How Stocks Escaped from 3 ‘Unavoidable’ Bear Markets

This bull market has been counted out many times. Just over the past few years, stocks faced three – allegedly – unavoidable bear markets … and escaped all of them.

Here are the three ‘unavoidable’ bear markets, and why stocks escaped:

Unavoidable Rate Hike Bear Market

Starting in 2015, the Federal Reserve let it be known that interest rates will be rising.

According to the pros, rising rates would sink stocks. After all, that’s why the Fed kept them near zero for so long.

However, history simply doesn’t agree with this conclusion. The April 26, 2015 Profit Radar Report used the chart below to illustrated that rising rates are not bearish.

In fact, 9 of the 13 periods of falling rates (since 1954) saw stocks rally. That’s why the Profit Radar Report concluded that: “A rate hike disclosed at the April, June, July or even September or October FOMC meetings is unlikely to coincide with a major S&P 500 top.”

Barron’s rates iSPYETF as a “trader with a good track record.” Click here for Barron’s assessment of the Profit Radar Report.

Unavoidable Oil Slump Bear Market

Falling oil prices were the hot topic as prices dropped 50% from June – December 2014.

The general opinion was that falling oil prices would send stocks lower, like in 2008.

The December 14, 2014 Profit Radar Report ousted this bogus reasoning with the chart and commentary below:

This year’s oil price collapse differs from the 2008 collapse relative to the S&P 500. In 2008, the S&P 500 topped before oil did. In fact, the S&P 500 recorded its all-time high in October 2007 and was already down 21% by the time oil topped on July 11, 2008. In 2014, the S&P 500 recorded new all-time highs five months after oil started to decline.

The chart below plots oil against the S&P 500 and shows that falling oil prices are not consistently bearish for stocks. If history can be used as a guide, stocks are likely to hold up despite the oil meltdown.”

Unavoidable QE Bear Market

In 2008, the Federal Reserve unleashed it’s first round of Quantitative Easing (QE). A couple trillion dollars later, QE came to an end in October 2014.

Investors feared the withdrawal of QE would sink stocks (just like a junkie will crash without new fix).

The simplified logic (QE started this bull market, the end of QE will finish the bull market) seemed logical, but it wasn’t factual.

The October 5, 2015 Profit Radar Report plotted the QE money flow against the S&P 500 and concluded that: “We expect new bull market highs in 2015.”

Why?

The correlation between QE and stocks (at least in 2013/2014) did not support the notion of a bull market end. More importantly, our major market top indicator said the bull market is not over.

2016 Bear Market?

At the beginning of the year, when the S&P traded near 1,900, the media found countless of reasons why the bear market is finally here (many of them are listed here).

About six months and a 15% rally later, it’s obvious that the bull market is alive and well.

Short-term, the S&P has reached the lower end of our up side target range, so a pullback becomes more likely (more details here). However, any pullback should serve as a buying opportunity.

If you are looking for common sense, out-of-the-box analysis, check out the Profit Radar Report. It may just make you the best-informed investor you know.

Simon Maierhofer is the founder of iSPYETF and the publisher of the Profit Radar Report. Barron’s rated iSPYETF as a “trader with a good track record” (click here for Barron’s profile of the Profit Radar Report). The Profit Radar Report presents complex market analysis (S&P 500, Dow Jones, gold, silver, euro and bonds) in an easy format. Technical analysis, sentiment indicators, seasonal patterns and common sense are all wrapped up into two or more easy-to-read weekly updates. All Profit Radar Report recommendations resulted in a 59.51% net gain in 2013, 17.59% in 2014, and 24.52% in 2015.

Follow Simon on Twitter @ iSPYETF or sign up for the FREE iSPYETF Newsletter to get actionable ETF trade ideas delivered for free.

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Has Gold Bottomed?

Gold’s second quarter will enter the history books as one of the biggest declines ever. Until yesterday, gold’s third quarter performance has been boring at best. Monday’s one day pop begs the ‘real rally or bull trap’ question.

