A true contrarian look at investing and at life in general.
WELCOME TO TRUE CONTRARIAN! I will attempt to create an entertaining, readable, and hopefully refreshing viewpoint from time to time. Each issue will feature my intermediate-term financial outlook, my long-term financial outlook, and a personal reminiscence. Those who believe in this investment philosophy should subscribe to my daily update service which I began in February 2006.
THE U.S. DOLLAR'S TEN-MONTH HIGH POINTS THE WAY LOWER FOR GLOBAL EQUITIES (March 24, 2010): The U.S. dollar index soared to an early evening peak of 82.026, its most elevated reading since May 20, 2009, which was more than ten months ago. If you live in a country with a high ratio of commodities to people, like Canada, Australia, South Africa, Brazil, Russia, or New Zealand, then you should shift your time deposits into U.S. dollars as soon as possible. Now that TLT is below 90 once again, non-U.S. residents especially should consider shifting their non-U.S. assets into TLT. Carpe diem (i.e., don't sit around waiting for even more favorable prices). Some Canadian subscribers have been waiting for the loonie to achieve parity with the greenback; while that would indeed be a powerful signal to switch, other traders have already been front-running this idea. With the loonie reaching 99.37 U.S. cents on March 19, it makes little sense to try to squeeze out that extra few percent and thereby risk missing a prime opportunity to accumulate U.S. dollars. The importance of doing this trade has increased to 8 on a scale of 0 to 10. Do not buy U.S. equities or U.S. real estate since those assets still have major bear markets ahead of them. Wait three years before shopping for that second home in Florida.
There has been a lot of talk in the media in recent weeks about an alleged breakout for global equity indices. On the surface, this appears to be accurate; the S&P 500, the Dow Jones Industrial Average, and many other well-known stock-market gauges have recently climbed to their highest levels since September 2008. However, as I discussed in detail in yesterday's update, this apparent strength disguises a sharply increasing number of negative divergences. For example, all of the commodity-share and emerging-market funds such as GDX, ASA, KOL, RSX, FCG, etc., which I had recommended buying in the fourth quarter of 2008 and the first quarter of 2009, and then selling in early January 2010, have remained below the levels at which I had sold them. Since commodity shares have led the market both higher and lower over the past few years, and will likely continue to do so for several more years, this is almost surely signaling that the recent alleged breakout for global equity indices is a patently false one. Chartists and momentum players have been chasing the breakout by buying just when they should be doing their most aggressive selling since the summer of 2008. Remember that the same chartists were aggressively selling in early March 2009 when they obviously should have bought at the lowest prices in 12-1/2 years, and they were aggressively buying in October 2007 when they should have been selling. So you could say that they have been very consistent, and the performance of technical-analysis-based hedge funds shows them to be among the bottom of all categories of hedge-fund performance during the past three years. The recent surge in insider selling relative to insider buying by top executives confirms that the equity breakout is a false move and should be used as a prime selling opportunity.
The real breakout is the surge in the U.S. dollar index to its highest level in more than ten months. I call it real not only because of the obvious chart behavior, which can be misleading, but since this breakout is confirmed by other indicators. If the U.S. dollar were making a false breakout, then commodity shares should be forming higher highs instead of lower highs. Thus, the message of the greenback coincides with the messages of GDX, KOL, EWZ, and similar commodity-share and emerging-market funds.
My definition of the underworld would be having to watch financial cable TV nonstop through eternity without even being permitted to take bathroom breaks. If you have been sufficiently brainwashed by the mainstream media, then you might conclude that the strength in the U.S. dollar has been due entirely to weakness in the euro caused by difficulties with some of the euro's weakest member nations. I don't want to minimize the importance of the demise of the euro, which in my opinion is a certainty rather than a possibility, and which I had forecast as a foregone conclusion three years ago in my updates before anyone in the media began to discuss this issue. Certainly the end of the euro, which will become increasingly apparent over the next several years depending upon how long it takes before it ceases to exist, will leave a gap in the foreign-exchange market, which will lend support to the greenback.
