By Scott Silva
2-13-13
Stocks are catching the bid again, trading higher. The S&P 500 has
topped 1500, a level not seen since 2007. The Dow has also recovered from its
lows to pre-meltdown levels, above 14,000. Stock traders shrugged off fiscal
cliff fears, to extend the rally into the new year. Small investors are now
joining the professional buyers, who have viewed stocks as undervalued assets
for over a year. They are cashing in their bonds and emptying the mattresses to
put money into stocks.
What has propelled US equity markets? The answer may surprise you.
We’ll we know the presidential election has not pushed the stock market
higher. To the contrary, stocks tumbled when the president was re-elected.
Stocks had rallied with pre-election hopes of a new, pro-growth occupant in the
Oval Office. But alas, that hope vanished when the final votes were tallied.
The president could have won over traders by announcing a change in his
economic policy to start his second term, but he didn’t, and his plan has
consequences. More on that later.
So if the president’s economic policy did not stimulate the current
rally, what did? The answer lies in a fundamental principle of free-market economics
(and everyday life), namely, substitution. In his 1978 text Microeconomic Theory, Nicholson defines substitute
goods as “those goods which, as a result of changed conditions, may replace
each other in use (or consumption).” Investors treat risk-free yield as a
desirable economic good. The world gold standard risk-free instrument has been
the US Treasury bond, or note. Buyers of AAA-rated
10-year Treasury notes would
typically collect 4% annual interest with virtually no risk of default. In
contrast, equities as an asset class typically return 7%, commensurate with
higher risk.
Companies could go bankrupt,
products could fall out of favor, or stock prices could fall for any number of
reasons. Throughout history, investors searching for yield have committed
capital both to stocks and bonds, overweighting their portfolios in one or the
other asset class according to their risk profile and investment objective.
But that time-tested strategy
not longer holds. That’s because the Federal Reserve has changed the game. In
his reverent adherence to Keynesian stimuli, Chairman Bernanke has taken away
risk –free yield (or pushed it out to 30 year maturities), by instituting his
Zero Interest Rate Policy (ZIRP). This massive credit intervention flattens the
yield curve and drives real returns on medium term Treasury instruments (and
CD’s) into negative territory. Investors naturally seek other instruments. They
look for substitute goods. Many select high-yield dividend stocks, not for
their equity value, but for their dividend income. When the buyers come in,
stock prices rise.
Many investors have been holding
cash since the great financial meltdown. They have lost capital while they held
because the Dollar has lost purchasing power since then (and will continue to
lose value). This too, is a result of the Federal Reserve’s massive credit
intervention.
Big Ben loves to print money.
But we know that Gresham’s Law still holds. The Fed debases and devalues the
currency each month by printing more money out of thin air in its $1 Trillion/
year Quantitative Easing program.
That’s not all QE is doing. QE is pumping up stocks with hot air. The
Fed’s ultra-easy money regime keeps margin rates low, which spurs stocks, and
also keeps borrowing rates low for corporate capital investment. Because of
investor substitution, incoming stock buyers benefit from low margin rates. But
companies are not rushing to but capital equipment at low interest rates.
Instead, companies are sitting on roughly $2 Trillion in cash here, and keeping
another $2 Trillion offshore and out of reach of Federal taxes. Some companies
can think of nothing better to do with their cash than buy back shares. Stock
buybacks tend to push stock prices higher (less stock outstanding, higher P/E
for the same earnings), but they are a tremendous waste of capital.
Excess corporate cash should rightly go to shareholder dividends or
expansion.
In general, US companies are not expanding. They certainly are not
hiring. No amount of Federal Reserve QE will force them to do either. Simply
put, the Fed cannot create aggregate demand. This is heresy, of course, to the
Chairman and the president’s economic team. But the reason that the president’s
entire economic team has deserted him is because their Keynesian policies have
utterly failed. TARP was a failure. The GM bailout was illegal. The $800
Billion Stimulus Package failed. Cash of Clunkers failed. Mortgage modification
failed. The Payroll tax holiday failed. GDP is hovering at low levels, and
dipped into negative territory last quarter. Unemployment has not declined
since 2009, despite the administration’s spin. It remains stubbornly at 14%
(U-6 measure), a level not seen since the 1930’s. We simply cannot print money,
tax, spend and regulate our way to prosperity.
