Today's Headlines for November 12, 2013

Hussman: It's a Classic Pre-Crash Bubble

This man is the most brilliant mind in economics today. God bless him!

Investors who believe that history has lessons to teach should take our present concerns with significant weight, but should also recognize that tendencies that repeatedly prove reliable over complete market cycles are sometimes defied over portions of those cycles. Meanwhile, investors who are convinced that this time is different can ignore what follows. The primary reason not to listen to a word of it is that similar concerns, particularly since late-2011, have been followed by yet further market gains. If one places full weight on this recent period, and no weight on history, it follows that stocks can only advance forever.

What seems different this time, enough to revive the conclusion that “this time is different,” is faith in the Federal Reserve’s policy of quantitative easing. Though quantitative easing has no mechanistic relationship to stock prices except to make low-risk assets psychologically uncomfortable to hold, investors place far more certainty in the effectiveness of QE than can be demonstrated by either theory or evidence. The argument essentially reduces to a claim that QE makes stocks go up because “it just does.” We doubt that the perception that an easy Fed can hold stock prices up will be any more durable in the next couple of years than it was in the 2000-2002 decline or the 2007-2009 decline – both periods of persistent and aggressive Fed easing.  But QE is novel, and like the internet bubble, novelty feeds imagination. Most of what investors believe about QE is imaginative.

As Ray Dalio of Bridgwater recently observed, “The dilemma the Fed faces now is that the tools currently at its disposal are pretty much used up. We think the question around the effectiveness of QE (and not the tapering, which gets all the headlines) is the big deal. In other words, we’re not worried about whether the Fed is going to hit or release the gas pedal, we’re worried about whether there’s much gas left in the tank and what will happen if there isn’t.”

While we can make our case on the basis of fact, theory, data, history, and sometimes just basic arithmetic, what we can’t do – and haven’t done well – is to disabuse perceptions. Beliefs are what they are, and are only as malleable as the minds that hold them. Like the nearly religious belief in the technology bubble, the dot-com boom, the housing bubble, and countless other bubbles across history, people are going to believe what they believe here until reality catches up in the most unpleasant way. The resilience of the market late in a bubble is part of the reason investors keep holding and hoping all the way down. In this market cycle, as in all market cycles, few investors will be able to unload their holdings to the last of the greater fools just after the market’s peak. Instead, most investors will hold all the way down, because even the initial decline will provoke the question “how much lower could it go?” It has always been that way.

The problem with bubbles is that they force one to decide whether to look like an idiot before the peak, or an idiot after the peak. There’s no calling the top, and most of the signals that have been most historically useful for that purpose have been blaring red since late-2011.

As a result, the Shiller P/E (the S&P 500 divided by the 10-year average of inflation-adjusted earnings) is now above 25, a level that prior to the late-1990’s bubble was seen only in the three weeks prior to the 1929 peak. Meanwhile, the price/revenue ratio of the S&P 500 is now double its pre-bubble norm, as is the ratio of stock market capitalization to GDP. Indeed, the median price/revenue ratio of the S&P 500 is actually above the 2000 peak – largely because small cap stocks were much more reasonably priced in 2000 than they are today (not that those better relative valuations prevented wicked losses in small caps during the 2000-2002 decline).

Despite the unusually extended period of speculation as a result of faith in quantitative easing, I continue to believe that normal historical regularities will exert themselves with a vengeance over the completion of this market cycle. Importantly, the market has now re-established the most hostile overvalued, overbought, overbullish syndrome we identify. Outside of 2013, we’ve observed this syndrome at only 6 other points in history: August 1929 (followed by the 85% market decline of the Great Depression), November 1972 (followed by a market plunge in excess of 50%), August 1987 (followed by a market crash in excess of 30%), March 2000 (followed by a market plunge in excess of 50%), May 2007 (followed by a market plunge in excess of 50%), and January 2011 (followed by a market decline limited to just under 20% as a result of central bank intervention).

These concerns are easily ignored since we also observed them at lower levels this year, both in February (see A Reluctant Bear’s Guide to the Universe) and in May. Still, the fact is that this syndrome of overvalued, overbought, overbullish, rising-yield conditions has emerged near the most significant market peaks – and preceded the most severe market declines – in history:

1. S&P 500 Index overvalued, with the Shiller P/E (S&P 500 divided by the 10-year average of inflation-adjusted earnings) greater than 18. The present multiple is actually 25.

2. S&P 500 Index overbought, with the index more than 7% above its 52-week smoothing, at least 50% above its 4-year low, and within 3% of its upper Bollinger bands (2 standard deviations above the 20-period moving average) at daily, weekly, and monthly resolutions. Presently, the S&P 500 is either at or slightly through each of those bands.

3. Investor sentiment overbullish (Investors Intelligence), with the 2-week average of advisory bulls greater than 52% and bearishness below 28%. The most recent weekly figures were 55.2% vs. 15.6%. The sentiment figures we use for 1929 are imputed using the extent and volatility of prior market movements, which explains a significant amount of variation in investor sentiment over time.

4. Yields rising, with the 10-year Treasury yield higher than 6 months earlier.

The blue bars in the chart below depict the complete set of instances since 1970 when these conditions have been observed.

Our investment approach remains to align our investment outlook with the prospective market return/risk profile that we estimate on the basis of prevailing conditions at each point in time. On that basis, the outlook is hard-defensive, and any other stance is essentially speculative. Such speculation is fine with insignificant risk-limited positions (such as call options), but I strongly believe that investors with a horizon of less than 5-7 years should limit their exposure to equities. At this horizon, even “buy-and-hold” strategies in stocks are inappropriate except for a small fraction of assets. In general, the appropriate rule for setting investment exposure for passive investors is to align the duration of the asset portfolio with the duration of expected liabilities. At a 2% dividend yield on the S&P 500, equities are effectively instruments with 50-year duration. That means that even stock holdings amounting to 10% of assets exhaust a 5-year duration. For most investors, a material exposure to equities requires a very long investment horizon and a wholly passive view about market prospects.

