04/13/2014 Bursting Bernanke's Bubble

Style Model	Mid Value
Sector Model	XLU	5.12%
Large Portfolio	Date	Return	Days
ABX	4/11/2013	-22.45%	366
NEM	9/30/2013	-12.11%	194
JOY	11/18/2013	6.57%	145
TM	2/3/2014	-8.60%	68
RS	2/10/2014	-0.35%	61
CSCO	2/12/2014	-0.27%	59
CBI	2/20/2014	2.55%	51
BHP	3/3/2014	3.97%	40
DUK	3/10/2014	2.54%	33
HFC	3/17/2014	-7.16%	26
(Since 5/31/2011)
S&P	Annualized	11.03%
Sector Model	Annualized	26.39%
Large Portfolio	Annualized	25.57%

 

Rotation: selling BHP; buying BX.

So far this little patch of volatility has ignored utilities, and the sector model has been comfortably boring:

 

The year to date return on the Sector Model is 13.57%.  The S&P, not so much.  The key to sector rotation is to understand that money does not just disappear.  When money is pulled out of one investment vehicle it is almost always put into another.

Of course, CASH is also an “investment” of sorts, when one considers that the dollar can spike in a market collapse. Which brings me to the subject at hand: Talk of a market collapse is premature, and with the distortion created by QE, I’m not sure what a market collapse would actually look like.

To put this into perspective, forget CPI or Shiller’s cyclically adjusted earnings, and just look at the S&P 500 compared to the amount of money that’s been printed from 1960 to today:

 

This is using the S&P divided by 100 dollars – fixed at the amount of money in existence in 1960.  There was some growth and a bit of a bubble in the late 1990s, but that’s all gone now, and the present “bull” market is barely a blip on the far right.

In other words, the market DID crash and it STAYED crashed.  All those capital gains you’ve been taxed on these last couple of years were in imaginary profits.  Oh, the delay in CPI growth means you can buy things with those imaginary profits for a while, so they aren’t entirely fictitious.  But fears of a market “crash” are a bit over blown if the market never really went up in the first place.

If anything, we’re still a bit UNDERVALUED when you filter out QE.

You can crash a bull market, but can you crash a baloney market? 

David Copperfield is good at illusion, but he’s a novice compared to Ben Bernanke.

Welcome to the new normal, where bear market bottoms look like raging bulls.

Yawn.

There’s nothing for us little investors to do but to look for decent companies in beaten down sectors.  That’s the one thing that stays the same, no matter how many dollars the Fed saws in half.

The usefulness of this S&P / Money Supply ratio comes into light when we consider the disconnect between demographics and S&P movements that I’ve been blogging about (most recently just last week).  In terms of pure price or even CPI adjusted price, there is a huge gap between where we should be and where we seem to be.  But in terms of money supply, we’re actually rather close:

Of all the demographic models I’ve plotted, this one is the best fit.  The blue “CurDev” line is the current deviation of the S&P / Money Supply ratio from its logarithmic mean.  The red BR+45 line is the current deviation of the birth rate 45 years earlier.

As I noted last week, Ned Davis has plotted a Birth Rate + 46 year fit in terms of S&P / CPI.  In terms of simple price it would SEEM to be a fit of the Birth Rate + 41 years.  BOTH of those correlations fail at the point QE began five years ago.

However, the correspondence does NOT break down when we adjust by money supply (above) rather than CPI (as per Ned Davis).

Now that QE is going away, where on earth does that leave us?

I’d say, about where we are now.

The market may go down from here in a typical correction or bear, but it is highly unlikely to CRASH, because it never really went up in the first place.

And that, ladies and gentlemen, is why I don’t time.  These kinds of distortions are hard enough on the long side, but doubly destructive on the short side.  Not only would a person shorting this baloney market have lost money, but what little money he would have left would have lost value at the same time.

Granted, a long-only investor can still lose money in the near term if the market goes down, but I’ve found that my greatest losses came from trying to avoid those downturns.

We’re due for another downturn in VALUE into 2015.

Good luck guessing what that will look like in terms of PRICE.  No harm in taking a guess, as long as you don’t base trading decisions on it.

With that caveat in mind, here is one example of a guess:

First, let’s take the median regression of Money Supply growth from 1960 through 2013.

Second, let’s run the Birth Rate deviations all the way forward into 2054.

Third, let’s apply that to the forward regression of the ratio of S&P / Money Supply.

Fourth, let’s multiply that by the forward regression of Money Supply itself.

Fifth, let’s take 1 standard deviation up and 1 standard deviation down to create a price channel.

What do we get?

We get this:

The mid-range on this price channel for the end of the year is (drum roll) – 1900 on the S&P.

That would explain the present stall.  However, the deviation channel ranges from 1350 to 2700.

And all of this assumes that there is no dramatic change to the QE taper that Yellen has announced.  Another bout of QE, or a Volker style vacuum of all that extra cash would directly affect the trajectory of the channel I’ve presented here.

So back to my point: you cannot TRADE something this big.  John Hussman tries valiantly at www.hussman.com – but there is no benefit to these kinds of decade long projections.  They look good on a graph, but are practically useless to someone trying to save for retirement.

Ignore the news.

Ignore the forecasts.

Ignore the economy.

Instead, find good companies in beaten down industries, with a reasonable amount of diversification, and call it a day.  If that’s not good enough for your retirement plans, then maybe you should save more.

Tim