Gold is special for many reasons. For example, a single ounce of gold can be stretched into a 5-mile long thread or beaten out into a 300-square foot sheet.

Gold is also non-toxic. In fact, you may find gold metal flakes in exotic foods or unusual Swiss liquor. I still have an old bottle of GoldSchlager schnapps in my bar.
This strong gold flake liquor may help drown the pain of this year’s gold performance, but other than that investors don’t care much about gold’s taste or pliability.
Investors buy gold as protection. What kind of protection? That’s a fair question. I guess unless you were looking to buy protection against making money, gold has been little more than an expensive placebo (ask John Paulson).
                                            
When central banks around the world started to quantitatively ease economies out of the ‘Great Recession,’ gold was considered an inflation hedge.
Quantitative easing (or QE) continues, but gold is trading 30% below its 2011 high.
This line of fundamental reasoning doesn’t make sense, but many investors still base their gold buying/selling decisions on a similar rationale.
Yesterday gold saw the biggest one-day spike of the year. Why? Perhaps you can make sense of this, I can’t.
Abe’s (Shinzo Abe, Japanese Prime Minister) party and its coalition partner won a majority of upper house seats in the weekend vote, boosting his opportunities to stimulate the economy.” – San Francisco Chronicle
Nutshell explanation: More easy money will mean higher gold prices.
If plenty of easy money over the last two years coincided with the steepest gold decline in decades, why would it propel prices higher now?
Has Gold Bottomed?
To answer the question that really counts – has gold bottomed? – I rely on technical analysis.
Technical analysis is not always correct (nothing ever is), but it got us out of gold when it traded around 1,800 and to this day I receive thank you e-mails from subscribers.
(Original August 21 and 24, 2011 subscriber update: “I don’t know how much higher gold will spike but I’m pretty sure it will melt down faster than its melting up. At some point investors will have to sell holdings to pay off debt or answer margin calls. The most profitable asset is sold first. Gold has been the best performing asset for a decade and a liquidity crunch could produce sellers en masse.”)
The chart below plots gold prices against the S&P 500. The resulting chart illustrates two key points:
  1. The S&P 500 and gold have been moving in the opposite direction since late 2011.
  2. The basic technical picture for gold.

Here’s what’s worth noting from a gold technical analysis point of view:
  • The June low occurred against green trend line support.
  • Monday’s bounce hoisted prices above resistance at 1,300.
  • Gold is bouncing against next resistance around 1,335.
After gold’s second quarter meltdown prices had to bounce. Until yesterday, it lacked the escape velocity needed to break above resistance (at 1,300), and still another move above 1,335 is needed to unlock higher price targets.
Since there was no bullish RSI divergence at the June low (not shown on chart), I’ve been hesitant to embrace this rally. In fact, I would prefer a new low.
But the market cares little about what I like. So, as per the July 10 Profit Radar Report, I recommended to take partial long positions in the SPDR Gold Shares (NYSEArca: GLD), or iShares Gold Trust (NYSEArca: IAU), and iShares Silver Trust (NYSEArca: SLV).
Thus far the positions have done well and we’ve locked in some profits already and increased our stop-loss to guarantee a winning trade.
Gold (and silver) will have to move higher to validate employing more capital on the long side.

Federal Reserve – How to Tame the Monster it Created

Thanks to quantitative easing (QE) stocks are up 130% and more. The Fed created a monster of a rally, but how do you tame the monster without killing it? As the most recent Fed minutes indicated, it may be ‘easier’ than some think.

Never under estimate the psychological power of a dangling carrot. For years the Federal Reserve used the promise of more QE as an incentive (carrot) to drive stocks higher.

This has worked well. Too well. The Dow Jones, Russell 2000 and other major indexes are trading at all time highs and the Fed’s next challenge is to tame the monster (rally) it created without killing it.