Again, our approach is to align our outlook with the prospective return/risk profile we estimate at each point in time. That places us in a defensive stance. Still, we’re quite aware of the tendency for investors to capitulate to seemingly relentless speculation at the very peak of bull markets, and saw it happen in 2000 and 2007 despite our arguments for caution.

As something of an inoculation against this tendency, the chart below presents what we estimate as the most “optimistic” pre-crash scenario for stocks. Though I don’t believe that markets follow math, it’s striking how closely market action in recent years has followed a “log-periodic bubble” as described by Didier Sornette (see Increasingly Immediate Impulses to Buy the Dip).

A log periodic pattern is essentially one where troughs occur at increasingly frequent and increasingly shallow intervals. As Sornette has demonstrated across numerous bubbles over history in a broad variety of asset classes, adjacent troughs (say T1, T2, T3, etc) are often related to the crash date (the “finite-time singularity” Tc) by a constant ratio: (Tc-T1)/(Tc-T2) = (Tc-T2)/(Tc-T3) and so forth, with the result that successive troughs come closer and closer in time until the final blowoff occurs.

Frankly, I thought that this pattern was nearly exhausted in April or May of this year. But here we are. What’s important here is that the only way to extend that finite-time singularity is for the advance to become even more vertical and for periodic fluctuations to become even more closely spaced. That’s exactly what has happened, and the fidelity to the log-periodic pattern is almost creepy. At this point, the only way to extend the singularity beyond the present date is to envision a nearly vertical pre-crash blowoff.

So let’s do that. Not because we should expect it, and surely not because we should rely on it, but because we should guard against it by envisioning the most “optimistic” (and equivalently, the worst case) scenario. So with the essential caveat that we should neither expect, rely or be shocked by a further blowoff, the following chart depicts the market action that would be consistent with a Sornette bubble with the latest “finite time singularity” that is consistent with market action since 2010.

To be very clear: conditions already allow a finite-time singularity at present, the scenario depicted above is the most extreme case, it should not be expected or relied on, but we should also not be shocked or dismayed if it occurs.

Just a final note, which may or may not prove relevant in the weeks ahead: in August 2008, just before the market collapsed (see Nervous Bunny), I noted that increasing volatility of the market at 10-minute intervals was one of the more ominous features of market action. This sort of accelerating volatility at micro-intervals is closely related to log-periodicity, and occurs in a variety of contexts where there’s a “phase transition” from one state to another. Spin a quarter on the table and watch it closely. You’ll notice that between the point where it spins smoothly and the point it falls flat, it will start vibrating uncontrollably at increasingly rapid frequency. That’s a phase transition. Again, I don’t really believe that markets follow math to any great degree, but there are enough historical examples of log-periodic behavior and phase-transitions in market action that it helps to recognize these regularities when they emerge.

Risk dominates. Hold tight.

Dow Closes At Another Record High

 

John Mauldin Asks the Questions That MUST Be Asked!

Three cheers for John Mauldin. He's asking the questions that Congress should be asking! I love this man!

The Fed's Dilemma
Conveniently, Ray Dalio and his team at Bridgewater penned an essay this week highlighting the Fed's dilemma. I offer a few key paragraphs and a chart or two as a setup to my list of questions. Turning right to their very prescient comments:
In the old days central banks moved interest rates to run monetary policy. By watching the flows, we could see how lowering interest rates stimulated the economy by 1) reducing debt service burdens which improved cash flows and spending, 2) making it easier to buy items marked on credit because the monthly payments declined, which raised demand (initially for interest rate sensitive items like durable goods and housing) and 3) producing a positive wealth effect because the lower interest rate would raise the present value of most investment assets (and we saw how raising interest rates has had the opposite effect).
All that changed when interest rates hit 0%; "printing money" (QE) replaced interest-rate changes. Because central banks can only buy financial assets, quantitative easing drove up the prices of financial assets and did not have as broad of an effect on the economy. The Fed's ability to stimulate the economy became increasingly reliant on those who experience the increased wealth trickling it down to spending and incomes, which happened in decreasing degrees (for logical reasons, given who owned the assets and their decreasing marginal propensities to consume). As shown in the charts below, the marginal effects of wealth increases on economic activity have been declining significantly. The Fed's dilemma is that its policy is creating a financial market bubble that is large relative to the pickup in the economy that it is producing. If it were targeting asset prices, it would tighten monetary policy to curtail the emerging bubble, whereas if it were targeting economic conditions, it would have a slight easing bias. In other words, 1) the Fed is faced with a difficult choice, and 2) it is losing its effectiveness."
(In the following charts HH stands for "Household.")

We expect this limit to worsen. As the Fed pushes asset prices higher and prospective asset returns lower, and cash yields can't decline, the spread between the prospective returns of risky assets and those of safe assets (i.e. risk premia) will shrink at the same time as the riskiness of risky assets will not decline, changing the reward-to-risk ratio in a way that will make it more difficult to push asset prices higher and create a wealth effect. Said differently, at higher prices and lower expected returns the compensation for taking risk will be too small to get investors to bid prices up and drive prospective returns down further. If that were to happen, it would become difficult for the Fed to produce much more of a wealth effect. If that were the case at the same time as the trickling down of the wealth effect to spending continues to diminish, which seems likely, the Fed's power to affect the economy would be greatly reduced.
What Would Yellen Do?
With that as a setup, let's turn to our hypothetical hearing. (Insert a picture of your favorite senator here.) With the hope that we will get a glimpse of what a Janet Yellen chairmanship of the Fed will actually look like, let's think about what we would like to know:
Vice-Chairman Yellen, thank you for agreeing to attend this hearing. We have already interviewed you extensively for your present position, so I believe that most members of the committee and Senate already believe that you are qualified to be chairperson. Therefore I would like to use this opportunity to learn a little more about the thinking that goes on with regard to Federal Reserve monetary policy. In the spirit of the transparency that has been a hallmark of the Bernanke Federal Reserve, I would like you to shed a little light on the thinking and philosophy that will guide the Federal Reserve under the chairmanship of Janet Yellen. Here are a few questions that I believe we would all like answers to.