However, what is far more significant is the U.S. dollar's performance relative to countries with a high ratio of commodities to people. The loonie (Canadian dollar) had recently climbed to its highest point versus the U.S. dollar since July 2008. However, all other commodity currencies show a very different picture. The aussie (Australian dollar) has already been forming a bearish pattern of lower highs since November 16, 2009. The kiwi (New Zealand dollar) has been forming a pattern of lower highs since October 21, 2009, while the South African rand had similarly peaked on October 14-15, 2009. The Brazilian real topped out on November 10, 2009, while the Russian ruble reached its most elevated point the following day on November 11, 2009. Thus, most currencies of major commodity-producing countries have already been quietly forming bearish downtrends for several months, with the Canadian dollar as the sole holdout. It is therefore much more likely that the loonie is simply late to the party, and will end up slumping more in percentage terms over the next two years in order to catch up to its sister commodity-country currencies.
Have you heard anyone on CNBC or any other cable TV channel even mentioning briefly the pattern of lower highs for non-euro currencies? As usual, the media are obsessed with one side of the story, while ignoring what could be a far more important issue. The mainstream media barely mentioned the potential impact of the proposed rise in the long-term federal capital gains tax from 15.0% to 23.8% by January 1, 2013, although they went on ad infinitum about tiny details of the recent health-care "reform" package (admittedly there were many tiny details involved; see update #1048). Imagine a photographer taking copious photos at the scene of a major event, but the important action which will be remembered for decades is occurring right behind his back. This is exactly what happens if you watch, listen to, or read the mainstream media; you will be getting most of the stories, but you will be missing all of their key points of significance.
If the S&P 500 index were to return to the same price as it was the last time the U.S. dollar index was at its current level of 82, then it would be in the low 900s. There are those who keep insisting year after year that well-established interrelationships between assets "are different this time", even though they are proven wrong year after year. Whenever assets which have a strong proven historic correlation vary from their normal ratios, it's almost always the case that certain assets are functioning in a typical leading fashion, while lagging assets will simply take somewhat longer to catch up. The U.S. dollar index is most certainly not sending a false signal, nor is it the case that the behavior of the greenback "doesn't matter any more". Just as gold mining shares are serving in their normal leading role, with nearly all other commodity-share and emerging-market shares following about one month behind, so are general equities set for a historic bear market which will end up becoming the most dramatic percentage pullback since the Great Depression. The more strong bounces there are along the way, and the more divergences between assets, the more 2010-2012 will resemble 1930-1932, when the Dow Jones Industrial Average lost 86% of its value in slightly more than two years. Probably most U.S. equity indices will lose "only" 60%-70% in their upcoming bear market, as compared with a more "moderate" decline of 57.7% for the S&P 500 from October 11, 2007 through March 6, 2009.
How high will the U.S. dollar index reach over the next few years? My guess is that just as the S&P 500 recently regained somewhat more than half of its total decline from top to bottom, the U.S. dollar index will recover somewhat more than half of its total pullback from its zenith of 120.99 on July 5, 2001 (its all-time high was 164.72 on February 25, 1985) to its nadir of 70.698 in the evening of March 16, 2008. The exact halfway point is 95.844, so perhaps the U.S. dollar index will peak near 97 or 98 about two years from now. That would cause the greenback to touch its highest mark since the fourth quarter of 2003.
There were many interesting developments in the financial markets today, but the one which was at least a thousand times more important than the others combined was the U.S. dollar index moving above 82 for the first time in more than ten months. The mainstream financial media barely mentioned this story, choosing to focus as usual on various transient bits of economic data which have close to zero predictive value. Whenever the U.S. dollar is this strong during any era of stagnation, it is signaling that equities and commodities are set for a major bear market. Even in the short run, there is significant downside risk for general global equity indices; gold mining shares have already been in a downtrend for several months, as have most commodity-country currencies. Most commodity-share and emerging-market funds have been forming patterns of lower highs since the early morning of January 11, 2010. Just as had been the case last Thursday and Friday, all 30 of the commodity-share funds I track were lower today, with GDXJ, a fund of junior gold mining shares, leading the downside parade with a pullback of 4.77%, while GDX slid 3.93%. You can pretend that "it's different this time", that the U.S. dollar's strength will not lead to a major pullback for global stock markets, or you can follow the example of history and learn how to use proven correlations to make better trading decisions. While we will probably not have an 86% decline for most U.S. equity indices over the next couple of years--probably "just" 60% or 70%--the shape of 2010-2012 is likely to closely resemble the bear market of 1930-1932. While the upside breakout in the S&P 500 is false, the upside breakout in the U.S. dollar index is true and significant. Those who ignore the greenback's message deserve the inevitable consequences. As for the future of the U.S. dollar index, it will probably recover somewhat more than half of its total loss from the 2001 peak and complete its next top in the upper 90s roughly two years from now.
