Markets are blissful as trouble mounts
A look at inflation, earnings and geopolitical woes tells you all you need to know about a looming buzzkill for stocks.
By Anthony Mirhaydari
It seems the stock markets have hit the snooze button, because all the action seems to have gone to sleep.
Stocks have pretty much gone nowhere this month after melting higher in late May, with the Dow Jones Industrial Average ($INDU) making not one but two attempts to breach the 17,000 level.
But all the price action has been relegated to a range between 16,980 and 16,700. In fact, the action has been so quiet that we recent saw one of the tightest two-day non-holiday trading ranges in market history. The last time this happened was back in 2004, and before that, you'd have to go all the way back to 1961 a get a similar period of market quiet.
Will it continue?
Historically, after a compression of volatility like this, the markets have tended to drift along for another week or two before suffering a correction that swiftly washes away the incremental gains. Stairs up. Elevator down.
Certainly, there are many negative catalysts investors are dismissing right now.
- The sectarian violence is only getting worse in Iraq, with Sunni militants in the north encouraging Shias in Baghdad to lash out against local Sunni populations. A tripartite fracturing of that country seems increasingly likely now, putting oil export infrastructure at risk of terrorist attack.
- The situation in Eastern Ukraine continues to simmer as well, with reports of clashes between Kiev's forces and pro-Russian separatists ongoing despite an apparent move toward a ceasefire agreement.
- Crude oil remains concerned, holding near $107 and $106 a barrel.
- Expectations of a big bounce back in economic growth and a solid Q2 earnings season are also fading somewhere.
Thursday's report on consumer expenditures suggested that rising inflationary pressures and diminished savings are forcing households to retrench, resulting in the second consecutive monthly drop in real spending. Wall Street analysts were forced to known back their second-quarter GDP estimates in the wake of an abysmal 2.9 percent annualized drop in the economy in the first quarter -- the 17th worst result in U.S. history.
The market is already discounting ongoing trouble for retail sales with the Retail SPDR (XRT) hitting resistance going back to the initial disappointment with Black Friday traffic in November.
I'm also seeing sellers hit payment processors MasterCard (MA) and Visa (V). I've recommended put contracts in both names to my Edge Pro clients, which are carrying gains of nearly 50 percent and 30 percent, respectively, so far.
As for earnings, corporate profitability is coming under pressure from a sizable drop in labor productivity. As a result, after-tax corporate profitability took a huge downturn last quarter, dropping on a scale that hasn't been seen since the recession ended. Those elevated Q2 EPS estimates are going to have to come down.
This is especially true given that bond-to-stocks wealth transfer is slowing down as companies like IBM (IBM) can no longer simply borrow tons of cash in the bond market which to fund share repurchase programs and boost earnings per share by reducing the number of shares outstanding. That's because this has gone on so long that debt levels are building up in a big way on corporate balance sheets. You can see this in the chart of corporate debt-to-GDP in the chart above.
All this will come back to bite when diminished profits make this new debt load harder and harder to carry. In other words, shifts in profitability and revenue are going to have a much larger impact on the bottom line now.
Finally, the true wildcard in all this is the course of monetary policy from the Federal Reserve going forward. The big takeaway from the last Fed meeting was that policymakers are trying their hardest to ignore bubbling inflationary pressures that would force them to raise short-term interest rates and start draining money from the financial system for the first time in 10 years.
But the longer they wait, the more inflationary pressures will build. A simple Taylor Rule analysis -- which is a yardstick to measure where interest rates should be based on inflation and the excess capacity in the economy -- suggests interest rates should be near 2 percent instead of the 0 percent they've been at since 2008. The longer the Fed is behind the curve on this, the faster prices will rise.
And while stocks are ignoring all this, the bond market has been sending a warning signal over the past few days with U.S. Treasury bonds -- a safe-haven asset -- blasting out of their June doldrums as yields decline. The fear is that we see "stagflation" -- a combination of higher prices and a stagnant economy as consumers struggle.
With all this to consider, it's no wonder options traders are looking for put option protection against a market decline. The CBOE Volatility Index -- known as Wall Street's "fear gauge," or the VIX -- tested its 50-day moving average for the first time since early May on Thursday.
So while stocks seem blissful on the surface, a look at the surroundings and the action deep within the market suggests trouble is building.
For now, I recommend a defensive approach with a focus on precious metals for inflation protection. Examples include mining stocks New Gold (NGD) and NovaGold (NG), which are up 16.4 percent and 19.7 percent, respectively, since they were added to the Edge Sample Portfolio on June 5.
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Anthony Mirhaydari is founder of the Edge and Edge Pro investment advisory newsletters, as well as Mirhaydari Capital Management, a registered investment advisory firm. As of this writing, Anthony had recommended put options against MA and V and common-stock longs in NGD and NG to his clients.
Hmmm... The democrats continued war on business. Economic growth at -2.9% and almost for certain sub 1% second quarter, maybe even negative again. Many companies missing earnings. Exports dropping like a rock. The price of oil going up. Massive debt. A revised deficit number in Barron's (page M50) this week that tops out at 1.453 trillion compared to last years 1.056 trillion. A lousy jobs picture, unless you want a minimum wage job and under 30 hours a week. Obamacare costs that are so bad, that the CBO can't even score it, except to say it will add 1.5 trillion to the deficit over the next 10 years, and "possibly 3 times that number". The Fed tapering their money printing to 35B/month, and likely to raise interest rates right after the election.
The lazy, LYING, arrogant, CORRUPT Imbecile '57 states' Obama still pursuing his far left socialist agenda of taking from the those that work to give to the democrats that vote for living, is going to finish off the middle class in classic Marxist fashion.
""It seems the stock markets have hit the snooze button, because all the action seems to have gone to sleep. ""
~ isn't that why they always say "sell in May and go away" ????
"They don't do anything, except block me and call me names," an indignant Obama said"
They must have a mop and bucket brigade following this loser around all the time to mop up tears.
Do the Democrats have enough control o keep things together until the election, that's what I want to know. Or, do the Republicans want to sabotage it all to win the election. This stuff is mostly politics anymore. If the US wants to compete in world markets, they may have to give up a lot more than anyone wants to. That may be why the economy will eventually fail. (or not. tough job, being a prophet. Get in touch with the Man upstairs before you try it. The test for an Old Testament prophet was, if anything he said didn't come true, he wasn't one.)
Wonder how this guy will do, this time. Maybe he should get to a good church, and find one. That is always my first rule of economics, do your homework then run it by God for a proofread, to correct any mistakes you might have made. You don't want to fail His test.. You need to be your own prophet.
2. Life Insurance. I have a policy from LifeAnt that pays 5% a year in dividends, tax deferred too so the net is even higher.
3. Bitcoins. Like it or not they are here to stay. You can be part of it or not.
4. I own a small business that makes water filters. Much of the developing world needs them, and who knows it there will ever be a run in this country as well.
5. Real estate. I like this for a few reason. The biggest is that there is a finite amount in the world, it will only go up long term IMO.
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As geopolitical tensions threaten to spin out of control, investors are wondering how best to position their portfolios for the global turmoil.
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