The Great Liquidity Crisis of 2014

Central banks of the world, as led by the U.S., have mostly conquered the short sellers and silenced the skeptics with the greatest global debasement of currencies ever known to man over the last five years. And despite the fact that monetary printing presses have been running 24/7 and at full tilt, inflation somehow remains subdued, interest rates are still near historic lows, and Gold is only now finding a bid after one of the worst years for precious metals prices on record.

For all intents and purposes, the U.S. stock market is at record highs following a 5-year bull run that saw the S&P 500 Index advance 178% from 667 in March 2009 to 1851 in January 2014. The Russell 2000 Index soared 245% over the same period. Except for the so-called “Emerging Markets”, stock prices worldwide have experienced exceptional gains over the last five years. The fact that economies in Turkey, Spain, Italy, Portugal, and Greece (among others) are in disarray seems to mean almost nothing to buyers of stocks. The focus of Big Money investors is on Central Banks. Is China poised on the precipice of a major debt crisis? Probably yes, but no worries, the PBOC was there in January last month to provide record monetary stimulus, and it will be there again when needed.

Now is the perfect time for Central Banks to demonstrate their “mastery of the universe”, but they just don’t understand what it takes to finish the game on top. Now is the time to drive a stake so deep into the bears that short-sellers never raise their heads again. George Soros just doubled down in the S&P 500 Index with $1.3 billion in put options. SO BURY HIM AND EVERYONE ELSE LIKE HIM! But no, Central Banks just don’t understand the game, and they never will. Now is the time when Central Banks should not only be buying sovereign debt, they should also be vigorously supporting the very life-blood of the system --- Stock Index Futures. Central Banks should immediately expand their reach and buy stock index futures (unannounced, and with no transparency, but with lots of leaked bullish rumors). Does anyone really believe they’ve never done it before? Now is the time to really step on the gas! Take the Dow Jones Industrial Average to 30,000 over the next two years. Heck, that’s not even a double from here!

It’s all about “Escape Velocity”, but we’re not there yet, and Central Banks just don’t seem to understand this concept. What does Escape Velocity mean in this context? It means that economic growth must be self-sustaining, but we’re not there yet. And unfortunately, we’re not even close.

And just like a sick man who takes antibiotics to get well, the global economy needs its monetary medicine now more than ever to finally get well. If the sick man feels better and stops taking antibiotics early, then his disease sometimes comes back stronger than ever. The same principle applies now to the global economy. Now is not the time to stop the medicine!

However, the Federal Reserve, under new leadership, appears to be taking away life-giving medicine with its “tapering” strategy. While the markets are currently acting well in the face of this negative change in monetary policy, I firmly believe this is all about to change. With the Fed’s tapering strategy, the window of opportunity for curing the sick economies of the world is closing. And incredibly, in the minutes of the Federal Reserve’s January 2014 meeting, as released last week, there is now even discussion among the hawks on the Board about possibly raising interest rates later this year. While most Fed watchers dismiss such thoughts, the mere fact that it was mentioned in the latest minutes must be considered another very real threat to liquidity and ANY bullish case for stocks.

Bottom Line: The stage is set for a sharp downturn in U.S. stocks that will surprise most investors with the scale and swiftness of its decline. When the dust settles 60 to 90 days from now, most observers will be justified in blaming this correction on a liquidity scare that originated with the Fed’s tapering policy and was then exacerbated by the minutes from the Fed’s January Meeting (as released on February 19^th) where actual rate hikes were discussed. How much will stocks decline over the next 60 to 90 days? A 20% correction must be considered a very real possibility here! In the interest of full disclosure, I hold a large position in the Pro-Shares Ultra-Short S&P 500 ETF (symbol SDS) in one of my managed accounts.

U.S. Federal Reserve - Changing Of The Guard

On Friday, February 14th, the Nasdaq Composite Index traded at its highest level since September 2000. And the S&P 500 Index is now less than 1% from its all-time high set last month at 1850.84. The new Federal Reserve Chairman Janet Yellen provided comfort to nervous investors this past week with comments indicating that she will effectively "stay the course" of easy monetary policy. While planned "tapering" of the Fed's monthly purchases of Treasury securities and Mortgage-backed Obligations is still on the table, the zero-interest-rate path will be preserved until the economy demonstrates additional strength.

Both the S&P 500 Index and the Nasdaq Composite Index corrected less than 7% from their mid-January intra-day highs to their early February intra-day lows. And both of these widely followed stock market barometers have now erased all or most of these losses.