THE FINANCIAL MARKETS ARE A MIRROR IMAGE OF MARCH 2009 (March 24, 2010): The financial markets tend to repeat the past. During eras of stagnation, this pattern of past repetition is considerably more notable than during eras of prosperity. That is partly since the correlations between various assets, as well as the relative behavior of leading and lagging sectors, is far more consistent during eras of stagnation when liquidity is the primary driving force in the global financial markets. As liquidity increases, all assets which benefit from higher liquidity will rise in tandem. As liquidity declines, the opposite will occur. It is therefore especially notable when there are major divergences between risk assets, as has been the case in recent weeks--and as also was the case in March 2009, but in exact reverse. The current situation is thus almost an exact mirror image of what we experienced one year ago.
In October and November 2008, commodity shares around the world completed historic multi-year bottoms after having suffered some of their worst percentage declines in history. In late February and early March 2009, while the S&P 500 continued to form a continued pattern of lower lows as compared with November 2008, virtually all funds of commodity shares formed higher lows. Gold mining shares in particular were substantially higher in early March 2009 than they had been at their nadirs in October 2008. If you look at a list of several dozen funds of commodity shares, there are only a few small subsectors which made slightly lower lows in March 2009.
However, if you look at general equity indices, then exactly the opposite is the case. The S&P 500 and the Dow Jones Industrial Average were among the most notable examples, with the S&P 500 slumping to a 12-1/2-year bottom on March 6, 2009. If you measure them in U.S. dollars, which is important since the U.S. dollar index was at a three-year high on March 4, 2009, then most major global equity indices with the notable exception of those in commodity-producing countries also completed multi-year lows in March 2009.
Since the mainstream media were heavily hyping the historic lows for the Dow and the S&P 500, the average investor believed one year ago that the stock market was much weaker than it really was. Those who had purchased my recommended funds of commodity shares had depressed portfolios in early March 2009, but the total value of these portfolios was notably above their most depressed levels from late October through early December 2008. The fact that commodity-share funds were making higher lows virtually across the board in early March 2009, while general equity indices were making lower lows, was one key factor in signaling that we were on the verge of a major bull market.
Today, the situation is almost exactly reversed. All of the commodity-share funds which I had recommended selling in early January 2010 are trading below the prices at which I had recommended selling them, without exception. Meanwhile, the S&P 500 is setting new highs almost every week. Because the media are, as usual, hyping the value of indices such as the Dow Jones Industrial Average and the S&P 500 index, the public currently believes that the stock market is much stronger than it really is. I have never seen any mainstream media outlet even briefly mention the very bearish divergence of lower highs for commodity shares, just as they completely ignored this critical message in reverse in March 2009.
We are even seeing a repeat of the emotional pattern of late 2008 and early 2009, but in reverse. In late 2008, those who sold stocks in the fourth quarter did so primarily out of panic, as we had the sharpest percentage pullbacks since the 1930s. In early 2009, and especially in late February and March 2009, others sold out of despondency as they became discouraged from continued monthly declines in their portfolios. We have seen exactly the reverse emotions over the past several months, ranging from euphoria when the financial markets were rallying strongly, to nearly total complacency in recent weeks. Even those investors who realize they should be selling cannot psychologically bring themselves to do so, because when they don't sell, the market is higher the next week and they thereby get positive emotional feedback telling them they were "right" not to sell. After several consecutive weeks of such feedback, it becomes emotionally as difficult to sell as it was equally difficult to buy stocks in late February and early March of 2009. Back then, those who didn't buy received positive psychological feedback each week as the market moved lower, thereby reminding them how much they "saved" by not taking action, and eventually convincing almost everyone not to buy stocks. Humans are just as emotional nowadays as they had been in past millennia, and therefore the vast majority of investors will always act emotionally even if it is completely irrational to do so--in fact, especially when the most logical behavior is to do exactly the opposite.