1. There were three papers delivered by highly regarded economists at Jackson Hole this summer that suggested that quantitative easing had no significant effect and that "forward guidance" was the actual effective policy. At about that time, economists from the regional reserve bank at which you were president (San Francisco) also published a paper suggesting the same thing. This past week major Federal Reserve staff economists, as well as other economists, reiterated this view and proposed a different set of policies. This growing discussion begs the following question: Do you agree with these papers and believe the quantitative easing has exceeded its usefulness, especially in its current rather massive form? If not, can you point us to research that supports your view, other than theoretical analysis?

2. The Federal Reserve balance sheet is currently at $4 trillion. At the current pace it is expanding by roughly $1 trillion per year.

1. Is there a theoretical limit in your mind as to the size to which the Fed's balance sheet should be allowed to grow? If so, what is that amount? Simply saying that this number would be dependent upon future economic data would imply that you have no true idea of the limit and are making up the rules as you go along. Perhaps we are indeed in unexplored territory for monetary policy and it is appropriate to adjust policies based upon unfolding economic events; but if that is the case, what are the guidelines you would use?
2. Given the time lag required to realize the impact of monetary policy upon the economy, at what point and by what standard might you determine that the balance sheet of the Federal Reserve had reached its limit and that any further stimulus must be the responsibility of the Congress and the executive branch?
3. Is there a discussion within the Federal Reserve that balance-sheet expansion has the potential to produce an asset bubble?

3. There seems to be an emerging consensus that it would be inappropriate for the Federal Reserve to pursue quantitative easing indefinitely at the levels we see today. There must be an endpoint, but the question of course is, when? Last May, Chairman Bernanke suggested that the Fed might begin to taper in the coming months. Market reactions worldwide were decidedly negative, and many members of the FOMC and Board of Governors were at great pains in the following weeks to suggest that tapering would be either very gradual or postponed altogether. Even so, the markets seemed to assume that a small reduction in the amount of quantitative easing would be announced at the September FOMC meeting. There was quite a lot of surprise when there was no tapering at all. The decision not to taper brings up several questions:

1. What data was the Federal Reserve looking at that caused it to back away from even a small reduction in the amount of quantitative easing?
2. Given that the balance sheet of the Federal Reserve is $4 trillion, what was the thought behind not reducing the ongoing increase of the balance sheet by a mere $10 billion a month?
3. All things considered, $10 billion would seem a rather negligible amount. Were you concerned that the economy might not be able to handle even such a small reduction in quantitative easing?

4. Recent papers from Federal Reserve economists and others suggest that QE (i.e., the large-scale purchase of assets) is not as effective as forward guidance and that the FOMC should indicate that interest rates will be held at very accommodative levels as far out as 2017, in contrast to the current guidance that suggests rates will be allowed to rise gradually beginning in late 2014, or more likely in 2015.

1. What do you think of this view?
2. If you agree with this, are you concerned that such a policy shift might encourage a dollar "carry trade"? By that I mean that banks and other financial institutions might be encouraged to borrow in dollars to invest in all manners of financial engineering projects, especially overseas, given that the cost of borrowing would be so cheap. This is different from traditional banking in that it would not foster lending for productive domestic purposes such as the expansion of plants or the purchase of productivity-enhancing equipment.
3. Given the problems we have seen with carry-trade currencies, especially the Japanese yen, how far out do you think forward guidance should go?
4. Again, viewing the experience of Japan, carry-trade currencies seem to strengthen unduly, apart from natural trade and investment flows. Further, given the extraordinary developments in energy production in the United States and the reduction in the trade deficit, it is quite possible the dollar could strengthen rather dramatically on its own. Do you agree that positioning the dollar as a potential carry-trade currency would strengthen the dollar? Is that a good thing in your view?
5. Given that the strength of the dollar is at least nominally (policy-wise) in the purview of the US Treasury Department, what kind of coordination with the Treasury do you think would be appropriate in extending forward guidance for a very-low-rate regime into 2017?

5. Chairman Bernanke and others have clearly hoped there would be a wealth effect from current monetary policy. By wealth effect I mean that if asset prices rise, people are encouraged to spend money, and the positive effects trickle down to the lower echelons of the economy.

1. There has been a significant amount of research which suggests that the wealth effect is no longer operative in the United States. Do you agree with this?
2. If you do believe in the wealth effect, where is the research, beyond theoretical models, that supports your view?
3. If you do not agree that current monetary policy is in effect a trickle-down monetary policy, then what do you believe is the transfer mechanism from quantitative easing to the general public?

6. Chairman Ben Bernanke has explicitly taken credit for the rise in the stock market from his policies of quantitative easing. Do you think he's right? In pursuing QE, has the Federal Reserve taken upon itself an implicit third mandate, that is, to support the level of the stock market? Should that be the Fed's responsibility?

7. When the Federal Reserve begins to taper, or even suggests it will begin to taper, it appears that the markets will react negatively; yet reactions from Federal Reserve Board of Governors members seem to suggest that the Fed is extraordinarily concerned about a negative market reaction and subsequent negative effects on the economy. UBS strategist Beat Siegenthaler wrote this last week:

The Fed seems to be facing two major risks: first, premature tapering disrupting markets and triggering global turmoil across asset classes, thereby threatening the fragile economy recovery; second, delayed tapering further fueling asset price bubbles, which could burst eventually and do major damage.
The September decision suggested a Fed more worried about the fragile recovery than about the potential for asset bubbles and other longer term problems associated with extended liquidity injections. Whereas it had originally assumed that a gradual tapering would result in a gradual market reaction, it now appears that the situation is much more binary. If so, the hurdles for tapering might be substantially higher than originally thought.

1. Do you agree with that assessment, and if not, why?
2. The Bank of England published the following chart in Q3 2011. 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. It also suggests that they felt it possible that real asset prices would fall after the withdrawal of quantitative easing. Did the Federal Reserve hold internal discussions (such as those evidently held at the Bank of England) regarding what would happen with the withdrawal of QE? Given the recent market response to the suggestion of tapering, was the possibility of a fall in asset prices accounted for in your decision to pursue quantitative easing?

