies that produced the bubble are still very active. These policies have driven financial assets to rich valuations and low prospective returns, which compete sufficiently well with zero interest rates, but offer little for long-term investors. Meanwhile, the financial sector has a continuing overhang of delinquent and unforeclosed homes, which the FASB still allows banks to carry on their books at amortized cost. When the main source of "prosperity" is the policy-induced elevation of asset prices - rather than the allocation of savings into productive investment - it helps to remember that present gratification often equates to future unpleasantness.

When we look around the world, we see difficult social tensions, particularly in North Africa and the Middle East where the poor are dealing with enormous increases in the prices of basic commodities (and where the much of their budgets go for food and fuel), at the same time that others in the same societies are enjoying disproportionate wealth, particularly based on strong oil revenues. Certainly, inequality and oppressive leadership has existed in many of these countries for a long time. But we have to ask what has heightened these tensions to the tipping point at this particular time.

The Buddha taught that you can only understand something by looking deeply at its interconnectedness to other things, and to our own selves - nothing has a separate existence. "This is, because that is; this is not, because that is not." The problems and imbalances that have inflamed the world did not emerge from a vacuum. Rather, this is, because that is. It cannot possibly help that the Fed continues to pursue an aggressive policy that drives short-term interest rates to negative levels, which predictably encourages commodity hoarding around the globe, and the unintended consequences that result.

In any event, our present investment stance is not driven by a thesis regarding QE2, underlying credit issues, or even the sustainability of economic growth. It is driven by present, observable conditions on a wide variety of measures. On the basis of a large ensemble of historical time periods, valuation thresholds, and indicator sets, present conditions map into the expectation of negative total returns per unit of risk. Strategic Growth and Strategic International Equity remain well-hedged, though the composition of those hedges reflects the conditions we observe in the U.S. versus other countries (risk aversion is weaker in the U.S., which creates the potential for more speculation, particularly if we clear overbought or overbullish conditions).

...And Hurts Some More!

Amazing that the Dow is down only a few points, while the S&P 500 has fallen off a cliff!

Stocks Grossly Overvalued on a Historical Basis

by John Hussman:


When we analyze historical relationships between economic and financial variables, it's important to examine the data for "outliers" that significantly depart from typical behavior. Very often, these outliers are corrected over time in a way that creates profit opportunities. In the office, we usually refer to these observations as being "outside the oval," because they diverge from the cluster that describes the majority of the data.

Failing to recognize data that is outside the oval can lead investors to learn dangerous lessons that aren't valid at all. A good example of this is the relationship between valuations and subsequent market returns. The chart below presents the historical relationship between the S&P 500 dividend yield and the actual annual total return achieved by the S&P 500 over the following decade. The majority of the points cluster nicely - higher yields are associated with higher subsequent returns. But there is a clear segment of the data that breaks away from the oval. I should note that the same departure is evident on the basis of P/E ratios that reflect normalized (full cycle) earnings, so this is not simply a dividend story.

Prior to about 1995, the lowest yield ever observed on the S&P 500 was 2.65%, and then only at the three most extreme valuation peaks in history - August 1929, December 1972, and August 1987. But in the mid-1990's, valuations broke free of their prior norms. As the bubble continued and yields fell further, investors observed that poor dividend yields were actually accompanied by high returns over the following decade anyway. By the time the market reached its peak in 2000, the dividend yield on the S&P 500 had declined to just 1.07%, and dividend yields were almost universally discarded as a measure of stock valuation. The intellectual case was seemingly reinforced by the idea that stock repurchases had made dividend yields an obsolete measure of valuation, even though the calculations made by Standard and Poors for both the level and the growth rate of index dividends for the S&P 500 properly reflect the impact of repurchases.

Unfortunately, discarding the information from dividend yields was the wrong lesson. As you can see in the chart, the data points eventually came back into the oval: the extraordinarily low yields observed at the tail of the bubble were followed by a decade of negative total returns, including two separate declines of more than 50% each.

Despite this outcome, investors have failed to recognize the wrong lesson that they learned. With the exception of the market bubble that took the relationship between yields and subsequent returns outside the oval, the historical evidence is very consistent that low yields (elevated valuations) are accompanied by dismal subsequent returns. At present, the yield on the S&P 500 is just 1.95%. This level can be expected to be followed with S&P 500 total returns of about 2.2% annually over the coming decade, with a confidence interval that easily includes zero. Based on normalized earnings, our projections are somewhat better, at about 4.8%. Meanwhile, our estimate based on forward operating earnings (see Valuing the S&P 500 Using Forward Operating Earnings) gives a 10-year total return projection of about 4.7% annually. Again, this is not simply a dividend story.

In recent months, we've heard a related, but also mistaken lesson from various corners of the investment community. This one suggests that poor market returns over a 10-year period, in and of themselves, can be taken as evidence that market returns over the following decade will be glorious. The problem is that this argument fails to take valuations into account. Historically, poor 10-year periods have invariably terminated with very low valuations and very high yields. It is the low valuations that resulted in high subsequent long-term returns, not the poor preceding market returns per se.

Likewise, high unemployment rates cannot be taken, in and of themselves, as a signal that subsequent market returns will be strong. Look at the relationship between the unemployment rate and the dividend yield, and what you'll find today is that the current dividend yield is way outside of the oval. Historically, high unemployment has been associated with high subsequent returns, but only because high unemployment was associated with high stock yields and depressed valuations. Not today.

