Thursday, December 26, 2013

Using Credit Market Signals as Stock Market Leading Indicators

Ben Bernanke's gift to the markets on Wednesday December 18, 2013 in my review was really no big surprise. What would have been a surprise was an announcement that in the coming year the Fed was actually going to move to a neutral monetary policy. But, as I stated in my last article, "now is not the time to exit stocks". Currently the signals are simply not ripe for a stock market breakdown because there is no resistance in place to trigger such an event. If you have the chance to read my book, Theory of Financial Relativity, you will have a much better understanding of the history behind my perspective and forces and metrics to be wary of when a true market correction is about to take place.

The stock market (SPY) (DIA) (QQQ) in 2013 will post gains which will rival many of the best years since WWII. And, the gains are not being posted in the year following a recession, a more common occurrence. And yet, the Fed is projecting by my estimation over $500B in additional asset purchases of Treasuries and Mortgage Backed Securities in 2014. This asset buying program will be the 3rd greatest bond buying program in Fed history behind the $1T purchase in 2013 and $600B in QE1 - hardly a step toward tightening. In addition, if the market does not produce the growth the FOMC has determined to be the level

Friday, December 20, 2013

Stock Market in 2014 - Can the Run Continue?

During 2013 the rise in stocks (SPY) (DIA) (QQQ) has, in my observation, been all about the flow of funds, not economic fundamentals.  What I mean by this statement is that currently investors have choices about where to invest their funds.  Presently with interest rates moving up from historically low, Fed regulated levels, the demand for long duration 10 to 30 year, and now even medium duration 5 to 10 year credit based securities is low.  Meanwhile, new supply of Treasury securities in the middle of 2013 was non-existent thanks to lower government spending levels and the constant Fed QE program.  The Fed QE program is ironically for the Democratic White House which is driving the current economic plan, designed on the premise that lower government financing needs combine with QE will displace funds in the Treasury market that will somehow “trickle down” into the real economy.  So far it appears the effect is widely uneven, as top line revenue growth at businesses is flat, even negative for the DOW companies by my measure on a trailing 12 month basis.

The net result is that investors are choosing more and more to put money to work in stocks rather than bonds in order to get a return on assets.  In watching this phenomenon unfold, it has been particularly evident that much of the money being flushed out of the Treasury market has a preference for the U.S. major market indexes, most likely due to the higher liquidity of the major exchanges and the ease of trading ETFs.  With this observation, I decided to do a correlation trend analysis on the market capitalization of the DOW as a function of the change in the size of the Fed balance sheet since the end of 2008.  The result is the visual graph shown below.

Friday, December 13, 2013

Theory of Financial Relativity Book Receives Positive Review

In the high speed internet world it is easy to get your message drowned by all the traffic.  But on  December 11, 2013  G Willis, a financial adviser to Federal Employees and Veterans in San Diego through his web portal know as GubMints, published a thorough review of Daniel Moore's book titled Theory of Financial Relativity.

He begins the book review with the following perspective:

"Daniel is who I like to call The Most Interesting Man in the Financial World. Not because he earned his MBA from from Duke's Fuqua School of Business, but because of his life experience. You see, Daniel has had ringside seats for the biggest financial freak shows of the past 3 decades- Creation of the Mega-Banks who were 'Too Big to Fail', The Internet Hardware Bubble, the Silicon Valley VC Frenzy of the late 90's, and the California Housing Bubble of the 2000's.This life experience led to Daniel's financial opus - The Theory of Financial Relativity." 

You can read the full review posted here: Book Review: Theory of Financial Relativity

Buy a copy today at:

Thursday, December 5, 2013

S&P 500 up 20% in 2014? Re-live the Bubbling 1990s

Is it by coincidence that this past year has been filled with events bearing resemblance to the market in the late 1990s?  I personally have battlefield experience in the technology capital market during the late 1990s, and the market trade is too analogous to ignore.  Show me social networking companies going public with sky-high valuations like Twitter (TWTR) and LinkedIn (LNKD) or other tech companies with high cash burn rates and uncertain revenue models doubling in price on the first trading day post-IPO, and I say deja vu.  Need I point back to the many companies that were taken public, only to fold in the late 90s boom like Sycamore Networks,,  The stream of IPOs is a function of the flow of funds in the capital market, triggered to a large degree by Fed policy and U.S. fiscal policy and the resulting interaction between the foreign capital markets and the United States.  Not by coincidence, many of the government bureaucrats from the Clinton administration have had a hand in architecting the Obama economic plan.  So, you can imagine why we are seeing comparable market results today.

