S&P 500 looks promising

The inverted fish hook on the S&P 500 looks promising, with a strong blue candle reversing most of Friday’s losses. Completion of an inverted fish hook (normally called an inverted scallop but I find the former more descriptive) requires a breakout above 2190/2200. Completion of the pattern would offer a strong bull signal with a target of 2400, calculated from the base of the pattern at 2000*.

S&P 500 Index

* Target calculation: 2200 + ( 2200 – 2000 ) = 2400

Credit bubbles and their consequences

Interesting paper from the San Francisco Fed by Òscar Jordà, VP Economic Research at the San Francisco Fed, Moritz Schularick, professor of economics at the University of Bonn, and Alan M. Taylor, professor of economics and finance at the University of California, Davis. They discuss the difficulty in identifying asset bubbles and the relationship of asset bubbles to credit.

A defining feature of advanced economies in the post-World War II era is the rise of credit documented in Jordà, Schularick, and Taylor (2016). This is visible in Figure 1, which displays the cross-country average ratio to GDP of unsecured and mortgage lending since 1870. Following a period of relative stability, both lending ratios grew rapidly after the war, with mortgages taking off in the mid-1980s….

Most buyers use mortgages to buy homes, but few savers use borrowed funds to invest in the stock market. Thus, one might expect equity price busts to be less dangerous than collapses in house prices: A crash in the price of assets financed with external (rather than internal) funds is likely to have deeper effects on the economy. As collateral values evaporate, some agents will delever to reduce their debt burden, in turn causing a further collapse in asset prices and in aggregate demand. The more widespread this type of leverage is, the more extensive the damage to the economy. Integrating the role of credit into the analysis of asset price bubbles is therefore critical.

Anna Schwartz discussed the issue in a 2008 interview with the Wall St Journal. Then 92 years old, the co-author with Milton Friedman of A Monetary History of the United States (1963) nailed the cause of asset bubbles:

If you investigate individually the manias that the market has so dubbed over the years, in every case, it was expansive monetary policy that generated the boom in an asset. The particular asset varied from one boom to another. But the basic underlying propagator was too-easy monetary policy and too-low interest rates …..

The problem is not asset bubbles, whether they be in stocks, housing or Dutch tulips. That is merely a symptom of a deeper malaise: too easy monetary policy. The threat is the underlying credit expansion that caused the problem in the first place.

And while asset bubbles may be difficult to measure, credit bubbles are easy to identify. If credit grows at a faster rate than GDP, that is a credit expansion. The ratio of credit to GDP should be maintained in a narrow, horizontal band.

US Bank Loans & Leases to GDP

Easy to monitor and easy to correct, if the Fed is looking in the right place. But central banks are good at looking elsewhere — and closing the gate long after the horse has bolted. A similar problem is evident in Australia.

Australia Credit to GDP

Even worse if we look at household credit to disposable income (on the left below).

Australia Credit to GDP

Unfortunately the horse has bolted and attempting to contract the level of debt would cause a deflationary spiral with devastating consequences. The only way to restore sanity is to hold debt steady at current (nominal) levels and allow growth and inflation to gradually reduce the GDP ratio to more stable levels.

Stocks Post Biggest Fall Since Brexit Over Rate Fears | WSJ

From Aaron Kuriloff and Corrie Driebusch at WSJ:

Stocks and bonds tumbled Friday, with the Dow industrials and S&P 500 posting their biggest percentage losses since the Brexit selloff.

Fresh signs that central banks could be backing away from easy-money policies helped boost the dollar, while investors sold shares of dividend payers like utilities and telecommunications companies that have been popular with income-seeking investors while rates have been low. Yields on some government bonds reached their highest levels since late June.

The Dow Jones Industrial Average fell 394.46 points, or 2.1%, to 18085.45, and the S&P 500 declined 2.45%, marking the biggest one-day declines for the indexes since late June when a selloff followed the U.K.’s vote to leave the European Union….

S&P 500 Index

Friday’s tall red candle is reminiscent of the sharp Brexit drop in June. That lasted two days. Respect of 2100 would complete an inverted scallop — a strong bullish signal — while respect of primary support at 2000 would completed a rounded top which, despite its name, has an even chance of continuing the primary up-trend. Breach of 2000 remains unlikely.