3. Has the Federal Reserve has, in reality, created a form of "monetary trap" for itself through its extensive use of quantitative easing? That is, do you see a way in which the Federal Reserve can exit QE without having a negative effect on the stock market, at least initially? And should the Federal Reserve care?

8. The current philosophy of the Federal Reserve seems to be that monetary easing is stimulative of consumer spending and therefore of the economy in general. This improvement is apparently supposed to be transmitted through lower interest rates for housing and for leveraged borrowing that facilitates consumer spending (on autos and other durable goods) as well as lower interest rates for businesses, which hopefully encourage spending on plants and facilities to increase productivity and boost employment.
   
   However, lower interest rates also mean that investors and pensioners get less income, so they must reduce their spending. I assume it is not the policy or the suggestion of the Federal Reserve that retired individuals should increase the level of risk they take on in the deployment of their retirement savings; but if the Fed seeks to increase the assets of those who hold equity in the stock market, an unintended consequence may be to penalize savers at the very moment in their lives when they need higher interest rates to be able to maintain their lifestyles.

1. Explain to us the economic rationale behind artificially lowering rates for an extended period of time, which penalizes savers at the expense of equity holders.
2. Do you believe that consumer spending fostered by quantitative easing is greater than the consumer spending lost by decreased returns to savers and investors on their fixed-income investments? Is there any data that suggests this is turning out to be the case?
3. If there is a greater good for the economy at large in pursuing massive QE, can you show us the research that proves it and explain why retirees should be content with your policies?
4. Do you have suggestions for those who have saved all their lives and are now being forced to either reduce their standard of living or dip into their savings?

9. If reserve injections by the Federal Reserve were evenly distributed throughout the economy, then the money multiplier would be higher and more stable. This has not happened, as evidenced by the graph below. Further, the availability of loans to middle-level banks and businesses does not seem to have risen. How has QE helped these banks and firms?

10. The Federal Reserve has a dual mandate to achieve the stability of the purchasing value of money and to foster an environment that affords full employment. If the money multiplier is inordinately low and if it should begin to revert to what was its norm prior to the Great Recession, there would seem to be a serious potential for the return of higher-than-acceptable inflation.

1. As chairperson of the Federal Reserve, which of the two mandates would you consider to be a higher priority in a time of rising inflation?
2. Are you prepared, as Chairman Volcker was in the early '80s, to raise interest rates in order to protect the value of money, in spite of the harm it caused to employment? As a follow-on, I would also like to know what, if anything, you would have done differently from Chairman Volcker.

11. Federal Reserve economic forecasts have proven notoriously inaccurate, historically speaking. Indeed, some have suggested that random models would have produced better results than those upon which the Fed relies.

1. How can we trust your models and your policy projections when the Fed’s forecasts have been so wrong for so many years? Why does the Fed persist, to this day, in the use of models that have been so consistently bad at predicting the future?
2. Will you be basing your monetary policy on projections generated by existing, clearly faulty models, or do you anticipate a change in the construction of your models?

12. Finally, let us turn to the employment mandate.

1. Can you explain to us precisely how monetary policy is supposed to work to improve employment? What is the transfer mechanism from quantitative easing to higher employment?
2. If you were designing a central bank system from scratch, would you include an employment mandate? Where do you think the primary responsibility for establishing an environment for full employment should rest, with the federal government or the Federal Reserve?

The Questions That Will Not Be Asked
The above questions will start the discussion, but I'm well aware that some of the questions I would really like to ask will have no chance to make it into the dialogue. These go to the very concept of a central bank. In my latest book, Code Red, I fully acknowledge the need for a central bank, but my view of its purpose is quite a bit more limited than is envisioned in the current manifestation. How can 12 men and women sit on a committee and think they can fine-tune the economy without creating imbalances and unintended consequences? Central banks should be for emergencies and for regulating banking institutions and making sure the playing field is level. They should not be responsible for the fate of the players on the field.
Current central bank policy has rewarded bankers and holders of assets. In an environment where everyone seems to be increasingly worried about the divide between the 1% and the 99%, our central bank has designed and implemented a policy that is explicitly rewarding the 1% to the detriment of savers and retirees. It is the rich who have assets and the poor who have liabilities. If you are looking for a reason why the spread between the rich and the poor is widening, one driver (and I admit there are others) is the central bank policies of the developed world.
Let me end by sharing the sentiments expressed by Ben Hunt this week after he had read the numerous academic papers that have recently been released. I totally share this sentiment, and he expresses it well:
I started writing this email as a detailed analysis of three monetary policy papers recently published by various Fed functionaries, papers that give a peek into how the Fed thinks about their role in the world and that have received some significant attention this week by our media arbiters of taste in articles such as "Fed Forward Guidance Proves Effective, NY Fed Research Says" and "Fed Study: Rate Peg Off Mark." Interpreting the meaning and impact of papers like this (and the media narrative around them) is a bread and butter topic for Epsilon Theory posts, as I feel a duty to read and report on these papers so you don't have to. It's not a pleasant duty.
Frankly, these papers frustrate me to tears, as they are written as post hoc "scientific" justifications of value-laden social assumptions and policy conclusions, not as an honest search for a truth that's larger than the local bureaucratic imperative. They're also … boring. As is the long analysis I wrote. So let's skip all that and go straight to the conclusion.
Spoiler Alert! The Fed believes that they are saving the world, and that any problems that persist in the world can be eliminated by doing more of what they've been doing and doing it for longer. I know this comes as a complete surprise to anyone who's been paying the least amount of attention over the past few years, but there you have it. That's what these papers say.
These papers say nothing that is terribly novel or interesting in terms of their content or intended purpose. The only interesting thing is how much media attention they are receiving and what that means. The triumphal procession of these papers is a reminder that the academic and bureaucratic capture of the Fed is complete, and that leads to what are (to me, anyway) much more interesting questions than the inside baseball topics of what these papers might imply for Yellen's policy preferences:
1) Has the academic and bureaucratic capture of US monetary policy been duplicated in other policy areas, such as national security and healthcare?
2) Is there a common academic and bureaucratic response across these policy areas to the economic and political duress of the past 10 years, such that emergency policy actions against immediate threats have been transformed into permanent insurance programs against future and potential threats?
3) Is this the common thread woven through the three most important and controversial policies of our day: QE, Obamacare, and NSA eavesdropping?
4) Are there useful lessons to be drawn from the last time we went through such a wholesale redefinition of the *meaning* of government policy, back in the 1930s?
5) What are the structural consequences for markets and investing that stem from this redefinition?
My answers: yes, yes, yes, yes, and I'm trying to figure it out.