Sunday, November 24, 2013

Gold the New Fed Conundrum

On November 14th, 2013 during testimony to the Senate Banking committee, Senator Dean Heller (R., Nev.) asked Fed vice Chairwoman Janet Yellen if she understood what drove the price of gold up in the market.  It was the same question he asked Ben Bernanke in his testimony on July 18th earlier this year.  In both cases, the answer given was an unequivocal dodge.  Chairman Bernanke’s answer ended with the following statement, “…nobody really understands gold prices and I don’t pretend to understand them either.”  Janet Yellen provided a equally anecdotal, but non-informative overview, saying “I haven’t seen a lot of models that are successful in predicting the price of gold” and, just as Bernanke did, attributed gold price increases to people being fearful saying “gold prices do rise when investors worry about financial catastrophe and tail risks in the economy.”

Most often when explanations are oversimplified, they become meaningless or more likely simply wrong.  As a financial historian, surely Ben Bernanke has a very good understanding of what drives the price of gold.  Even Pedro, the ever present welcoming committee of travelers along Intersate-95 as you enter the state of South Carolina, most likely has a good idea what drives the price of gold.  Why?  Because, the commodity most correlated to the value of gold over time is refined to power the automobiles parked at his feet in the picture below.

Sunday, November 17, 2013

Fed Policy 101 - How to Create Inflation, Target Unemployment

The 1960s and 1970s are the poster child of inflation gone awry.  Government spending during this time period grew at an above average historical rate, on average 10.6% per year during the decade of 1970.  Why did inflation become such a problem in this period? 

Wednesday, November 6, 2013

Oil Supportive of Higher Stocks - For How Long?

Bubbles, bubbles everywhere – except in the oil market?

Crude oil opened on November 4th, 2013 at a four month low.  By comparison, the S&P 500 (SPY) just completed the month of October up 4.2% over the previous four months, and 24.4% year over year. The DOW (DOW) posted similar gains.  The stock market has been handily beating the oil on a return basis recently.  The tranquil activity in the oil market has transpired during the biggest conventional quantitative easing program ever undertaken by the Federal Reserve – the $1T Treasury and MBS purchase program launched at the beginning of 2013.

Is the crude down, stocks up, QE up scenario a good sign for stock investors, or just the calm before the storm like the tide receding before a tsunami?

Thursday, August 1, 2013

Muni Bond Market Troubles – What You Might Like to Know

As the news feeding frenzy has begun to focus on the $18B Detroit bankruptcy filing on July 18, 2013, it is time for investors who have exposure to the market, or are thinking about taking on new positions to get a better understanding of what is happening in this game.   There are countless headlines about the impending doomsday for municipal bonds driven by the underfunded pension system for public workers in many municipalities across this country.   I would say that this is not really new information, but it does make good conversation.  But, this conversation is impacting the market, so it is a good idea to understand why, and whether you should be bailing out before financial Armageddon, or looking for opportunities that are being created by the fear mongers.

Monday, July 8, 2013

Jobs Up, Interest Rates Up, Buy Cyclical Energy Stocks

Over the past 6 months, I have watched the steady under-performance of the large cap oil stocks such as Exxon Mobil (XOM), ConocoPhillips (COP), BP (BP) or Royal Dutch Shell (RDS.A). Even the recent stir in Egypt, although producing a risk premium in the near-term price per barrel of crude, is not sparking a major rally in large cap oil stocks.

The relative under-performance to the S&P500 (SPY) index of the major integrated oil companies since the beginning of February 2013 is very distinct in the graph above. This is after an extended period in which the stocks and the market index were highly correlated. Given the change in economic fundamentals recently and the rising rate market environment we are now entering, this break down in correlation may be a market signal of a value play in the making.

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Tuesday, June 18, 2013

Data Shows Pressure on YEN to Strengthen - Risk to S&P

Why the Pressure is on for the YEN to Strengthen

The break-down of the YEN weakening relative to the US stock market may seem incidental to many.  But strong correlations of a foreign currency to an exponential rise in the S&P500 since the first of 2013, after already significant gains from the lows of 2009, is a sign that something is changing.   In other words, it is time to pay attention.   Unfortunately, when things begin to change after large advances in asset prices, it usually means there is a busted trade and the risk of cascading losses start to build up in the markets.  I raise this concern because since the first of this year investors have witnessed a growing number of market unwinds – gold, emerging markets, U.S. Treasury markets and the Nikkei.   And now we see a changing dynamic in the YEN relative to the dollar, at a time when many are expecting further YEN weakening. 

To assess the risk and understand why this is happening, I decided to do an in-depth review of the capital flows into and out of Japan that would influence the price of the JPY relative to the USD.

The following series of charts examine the investment capital flows from sales and purchases of investments by various groups that would influence the relative strength or weakness of the YEN over the last year (YEN has been converted to USD based on the prevailing average monthly exchange rate in all data obtained from the Japan Ministry of Finance).

Monday, June 10, 2013

Correlation of USDJPY to S&P500 Explains Why Economic Fundamentals Have Not Mattered

The S&P500 (SPY) started this year at 1425.  In May it reached an intra-day high of 1690, a gain of 18.5%, before pulling back to its current range.  The economic fundamentals have been weak during this time period and the outlook is not cause for making a big bet on “hope”.  Fourth quarter real GDP was first announced negative, and subsequently was updated to a slight positive of 1.6%.  The first quarter was a similar anemic growth rate of 1.8% TTM growth.  When you add in inflation the constant dollar growth rate of the U.S. economy is between 3-4%. 