Read more at Stocks Post Biggest Fall Since Brexit Over Rate Fears | WSJ

Gold rallies

Spot Gold rallied to test resistance at $1350/ounce. Momentum above zero continues to indicate a primary up-trend. Short retracement (short candles and short duration) would signal a test of the July 2016 high at $1375. Breakout above $1375 would offer a target of $1450*. Breach of support at $1300 is unlikely but would warn of a test of primary support at $1200/ounce.

Spot Gold

* Target calculation: 1375 + ( 1375 – 1300 ) = 1450

In Australia the All Ordinaries Gold Index ($XGD) found support at 4500. Expect a test of the recent highs around 5500. The Index is likely to follow the spot gold price, provided the Australian Dollar/US Dollar remains fairly stable. Breakout above 5500 would signal a fresh advance, with a target of 6500*. Breach of 4500 is unlikely but would warn of trend reversal.

All Ordinaries Gold Index $XGD

* Target calculation: 5500 + ( 5500 – 4500 ) = 6500

Happiness, stress, and age: How the U-curve varies across people and places | Brookings Institution

From Carol Graham and Julia Ruiz at Brookings Institution:

…Numerous studies have found recurrent patterns between happiness and life satisfaction (while the terms are often used inter-changeably, the latter is a better-specified question) and important experiences such as employment, marital status, and/or earnings. These, in turn, lead to differences in investment profiles, productivity, voting incentives, and attitudes toward health (Graham, Eggers, and Sukhtankar, 2004; DeNeve and Oswald, 2012; De Neve et al., 2013).

Among these relationships, the one between age and happiness—often referred to as “the U-curve”—is particularly striking due to its consistency across individuals, countries, and cultures (Blanchflower and Oswald, 2007; Steptoe, Deaton and Stone, 2015; Graham and Pettinato, 2002). Happiness declines with age for about two decades from early adulthood up until roughly the middle-age years, and then turns upward and increases with age. Although the exact shape differs across countries, the bottom of the curve (or, the nadir of happiness) ranges from 40 to 60 plus years old. Blanchflower and Oswald (2016) find that some markers of ill-being, such as reported mental health and the use of anti-depressants, meanwhile, display inverse patterns, and turn down (as opposed to up) at roughly the same age range in the U.S. and Britain.

Further research is needed to confirm that the bottom of the U-curve coincides with teenage children😉

Source: Happiness, stress, and age: How the U-curve varies across people and places | Brookings Institution

Asia steadies

China’s Shanghai Composite Index steadied and is again testing resistance at 3100. Breakout would signal a primary up-trend. Rising troughs on Twiggs Money Flow indicate buying pressure.

Shanghai Composite Index

Japan’s Nikkei 225 Index rallied for another test of resistance at 17000. Breakout above 17000 would suggest a primary up-trend. Follow-through above 17600, completing a broad double-bottom, would confirm. Further consolidation, however, is more likely.

Nikkei 225 Index

India’s BSE Sensex broke out of its narrow rectangle at 28000, signaling another advance. Expect a test of the 2015 high at 30000. Bearish divergence on Twiggs Money Flow now appears misleading.

SENSEX

Europe on the mend

Germany’s DAX is holding above its new support level at 10500. Respect, with follow-through above 10800, would confirm the primary up-trend.

DAX

* Target calculation: 10500 + ( 10500 – 9500 ) = 11500

France’s CAC-40 Index is consolidating in a narrow band between 4400 and 4500. Upward breakout would suggest a primary up-trend. Follow-through above 4600, completing a broad double bottom, would confirm. Rising Twiggs Money Flow reflects buying pressure.

CAC-40

The Footsie retreated from resistance at 7000 but short candles and strong Twiggs Money Flow, high above zero, suggest long-term buying pressure. Expect strong resistance between 7000 and 7100. Correction to 6500 would establish a more stable base for further advances.

