Juggling Dynamite

One of the hardest things for shallow-thinkers to grasp is that price in asset markets is not the only metric of import. As David Rosenberg says, most mainstream commentators (CNBC hosts) and investors “live only in the moment”. Sadly that approach is a sure way to suffer great capital losses repeatedly over time. Volume is one of the rare technical gauges that can actually help us get ahead of the curve a bit. This is why seasoned market analysts always want to look at volume as one of the most important barometers. It is worthwhile to note that volume in the stock rally off the March 2009 lows began to wane a few months in and by last June was showing more selling pressure on up days than buying pressure. Only on down days did volume pick up. Interestingly while markets rebounded from June 2010 losses in July, the volume of buyers hit a fresh low. Lasting gains need a steady stream of new buyers and believers to sustain. Thinly traded markets are notorious for sharp, shocking losses in short periods of time. It's just the way it is…

Excellent interview clip with famed money manager Felix Zulauf. His career journey was incredibly similar to my own it turns out: learned what not to do with money by working at large institutions, realized the conventional wisdom about portfolio management was farcical, founded his own independent management firm to have needed flexibility, starved in the beginning(with two young kids) before he could attract good clients (yikes, I still have post-traumatic stress disorder from this time, my husband and I both quit our bank jobs to start our company, we had no net income for more than 2 years ), he avoids leverage at all cost, realized that understanding and tracking business and market cycles is essential to capturing and keeping returns…all his experience has made him very risk averse, he would rather earn less than lose money…
Interesting to me is that he grew into running mutual funds before realizing it was a bad approach, then cashed out and went full-circle back to managing individual accounts out of a small boutique again…He explains the calls that made him successful along the way, importantly in part 2 Barry gets him to talk about some of the inevitable mistakes he made over the years. Discussing our mistakes is always painful, but generous and helpful to others.
Very worthwhile discussion. Listen to the full audio clip including his take on present conditions here.

Stocks are feeling wildly optimistic this morning. The ISM reported its manufacturing gauge fell to 55.5 in July from 56.2 in June, but that came in 1.5 better than the 54 level that economists had expected. The trend is clearly for weaker levels ahead as explained by TD securities this morning:

“New orders, which drives activity in related and downstream manufacturing efforts was weaker than expected falling to 53.5, the lowest level since mid-2009. Production was also down falling for the third straight month and while a reading of 57.0 is still pretty good, more downside is expected. The area of strength that cushioned the decline in July may have been unintentional. Inventories produced a tidy gain rising from a depressed level of 45 to just over 50, but like the Q2 GDP report, the jump in inventories is likely not intentional given the paucity of real final sales. As the ratio of new orders to inventories gets compressed, it suggests that production will continue to weaken with a lag, as will most other components. This is reinforced by orders backlog which also is moving lower, falling to 54.5 from 57.0. With orders being worked off and new orders becoming sluggish, inventories will be pared down and real demand will edge lower. We expect this to be reflected in Q3 GDP which should come in close to 1.6%.”

It is important to note that the ECRI leading indicator index which most recently reported a -10.9% weekly growth rate typically leads the ISM PMI by 13 weeks and 13 weeks ago the ECRI WLI was still a positive 12.7. This trend suggests that we could see the ISM PMI data fall officially into contraction mode this fall. This would be bad news for a stock market that is presently pricing in robust earnings growth.
For a series of very illuminating charts on the quality of this economic “recovery”, see Bill Hester's article today Subpar recovery gets premium market valuation at Hussman Funds:

“For investors, what's important is the extent to which expected growth in the economy and earnings is priced, or possibly overpriced, into the market. The current subpar recovery should probably warrant a below-average level of valuation compared with prior recoveries. Unfortunately, the opposite is true. To put the current level of valuation into perspective, the table below shows Robert Shiller's Cyclically Adjusted P/E Ratio (CAPE), which normalizes earnings by averaging the prior decade's results. The table shows that there have only been two other periods where the economy was recovering from a recession and the level of valuation was higher. One was in November 2002, a year following the end of the 2001 recession. The S&P 500 has achieved a total return of just 4.2% annually in the 8 years since then. The other instance was in February 1962, a year after the 1961 recession ended, when the CAPE was at 21.45 (the S&P 500 quickly lost a quarter of its value over the next few months). The average CAPE level for the periods shown is 16, versus the current level over 20”.

Seriously, these pictures cut through the spin of a thousand bullish commentators…well worth a look…