Is it safe?

In the 1976 suspense film Marathon Man, one of the scarier scenes was when Laurence Olivier asks his prisoner Dustin Hoffman "Is it safe?". Hoffman, of course, has no idea what Olivier is talking about and responds to this effect. Olivier than asks again "Is it safe?". Hoffman then says "Yes, it's safe". Olivier than asks again "Is it safe?". Hoffman is confused and scared and then says "No, it's not safe". For those of you who have never seen the movie, the real answer for Olivier's character was IT WAS NOT SAFE!

For investors in the U.S. Stock Market, my view is that IT'S NOT SAFE to commit new money here. I believe that the current path of "Fed Tapering" will soon take its toll on investors. Is it possible that we now have a "Yellen Put" in place of the previous "Bernanke Put" for U.S. stocks? The answer is maybe. Will the current Federal Reserve under Yellen's stewardship react the same way as the Bernanke Fed if a major stock market correction unfolds? Probably yes, but we won't know for sure until we actually see a real correction. My view of the the landscape here is that the U.S. economy is heading into a new recession. The level of current stock prices clearly does not reflect the probability of this potential recession. And while the Federal Reserve may be there to "cushion the blow" of any recessionary winds, most major stock indices may be down 20% to 25% before the new Yellen Fed responds appropriately.

What else is happening in the financial markets? The Gold/Silver Mining Stocks Sector is the number one performing stock sector year-to-date so far. The widely followed Philadelphia Gold/Silver Mining Index (XAU) was up 10.59% last week and is now up 21.20% year-to-date so far in 2014. The next best performing sector is Biotech at +13.01% year-to-date. REIT's, Energy, and Tech-related indices are up between 3% and 5% year-to-date, but most other indices are flat-to-down on the year so far.

The financial press is finally starting to focus on the extraordinary rebound in Gold/Silver and related investments. Naysayers on Wall Street have lost all credibility now with their bearish calls for this sector, and any investor who was willing to "trade against the bearish herd" last December 2013 has been handsomely rewarded.

Here are Friday's closing prices in the most popular Gold and Silver ETF's as compared to the panic intra-day lows as posted on Tuesday, December 31st:

                                                                          Panic 

                                                                  Intra-day Low      Closing Price

                                                                      12/31/13            02/14/14          Change

Gold ETF  (Symbol GLD)                               114.46               127.15           +11.09%              

Silver ETF (Symbol SLV)                                 18.26                20.65            +13.09%  

Here are Friday's closing prices in the most popular Gold and Silver Miners ETF's and a representative sampling of individual Gold and Silver Mining Stocks as compared to their December lows:                                                 

                                                                           Low        Closing Price

                                                                      Dec 2013           02/14/14          Change

Gold Miner ETF  (Symbol GDX)                     20.24                26.35            +30.19%              

Silver Miner  ETF (Symbol SIL)                      10.46                14.53            +38.91%  

Goldcorp (Symbol GG)                                       20.54                27.55            +34.13%

Primero Gold (PPP)                                              4.27                  6.75            +58.08%

First Majestic Silver (AG)                                     8.82                 12.19            +38.21%

Endeavour Silver (EXK)                                       3.12                   5.60            +79.49%

Fair or not, it's been my experience that "you're only as good as your last trade" in the investment advisory business. The bullish call on Gold/Silver mining stocks in this column over the last eight weeks has worked out well for anyone who listened. The bearish call on the U.S. stock market has yielded only mixed results. 

So what now? 

Bottom line: Gold/Silver mining stocks are probably "fairly valued" now and should therefore be scaled back or completely liquidated in most portfolios. While the rebound in U.S. stock prices over the last two weeks has been impressive, I remain convinced that a major correction is imminent and that a new bear market in equities will dominate the financial landscape for most of 2014. As of Friday's close February 14th, according to my proprietary valuation screen, here are the 25 most overvalued U.S. stocks:

Twenty-five (25) Most Overvalued U.S. Stocks (Proprietary Computer Screen)

The average stock on this list trades at 115x Forward 12-month earnings estimates (F P/E), 11.56x Sales (P/S), and 24.68x Book Value (P/B). The average stock on this list has a current market capitalization of more than $14.5 billion, but produced negative earnings of $0.09 per share over the Trailing Twelve Months (EPS ttm). At one point in 2014, I believe that most of these stocks will be down as much as 50% or more. Biotech and drug-related companies have been purposely excluded from the above list given the need for special valuation metrics to analyze this particular sector. In the interest of full disclosure, I am NOT short any of the stocks on this list, but I do currently hold a large position in the Pro-Shares Ultra-Short S&P 500 ETF (symbol SDS) in one of my managed accounts.