Our estimates for S&P 500 total returns remain below 5% at every horizon shorter than a decade. One can argue that 5% is "attractive" relative to less than 3% on a 10-year Treasury bond, but that assumes a static world where stocks are risk-free and securities deliver their returns smoothly. If investors decide that they are no longer ecstatic about these low prospective rates of return a year or two from now, they will promptly re-price the assets to build in higher rates of expected return. Unfortunately, the way you increase the future expected rate of return is to drop the current price, and the amount by which prices would have to drop in order to normalize expected returns is enormous.

From our standpoint, it isn't likely that investors will get their expected 5% return over the coming decade in a smooth, diagonal line. Our guess is that they will instead see a large negative return over the first two years or so, followed by subsequent returns that are much closer to the historical norm. The third alternative, of course, is the bubble scenario, where stocks achieve returns above 5% annually in the immediate few years, followed by flat or negative returns for the remainder of the decade. That is certainly the pattern we observed beginning in the late-1990's.

We'll take our evidence as it comes. As I noted at the beginning of this year, as move toward 2011, we are increasingly weighting post-1940 data in setting expectations about prospective returns and risks, in the expectation that there is a wide enough range in that data to manage the residual economic risks we observe.

Presently, we have a combination of overvalued, overbought, overbullish, rising yield conditions that have been very hostile for stocks even in post-1940 data. We also have not cleared our economic concerns sufficiently to lift that depressing factor on the expected return/risk profile for stocks. It follows that changes in some combination of those factors - valuation, overbought conditions, sentiment, and economic conditions, provided that those changes aren't accompanied by a clear deterioration in market internals - would prompt us to remove a portion of our hedges (most probably covering short calls and leaving at least an out-of-the money index put option exposure in place). Unfortunately, with stocks overvalued, a shallow decline that simply clears the overbought condition would not leave much room to advance until stocks were overbought again, so the latitude for a constructive position would be limited. Ideally, we'd prefer a very substantial improvement in valuation, that is, significant price weakness that would also be accompanied by internal deterioration. In that event, as in 2003, we would look for early divergences and internal strength as an indication to remove the short-call portion of our hedges, and possibly more depending on the status of valuations and other factors at the time.

For now, we remain defensive, even purely on the basis of post-1940 relationships.

SocGen Strategist Forecasts Stock Market "Rude Shock", S&P 500 Plunging to 450 Level

Albert Edwards, whose opinion, of all macro economists, is among the most respected by Zero Hedge staff, has just thrown down the gauntlet. In his just released piece he mocks the Black Knight, compares the market to a Polish dude with a bullet stuck in his head, makes fun of koolaid drinking permabulls, and sets his estimate for the S&P... at 450.

Investors cannot move for the weight of broker research comparing the current conjuncture in the US with Japan a decade ago. While bond markets at least, move to discount deflation, most sell-side analysts still say the current situation is unlike Japan a decade ago. They are right. Things now in the US are much, much worse than Japan a decade ago.

Equity investors are in for a rude shock. The global economy is sliding back into recession and they are still not even aware that these events will trigger another leg down in valuations, the third major bear market since the equity valuation bubble burst.

This lack of awareness reminds me of reports this week that a 35 year old Polish man hadn?t noticed for five years that he had a bullet lodged in his head. Like the equity market in 2000, the Polish man had been partying too hard to notice that he had been shot. The BBC report the police as saying "He told us he remembered having a sore head, but that he wasn't really one for going to the doctor."

As the equity bloodbath of the last decade enters its final, even bloodier phase, investors continued optimism also reminds me of the Black Knight in Monty Python & the Holy Grail - link. Despite being grievously wounded by King Arthur, the Black Knight makes light of his injuries which he dismisses as a flesh wound. The vast bulk of the investment industry fails to appreciate that we are locked in a structural bear market and about to enter Act III.

In case anyone needs a graphic summary of all that was just said, the chart below summarizes it best:

Some more observations:

This year has already seen a dramatic flip-flop in sentiment as the market has begun to acknowledge it is sinking into the deflationary quicksand. For this year outperformance in the US, for example, is over 20 percentage points (see chart below).

Another pet peeve of the SocGen strategist, as demonstrated repeatedly by Zero Hedge when we show that bonds imply stocks should be at about 750-800, is why have stocks not followed bonds down into the deflationary abyss. His conclusion:

So far the equity market has shrugged off much of the weaker data that abounds, and has not joined the bond market in a perceptive move. The equity market will though crumble like the house of cards it is, when the nationwide manufacturing ISM slides below 50 into recession territory in coming months. Indeed the new orders data for August, already reported in regional ISM?s suggests the equity market is going to get some sentiment crushing data in the very near term. But never mind the last standing optimist will tell us ? it is only a flesh wound!

Yet all logic aside, we know readers are just waiting for the punchline. So here it is:

The structural bear market has not reached the end. We have long said that the de-bubbling process would end only when equities became very cheap and revulsion in equities as an asset class hangs in the air like a fog. The problem remains more of excess valuation within the US rather than Europe, but that will not prevent the bear market hurting other cheaper markets as much. We will return to the valuation nadir last seen in 1982 with the S&P bottoming around 450 (see chart below).

S&P 500 Goes Red Too!

Will it hold? We'll find out!

8 Months' Gains Lost for Stocks

Wow! Amazing graphic! We're back to September 2009 again! Note that we are below the 200-day moving average, and at February's low. We are also at the low May6th when the infamous 1,000-point Dow drop occurred.