Are We In The 3rd (And Final) Stage Of The Bull Market?

Submitted by Lance Roberts of STA Wealth Management,

Throughout human history the emotions of "fear" and "greed" have influenced market dynamics.  From soaring bull markets to crashing bear markets, tulip bubbles to the South Sea, railroads to technology; the emotions of greed, fear, panic, hope and despair have remained a constant driver of investor behavior.  The chart below shows the investor psychology cycle overlaid against the S&P 500. 

Investor-psychology-cycle-102313-2

With the current bull market now stretching into its fifth year; it seems appropriate to review the three very distinct phases of historical bull market cycles.  While I am not suggesting that the current bull market cycle is set to end tomorrow; I am suggesting that we take a pause to question mainstream beliefs.

Phase 1) “What bull market? The fall is right around the corner”

Following a massive, mean reverting, correction – markets tend to bottom and begin an initial recovery. Most individuals have been crushed by the previous market decline and only recently “panicked sold” into cash.

There are many signs during the initial phase that a new bullish uptrend has started.  Money flows from defensive names in order to chase higher yield, market breadth is improving, and volatility declines substantially.  

However, despite those indications, many individuals do not believe that the rally is real.  They use the rally to sell into cash and angrily leave the markets or continue to stay in cash expecting another failure.

Note: The fastest price appreciation in the market happens during the first and third stages of the bull market.

2) Acceptance stage 

During the second phase individuals gradually warm up to the idea that the markets have indeed bottomed the psychology changes to one of acceptance.  At this point, the market is generally considered “innocent until proven guilty.“

The overall psychology remains very cautionary during this second phase.  Investors react very negatively any short term market correction believing the bull market just ended.  They continue to remain underweight equities and overweight defensive positions and cash. 

During the second phase stocks continue to climb higher and market corrections are short-lived.  It is between second and third phases that a deeper market pullback occurs.  This pullback tests the resilience of the rally, shakes weak hands out of the market and allows for new bases to be formed.  This deeper pullback is used as a buying opportunity by institutions, which missed the initial stages of the rally, and their buying continues to push the markets to new highs.

3) Everything will go up forever

During the first phase, most individuals remain skeptical of a market that has just gone through a high-correlation, mean-reverting correction.  It is at this point that most investors are unwilling to see the positive change in market dynamics.

In phase two, however, investors gradually turn bullish for the simple reason that prices have been steadily rising for some time. Analysts and strategists are also turning universally "bullish" in an attempt to manage their career risk and attract investor dollars.

In the final phase of the bull market, market participants become ecstatic.  This euphoria is driven by continually rising prices but a belief that the markets have become a "no risk opportunity.”  Fundamental arguments are generally dismissed as "this time is different."  The media chastises anyone who contradicts the bullish view, bad news is ignored, and everything seems easy. The future looks "rosy" and complacency takes over proper due diligence.  During the third phase there is a near complete rotation out of “safety” and into “risk.”  Previously cautious investors dump conservative advice, and holdings, for last year’s hot “hand”  and picks.  

The chart below shows these three phases of the bull market over the past three market cycles. 

3-phases-of-bullmarkets-102313

It is necessary to remember what was being said during the third phase of the previous two bull market cycles.

  • Low inflation supports higher valuations
  • Valuation based on forward estimates shows stocks are cheap.
  • Low interest rates suggests that stocks can go higher.
  • Nothing can stop this market from going higher.
  • There is no risk of a recession on the horizon.
  • Markets always climb a wall of worry.
  • "This time is different than last time."
  • This market is not anything like (name your previous correction year.)

Well, you get the idea.

Things That Make You Go Hmmm?

Of course, just by looking at a price chart, it is difficult to state that we have definitively entered into the third phase of the bull market.  However, there are a couple of data points that go to support this premise.  If we reflect on investor psychology it is evident that individuals have generally done the opposite of what they should.  Individuals have, more often than not, bought into market peaks and sold market bottoms as the "emotional panic" to get in, or out, has taken control over logic.

The chart below shows the flows of funds into and out of equity based mutual funds as tracked by ICI.

ICI-NetEquity-Inflows-102313-2

What is clearly evident is that investors, four years after the bull market started
, are finally buying into the equity market.  This behavior has historically been associated with both short-term market peaks and major market tops.

The magnitude of the rotation into equity based funds by retail investors suggests some caution about the current market environment.

