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The Crystal Ball

December 7, 2013

owl_birthday

It has been a year since I started this blog and to those of you that have read my musings and still return, I would like to say thank you. As I had announced in the beginning, I have written many articles that incorporate my economics back ground into the financial thinking process which I employ to survive and strive in the financial market place. To that extent, I think most of the theories have been explained in detail and now is the time to focus on finance and game changing events rather than theory. As a consequence, the frequency of my posts will depend on the flow of events that are worthy of discussion and action.

In the past month, the financial markets have been extremely calm. I want to use today’s post as a personal outlook to what lies ahead in 2014. In the end, this is a finance blog and as an active trader who participates in all major markets, I have an opinion that I want to share. Having said that, be careful to follow my advice. The financial market is a set of “moving targets” and what I think today is based on today’s facts. If I change my mind tomorrow due to changing fundamentals, things may look different. I shall revisit this article in a year to see how my “crystal ball” has performed and if the name of the blog should be changed to “market mole”…

Eurpean-mole-with-mouth-open

Stocks

As I have written in my latest post “Surfing the Elliot Wave”, the developed world’s stock markets have been the best performers in any investment class in 2013. Corporate balance sheets are relatively healthy, government policy remains friendly and fixed income yields little to zero. Looking at the chart of the S&P500, you can see a healthy uptrend in which both the 50 day moving average(medium term trend) and the 200 day(long term trend) point up with the 50 day above the 200day MA. This is a very healthy chart and I don’t expect a trend reversal below the 200day average anytime soon. A correction of 7% to the 1650 level is possible and even likely at some point but as long as (government) bonds yield little and interest rates have no place to go but up, the trend in stocks will continue to be up. If economic numbers should improve I would not rule out a stock mania in a year or two.

sp

Bonds

The seed of the next financial crisis lies here. Governments all over the world are hopelessly indebted and the future pension obligations alone cannot be honored. As you can see below, the Federal Reserve now holds roughly 30% of all long term US debt. Needless to say, this situation is unsustainable and will be at least a $4 trillion dollar issue down the road. Considering $4 trillion is roughly 25% of the entire economy’s annual output, the next crisis will surely be a big one.  On top of that, this is the US situation alone. Add Europe, Japan and emerging market indebtedness to the mix and the consequences will surely be historical. Therefore, stay away from long term bonds, if you need security, you are better off holding short term debt or stocks that yield about the same as government debt.

Fed%20Duration%20Holdings%20December

Source

Now, take a look at the chart below and you can see the opposite trend as in the stock market. Both 50 and 200 day moving average are trending down and the 50 day is below the 200 day average. Stay away.

TLT

Gold

Considering the monumental money creation on a global scale it is truly baffling why the gold price has gone down considerably this year. That is until you realize that gold has gone up 12 years in a row and needed a break from hot money flows. While my opinion on gold as essential financial insurance hasn’t changed, AU too, is in a confirmed down trend as the chart below shows. Unlike bonds however, the future is likely to be rosier for the shiny metal. After all, average mining cost is $1250 an ounce and with the gold price right there, many mines are reducing production and/or shutting down and thus, future supply is decreasing. Lower future supply will lead to higher prices eventually. For the next 12 months, I wouldn’t be surprised to see a capitulation phase in which gold craters to $1000 or so which will wipe out any hot money interest in the metal. That should mark the end of the down trend and I do expect significantly higher gold prices a few years into the future as the government bond crisis unfolds.

GLD

Dollar

Despite $1,000,000,000,000 trillion of money creation by the Federal Reserve in 2013 alone, the dollar’s value has only declined marginally against the rest of the world’s currencies. The main reasons for only a minor decline are to be found in the fact that most global central banks are creating currency at mind-boggling speed. Furthermore, the US economy enjoys an energy revolution that has led to a fast shrinking of the trade deficit which supports the US $. The most interesting currency to me remains the Japanese Yen. It has fallen 25% in 2013 alone yet Japanese bondholders are happy being paid less than a per cent a year to hold Japanese debt, for now… At some point, the decline in the yen will accelerate and a Japanese bond crisis will emerge. I’ll keep you posted.