Corn, Beans Spike Following USDA Report

Corn:

Soybeans:

Back to Bullish

Following a one-day dip, stocks are rising again. I expected that yesterday's sell-off would be short-lived. We haven't seen this degree of bullishness since the zenith of the 2007 stock market peak.

Household Survey Shows 623,000 Jobs Lost

This Jobs Trend Is Not Good!

The number of Americans NOT working increased last month by nearly 1 million -- 932,000 to be precise. Not good!

This is the labor force participation rate, which represents the percentage of American adults who have jobs. It fell to a fresh 35-year low this morning. This is the worst since 1978!

Unexpectedly-High 204,000 Jobs Created In October

Analysts had been expecting only about half this number. I guess government shut-downs aren't so bad after all!

The Costs of QE

from Bloomberg:

Full article here.

Barely a Blip!

The magnitude of the stock market bubble is now so pronounced that, even with today's 153-point drop in the stock market, it barely registers on this monthly chart.

Here's an enlargement of that top right corner, with that little red blip.

Market Distortions! Strong Data = Stumbling Stocks

The better-than-expected GDP data this morning has sent stocks lower. Here are the headlines:

Bloomberg:

Fox Business:

Stocks slip on strong economic data? It's a strong sign of a grossly-distorted market when good economic data sends stocks into a tailspin!

Wow! What a Reversal!

The supposedly-good (which isn't, really) GDP news this morning has sent stock scrambling for cover, as the perception that the Fed just might taper after all, has altered the dynamics for a day. I expect it to be short-lived!

Intangibles for Ignoramuses

Minutes ago, the government released it's latest GDP calculation, which came in at a decent 2.8%. It's not robust, but sufficient to get by and kick the can.

But there's a problem. Beginning in August, they changed the calculation methodology. They now add in a nebulous figure for what they are calling "intangibles". INTANGIBLES???? In other words, an amount that can't be calculated or measured. After all, they are "intangible". The word IDIOCIES would be a better word! Idiocies for the economic ignoramuses!

Those "intangibles" caused 2Q GDP to jump from 1.7% to 2.5%, about a 50% increase. Thus, this new figure is probably much closer to 1.85% than the figure that will be publicized in the new media. That is nothing to crow about!

Update #1:
And consumer spending, called PCE (personal consumption expenditure), which constitutes 2/3 of the US economy, was the lowest since 2Q 2011. So the most important element of the US GDP calculation was the lowest in more than 2 1/2 YEARS!

Something is ROTTEN in that apple!

Update #2:

Following this announcement and the ECB rate cut news, stocks have now dropped back to flat.
Wall St must be viewing this GDP figure as the good news that will dampen Fed enthusiasm for money printing. They needn't worry! It won't!

UPDATE #3:
PCE was just a paltry 1.04%! Does that sound like robust consumer spending to you? Yeah, me neither! 

ECB's Unexpected Rate Cut Jars Markets

An hour ago, the European Central Bank President (and former Goldman Sachs Exec) Mario Draghi shocked the financial markets by unexpectedly cutting interest rates. The Euro was butchered, the Dollar leaped, and stock market futures leaped also. Stocks are already at fresh new all-time record highs, just 30 minutes before the NYSE opens for trading this morning.

from the news media:
*DRAGHI SAYS EURO AREA GROWTH RISKS REMAIN `ON THE DOWNSIDE'
*DRAGHI SAYS EURO AREA INFLATION RISKS ARE `BROADLY BALANCED'
*DRAGHI: MARKET CONDITIONS POTENTIALLY NEGATIVE FOR ECONOMY
*DRAGHI SAYS UNEMPLOYMENT REMAINS HIGH
*DRAGHI: EURO AREA MAY FACE PROLONGED PERIOD OF LOW INFLATION

And so, since the "Euro Area growth risks remain 'on the downside'", 'unemployment remains high', and they have a 'potentially negative economy', stocks are leaping HIGHER and are in new record territory as a result! Is logic, reason, and risk so foreign to these people in the financial markets, that they ignore all reality?

CONGRATS! YOU ARE GREENSPAN/YELLEN'S GUINEA PIG FOR EXPERIMENTATION!

In a Bloomberg article today, former Fed Chairman Alan Greenspan says that Janet Yellen, Obama's new proposed Fed Chair, was his primary inspiration for monetary and economic policy, presenting him regularly with "various new theories /that/ were coming up and the like in academia". Greenspan was and is so entranced with Yellen's "new theories" and "academia" that he fully endorses his beloved inspiration source as the next Fed Chair. 

But do these people ever consider that the latest fad and "new economic theory" may be WRONG? That it may be incomplete? That it may even be destructive? That it may bring a disaster? Does it ever occur to them that these "theories" may be overly simplistic, or that they may ignore the complexities of millions of people acting independently, and often irrationally (contrary to the latest "theory")? NO! To them, it's just a new toy or tool to use on US and the US economy as their latest guinea pig to experiment on!

"Greenspan's put", as it was called at the time, was likely the primary cause of the housing bubble, and when it collapsed, the housing crisis and resulting Great Recession. But does he show even a hint of remorse for what he did? No!

How many people lost their jobs and therefore livelihoods because of the Greenspan/Yellen penchant for playing with the latest "new economic theory" that resulted in catastrophic collapse? How many people lost their homes? How many people's lives were ruined because of his obsession with the latest economic toy from the ivory towers of academia? Greenspan is still in denial of his mistakes and the resulting chaos he brought. Worse still, he is unapologetic, and thinks that Yellen, his economic playmate in his science experiments, should now be empowered to play with us, by putting their pattycake experimentation on steroids!

