HOME OF "PICTURES OF A STOCK MARKET MANIA" June 30, 2010
Alan M. Newman's Stock Market CROSSCURRENTS
Alan M. Newman, Editor
Excerpts from our June 21st issue
Rationales & Targets
Please note: we are closing out the oldest 5% position idea of Newmont Mining (NEM) from June 4, 2007 but are retaining the other 10%. This position was up 51.4% (with dividends) and in the same span of time the Dow Industrials declined 25.8%. This position was originally taken in the Trading Stance and later shunted to the Investment Stance. In the March 9, 2009 issue (see www.cross-currents.net/m030909r.pdf), we claimed upside to the old highs ($62.72) but there seems to be little reason to wait for less than a buck more, so we’ll pare down here and now.
Stocks continue in a very dangerous mode for both longs and shorts. As of today, we stand almost exactly between our support and resistance points, with the perceived odds for each direction about equal. The volatility expansion into the June 8th print low of Dow 9757 was by no means climactic, nor were the readings registered in our other indicators. We don’t think the bottom is quite in yet but before long, we certainly expect the traditional summer rally to get underway. We do not expect much from the rally, when it finally gets going. Stocks are not yet attractive.
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YOUR COST IF YOU RENEW FOR A YEAR = ZERO! Greece CDS Hit Record Highs
One of the scenarios cited in our "Odds Have It" feature in the January 4th issue was "Sovereign Debt Risk," which we then placed at 15%. Clearly, those odds should have been placed significantly higher. Greece's debt problems seem to be getting much worse, despite a “deal” recently put into place to supposedly assure there would be no default. However, as of Friday’s close, Greece CDSs have taken out the May 7th highs. Negative assumptions about Greece's fiscal survival are playing out as if self fulfilling, a downwards spiral catalyzed by derivatives. Worse yet, there is ample speculation that some of the very banks that "helped" Greece with debt problems have actually bet against the country and are pushing it to the edge of the precipice. In a recent report by Nelson D. Schwartz and Eric Dash in the NY Times (see tinyurl.com/y9easkr), Goldman Sachs is once again on the receiving end of criticism (why are we not surprised?). We would also point out the story's reference to the Markit Group (www.markit.com), a company that devises indexes that allegedly provide "price transparency" and "reduce risk," do not reduce risk at all. In the final analysis, what Markit really does is to enable derivative bets that equate to the short side. We feel constrained to reiterate the ultimate truth of markets; systemic risk remains inviolable. Risk can never be removed from the system, and can only be transferred. What hedging accomplishes in large part is simply additional complacency as participants believe their markets will remain in balance. However, as history has painfully shown, complacency equates to the accommodation of additional risk. Systemic risk is never reduced by the establishment or creation of derivatives, only increased.
Regarding the situation with Greece's financial situation, there is also speculation that deals Goldman helped structure were so beneficial to Goldman that Greece was always going to lose on the proposition (see www.cnbc.com/id/35392686). We believe there is overwhelming importance in determining if Goldman Sachs or others that helped Greece hide its problems to begin with, are now betting against the country and other countries, for that matter. Perhaps the world economy can survive Greece but can we survive a debacle with the PIIGs? See the May 18th Economist (www.economist.com/node/15838029) for more info. As usual, we are standing perilously close to the edge.
Marginal Behavior
We haven’t seen any discussions of leverage recently but clearly, this is a matter that requires exposure once again. There have been three huge market tops in the last 23 years accompanied by extreme leverage and apparently, a fourth is now in the process of unfolding. Ironically, as illustrated by our chart at lower left, the third top was unwound only in price and not in leverage, which is still very much in evidence.
Although our chart only takes us back to 1958, there was another obvious instance in 1929, when leverage ran rampant. According to some of the data we have seen, margin debt represented as much as 11% of market cap as the Roaring Twenties soared to their final peak. Stocks could be purchased with as little as 10% down (the current requirement is 50%) and the only fair comparison since then is the mortgage mess that fomented the housing mania and subsequent bust. To this day, we can only wonder how it was not only possible to buy for no money down but to acquire a mortgage for as much as 115% of the alleged value of the property.
As seen below, although margin debt finished the year at only 1.3% of market cap, it ran as high as 1.8% in 1987 and was likely one of the catalysts for the crash that followed. A market weighed down by leverage is less likely to weather any storms. Again, in 2000, leverage ran rampant and although the year end tally was almost identical to that of 1987, margin exposure ran far higher as the tech mania peaked in March. In 2007, margin debt finished the year at very nearly 2% of market cap, where it has remained, barely budging through a collapse in price, the subsequent recovery and finally, the present price correction now in progress. What staggers the mind is that all the previous occurrences of extreme leverage were met by a significant draw down. By 1991, margin debt fell to 0.91% of market cap. By 2001, margin debt fell to 1.24% of market cap. But in recent years, the percentage of market capitalization represented by margin debt has remained constant; 2007, 1.96%, 2008, 1.98%, 2009, 1.94% and in 2010, 1.97%. The behavior of market participants is totally unexpected and illogical. This measure of sentiment stands out for its stubborn recalcitrance in the face of adversity. The vast majority of those still in stocks do not believe that price damage can be significant nor can a correction unfold to the point it can no longer be endured. Given the many follies leverage has exposed in the past, we expect this one to disappoint those similarly exposed this time around. We see much lower prices ahead with little chance of a bottom until margin contracts.
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ABOUT ALAN M. NEWMAN
Alan M. Newman has been the Editor of CROSSCURRENTS since the first issue was published in May of 1990. Mr. Newman is also a member of the Market Technician's Association and has been widely quoted for years by the financial press, media, and other newsletters and has written articles for BARRON'S.
The newsletter is published roughly every three weeks and focuses on economic and stock market commentary, often covering controversial subjects. Several proprietary technical indicators are usually featured in every issue accompanied by current interpretation. Broad samples of our work can be viewed at http://www.cross-currents.net/.
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