MY OPINION ON HEALTH-CARE "REFORM" (March 24, 2010): On Sunday night, the U.S. House of Representatives passed legislation known euphemistically as "health care reform". They also passed a bill to increase the tax on investment income by 3.8% for those couples earning $250,000 or more per year, and to increase the tax on earned income by 0.45% (0.9% for self-employed individuals). While the tax increase is allegedly to pay for the health-care provisions, the reality is that it will not be targeted for that purpose, but will go into the general fund. Therefore, the 3.8% investment tax increase is really going to pay for the massive stimulus program, "cash for clunkers", and similar clunky legislation that had no beneficial impact whatsoever except to increase the federal deficit. In the future, there could well be additional programs to bail out homeowners who bought houses they knew they couldn't afford, to subsidize banks which should have been allowed to go bankrupt, and probably additional future stimulus plans and other wasteful government programs. It would not be surprising to see additional tax increases. Since it is politically much easier to raise taxes on investment than to impose gasoline or value-added consumption taxes, Congress and the President may well continue to behave in this manner especially if they believe it will not noticeably impact their chances of re-election.
It has been proven that modified taxes on investment income have the most direct impact on the behavior of the financial markets as compared with all other legislation. In this case, there will be several major negative consequences from the new higher rates for all forms of investment income for those earning more than $200,000 as individuals, or $250,000 as married couples.
The first and most important direct impact is that anyone who has been sitting on the fence so far in 2010, trying to decide exactly what will happen with taxes in 2011 and beyond, no longer has any shadow of a doubt that it will be far better to sell this year than in any future year. Many wealthy individual and institutional investors are holding trillions of dollars of assets which they have held in many cases for years or even decades. They have not been particularly interested in selling, and in many cases have enormous unrealized capital gains. It is always painful to have to convert unrealized gains into realized ones, since it then requires the payment of many years of accrued imputed taxes. However, if long-term capital gains tax rates seem certain to increase on January 1, 2011 from 15% to 20%, and especially if it appears that many years or even decades will pass before these rates are lowered the next time, then many will sell as their last chance to get the lower rate. Especially since long-term rates are scheduled to be 23.8% on January 1, 2013, those who may have been hesitant about selling to save 5% will be far more motivated to sell in order to save 8.8%.
In addition to the reality being different, the perceived future reality is also different. Before last night, many doubted that Congress would actually raise taxes. Now that they have done so, people will begin to ask how much more they will raise them. This will make undecided wealthy investors even more likely to sell in 2010 than to postpone their decisions to a later year. Of course, since most people naturally procrastinate, many will continue to wait since they know they have more than nine months to get the 15% rate. Once others begin to sell and this pushes down the stock market, people will realize that they had better act sooner rather than later in order to front-run everyone else who wants to do likewise. This will accelerate the two-year bear market which would have occurred no matter what Congress had done, but which will now likely be more severe in percentage terms than it otherwise would have been.
Being cowards, Congress and the President naturally decided that these tax increases would not begin until January 1, 2013, instead of January 1, 2011 when all other tax rates will revert to what they had been in the final years of President Bill Clinton's administration. There is a silver lining in this postponement, since anything which is postponed may perhaps be repealed. If the stock market does indeed plunge as a combination of the natural continuation of the current era of stagnation, along with the additional downward pressure from many wealthy investors unloading their holdings to get the lower long-term capital-gains rates, then perhaps it will become so depressed--let's assume the S&P 500 slumps below 400--that Congress and/or the President propose a capital-gains "cut all the way back to 20%" as a way to stimulate the economy in 2012. Naturally, that is an election year, so such a cut is probably much more likely than normal. So maybe this will be a phantom tax increase after all; ironically, the more that investors sell in anticipation of higher tax rates, the less likely that these higher rates will be implemented. Perhaps the rate increase will continue to be postponed just long enough to occur after the next election, and then postponed again until the following election, and so on. While this may sound irrational, each year the alternative minimum tax is amended so that its full force is not felt by the vast majority of tax filers. One should not underestimate the eagerness with which politicians will play games.