On what basis would these results cause buyers of the market to rush out and bid the market up by 16%-18% in the first 5 months of 2013?  Do some investors know something everyone else is missing?  Is the market just so undervalued because of the 2008 sell-off that now it can still go up without fundamental economic support?  Count me as skeptical, but I do have a good idea why it has been rising in spite of the numbers, and it is contained in the chart below:

Friday, June 7, 2013

Interest Rates Up - Senior Bank Loan CEFs and BDCs Down, What’s Up?

In my recent articles concerning the upward directional change in interest rate ( Data Shows Interest Rates will Continue Higher In 2013 - What to Do Now ) I have described strategies which are intended to hedge or deaden the blow of basis loss in an investment  portfolio as the market trades lower in price, higher in yield on fixed income investments.   One of the strategies that many investors assume should work is the purchase of variable rate bank loans, either through a Closed End Fund, [CEF] or a Business Development Corporation [BDC].    But when you look at the market trading data since the beginning of May across the board on these companies, there is a definite under performance in the issues.  It is an under performance which in relative magnitude equals the decline in the highest duration Treasury ETFs.

A bank loan which is variable is supposed to be a low duration, not high duration security.  So, there must be something else going on which is driving the trading pattern across an entire market sector; and, I will explain what it is in this article.

Monday, June 3, 2013

Strength in the US Dollar Shows Support for US Stocks – But for How Long

In a never ending quest to unlock how the Central Bank monetary actions and Government fiscal policies around the world are inter-acting to move the stock markets and interest rates, my research drew me to a review of the changes in the value of the US Dollar Index (DXY).  

When looking at the Dollar Index over time based on the changes in Federal Reserve quantitative easing (QE) policy, there is very little relational value.   When the Fed increased QE in the late 90s, the dollar went up.  When the Fed increased QE in post 9/11, the dollar went down.  Looked at today with the Fed’s massive QE program in place since 2009 the dollar has been fairly flat and is now strengthening.   The directional move in interest rates gives a little better understanding in what makes the dollar move.  When interest rates rose in the late 90’s, the dollar went up.  When interest rates fell dramatically after 9/11, the dollar went down.  What about the past several years and today?  Historically low rates, major Fed quantitative easing (QE), and the dollar since 2011 has been on an - uptrend?  Confusion.

 I finally found a much better way to understand the movement of the USD, and therefore get better signals on directional moves in interest rates and equity markets from its change in value.  What I track is the  relative change in the amount of borrowing the U.S government needs to finance its on-going deficits, and the change in financing levels supplied by foreign entities (inflows).

With this framework in mind, I have created the chart below.  The top line (blue) tracks the value of the dollar index for the last 18 years. 

The red line in the chart is the trailing twelve month average in net investment into the U.S. Treasury market by foreign investors.  As the graph shows, when the relative magnitude of inflows are on the decline, the dollar generally strengthens.  And the opposite happens when inflows go up.

Tuesday, May 28, 2013

Should Investors Chase the Current Stock Market Rally?

There is an on-going debate about just how much the Federal Reserve quantitative easing (QE) policy has influenced the rise in stock market prices.  From January 2009 until April 2013, I estimate it is almost 100%.

In the example above, the stock market return over the time period is compared to a hypothetical 4.52% perpetual bond which has an investment grade of BAA1. The BAA1 interest rate was chosen as a proxy for the relative risk of the highly liquid U.S. stock market.   In January of 2009, the bond would have been priced at an interest rate of approximately 8.14%, giving it a market traded price of $55.53.  At the end of April 2013, with BAA1 rates at 4.52%, the bond would be trading at par value.

Sunday, May 26, 2013

Fed Tapering Comment in Bernanke Testimony on May 22nd Exposes Stock Rally Weakness

Nothing surprises me in the stock market (SPY) (DIA) these days. Another week and stocks are up another 1%-17% so far this year. But there must be something surprising in the data that investors need to know. Some intriguing nugget of information that will satisfy the thirst for understanding just why the stock market is levitating like a Maglev train that can reach speeds of up to 300 mph while bog standard technology has passengers cruising from D.C. to New York at a snail's pace. Maybe the financial markets have just entered a gravitational weightlessness zone where the laws of financial physics no longer apply. Warren Buffet often comments that the Fed supplies the gravity. Lately I think he must mean anti-gravity.

What is driving the U.S. equities so much higher at this time in the face of slow growth prospects? And, why has the market churned higher over the past month even as the interest rates moved higher? This would be a great sign for the economy if it could be sustained. It might actually mean that the Fed can exit its stimulus program without the stock market imploding.

These are questions that in light of the change in direction of market interest rates are worth analyzing further.

For full article:  Fed Tapering Comments Expose Stock Market Rally Weakness