FTSE 100

* Target calculation: 6500 + ( 6500 – 5900 ) = 7100

Europe strengthens

Germany’s DAX respected its new support at 10500. Follow-through above 10800 would confirm the primary up-trend.

DAX

* Target calculation: 10500 + ( 10500 – 9500 ) = 11500

Italy’s FTSE MIB (Milano Italia Borsa) Index remains in a primary down-trend. Breakout above 17000 and the descending trendline, however, would suggest that a base is forming. Rising Twiggs Money Flow highlights buying pressure.

FTSE MIB

The Footsie retreated from resistance at 7000 but short candles and rising Twiggs Money Flow suggest buying pressure. Expect another test of 7000/7100 but resistance is strong. Correction to 6500 would establish a more stable base for further advances.

FTSE 100

* Target calculation: 6500 + ( 6500 – 5900 ) = 7100

Asia pulls back

China’s Shanghai Composite Index retreated below resistance at 3100. Prospects of a primary up-trend have dimmed and further consolidation between 2800 and 3100 is likely.

Shanghai Composite Index

Japan’s Nikkei 225 Index is pretty directionless, retreating from resistance at 17000. Breach of 16000 would warn of another test of primary support at 15000. But a broad base between 15000 and 17000 is likely.

Nikkei 225 Index

India’s BSE Sensex is the most promising, consolidating in a bullish narrow range around 28000. Upward breakout would signal a further advance towards the 2015 high of 30000. Bearish divergence on Twiggs Money Flow warns of long-term selling pressure, however, and downward breakout would warn of a correction to 25000 or 26000.

SENSEX

Oil Industry Shifts From Survival to Growth | Bloomberg

There has been a spike in oil & gas mergers and takeovers in recent months as sellers expectations of a return to $100/barrel oil prices have finally faded.

From Bloomberg:

While crude has recovered, “there seems to be an increasing consensus that oil will not go back to over $100 any time soon,” said Philipp Chladek, a senior industry analyst for BI in London. “So the differing perceptions about the asset values that, next to the volatility, was the main deal-breaker in the past, are gradually converging.”

Light crude prices have rallied from early 2016 lows to test resistance above $50/barrel. December futures retreated from $52/barrel but this does not seem to indicate a reversal. Breakout above $52 would signal a long-term up-trend with a test of resistance around $64/barrel. With slow global growth, however, further consolidation below $52 is more likely.

WTI Light Crude - December 2016

From Tsvetana Paraskova at Oilprice.com:

Earlier this week, the Russian Economy Ministry said that it expected crude oil prices to remain stable at their current range of US$45-50 over the next two years, with a sustainable improvement beginning in late 2017.

The latest rally in prices, according to a statement by the ministry, has “a speculative nature” and will not last long. The Economy Ministry went on to add in the statement that oil fundamentals were moving in line with “basic forecasts”; that is, the market is on its way to rebalancing, with the glut gradually easing. But this process will take time.

Source: Oil Industry Shifts From Survival to Growth – Bloomberg

UK investor Neil Woodford scraps bonuses as it leads to ‘wrong behaviours’

Colin Kruger, CBD:

One of Britain’s most respected investors, Neil Woodford, has scrapped staff bonuses at his investment group, saying it has proved to be “largely ineffective” which can lead to “wrong behaviours” by staff.

“There is little correlation between bonus and performance, and this is backed by widespread academic evidence,” said the firm’s chief executive Craig Newman.

The academic evidence directly cited by the group was even more damning. “Financial incentives are often counterproductive as they encourage gaming, fraud and other dysfunctional behaviours that damage the reputation and culture of the organisation,” said an extract from The Journal of Corporation Law. “They produce the misleading assumption that most people are selfish and self-interested, which in turn erodes trust.”

I hope we see more of this. Large corporations need to wake up to the fact that bonuses are counter-productive. Not only do they encourage “wrong behaviors” among company executives, they also destroy trust within the organization and with shareholders and the public. Share options are simply a variation on the same theme.

Rather encourage staff to become shareholders, with low-interest loans linked to a clause that prevents sale of the shares for a minimum of 5 to 10 years. That gives employees some skin in the game and aligns their interests with shareholders.