Dollar

As for trading the currency market, I would like to refer to Kyle Bass’ recent suggestion of which trade he would initiate for the next 10 years if he only had one option: Buy Gold in(short) yen. I concur.

In conclusion, I want to point out that I expect 2014 to be a largely benevolent year to stock investors but do not forget about the underlying seeds for the next crisis which will surely be upon us within a few years. For now, happy holidays and enjoy the New Year celebrations.

sydney-harbour-new-years-eve-fireworks-2012

From → Articles

5 Comments
  1. Thomas Linke permalink

    Hallo Richi,

    ich muss es dir einfach nochmal sagen: dein Blog ist spannend, interessant, angenehm zu lesen und liefert mMn wirklichen Mehrwert!

    Mit meinem Depot haettest du sicher viel Freude. Halte dir also fest die Daumen, dass du deinen Blog nicht dem Maulwurf widmen wirst muessen😉

    Bis bald,

    Thommy

    >

  2. Tim permalink

    Hi Rich,

    Great to read your two posts these past few days. Always enjoy reading your nicely balanced and well-informed market musings. As someone that tends to be (overly) pessimistic on markets (especially ones egged on by easy money), I benefit from having my own assumptions challenged. Which, I guess brings me to a few questions (if convenient).

    1) You noted that the overall picture for the stock market continues to look good. And yet bond yields have been inching higher. Is there a point where bond yields become problematic for the stock market?

    2) Do you believe the stock market respesents the current state of the economy? Or do you believe there is a fundamental disconnect?

    3) Are you concerned about the possibility of “the taper”. Or is the Fed just a taper tiger? And speaking of tigers, Singer I think it was not so long ago commented that the Fed essentially “feels it has a tiger by the tail.” And that “tapering is essentially off the table.” Do you agree?

    4) I have been struck by the total change in tenor in reporting about Euroland. Not that long ago the sky was falling. These days it seems rather nonchalant. In the Euro powerhouse, the “eisener Kanzlerin” came within a whisker of a crushing victory, and had to “settle” for “just” a very impressive win. Government formation still needs to play out, but do you have a opinion on a German centric Euroland these days? Berlin über alles?

    Thanks for sharing your insights over the past year.

    Wishing you a schöne Weihnachtszeit, Cheers.

  3. Tim,
    thank you for the kind words. I’ll try to concisely answer your questions which is difficult because of the scope of the issues.
    1) The short term picture for the stock market looks good. I fully expect the next bear market to take the stock indices below today’s level but a rise from here first(Wave 5). Bond yields will become problematic once people assume yields are rising and out of control due to inflation. Right now, market participants assume rising yields mean a better economy, thus positive for stocks.

    2) No, the current overall economy is disconnected from the stock market. The Fed has created $3 trillion dollars in the past 4 years and if you are on the receiving end of that spigot(federal government plus corporations and their affiliates), the economy looks good, thus high bond and stock prices. If you are a small unconnected business owner or a retiree trying to live off your nest egg, you are simply out of luck.

    3) The taper from $85 billion to $75 billion a month is a drop in the bucket and misses the larger picture. We have zero interest rates and money creation of $4,250,000,000 every single business day. This is the largest monetary experiment in history and history has not been kind to expirements in money creation. Perhaps, it is different this time but I doubt it. As for the show of “taper”, we heard about “Fed exit strategies” in 2010 that never materialized. Let’s watch what is done over what is said.

    4) When I wrote “A cautious bull in Europe” a year ago, I outlined the fact that Europe is comprised of a strong economic north and weak South. Aside from the structural currency flaw of the Euro, the overall picture is ok as the north has competitive global economies. On top of that, Europe is at least trying to get its fiscal house in order. All is not well in Euroland but I believe it is moving in the right direction.

    I hope this answers in a nutshell what you were thinking. Happy holidays,

    Rich

  4. Tim permalink

    Rich,

    Thank you. It does indeed, and good food for thought.

    Happy New Year, too. Cheers.

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