How can this be done? Perhaps with the ‘reverse dangling carrot approach.’ Before we talk about the reverse carrot approach, let’s review how the ‘dangling carrot approach’ works.

The ‘Dangling Carrot Approach’

At how many post FOMC meeting conferences did we hear Ben Bernanke assure Wall Street that the Federal Reserve is ready and willing to assist?

From July – November 2010 Bernanke’s steady assurance was nearly as potent as QE2. Do you remember the August 2010 Jackson Hole summit? Bernanke then said: “I believe that additional purchases of longer-term securities … would be effective in further easing financial conditions.”

The placebo QE effect was strong enough to lift the S&P 18% before QE2 became official on November 2, 2011. Thereafter the S&P 500 rallied another 16% to the April 2011 high. QE2 ended in June 2011.

From October 2011 – September 2012 the Fed did nothing more than dangle the QE3 hopium carrot and the S&P 500 rallied 36%. QE3 was finally announced in September 2012, followed by “QE4” (replacement of Operation Twist by outright Treasury purchases).

Containing The Fed Monster – The ‘Reverse Dangling Carrot Approach’

From 2009 – 2012 the Fed talked up QE and stocks. Today the S&P 500 trades 135% above its 2009 low and the Fed knows it created a monster (rally). The Fed also knows that everyone else knows this is a phony funny money rally.

How can the Fed contain the monster it created – take away the punchbowl without causing a severe hangover. The ‘reverse dangling carrot approach’ is born.

Dropping hints about more QE contained the bear market, so dropping hints about reducing QE should tame the QE bull market. This process may have already begun.

The release of the Fed minutes on February 20, showed dissention among committee members about the duration and scope of QE.

Whether this division over the issue is real or just a new PR strategy to contain the Fed monster, I do not know. But we do know that stocks sold off right after the Fed minutes were released.

Just like controlled fires can stimulate a forest, the Fed may try to light ‘controlled burns’ to manage the stock market. As in nature, the summer time (starting in May) is a good time for a ‘controlled burn’ on Wall Street. Shareholders should plan accordingly.

I personally view the Fed like an unwelcome guest. Some guests bring happiness wherever they go. Some (like the Fed), whenever they go. Unfortunately, the Fed’s comment about leaving (scaling back QE) appear to be only a tease.

Glaring but Misunderstood QE – How Much the Fed is Really Spending

QE1, QE2, QE3, expiring Operation Twist, and now QE4. Which of those programs are “sterilized” (non-inflationary) and which ones devalue the dollar? If you’ve lost track, here’s a quick visual summary.

Will Operation Twist be replaced by outright QE was a question addressed here early in December. As it turns out, the Fed decided to do just that.

We now have multiple layers of QE working simultaneously. What’s the total amount being spent and will inflation finally take off?

QE Tally

There are three official tranches of quantitative easing (QE):

1) QE3, announced on September 13, 2012. The Federal Reserve will buy $40 billion per month worth of mortgage-backed securities.

2) QE4, announced on December 12, 2012. The Federal Reserve will buy $45 billion per month worth of longer term Treasuries (corresponding ETF: iShares Barclays 20+ Treasury ETFTLT).

QE4 will be replacing Operation Twist in 2013. Operation Twist is considered “sterilized” or cash neutral QE. Operation Twist simply reshuffled the balanced sheet (sell shorter term in favor of longer term maturities). It did not expand the balance sheet.

Unlike Operation Twist, QE4 will be financed by “non-sterilized” or freshly printed money. This process increases the Federal Reserve’s balance sheet and the amount of money in circulation.

3) Reinvestment of maturing securities. In a December 12 press release, the Federal Reserve stated: “The Committee is maintaining its existing policy of reinvesting principal payments from its holdings mortgage-backed securities and, in January, will resume rolling over maturing Treasury at auction.” This amounts to roughly $25 billion/month of sterilized QE.