If Congress does not repeal the tax increase, then this will provide easy fodder for Republicans to assume the mantle of tax-cutting champions, even as they need do nothing more than simply restore the Clinton tax code of the late 1990s to win the hearts of voters. The Democrats are taking a huge risk that health care "reform" will be so widely popular that people won't mind paying higher investment taxes in order to enjoy the munificent benefits of the new legislation. If this is the tradeoff that Democrats are making, then I think it will be a serious mistake. In New Jersey, Governor Corzine increased the maximum tax rate from 6.37% to 10.75%, making it child's play for Chris Christie to win the governorship in November 2009 even with far more Democrats than Republicans registered to vote. All Christie had to do was to vaguely promise to "try to lower this rate down to maybe 9%", which of course would still leave it significantly above what it had been when Corzine first took office.
One notable factor in the incessant media coverage of this event in recent days was the obsession with language on various matters which I personally consider trivial, and almost no serious discussion of this tax increase. I spoke with many people over the past several days, and the vast majority of them did not even know that a tax increase was a key part of the bill.
The irony, of course, is that whatever alleged increased government revenue may arise from these higher marginal tax rates, the total decline in investment income as the result of the most severe bear market since the Great Depression will far exceed it. We would have had a major bear market no matter what Congress had done; now that the health-care bill has been passed at virtually the same time as a historic bull-market top, the bill will end up getting "credit" in many people's minds for "causing" the bear market. This will make it even easier for Republicans to win a significant number of seats in the 2010 elections, and perhaps even beyond. Turnabout is fair play; the beginning of the current era of stagnation in March 2000, combined with the housing bubble and its collapse, led many to conclude that George W. Bush's economic policies were a failure. Now the Democrats will have their own pet legislation perfectly set up as the scapegoat for the upcoming bear market.
MY CURRENT INVESTMENT ANALYSIS (March 24, 2010): TLT, a fund of U.S. Treasuries averaging 25 years to maturity, has continued to form a bullish pattern of higher lows since it had bottomed at 88.51 on February 18, which itself was above its 87.56 nadir of June 10, 2009. Today, TLT plummeted to an early afternoon bottom of 89.06, its lowest level since February 22, before closing down 1.66 at 89.27. Intelligent investors have been purchasing long-dated U.S. Treasuries into weakness in the face of repeated media hype about a future surge in U.S. government borrowing; while the future borrowing is quite real, it is already fully known and has been more than fully priced into long-dated U.S. Treasury valuations. Buy TLT before it goes back above 90.
VIX, probably the best-known measure of implied volatility, gained 1.20 to close at 17.55. On March 19, VIX touched an intraday bottom of 16.17, its lowest level since way back on May 19, 2008, and then almost exactly repeated this intraday low on March 23 at 16.21. While even lower readings for VIX have occurred after several years without a serious market correction or bear market, such a depressed reading is extraordinary so soon after a major bear market. VIX has dipped below 16 only once since July 20, 2007, when it bottomed at 15.82 on May 19, 2008. Since the recently depressed level for VIX is reflecting almost a complete lack of investors' concern about a second bear market, a huge global equity decline is far more likely to occur. When investors have such low fear, this means that they have already committed to the stock market whichever funds they have considered using for that purpose, leaving no money "on the fence" with which to make future purchases. If you are still holding equities or equity funds for any reason, be certain to sell them as soon as possible. I would rate the importance of doing so as 9 on a scale of 0 to 10.
The S&P 500 index fell 6.45 to close at 1167.72. Yesterday, the S&P 500 touched a late afternoon peak of 1174.72, its highest mark since September 29, 2008. Most leading sectors such as commodity-share funds and semiconductor funds have remained below their respective January 2010 tops, and continue to generally underperform. Semiconductor shares gave it the old college try, with SMH reaching an intraday high of 28.63 yesterday which had been its most elevated price since its post-2008 peak of 28.72 on January 11, 2010. The S&P 500 continues to blissfully ignore an increasing number of important negative divergences and stands at one of its most overbought and overextended levels of the past several decades. Look out below.