Secondly, margin debt and specifically net credit balances of brokers as reported by the NYSE should at least warrant some consideration.  When investors are extremely bullish, and pushing the edges of speculation, the "risk" of leveraging a portfolio is easily dismissed.  The chart below shows the positive and negative net credit balances relative to the peaks and troughs of the S&P 500.

Margin-balance-vs-SP500-102313-2

While these are only two data points; they suggest that the risk of a more meaningful reversion is rising.  However, it is necessary to note that "reversions" do not occur without a catalyst.  What will that catalyst be?  I have no idea and nor does anyone else.  Things that we are already aware of, like the upcoming debt ceiling debate, are already factored into the market. 

It is unknown, unexpected and unanticipated events that strike the crucial blow that begins the market rout.  Unfortunately, due to the increased impact of high frequency and program trading, reversions are likely to occur faster than most can adequately respond to.  This is the danger that exists today.

Are we in the third phase of a bull market?  Most who read this article will immediately say "no."  However, those were the utterances made at the peak of every previous bull market cycle.  The reality is that, as investors, we should consider the possibility, evaluate the risk and manage accordingly.

 


    



via Zero Hedge http://feedproxy.google.com/~r/zerohedge/feed/~3/-BOjA8fAwB8/story01.htm Tyler Durden

President Obama To Present Ultimatum On Immigration Reform – Live Webcast

Having seen his “unconditional surrender or default” strategy work over the debt ceiling, we wonder what ‘ultimatum’ President Obama has up his sleeve to get the Immigration Bill passed…

 


    



via Zero Hedge http://feedproxy.google.com/~r/zerohedge/feed/~3/dMQUH1pq89Q/story01.htm Tyler Durden

Stocks Stumble On $200bn Liquidity Shortfall From Fed’s Tougher-Than-Expected Bank Rules

In a tougher-than-expected proposal, the Fed has decided that “internationally active banks” raise their minimum liquidity standards (more than some expected, it would seem by the reaction in stocks).

  • *FED PROPOSAL CALLS FOR BANKS TO HOLD 30 DAYS OF READY ASSETS
  • *FED: US BANKS ROUGHLY $200 BILLION SHORT OF PROPOSED LIQUIDITY REQUIREMENT.
  • *BERNANKE SAYS LIQUIDITY RULE WILL MAKE FINANCIAL SYSTEM `SAFER’

The Fed seeks comments on this proposal over the next 90 days – which we presume will involve much hand-wringing and jawboning until the shortfall disappears magically with transformed collateral… but for now, it is yet another ‘tightening’ stance in global policy that will impact ‘trading’ banks considerably more than ‘deposit-taking’ banks.

 

 

Via Bloomberg,

Banks would have to hold enough easy-to-sell assets to survive a 30-day credit drought under a rule to be proposed today by the Federal Reserve that may have the greatest effect on banks with big trading operations such as JPMorgan Chase & Co. (JPM) and Goldman Sachs Group Inc. (GS)

 

The demand for 30 days of liquidity is intended to satisfy global Basel III accords for strengthening the financial system. Increasing the banks’ liquid assets is meant to make them less vulnerable in a crisis like the one that struck in 2008.

 

…

 

“It’s always been viewed as something that had more relevance for the trading banks,” said former Fed lawyer William Sweet, adding that it will hit them harder because of their more urgent need for short-term funding. Banks’ broker-dealer units must raise money in the market because they can’t rely on deposits to finance their activities.

 

…

 

“The implementation by the U.S. of the Basel rules have had more rigorous requirements than those implemented elsewhere,”

 

…

 

The liquidity coverage ratio was at the center of an international tussle last year, as some central bankers and regulators warned that a draft version of the standard risked causing a credit crunch, while others urged against a wholesale watering down of the measure.


    



via Zero Hedge http://feedproxy.google.com/~r/zerohedge/feed/~3/ZIsmGZ6JqOM/story01.htm Tyler Durden

Stocks Stumble On $200bn Liquidity Shortfall From Fed's Tougher-Than-Expected Bank Rules

In a tougher-than-expected proposal, the Fed has decided that “internationally active banks” raise their minimum liquidity standards (more than some expected, it would seem by the reaction in stocks).

  • *FED PROPOSAL CALLS FOR BANKS TO HOLD 30 DAYS OF READY ASSETS
  • *FED: US BANKS ROUGHLY $200 BILLION SHORT OF PROPOSED LIQUIDITY REQUIREMENT.
  • *BERNANKE SAYS LIQUIDITY RULE WILL MAKE FINANCIAL SYSTEM `SAFER’

The Fed seeks comments on this proposal over the next 90 days – which we presume will involve much hand-wringing and jawboning until the shortfall disappears magically with transformed collateral… but for now, it is yet another ‘tightening’ stance in global policy that will impact ‘trading’ banks considerably more than ‘deposit-taking’ banks.

