Beware of Chinese bearing gifts
Steve Cook on Disciplined Investing


Have You Seen This?


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Have You Seen This?

The Market

The Averages (12402, S&P 1325) continued their rally yesterday.  They remain within their intermediated term up trends (12273-15691, 1290-1719).  Short term they are still searching for a lower boundary to their new trading range.  Possible candidates include the lower boundary of intermediate term up trend (12273, 1290) and the shoulder line of the recent inverse head and shoulders (11995, 1293).  The upper boundary is the recent high (12919, 1372). 

As you know, I believe that the most important levels to watch right now are (1) the down trend off the recent high [12516, 1335] and (2) the aforementioned lower boundary of the intermediate term up trend.

Volume remains light; breadth continues to improve; the VIX fell but closed within its current trading range.

GLD sold off, but closed right on the lower boundary of its former short term up trend.

Bottom line: month end window dressing is likely playing a role in this week’s pin action as is the movement of the dollar (which I noted in yesterday’s Morning Call.  That said, whether the indices break the very short term down trend or the intermediate term up trend will tell us a lot about how much strength is left in the momentum underlying the Market.  Until we know that, I am not inclined to any action save one prompted by our Sell Half Discipline.


    The economic numbers yesterday were not good: jobless claims rose versus estimates of a drop and first quarter GDP was revised down for a second time.  Clearly both lend credence to the double dip expectations of the worry warts.  However,  investors took the news in stride.  Their focus was apparently on the Chinese pledge to buy more EU sovereign debt bonds, raising the hope that this problem will once again fade into the sunset.  That lifted the euro, pushed the dollar down and stocks rallied. 

    I see two issues here:

(1) are the Chinese really going to throw good money after bad, buying enough debt obligations of bankrupt countries to keep them afloat?  Clearly, I can’t speak for the Chinese; but I have had enough dealings with them on an individual basis to know that they are not stupid, they are hard-ass traders, they think very long term, they do not engage in the kind of wistfully ignorant optimism common among the Western political class and whatever outcome they envision from such a remarkable act of charity will in the end be to their advantage; which suggests to me they are buying economic leverage that will in the end allow them to extract far more value than they invested.  Beware of Chinese bearing gifts. 

(2) even if they are going to throw good money after bad, will that do anything other than postpone the inevitable?  How many bailouts of the PIIGS has there already been?  No matter what the pledges of the debtor nations have been to get their houses in order, they have failed each and every time.  Why in the world would we assume that they will be any more responsible with Chinese money than they were with bank, IMF or ECB money?

In my opinion, this problem is not going away. I don’t think that the Chinese can improve the global growth outlook by papering over years of financial mismanagement or changing the mindset that led to this crisis in the first place>  I don’t care how much money the Chinese throw at it; the more money that does get thrown at it, the more tragic will be the outcome. 

Bottom line:  stocks are overvalued based on the calculations of our Models.  Potentially making this overvaluation even more extreme is risk of a weaker than expected economy being suggested by the recent extended period of lousy economic data.  As I noted previously, our forecast is below present consensus; so I am not at this moment concerned about scaling our numbers down.  That said, if the stream of poor stats continues unabated, some adjustment will be inevitable. 

    Thoughts on Investing—from Bob Farrell

1. Markets tend to return to the mean over time

When stocks go too far in one direction, they come back. Euphoria and pessimism can cloud people’s heads. It’s easy to get caught up in the heat of the moment and lose perspective.

2. Excesses in one direction will lead to an opposite excess in the other direction

Think of the market baseline as attached to a rubber string. Any action to far in one direction not only brings you back to the baseline, but leads to an overshoot in the opposite direction.

3. There are no new eras — excesses are never permanent

Whatever the latest hot sector is, it eventually overheats, mean reverts, and then overshoots. Look at how far the emerging markets and BRIC nations ran over the past 6 years, only to get cut in half.

As the fever builds, a chorus of "this time it’s different" will be heard, even if those exact words are never used. And of course, it — Human Nature — never is different.

4. Exponential rapidly rising or falling markets usually go further than you think, but they do not correct by going sideways

Regardless of how hot a sector is, don’t expect a plateau to work off the excesses. Profits are locked in by selling, and that invariably leads to a significant correction — eventually.  comes.

5. The public buys the most at the top and the least at the bottom

That’s why contrarian-minded investors can make good money if they follow the sentiment indicators and have good timing.
Watch Investors Intelligence (measuring the mood of more than 100 investment newsletter writers) and the American Association of Individual Investors survey.

6. Fear and greed are stronger than long-term resolve

Investors can be their own worst enemy, particularly when emotions take hold. Gains "make us exuberant; they enhance well-being and promote optimism," says Santa Clara University finance professor  Meir Statman. His studies of investor behavior show that "Losses bring sadness, disgust, fear, regret. Fear increases the sense of risk and some react by shunning stocks."

7. Markets are strongest when they are broad and weakest when they narrow to a handful of blue-chip names

Hence, why breadth and volume are so important. Think of it as strength in numbers. Broad momentum is hard to stop, Farrell observes. Watch for when momentum channels into a small number of stocks ("Nifty 50" stocks).

8. Bear markets have three stages — sharp down, reflexive rebound and a drawn-out fundamental downtrend

I would suggest that as of August 2008, we are on our third reflexive rebound — the January rate cuts, the Bear Stearns low in March, and now the Fannie/Freddie rescue lows of July. 

Even with these sporadic rallies end, we have yet to see the  long drawn out fundamental portion of the Bear Market.

9. When all the experts and forecasts agree — something else is going to happen

As Stovall, the S&P investment strategist, puts it: "If everybody’s optimistic, who is left to buy? If everybody’s pessimistic, who’s left to sell?"

Going against the herd as Farrell repeatedly suggests can be very profitable, especially for patient buyers who raise cash from frothy markets and reinvest it when sentiment is darkest.

10. Bull markets are more fun than bear markets

Especially if you are long only or mandated to be full invested. Those with more flexible charters might squeak out a smile or two here and there.


   This Week’s Data

    Both the April personal income and spending numbers rose 0.4% and both were in line with expectations; the personal consumption expenditure index (inflation) was up 0.3% while core PCE was up 0.2%--which is an increase over the March reading.


    Here is an optimistic take on yesterday’s disappointing jobless claims number (short):

Posted 05-27-2011 8:18 AM by Steve Cook