The dollar-weighted ratio of insider selling to insider buying by top corporate executives recently climbed to its highest point since the summer of 2008, and is especially elevated for those insiders who have the best historic track record of buying low and selling high.
A SINCERE THANK YOU to Barron's for featuring me on page 50 of their November 19, 2007 issue, and then again on February 25, 2008 (page M14) and June 2, 2008 (page 41), as well as August 25, 2008 (page 32).
CURRENT ASSET ALLOCATION (fully marked to market on January 24, 2010):
My own personal funds are currently allocated as follows:
Vanguard Municipal Money Market Fund VMSXX and other cash equivalents, 47.9%;
Putnam Stable Value Fund (retirement fund with stable principal paying variable interest, no ticker symbol), 22.7%;
U.S. Treasury fund TLT, 10.8%;
Volatility fund VXX (a losing position), 7.5%;
Claymore natural gas futures fund CYMGF/GAS-T (Toronto), 5.7%;
Coins and related collectibles, 5.4%;
Gold mining funds GDX, ASA, BGEIX, INIVX, 0.0% (GDX mostly sold at 50.12-50.17 on January 11, 2010, some sold at the open at 49.48 on January 12, 2010, average gain 81%; ASA sold at 80.00 on January 12, 2010, average gain 100%);
Coal mining fund KOL, 0.0% (sold near 40 on January 6, 2010; 8th-best mutual fund in 2009, average gain 212%);
Russian fund RSX, 0.0% (sold near 33.25 on January 6, 2010; 11th-best mutual fund in 2009, average gain 202%);
Natural gas producers' fund FCG, 0.0% (sold slightly below 19 on January 6, 2010, average gain 81%);
High-yield BB corporate bond fund VWEHX, 0.0% (sold on January 6, 2010, average gain 48%);
Japanese smallcap funds DFJ, SCJ, JSC, JOF, SPJSX, 0.0% (sold on January 6, 2010, with JOF at 7.58, average gain 28%);
Energy closed-end fund PEO, 0.0% (sold on January 6, 2010);
General equity closed-end funds ADX, CET, 0.0% (sold on January 6, 2010);
Crude-oil futures fund USO, 0.0% (sold on January 6, 2010);
Thomson-Reuters TRI, 0.0% (sold my remaining position on March 17, 2010 at 37.18).
None; covered ALL of them in October 2008 which had amounted to just over half of my entire net worth.
REMINISCENCE OF THE WEEK (March 24, 2010): When I was a senior university undergraduate, I was walking one late Friday afternoon toward my apartment a few blocks away from the campus. Usually I wore very casual attire, but for the final class of the week I often dressed up since there was an event at the Rathskellar most Friday evenings which I liked to attend. Out of the corner of my eye, I saw a group of people on the lawn who would not normally be there, and decided to take a detour to see what was going on. I was startled to see an array of lavish food and drink (alcoholic and otherwise) which rivaled that of the best restaurant in Baltimore. Not sure what to do, I noticed that everyone around me was wearing a name tag, and that immediately to my right was a table full of unclaimed name tags. I quickly went over, picked one up which looked reasonable, and put it on my shirt pocket. I then proceeded to mingle with the other folks; fortunately, my jacket and tie helped me to fit in comfortably, and I even met a few interesting people. I made sure not to overlook my main objective as I progressively enjoyed the fanciest meal during my entire time at college, eaten almost entirely with toothpicks as I frequently obtained refills of high-quality red wine. Fortunately, the person whose name tag I had appropriated either never showed up, or didn't notice what had happened, and not a single person displayed any doubt that I really belonged there. The next issue of the school newspaper had a front-page photo about a special reception to dedicate a new building on campus; while everyone else appeared to be toasting the camera, I was off to the side but still clearly visible, wine glass in hand, obviously intent on completing my repast.
(c) 1996-2010 Steven Jon Kaplan Your comments are always welcome.