 

 

Via Bloomberg,

Banks would have to hold enough easy-to-sell assets to survive a 30-day credit drought under a rule to be proposed today by the Federal Reserve that may have the greatest effect on banks with big trading operations such as JPMorgan Chase & Co. (JPM) and Goldman Sachs Group Inc. (GS)

 

The demand for 30 days of liquidity is intended to satisfy global Basel III accords for strengthening the financial system. Increasing the banks’ liquid assets is meant to make them less vulnerable in a crisis like the one that struck in 2008.

 

…

 

“It’s always been viewed as something that had more relevance for the trading banks,” said former Fed lawyer William Sweet, adding that it will hit them harder because of their more urgent need for short-term funding. Banks’ broker-dealer units must raise money in the market because they can’t rely on deposits to finance their activities.

 

…

 

“The implementation by the U.S. of the Basel rules have had more rigorous requirements than those implemented elsewhere,”

 

…

 

The liquidity coverage ratio was at the center of an international tussle last year, as some central bankers and regulators warned that a draft version of the standard risked causing a credit crunch, while others urged against a wholesale watering down of the measure.


    



via Zero Hedge http://feedproxy.google.com/~r/zerohedge/feed/~3/ZIsmGZ6JqOM/story01.htm Tyler Durden

PIMPCO Smack Down: Gross Vs Icahn, Or Fight Of The Book-Talking Titans

Because Icahn vs Ackman was so January 2013 (and Ackman was promtply crucified), here comes the great distraction of late-2013: Gross vs Icahn, aka the book-talking titans.

Ladies and gentlemen, place your bets.

And since the enemy of Ackman’s enemy is Ackman’s friend, does this mean that Allianz will now be funding Ackman’s imminent AAPL short?


    



via Zero Hedge http://feedproxy.google.com/~r/zerohedge/feed/~3/S7-8Q1TE8hM/story01.htm Tyler Durden

The boom and bust cycle

This post was first published at Bawerk.net. You may also follow us on @EBawerk

As is clear to all with half a brain the production of un-backed fiat money distorts the economic system. Simply told, when an entity in society is given monopoly to manufacture medium of exchange at its own discretion they will harness this power. Slowly at first, unsure about its effects, but always testing the limits of the privilege bestowed upon them.  

As always, they will overexploit the power. They will manufacture money and give it to the masters that coercively secure the continuation of the power. The masters will obviously spend the money, creating a transaction in which nothing is payment for something. These transactions are by definition unsustainable because they violates Say`s law. We call them “bubbles”

In a free market supply is used to create its own demand. When people spend fiat money they exercise demand without providing supply. Said in other words, spending fiat money is tantamount to capital consumption and makes society poorer.

While the boom that follows money spending feels good, it must inevitably come to an end because the economic system cannot maintain the constellation that was induced by the money printing in the first place. Within the boom lays the seed for the necessary bust.

We have made a metric that sums up fiat money in its purest sense and compared that to the underlying trend growth of nominal GDC.

Our hypothesis is simple: if money growth exceeds the GDC metric a deflationary busts will inevitably come. If authorities refuse to accept reality and print more fiat money at the first sign of bust, they may “save the day” but they will “ruin tomorrow”!

For every action taken there will be an equal and opposite reaction! When the fiat masters go too far they create the set-up for an imminent deflation.

We looked at this relationship and as the chart below show, a boom-bust cycle based on monetary expansion is clearly visible.

  

Source: Federal Reserve of St. Louis (FRED), own calculations

Our main concern is obviously what happens when the equal, but opposite reaction comes as a consequence to the monetary experiment dubbed the “Bernanke-put”.

A secondary concern is indirectly derived from this. Money printing tears the social fabric apart and people react by taking up massive amounts of debt; debt that will never be repaid in currency units of equal purchasing power.

Now, if the equal reaction comes, that will raise the real burden of outstanding debt, which consequently will bankrupt all debtors.

The next chart looks at various sovereigns’ roll-over risk for 2014. The exceptionally large amount of debt taken on since the financial bust in 2008 will forever constitute a massive risk for the issuing country as debt is never repaid, only rolled-over, that is old debt is paid with new debt.