Source: UK investor Neil Woodford scraps bonuses as it leads to ‘wrong behaviours’

US equity prices | Bob Doll

Bob Doll’s view on equities:

Equity indices have again hit new records, but we believe fundamental changes may be necessary for prices to continue advancing strongly. Specifically, earnings would have to improve further and/or investor flows would have to turn notably toward stocks. Neither is out of the question, but aren’t likely….

Source: Weekly Investment Commentary from Bob Doll | Nuveen

Beware of recency bias

Every the year the 2016 Russell Investments/ASX Long-term Investing Report provides an invaluable summary of before and after-tax returns on various asset classes for Australian investors, over 10 and 20 years.

Naive investors are likely to automatically pursue the asset classes that offer the highest yields. Recent performance is more likely to attract our attention than more stable longer-term performance. Josh Brown highlighted last year that mutual funds that attracted the most new investment tended to underperform funds that attracted the least new inflows. I suspect that the same applies to asset classes.

If we consider each of the asset classes highlighted, it is clear that performance over the next 10 years is likely to be substantially different from the last decade.

Australian Asset Classes 10-year Performance to 31 December 2015

Source: 2016 Russell Investments/ASX Long-term Investing Report

Australian Shares

Australian Shares endured a (hopefully) once-in-a-lifetime financial crisis in 2008. 10-Year performance is going to look a lot different in two years time (20-years is 8.7% p.a.). Prices of Defensive stocks, on the other hand, have since been inflated by record low interest rates.

Residential Property

Residential property prices boomed on the back of low interest rates and an influx of offshore investors. But growth is now slowing.

RBA: Australian Housing Growth

Listed Property

REITS were smashed in 2008 (20-years is 7.7% p.a.). But before contrarians leap into this sector they should consider the impact of low interest rates, with many trading at substantial premiums to net asset value.

Bonds & Cash

Low interest rates again are likely to impact future returns.

Global Shares

Global Shares also weathered the 2008 financial crisis (20-year performance (unhedged) is 6.4% p.a.). Subsequent low interest rates had the greatest impact on Defensives, while Growth & Cyclicals trade at more conservative PEs.

I won’t go through the rest of the classes, but there doesn’t seem to be many attractive alternatives. It may be a case of settling for the cleanest dirty shirt, and the least smelly pair of socks, in the laundry basket.

Defensive PE at a dangerous high

Low interest rates and the accompanying search for yield have driven the forward Price-Earnings ratio for Defensives to a 20-year high. This is likely to reverse when (not if) rates eventually rise. Cyclicals and Growth, however, still look reasonable.

Economists Turn a Blind Eye to Historical Data | Bloomberg View

Barry Ritholz explains where many economists are going wrong when comparing the current recovery to previous recessions:

Why are so many economists, journalists and asset managers using the wrong history for their analysis? In a word: context. As I have been pointing out for nearly a decade (see here, here and here), most are looking at the wrong data set to analyze and compare this recovery to prior ones, using post-World War II recession recoveries as their frame of reference. The proper frame of reference, as Carmen Reinhart of the University of Maryland and Kenneth Rogoff of Harvard University explained in 2008, are debt-induced financial crises…..

Why is there such a difference between economic recoveries? The defining characteristic of any recovery from a credit crisis is ongoing debt deleveraging, meaning that households, companies and governments are primarily using any economic gains in income or borrowing costs to reduce their debt. Low rates are not being used to buy homes, but rather to refinance existing obligations. Hence, the entire current post-crisis period has seen only mediocre retail sales gains and slow GDP growth. Reinhart and Rogoff observed that, while rarer, post-credit-crisis recoveries are weaker, more protracted and much more painful.

There is normally only one credit crisis per generation. They take a long time to fade from memory. And recoveries are slow and protracted. Which is why we should insist that steps are taken to prevent rapid debt growth and a long-term repeat of the 2008 disaster. Increasing bank capital requirements and targeting nominal GDP growth (as suggested by market monetarists) are two important bulwarks against future credit crises.

