I love this market action. For me, it means that we are setting up ideal entry points for a broad range of asset classes that will deliver another +67% year.
It will set up for you too, if you continue to read this letter.
What the market is in fact doing is giving us three corrections for the price of one. Remember the traditional September swoon that never happened, the worst trading month of the year? How about the forgotten ritual October crash? And the November dip that always precedes the December yearend rally?
Well guess what? After forgetting how to go down for the longest period of time, we are getting all three downturns compressed into a single big one. That will give us a start finish decline of 7.2% in the (SPX) down to 1730, in line with every correction of the past two years (see chart below), and worst case the proverbial 10% textbook correction.
If my assumptions are correct, then in a worst-case scenario we are already 75% through this pullback on a price basis, and 65% on a time basis. Needless to say, selling short stocks here is out of the question. That train left the station at New Years.
After sitting on my hands, shuffling the papers around my desk several times, and going for my umpteenth coffee refill, I finally pulled the trigger on my iShares Barclays 20+ Year Treasury Bond Fund June, 2014 $106 puts trade. It finally entered no brainer territory.
It hit me what had been driving markets this year, but it took a ten-pound sledgehammer to do it.
Bonds have had it absolutely right this year. They took off right out of the gate on January 2 and never looked back.
Stocks on the other hand have been much more confused and disoriented, like an airplane pilot doing aerobatics on Instrument Flight Rules. They initially rose a little bit, right along with bonds, which almost never happens. You knew that wasn?t going to last.
Then they flat lined for two weeks. It took almost a month before traders realized that the punch bowl was gone and it was time to head into ?RISK OFF? mode. The tardy call can be traced to the fact that you calculate your average stock traders? IQ by taking a bond trader?s and then dividing by two.
What all this means is that the bond market has been correctly calling market direction two weeks before the stock market has. This is bound to continue.
There is another factor to consider here. Bond traders have now seen a whopping great eight point rally in a month, taking the yield on the ten year Treasury bond down a massive 45 basis points, from 3.05% to 2.61%. That is just too much profit to sit on.
That is a world ending performance for bonds. Except that Armageddon, it is not. So the pros that got this one right are increasingly going to be sellers on rallies from here on.
Don?t forget that the Federal Reserve will probably continue to knock $10 billion off of its quantitative easing program every six weeks if the economic data continues to come in, as I expect. That could drop its monthly bond purchases from $85 billion a month in December to only $35 billion by June. This is not good for the (TLT). It?s nice to see all of those lunches at the Federal Reserve Bank of San Francisco with the new chairman, Janet Yellen, finally paying off.
If I am wrong on this one, it will be only by a couple of basis points, with the ten year possibly making it to the high 2.50%?s. The global synchronized economic recovery is still on schedule. The economic data and corporate earnings are just too good to see yields drop to 2.50% or lower.
Bull markets don?t die of old age, they die from recessions, and there is absolutely none on the horizon. The weakness in emerging markets is happening because some of their growth is moving back to the US. That is bad for them and great for us. I never liked their food anyway.
Markets also don?t peak at the middle of historic valuation range of 9-22. We are now at 14.5 if the $120/share earnings forecast for 2014 is good.
Profit margins are at all time highs, and rising (see chart below). The heart-rending volatility we have seen so far in 2014 is therefore technical in nature, and not fundamentally driven. It is just a matter of a few days or weeks until the fundamentals reassert themselves, as they always do.
Strip out the drag of government spending, and the private sector is growing at a positively meteoric 5.1% annual rate.
That could happen as early as Friday, when a blockbuster nonfarm payroll is expected to hit. The shocking 84,000 December number reported in January was a weather driven anomaly. Expect this week?s January figure to come in strong, as well as providing big upward revisions to the December report.
Which brings me to the iShares Barclays 20+ Year Treasury Bond Fund June, 2014 $106 put. Only a global synchronized recession would prevent the (TLT) from trading below $103.58, my breakeven point on an expiration basis, over the next five months. Those who can?t buy options can substitute the ProShares Ultra Short 20+ Treasury ETF (TBT) instead.
If the (TLT) makes it back to unchanged on the year at $101 by the June 20 expiration, this position will be up $5,418, or $5.41% for our notional $100,000 portfolio. If it makes it down to $101 sooner, we will make even more money, as there will still put some remaining time value in the put option.
That is up 108% from my initial cost. For that I am willing to take a few basis points of heat for a few days or weeks. It is an ideal buy and hold position, like, for example, you were just about to take a long trip to New Zealand and Australia.
Sounds like a no brainer to me!
The Fat Lady is Singing for the Bond Market