 

Source: Bloomberg, International Monetary Fund (IMF – WEO), own calculations

 

By this it is obvious to us that deflation simply cannot be allowed to happen! Our monetary masters will lose everything if they even flirt with the mere idea! Witness the taper scare this summer!

And since we are getting close to the next cycle low, why even bother try.

 

Source: National Bureau of Economic Research (NBER), Bureau of Labor Statistics (BLS), own calculations

 

Concluding Remarks

We leave the last word to the real Maestro

“There is no means of avoiding a final collapse of a boom brought about by credit expansion. The alternative is only whether the crisis should come sooner as a result of a voluntary abandonment of further credit expansion or later as a final and total catastrophe of the currency system involved.”

 

– Ludwig von Mises


    



via Zero Hedge http://feedproxy.google.com/~r/zerohedge/feed/~3/rnrZcdsnFto/story01.htm Eugen Bohm-Bawerk

October US Manufacturing Output Tumbles To 2009 Levels

While hardly as followed as the other two key US manufacturing indices, the Mfg ISM and the Chicago PMI, the recently introduced Markit PMI, which comes from the same firm that tracks manufacturing data across the rest of the world, shows that in addition to the sliding job picture in September (and soon October), one other aspect of the US economy that took a big hit in October was manufacturing. As Markit just reported, “the U.S. manufacturing sector grew at its weakest pace for a year in October… based on approximately 85% of usual monthly survey replies. The flash PMI index registered 51.1, down from 52.8 in September, and was consistent with only a modest rate of expansion.” Not only was this the lowest headline print in one year, and should the drop continue it would be the worst print since 2009, not only was the New Order index had its weakest number in 6 months, but worst of all, the Output index, plunging from 55.3 to 49.5, had its first contrationary print since 2009!

Headline Mfg PMI:

And the suddenly plunging Output index:

The full data table:

Summarizing the atrocious print is Chris Williamson, Chief Economist at Markit said:

“The flash PMI provides the first insight into how business fared against the backdrop of the government shutdown in October, and suggests that the disruptions and uncertainty caused by the crisis hit companies hard. The survey showed the first fall in manufacturing output since the height of the global financial crisis back in September 2009. We can expect GDP growth to have suffered a set-back in the fourth quarter, but it is too early to estimate the extent of the slowdown. It is impossible to disentangle the impact of the shutdown from other factors that might have been at play during the month, so equally impossible to judge the extent to which business might bounce back in November.

 

“The Fed will be equally unsure of the underlying health of the economy, and will no doubt want to see the economic data stabilise, which could take until the end of the year, before making any firm policy decisions.”

Of course: bullish spin. How else.


    



via Zero Hedge http://feedproxy.google.com/~r/zerohedge/feed/~3/FZSyaunlsX0/story01.htm Tyler Durden

Baltic Dry Bear Market Index

As much as we loathe saying “we told you so” – especially when it relates to highlighting the fallacious bullshit of one James Cramer – the truth is that just 3 weeks ago we pointed out the fact that the Baltic Dry Index was being heralded as proof of China’s (and therefore the world’s great recovery) was a mistake. At the time, we noted the temporary nature of the move and now forward markets indicated it was not sustainable; and of course, were met with a chorus of deniers. Well, following a 4.4% decline today, the Baltic Dry Index has now plunged over 20% from its recent peak (and the more crucial Capesize container rates even more) as underlying demand simply cannot keep pace with the massive (overbuilt) ship glut that remains. Added to this is the apparent ‘tightening’ stance by the PBOC that we have been noting and we suspect, as we warned, the 2011 deja vus will be clear.

 

 

Chart: Bloomberg


    



via Zero Hedge http://feedproxy.google.com/~r/zerohedge/feed/~3/Jk1gn_pdQxA/story01.htm Tyler Durden

Initial Claims Still “Idiotic”, Still “Rising Above” As California ObamaVista Glitch Persists

With claims from the backlog in California’s systems “glitch” (which began in September) still working their way through the system, one can only imagine the debacle that this data really is as more people filed for unemployment claims that expected for the 3rd week in a row. 44,100 Federal workers applied for claims two weeks ago (and received it we presume as well as their back pay now) but the Labor department notes these claims are not reflected in the total. At 350k, vs 340k expectations, this is the first time since early January that we have seen 3 weeks in a row of missed expectations…

 

 

The smoother 4-week-moving-average has surged back to almost 4-month highs.

 

Charts: Bloomberg


    



via Zero Hedge http://feedproxy.google.com/~r/zerohedge/feed/~3/eGO59WqsUc4/story01.htm Tyler Durden