Source: Economists Turn a Blind Eye to Historical Data – Bloomberg View

Lies Politicians Tell Us | Hoover Institution

Great insights from Allan H. Meltzer at the Hoover Institution:

Most of us learn at some point that politicians tell lies. We expect them to stop once they hold office or to face the consequences. In the past, politicians that violated the public trust resigned, most notably President Richard Nixon. Other lesser officials have also been punished for abusing public trust. No longer. In campaigns, and in office, politicians and their aides or supporters deliberately lie about matters of importance.

….The Obama administration lied to change a major foreign policy issue. Other lies are about less important but not unimportant issues. The French economist Thomas Piketty claimed that capitalism squeezes the middle and lower classes to favor the rich. Piketty’s book Capital in the Twenty-First Century and other studies that followed supported that argument by relying on deceptive data—specifically, income before taxes and transfers. Critics pointed out that the case is much weaker if income after taxes and transfers is used, as it should be. That’s much closer to the receipts that people have. And the differences are large. Transfers that are not part of income before taxes amount to more than $1 billion annually. The top 20 percent of taxpayers paid 84 percent of all income taxes in recent years. And the derided top 1 percent paid 23.5 percent of the income tax.The failure to use income after taxes and transfers cannot be accidental. It seems to be a deliberate attempt to mislead the public. And it is not the only misuse of data. Much of the recent large rise in the income received by the top 1 or 10 percent results from the Federal Reserve’s policy of lowering interest rates and raising housing and stock prices.

…..Hillary Clinton proclaims almost daily that women receive only 78 percent of the income that men receive. Her message is so misleading as to be dishonest. The 78 percent number is the ratio of women’s to men’s median pay. It does not adjust for occupational and other differences in the work that men and women do. For example, skilled neurosurgeons and football, baseball, and basketball stars are men. Domestic workers and hospital cleaning crews are mainly women. A recent paper by Diana Furchtgott-Roth summarized studies at Cornell and other quality economic departments. When adjustment for occupational differences are considered, the ratio is 92 or 94 percent, not the advertised 78 percent. And the remaining difference may not be due to discrimination. Differences in time in the work force, hours worked, and other factors may play a role.

….These are just a few examples of lies and misleading statements that we encounter every day. Clinton lies frequently and Trump shouts a falsehood a day—and probably more—as a major part of his campaign. This is not what citizens of a free country should expect and demand.

….Free societies require truth and honesty.

Worth reading the entire article at: Lies Politicians Tell Us | Hoover Institution

Hat tip to David Kotok.

ASIC review of investment banks shows poor practice

From Sarah Danckert:

The ASIC review of investments banks found that not only do the heavyweights of Australia’s financial system have difficulty in managing their conflicts of interest they also financially reward staff for potentially conflicted behaviour.

…..So ugly is the result the Australian Securities and Investments Commission has warned the people often known as the smartest men and women in the room it will take action against the culprits if the poor behaviour continues.

……Managing conflicts of interest are crucial for investment banks because often one part of the bank is advising on an asset sale or an initial public offering while the bank’s research arm is producing research for the investment banks’ investor clients about the quality of the assets or the IPO.

….ASIC said it had also found “instances of remuneration structures where research remuneration decisions, including discretionary bonuses, took into account research analyst involvement in marketing corporate transactions”.

The review also found “instances with mid-sized firms where research reports on a company were authored by the corporate advisory team that advised the company on a capital-raising transaction or had an ongoing corporate advisory mandate”.

Results of the review come as no surprise. When there is a conflict between profits with multi-million dollar bonuses and independence the outcome should be obvious.

Having worked in the industry, I believe that the only way to achieve independence is to separate investment banks from research houses, with no financial linkage. A professional body for research houses would ensure independence in much the same way as the auditing profession. There is no better way of enforcing good behavior than the threat of censure from a professional body that has the power to prevent its members from practicing.

Source: ASIC review of investment banks post UBS-Baird government run-in shows poor practice

US Light Vehicle Sales disappointing

June US Light Vehicle Sales came in at a disappointing seasonally adjusted annual rate of 16.689 million vehicles. Light vehicle sales, an important barometer of consumer confidence, have been trending lower since November 2015. Further falls would be cause for concern.

Light Vehicle Sales