We should remember that theory is not proven reality, but Greenspan became so dependent on Yellen presenting him with the latest THEORY -- unproven by time, peer review, or experience -- that he gleefully accepted all those new theories and would often use them to experiment on the US economy!

I've said before that these Fed execs are like a bunch of teenagers who received a chemistry set for Christmas, and are so blind to their power that they keep experimenting with the chemicals until they blow up the house! 

I remember in the 1970s occasionally hearing news stories about teens who received chemistry sets from their parents for Christmas. They would then experiment with them endlessly, creating bigger and bigger explosions, until they would inevitably blow up their parents' house! Eventually, those chemistry sets were deemed too dangerous and were banned from hobby stores and relegated to controlled labs and schools where supervision could be maintained.

Now we have elitist academics who think they are so smart that they should have unlimited power to experiment upon all of us, just like the out-of-control teenager in those former news stories of yesteryear. And these out-of-control central bankers are just as blind to their hubris, as those teenagers who destroyed their parents' homes decades ago.

Bizarre! A Spike in Layoff Announcements Sends Stocks Soaring

Dow futures up 60+ points!

Fed Holds Steady, Invites Confusion

More on VWAP

another explanation of VWAP:

In finance, volume-weighted average price (VWAP) is the ratio of the value traded to total volume traded over a particular time horizon (usually one day). It is a measure of the average price a stock traded at over the trading horizon.^[1]
VWAP is often used as a trading benchmark by investors who aim to be as passive as possible in their execution. Many pension funds, and some mutual funds, fall into this category. The aim of using a VWAP trading target is to ensure that the trader executing the order does so in-line with volume on the market. It is sometimes argued that such execution reduces transaction costs by minimizing market impact costs (the additional cost due to the market impact, i.e. the adverse effect of a trader's activities on the price of a security).
VWAP can be measured between any two points in time but is displayed as the one corresponding to elapsed time during the trading day by the information provider.
VWAP is often used in algorithmic trading. Indeed, a broker may guarantee execution of an order at the VWAP and have a computer program enter the orders into the market in order to earn the trader's commission and create P&L. This is called a guaranteed VWAP execution. The broker can also trade in a best effort way and answer to the client the realized price. This is called a VWAP target execution; it incurs more dispersion in the answered price compared to the VWAP price for the client but a lower received/paid commission. Trading algorithms that use VWAP as a target belong to a class of algorithms known as volume participation algorithms.

 

	Table of Contents 1 Formula 2 See also 3 External links 4 References

Formula

VWAP is calculated using the following formula:

where:

is Volume Weighted Average Price;

is price of trade ;

is quantity of trade ;

is each individual trade that takes place over the defined period of time, excluding cross trades and basket cross trades.^[2]

VWAP Explained

By Frederic Palmliden, CMT
Senior Market Technician, TradeStation Labs
TSLabs@TradeStation.com

Summary

This custom intraday Volume-Weighted Average Price (VWAP) indicator provides estimated current and historical intraday VWAP values. The indicator plots as many as the last four daily VWAPs, as well as the real-time VWAP on the current session of the analyzed security. The historical VWAPs can serve as support and resistance lines as the current session's price action unfolds and can offer valuable information for traders. The intraday VWAP is reset at the beginning of each new trading session and the historical VWAP lines are color coded for visual differentiation of the age of each VWAP line.

Introduction

VWAP is a ratio widely used in trading. It is based on the price of the security and its volume over a specified time period (usually one day). The numerator is the sum of the security's price over the specified time period multiplied by the corresponding volume; the denominator is the total shares/contracts traded for the time period. The formula for the VWAP can be written as follows:

where:
PVWAP = Volume Weighted Average Price
Pj = price of trade j
Qj = quantity of trade j
j = each individual trade that takes place over the defined period of time
Source: http://en.wikipedia.org/wiki/VWAP

Background

VWAP has numerous applications in the trading world. It is often used in algorithmic trading, more specifically in volume-participation algorithms. For example, a broker may guarantee the execution of a trade at the VWAP price (known as a Guaranteed VWAP execution). A broker may also offer a VWAP target execution where the broker makes a best effort to execute near the VWAP.
VWAP is also used as a trading benchmark by investors who are not worried about the timing of the trade, but who are concerned about the adverse impact of their trades on the price of the security. The goal is to execute orders in-line with the volume of the market. Many pension funds and some mutual funds fall into this category.
The performance of passive traders is sometimes measured according to the VWAP. Long entry prices that are lower than the VWAP are considered favorable, while entries above the VWAP are considered unfavorable. These non-discretionary trades take place with a general disregard for timing. In this case, VWAP is used to calculate trading costs, since the average entry price would be compared to the VWAP benchmark price. This is the main reason why some argue that using the VWAP as a target reduces transaction costs.
The VWAP calculation can take numerous other forms in practice. In addition to the standard definition above, traders may use VWAP excluding their own transactions, non-block VWAP, VWAP proxies when tick data is unavailable, and value-weighted average for volatile markets in which prices weighted by dollar value of trade are used instead of share/contract volume.

Current Application

VWAP can also be a useful tool for short-term discretionary traders and many different strategies can employ this measurement. One simple well-known strategy is to wait for the price to pierce through the VWAP to the upside when a long position is sought and when the trader is looking for buyers to regain control, since a breakout above VWAP may show upside momentum. The core idea is that the current VWAP and past VWAPs can act as potential support and resistance levels.
Most trading applications only show the current day's VWAP. This is mainly because historical VWAPs require enormous amounts of data, since all the tick and volume data for the different sessions would need to be referenced. One solution is to approximate the historical VWAPs using 1-minute intraday data, cutting down dramatically on the amount of historical data needed. The resulting VWAPs are not exact, but are very close to the actual values.

