They say the worst thing you can do when you are in quicksand is to struggle.
Efforts to get out quickly are for naught and end badly. At least that is what I recall on the cartoons I watched when I was a kid.
Keep The Faith
In order to keep your sanity, we have tried to help here by prepping your latest two videos.
The first video below will take a few minutes to watch (16:15 to be exact).
It will take you through the review of the review we sent out as summer began.
We suggested all summer long that the ideal time for a “summer breakdown” would be in the later hazy days of August.
Well, what we have witnessed since August 18 could surely be deemed effective.
Note at the time we referred to it as a fake-out breakdown as the bottom of the trade range is washed away and all stops are triggered.
Next, please take a moment to watch the second video below which is only 4 minutes long.
It is designed to help you see the larger events unfolding under the surface – far away from the spotlight of the heated (and emotionally charged) news headlines. These events will drive our economy for the next 30++ years.
Step Back and Take a Breath
Does this all sound logical to you? Think about it for just a moment.
Do you think that China just started slowing down?
Do you really think that China has been growing as fast as it has “been reported”?
Did you recall they are a communist government – have been for awhile now – and as such, the data should almost always be taken with a grain of salt?
It is why we have cautioned on that marketplace for years now.
The point? Slowing China data is not news. It is not even fresh news.
Why do I point this out? Because the business our corporations have been reporting has been based on a slowing China for years!
And here is the big news: Even after a “terrible” (as only experts can define it) Q1 and Q2 earnings season, we are at record highs in forward earnings for the next 12 months – as covered for us by our good friend Dr. Ed.
To think that somehow just a few weeks ago (while all about us was the fear of Greece falling into the ocean and taking us all down with it) China was doing just fine and now they are not – is, well, disconnected at best.
Guys–listen, we just reported an increasing GDP growth rate for Q2!
Driving momentum into Q3?
Housing, autos, solid ISM numbers and durable goods orders rising.
I could go on but in a hail storm of fear about China, we are once again seeing emotionally-jacked responses to events.
Elements which later will be deemed “false alarms” – again – is my guess.
Fearing “What’s Next”
I want to make sure I drive this point home for you:
We are witnessing a replay of the early 80’s – demographically – but this time on steroids.
Do not be fooled by waves of fear.
Fear is designed to come across as a larger event than it really is – like fog. When an area of your city is fogged in – like we often see on the lakefront here – the fog masks the vision. It looks like it covers everything. However, if we just travel a few blocks, we note that the blue sky is still there – and the world is just fine.
Fear in markets has this same tendency. Do not fall for the mind-game. And indeed, we are witnessing a mind-game.
Let’s recall the facts –
Let’s realize we are still the strongest economy on the planet.
Let’s realize that for years, we have been told by the rest of the world we had lost that mantle.
Just 12 months ago, China’s currency was going to become a world currency. At the time we stated the foolishness of this thought – assuming eventually that a free world would never take a currency produced by a communist government.
Even today – it is reported that the president of one of their largest brokerage houses is “missing” – only to be later told that she is “cooperating with the government in an investigation into market manipulation.”
And we thought this was a good place right?
There is a long road to travel before the globe will accept events like this as normal.
Rest assured of these thoughts:
We wanted a correction – it’s why we had cash
My fear is it will not last long enough to take advantage of solid values as they settle in.
I am not sure it is over yet – and I’d like to see it go on a little further
The Fed needs to raise rates – the market is already pricing it in – so raise
We suspect with the latest carnage in the near-term, the market is highly likely to even rally after the Fed raises – as Yellen more than likely soothes the audience with a notice that the next hike is a ways off.
Fear is driving rates down again as investors flood out of equities and into bonds.
Insiders are buying hand over fist – just like they do when panics hit (see data below)
Sentiment is in the dumps as bears once again outnumber bulls and we see readings from 2009 repeat.
All of these are good things.
The interest rate game will be managed effectively. China has been slow or slowing for years – but they will be fine too. Assuming they were growing as quickly as previously reported was the error – as we repeatedly noted in these morning messages.
Today, the auto companies reported August sales – FORD was up over 5% – young kids were the buyers. Expect more of the same. Amazingly, I was just thinking – Max will be getting a car in another two years – wow. There are millions and millions just like him.
When fear knocks – as it is knocking now – make sure you answer with the faith from decades of history. Remember, we have a perfect record since WWII – 11 recessions and 11 recoveries.
Mr. Buffett’s Actions
While everyone has been afraid for the last 20 days or so as markets get their summer setbacks – Mr. Buffett as once again taught us a lesson.