In total, the Federal Reserve will buy $110 billion worth of Treasuries and mortgage-backed securities every month until the unemployment rate drops below 6.5% and inflation remains below 2.5%.

The first chart below illustrates QE3, QE4, and reinvestments separately and how the three layers combined compare with QE1 and QE2.

The second chart provides a more detailed glimpse of the Fed’s balance sheet (and a mere glimpse is all mere mortals are allowed).

The Fed’s balance sheet as of November 21, 2012 stood at $2.84 trillion and is expected to balloon another $1 trillion over the next 12 months.

Currently $966 billion or 34% are invested in agency debt, mainly mortgage-backed securities. In other words, one of every three dollars in circulation is backed by toxic assets, the same stuff that caused the “Great Recession.”

Inflation

Inflation, where art thou? The Fed’s balance sheet exploded from below $1 trillion to nearly $3 trillion, but inflation (let alone hyper inflation) has been a no show.

Will the current round of QE deliver on inflationist’s predictions? I doubt it.

Simon Maierhofer shares his market analysis and points out high probability, low risk buy/sell recommendations via the Profit Radar Report. Click here for a free trial to Simon’s Profit Radar Report.

Operation Twist about to Expire – Will it be Replaced by Outright QE?

The Federal Reserve’s $45 billion a month Operation Twist program is scheduled to expire at the end of this month. Based on the sound bites of several Reserve presidents, there will be a replacement. Will it be more outright QE?

Operation Twist is circling the drain, set to expire on December 31, 2012.

Will Operation Twist be extended or even be replaced by outright QE?

What’s the difference between Operation Twist and Quantitative Easing (QE)?

Operation Twist Basics

Since September 2011, the Federal Reserve has been buying about $45 billion of longer-term Treasuries per month with the proceeds from sales of a like amount of shorter-term debt.

Unlike outright QE purchases, the Operation Twist asset reshuffle does not add to the Fed’s balance sheet.

Will Operation Twist be Replaced by Outright QE?

Boston Federal Reserve Bank president Eric Rosengren, one of the most vocal proponents of Fed asset purchases, advocates to continue spending $45 billion a month buying long-term Treasuries.

St. Lois Federal Reserve Bank president James Bullard has a different opinion. He said that the expiring Operation Twist program should not be replaced on a dollar-for-dollar bases, because asset purchases that expand the balance sheet (like QE) have a bigger effect than Twist.

QE Tally

So far the Federal Reserve has purchased about $2.4 trillion worth of government bonds and mortgage-backed securities.

During QE1, the Fed spent about $78 billion a month.

During QE2, the Fed spent about $75 billion a month.

During QE3, the Fed is spending about $40 billion a month.

Concurrent to QE2 and QE3 the Fed is reinvesting the proceeds of maturing securities. Based on a balance sheet of $2.4 trillion, this is a significant amount.
Abount $25 billion a month.

For the month of December, the Fed will spend about $65 billion buying Treasuries and mortgage-backed securities. This is “new” money.

An additional $45 billion of the proceeds from selling short-term Treasuries is re-invested in long-term Treasuries.

QE’s Effect on Treasury Prices

What does all of this artificial demand for long-term Treasuries mean for Treasury prices and corresponding ETFs like the iShares Barclays 20+ year Treasury Bond ETF (TLT)? It appears that the effect of QE3 on Treasury prices has been muted. It certainly hasn’t driven prices up as should be expected.

In fact, 30-year Treasury prices have been stuck in a trading range capped by two long-term resistance lines and buoyed by an 18-month support line. As long as prices remain in that range the stalemate is likely to continue.

With strong seasonality for stocks straight ahead (and an inverse correlation between stocks and long-term Treasuries), I assume that price will break down.

Simon Maierhofer shares his market analysis and points out high probability, low risk buy/sell recommendations via the Profit Radar Report. Click here for a free trial to Simon’s Profit Radar Report.