Indicator Inputs

Name	Value	Description
TodaysVWAPColor	Red	Color used for the current intraday VWAP
YesterdaysVWAPCol	Blue	Color used for yesterday's final VWAP value
TwoDaysAgoVWAPCol	Yellow	Color used for the final VWAP value of 2 days ago
ThreeDaysAgoVWAPCol	Cyan	Color used for the final VWAP value of 3 days ago
ThreeDaysAgoVWAPCol	Magenta	Color used for the final VWAP value of 4 days ago

Indicator Construction

The current intraday VWAP is approximated using a 1-minute intraday chart and the formula listed in the beginning of this paper. The intraday VWAP is displayed using a red line (TodaysVWAPColor input). Depending on how much data is loaded into the chart, the maximum number of VWAPs that can be seen is five at any one time (current VWAP plus previous four daily VWAPs). The last four historical daily VWAPs are color coded using user-defined colors (YesterdaysVWAPCol, TwoDaysAgoVWAPCol, ThreeDaysAgoVWAPCol, and FourDaysAgoVWAPCol inputs) in order to identify how old each VWAP is no matter where on the chart you are looking.
The indicator recognizes whether pre- and/or post-market data is used for equities and the VWAP values are not reset after the pre-market session ends or when the post-market session starts. Therefore, if pre- and post-market data is used, each one of the five different VWAPS includes the data from its pre- and post-market session in the calculations. A 1-minute intraday interval is recommended to better estimate the VWAPs; however, depending on your willingness to accept a margin of error, you may want to experiment with slower intervals (i.e., 5 minutes). The indicator will be able to detect pre- and/or post-market equity data no matter which intraday interval is used (i.e., 5-minute intraday interval).
For additional information on the indicator construction, please refer to the comments inside the EasyLanguage® document.
After you have imported the indicator from the attached .eld file, you can use the workspace provided. Please look for "IntradayVWAPs" in your list of indicators to insert this indicator on a new chart.

Analysis

Viewing this custom VWAP indicator on an intraday chart reveals that the different VWAP lines often act as resistance and support lines. A VWAP line that was acting as resistance often becomes support once penetrated, while a VWAP line acting as support often becomes resistance once penetrated. The different VWAP lines can also serve as target lines intraday when the price action is caught between lines.
As with any other technical analysis tool, the VWAP lines can work well at times and not so well at other times. A VWAP on stronger-than-average daily volume and/or different VWAPs near the same price may provide a higher probability of acting as potential support or resistance. It might also be interesting to use other technical analysis tools in conjunction with the VWAP lines in order to better discern which line might be providing a stronger support or resistance level.
As described in the Indicator Construction section, the indicator works with, or without pre- and/or post-market equity data. The indicator can be applied to any security where volume is accessible. For example, the indicator works with futures, such as the S&P E-mini futures contract. In that case, the indicator is able to recognize that 17:00 U.S. Central Time on Sunday is the opening time for Monday's session and the VWAP is then reset on the first bar after 15:30 U.S. Central Time.

Conclusion

This custom intraday VWAP indicator sheds light on an area of analysis that is often obscured by the inaccessibility of the needed data. Using intraday data of a short interval provides active traders with VWAP values accurate enough to be of practical use. The different VWAP lines often act as support and resistance lines for the considered security and can offer valuable information for traders.
Potential future versions of this indicator may include the flexibility to specify an exact time period to take into consideration for the VWAP calculations. In addition, inputs could be made available to create custom sessions to consider for the VWAP calculations. For example, maybe only the first and last hours of the regular session should be included in the VWAP calculation. Lastly, the width of the VWAP lines could be made to vary depending on the daily volume for additional visual assistance as to which line might be relatively more important. Stay tuned!

Attachments

   Intraday VWWAPs
In order to open the sample workspaces provided, you may first need to import the custom EasyLanguage® file with the extension .eld. Copy the attached .eld file and workspaces to your computer. Then import the indicators or strategies by double-clicking on the EasyLanguage .eld file. This will automatically start the TradeStation import wizard. Click 'Next' until the Analysis Techniques and/or strategies have been imported. The indicators are now available and you can now open the provided workspaces. Other supportive documents or files may also be attached to this e-mail.
All support, education and training services and materials on the TradeStation Securities website are for informational purposes and to help customers learn more about how to use the power of TradeStation software and services. No type of trading or investment advice is being made, given or in any manner provided by TradeStation Securities or its affiliates.
This material may also discuss in detail how TradeStation is designed to help you develop, test and implement trading strategies. However, TradeStation Securities does not provide or suggest trading strategies. We offer you unique tools to help you design your own strategies and look at how they could have performed in the past. While we believe this is very valuable information, we caution you that simulated past performance of a trading strategy is no guarantee of its future performance or success. We also do not recommend or solicit the purchase or sale of any particular securities or derivative products. Any symbols referenced are used only for the purposes of the demonstration, as an example ---- not a recommendation.
Finally, this material may discuss automated electronic order placement and execution. Please note that even though TradeStation has been designed to automate your trading strategies and deliver timely order placement, routing and execution, these things, as well as access to the system itself, may at times be delayed or even fail due to market volatility, quote delays, system and software errors, Internet traffic, outages and other factors.

Another view from Stockcharts.com:

Introduction

Volume-Weighted Average Price (VWAP) is exactly what it sounds like: the average price weighted by volume. VWAP equals the dollar value of all trading periods divided by the total trading volume for the current day. Calculation starts when trading opens and ends when trading closes. Because it is good for the current trading day only, intraday periods and data are used in the calculation.

Tick versus Minute

Traditional VWAP is based on tick data. As one can imagine, there are many ticks (trades) during each minute of the day. Active securities during active time periods can have 20-30 ticks in one minute alone. With 390 minutes in a typical stock exchange trading day, many stocks end up with well over 5000 ticks per day. There are over 5000 stocks traded every day and these ticks start adding up exponentially. Needless to say, tick-data is very resource intensive.

Instead of VWAP based on tick data, StockCharts.com offers intraday VWAP based on intraday periods (1, 5, 10, 15, 30 or 60 minute). Note that VWAP is not defined for daily, weekly or monthly periods due to the nature of the calculation (see below).

Calculation

There are five steps involved in the VWAP calculation. First, compute the typical price for the intraday period. This is the average of the high, low and close {(H+L+C)/3)}. Second, multiply the typical price by the period's volume. Third, create a running total of these values. This is also known as a cumulative total. Fourth, create a running total of volume (cumulative volume). Fifth, divide the running total of price-volume by the running total of volume.