While red ink flowed, he purchased $4.5 Billion of PSX stock.
He also added another entire company to the 80 he already owns by purchasing PCP for $33 Billion.
Do you think he is worried about China? Greece? The “death cross” moving average rollover?
We Forget Easily
I have stated this often before:
Whenever things get a bit choppy – and that is all this is – our brains go on tilt. We forget from whence we came. We erase all improvements over time. We chatter on our smart phones, while we drive around in our connected cars burning much cheaper gas and using satellites and wi-fi to speak.
We complain about how bad it is. Preposterous.
Back to the Quicksand Effect
Markets are people. The market is not a physical thing. It is not something you can touch or feel. It is a combination of thought driving action. Every buy or sell is driven by a perception first – an idea – energy in our brain. It then runs through our mind, causes us to decide good or bad, buy or sell – and then we act.
The combination of millions of those events each second of the trading day is what drives price.
People drive price. People’s actions drive business.
Make no mistake about this – struggling in the near-term thinking quicksand is futile.
These periods pass – they always do.
It is those who get lost in the effect that often find recovery more difficult.
A Few Nice Pictures?
As readers know, we often reference the psychology of the crowd.
Psychological indicators are often contrary in nature. Fear and greed make traders do stupid things with their portfolios. We are surely square in the middle of the ideal times of the year for those types of events to occur – just as stated when the summer began.
Surveys of investment opinion don’t always reflect actions. People can say anything they like to the survey takers – though they usually do “talk their book.”
Insider buying can only happen, though, when officers are willing to commit real money. That makes it much more reliable.
A quick glance at the chart snapshot above confirms that the most recent previous eight ‘bullish’ signals preceded decent percentage gains over the subsequent two to five weeks. That figure would move up to nine out of nine if you are willing to count the 13% rebound from the Aug. 25 nadir to that same week’s finish.
Odds like that, accompanied by the outrageously below-normal insider sell to buy ratio, imply that it is probably safe to go back into the water.
Let this wash through the markets – our buy lists are ready – just as fear is hitting highs again.
Getting Carried Away
It’s ironic that the stock market suffered a huge “correction” only days before the second revision to Q2 GDP growth came in surprisingly strong. Sometimes the market gets carried away by emot ions, and sometimes the economic statistics get revised significantly after the fact, so it pays to keep an eye on the fundamentals as revealed by key market-based prices (e.g., real yields on TIPS, swap spreads, the dollar, gold).
It has been long argued that real yields on 5-year TIPS were a good indicator of the market’s expectation for the trend of real economic growth. As the chart above shows, the two tend to track each other over time. Real yields on 5-year TIPS have moved quite a bit higher over the past two years, and now we discover that the economy strengthened over that same period.
Note this though:
The annualized rate of economic growth over the past two years was 2.7%, a good deal better than the 2.2% annualized growth since the recovery started in mid-2009.
Despite the pickup in growth, the economy is still a lot smaller than it could/should have been. As the chart above shows, the shortfall in growth relative to long-term trends is about $2.8 trillion. Per year. We’re talking about a lot of income that’s being left on the table, and a lot of people unemployed or underemployed, most likely because of higher tax and regulatory burdens.
Burdens we should expect to move in the other direction as soon as a new administration is in DC.
The latest GDP revisions also gave us the first look at corporate profits after tax for the second quarter.
They reached a new nominal high of $1.82 trillion.
As the chart above shows, that puts corporate profits very close to an all-time high relative to GDP.
From a long-term historical perspective, corporate profits have been exceptionally strong throughout the current business cycle expansion.
The last chart above (all compliments of great charts from California Beach) shows the PE ratio of the S&P 500 using the after-tax corporate profits (with adjustments for inventory valuation and capital consumption allowances and normalized in order to facilitate comparisons to reported PE ratios) as the “E” instead of trailing GAAP earnings.
By this measure, the stock market at the end of June was trading very close to its long-term average valuation.
What does all this say?
The economy is doing OK, and has even managed to improve somewhat in recent years, despite all the moaning and groaning.
Corporate profits have been absolutely fabulous, and certainly supportive of higher equity prices.
Stocks aren’t in a bubble, and monetary policy hasn’t stimulated the economy or caused equity prices to artificially inflate.
So why is the market so worried? Why is the Fed so worried about the economy that they have to keep interest rates at zero? Sure, things could be a lot better, but we’re not talking about a fragile economy that needs an extraordinary dose of TLC (aka low interest rates) to survive.
If we want things to improve, we need to look to fiscal policy (read: politicians who have been effectively useless for years), not the Fed.