U.S. Stock Market - Is The Correction Over?

The rebound in U.S. stock prices late last week was impressive, but does this mean that investors now have the green light to add to their equity holdings in anticipation of a new sustained uptrend?

A review of recent price history may prove helpful.

On Thursday and Friday of last week, the S&P 500 Index rebounded 3.40% from its intra-week low. The entire recent correction from mid-January’s peak to last week’s low in the S&P 500 was -6.10%. For the Nasdaq Composite, the numbers are very similar (-6.55% correction followed by a 3.95% recovery). However, the correction in the Russell 2000 Index was significantly more at -8.45%, and the rebound was significantly less at 3.12%.

Is it important that small-cap stocks have underperformed larger cap stocks since mid-January? I think maybe yes, but it’s clearly not the whole picture.

For your review, I have attached four key daily prices charts below. These include the S&P 500 Index, the Russell 2000 Index, the Gold ETF (GLD), and the Silver ETF (SLV). The 20-day, 50-day, and 150-day moving average lines have been drawn in all four charts.

Here are my observations:

1. The 150-day moving average line has provided excellent support for about 15 months in the S&P 500 Index and the Russell 2000 Index. In fact, the last time the S&P 500 closed below its 150-day moving average line was November 15, 2012. And for the Russell 2000, that date is November 21, 2012. Last Wednesday, February 5^th, both of these key indexes successfully tested their 150-day moving average support lines, although just barely for the Russell 2000 Index.
2. The S&P 500 Index rebounded sharply from Wednesday's intra-day low and is now knocking at the door of overhead resistance in the form of declining 20-day and 50-day moving average lines.
3. While the Russell 2000 also bounced nicely from support at its 150-day moving average, unlike the S&P 500, the Russell 2000 needs to rally quite a bit more (+2.2%) in order to test its overhead resistance at the 20-day and 50-day moving averages.
4. The Gold (GLD) and Silver (SLV) ETF’s are both now above their 20-day and 50-day moving averages after basing price action which has lasted more six months.

Except for a few brave analysts (Citi’s FX Technical Group is notable), Gold and Silver still appear to me to be the most hated investment classes among so-called Wall Street experts. And while equities aren’t quite as loved as they were six weeks ago, the stock market is clearly still the preferred class by most sell side analysts. If we view sentiment as a contrary indicator (which I do), then equity prices are immediately vulnerable to another selling spree and gold/silver prices will continue to outperform most investment classes at least over the near term.

In the interest of full disclosure, I am long Gold/Silver mining shares and/or short the S&P 500 in all my managed accounts. The short S&P 500 position is executed with the Pro-Shares SDS double short ETF.

S&P 500 Index with 20-Day, 50-Day, and 150-Day Moving Average Lines

 

Russell 2000 Index with 20-Day, 50-Day, and 150-Day Moving Average Lines

Silver ETF (SLV) with 20-Day, 50-Day, and 150-Day Moving Average Lines

Gold ETF (GLD) with 20-Day, 50-Day, and 150-Day Moving Average Lines

U.S. Stock Market - Monthly Chart Sell Signals Now Triggered !

In my last post dated Saturday, January 25th, I indicated that conditions were right for possible monthly chart sell signals to be triggered within my computer-based trading system for the first time since July 2007. In fact, monthly chart sell signals have now been triggered and they all became official at Friday's close, January 31st, in the following popular indexes and ETF's:

Dow Jones Industrial Average

Dow Jones Transportation Average

Semiconductor Holders Index ETF (SMH)

Among major bellwether stocks, monthly chart sell signals were triggered for January in AMZN, AXP, BA, BMY, COF, C, FDX, GS, HD, JNJ, JPM, MS, NOK, X, and YHOO. 

Has a new bear market begun? My computer-trading system is flashing its strongest possible sell signals for both the weekly charts and the monthly charts. I believe the stage is set for a major correction of at least 20% from the recent record highs. While it may be too early to project a new bear market, where average losses could reach 50%, I am already on record as saying that a new bear market has in fact begun. I see no compelling reasons to own U.S equities right now with the exception of Gold/Silver mining stocks.