Cumulative(Volume x Typical Price)/Cumulative(Volume)

The example above shows 1-minute VWAP for the first 30 minutes of trading in IBM. Dividing cumulative price-volume by cumulative volume produces a price level that is adjusted (weighted) by volume. The first VWAP value is always the typical price because volume is equal in the numerator and the denominator. They cancel each other out in the first calculation. The chart below shows 1-minute bars with VWAP for IBM. Prices ranged from 127.36 on the high to 126.67 on the low for the first 30 minutes of trading. It was actually a pretty volatile first 30 minutes. VWAP ranged from 127.21 to 127.09 and spent its time in the middle of this range.

Characteristics

Like moving averages, VWAP lags price because it is an average based on past data. The more data there is, the greater the lag. A stock has been trading for some 331 minutes by 3PM. As a cumulative "average", this indicator is akin to a 330 period moving average. That is a lot of past data. The 1-minute VWAP value at the end of the day is often quite close to the ending value for a 390 minute moving average. Both moving averages are based on the 1 minute bars for that day. At the close, both are based on 390 minutes of data (one full day). One cannot compare the 390 minute moving average to VWAP during the day though. A 390 minute moving average at 12:00PM will include data from the previous day. VWAP will not. Remember, VWAP calculations start fresh at the open and end at the close. 150 minutes of trading have elapsed by 12:00PM. Therefore, VWAP at 12:00 would need to be compared with a 150 minute moving average.

Despite this lag, chartists can compare VWAP with the current price to determine the general direction of intraday prices. It works similar to a moving average. In general, intraday prices are falling when below VWAP and intraday prices are rising when above VWAP. VWAP will fall somewhere between the day's high-low range when prices are range bound for the day. The next three charts show examples of rising, falling and flat VWAP.

Uses for VWAP

VWAP is used to identify liquidity points. As a volume-weighted price measure, VWAP reflects price levels weighted by volume. This can help institutions with large orders. The idea is not to disrupt the market when entering large buy or sell orders. VWAP helps these institutions determine the liquid and illiquid price points for a specific security over a very short time period.
VWAP can also be used to measure trading efficiency. After buying or selling a security, institutions or individuals can compare their price to VWAP values. A buy order executed below the VWAP value would be considered a good fill because the security was bought at a below average price. Conversely, a sell order executed above the VWAP would be deemed a good fill because it was sold at an above average price.

Conclusions

VWAP serves as a reference point for prices for one day. As such, it is best suited for intraday analysis. Chartists can compare current prices with the VWAP values to determine the intraday trend. VWAP can also be used to determine relative value. Prices below VWAP values are relatively low for that day or specific time. Prices above VWAP values are relatively high for that day or specific time. Keep in mind that VWAP is a cumulative indicator, which means the number of data points progressively increases throughout the day. On a 1-minute chart, IBM will have 90 data points (minutes) by 11AM, 210 data points by 1PM and 390 data points by the close. The number dramatically increases as the day extends. This is why VWAP lags price and this lag increases as the day extends.

SharpCharts

Volume-Weighted Average Price (VWAP) can be plotted as an "overlay" indicator on Sharpcharts. After entering the security symbol, choose an "intraday" period and a "range." This can be for 1 day or "fill the chart." Chartists looking for more detail can choose "fill the chart." Chartist looking for general levels can choose 1 day. VWAP can be plotted over more than one day, but the indicator will jump from its prior closing value to the typical price for the next open as a new calculation period begins. Also note that VWAP values can sometimes fall off the price chart. VWAP at 45.5 will be show up on a chart with a price range from 45.8 to 47. Chartists sometimes need to extend the range to a full day to see VWAP on the chart. The VWAP value is always displayed at the top left of the chart. Click the chart below to see a live example.

and still another, very simple, from Investopedia:

Definition of 'Volume Weighted Average Price - VWAP' A trading benchmark used especially in pension plans. VWAP is calculated by adding up the dollars traded for every transaction (price multiplied by number of shares traded) and then dividing by the total shares traded for the day.
	Investopedia explains 'Volume Weighted Average Price - VWAP' The theory is that if the price of a buy trade is lower than the VWAP, it is a good trade. The opposite is true if the price is higher than the VWAP.

Stocks Back to Flat 30 Minutes Into Trading Day

Terrible Asian Macro Data Sends Stocks to New Record Highs

Terrible economic news from Asia, and especially Japan, has sent stock futures to a fresh all-time record high overnight. Find the logic in that!

Stock Market Rise Tied to Collapse of Yen

Do you see any pattern here? Why is the collapse of the Japanese Yen so closely correlated to the rise in the US stock market? I wonder if Japanese investors are beginning to panic over their own government's QE-In-Perpetuity, and pull their money out to send to the US stock market instead. I suspect they'll ultimately be disappointed. Note also the sharp rise in stocks lately.

I have a rule that is really an observation of the financial markets: Parabolic UP, parabolic DOWN! It means that when (stock) markets rise as a parabolic rate, they are also prone to plunge at a similarly parabolic rate!

View Less

DANGER! DANGER! BUBBLE WARNING FROM WORLD'S LARGEST FUNDS!

The three largest asset management companies in the world have ALL now warned that the Fed must begin removing it's QE stimulus to stop a "bubble-like market". Executives of JP Morgan, PIMCO, and BlackRock, who was the latest to warn of a bubble, are all now on the same page. Larry Fink is head of BlackRock, the world's largest investment management company, with more than $178 billion in assets as of 2010.

Meanwhile, the Fed is widely expected to INCREASE it tomorrow, instead!

Note the verbiage that Fink is using. Words like "imperative", "over-zealous" market, and "bubble-like markets" are ignored by the the Fed Heads!

* FINK SAYS IT'S "IMPERATIVE" THAT THE FED BEGIN TO TAPER
* FINK CALLS MARKET `OVER-ZEALOUS'
* FINK SAYS THERE ARE "REAL BUBBLE-LIKE MARKETS AGAIN"

Worker Bees Now Outnumbered By Drones

This Is What a Bubble Looks Like!