So should investors join the buying spree in stocks? Well, the speculator and the aggressive
investor may find some gains in equities now. We have been realizing good
profits each week in our Model Aggressive Portfolio (MAP), where we focus on
near term trade (weekly) setups in stocks, options and futures. In MAP, we have
been focused on stocks since November 2011 and our recommendations have made
money each week. But the market holds risks for more conservative investors
that enter at these levels. That’s because earnings, the mother’s milk of
stocks, are beginning to top out for many large cap companies. We are seeing
companies meet or beat 4th quarter earnings expectations and miss
revenue expectations. Revenue growth is essential to earnings growth. Many
companies are guiding analysts lower going forward. These companies are
reflecting lower global demand and the realities of continued recession in
Europe, a slowdown in China and slowing demand in the US.
Slowing, low demand in the US won’t be reversed by raising taxes. But
raising taxes yet again is exactly what the president intends to do. What is
puzzling about the president’s tax obsession is history shows cutting taxes
stimulates the economy. The economy jumps when consumers have more
discretionary income to spend. What’s more, the Federal government gets more
revenue when marginal tax rates are reduced. This happened as a result of the
Kennedy tax cuts, the Reagan tax cuts, the Clinton tax cuts and the Bush tax
cuts. Reducing federal regulation also stimulates the economy, as we saw most
prominently in the Reagan years, the longest period of prosperity and economic
growth in our time.
The technical indicators are signaling stocks are reaching major
resistance. For the S&P 500 index (SPX), a good measure of the broad equity
market, prices has climbed to just over 1500, a key resistance level. Price
action of the SPX has formed a bullish inverted head-and-shoulders pattern on
the daily charts with a neckline at 1458. The measured move on a bullish
breakout above the neckline is 105, which brings a target level of 1563. The
SPX made its breakout of the bullish pattern on January 10th, and
has been climbing steadily since. Yesterday, the SPX closed at 1522.29.
This move up can also be seen in the Fibonacci extensions of the previous
run up (June -Sept 2012) and pullback (Sept-Election swoon of November 2012). Since
the November lows, price action has powered up to the 50% Fib (1448) at circle
#1 on the chart below, then fell back to just above the 23.6% Fibo (1398 at
circle #2), and quickly jumped past the 38.2% Fibo and surged right up to the
61.8 Fibo at 1472 (circle #3). After
five days of consolidation at the 61.8 Fib, the SPX climbed steadily to the
78.6% Fibo at 1507 (circle #4) and appears to be headed higher still.
It is gratifying to see separate technical analyses in such lockstep
agreement.
The speculator or aggressive investor that followed our Model Aggressive
Portfolio (MAP) Recommendations has done very well with selected stocks, stock
options and futures contracts over the last several months. Weekly returns have
ranged from 30% to 77%. What choices are available to the conservative investor
in today’s investment environment?
The answer certainly is not bonds, especially Treasurys. Treasury bonds
yield negative real interest returns. Investment grade corporate bonds don’t
offer much more for the added risk.
Conservative and prudent investors choose gold.
The case for choosing gold today is as strong as it has ever been. It can
be made efficiently in the form of a parliamentary inquiry, so often used in my
own sovereign state of New Hampshire’s General Court:
If you know, as I know, that
stocks are full of Fed hot air, and the Fed has fenced off reasonable yields in
fixed income instruments by intervening in the credit markets, and,
If you know, as I know, that corporate
bonds offer yields only at a significant risk of default, and,
If you know, as I know, that
the Federal Reserve is continuing to print money under its Quantitative Easing program, and has
stated it will not stop until the unemployment rate is lower than 6.5%, and
If you know, as I know, that
unlimited QE has no effect on the unemployment rate, and that
QE debases the currency and its purchasing power, and
If you know, as I know, that
gold increases in value as the Dollar decreases in value, and that gold is
recognized as the ultimate global currency,
Would you not agree with me
that owning gold today will protect your wealth against the ravishing of fiat
currency and tyrannical federal overreach?
That’s right. The answer for conservative investors is gold. In fact,
aggressive investors should also own some gold to diversify their portfolios. Here’s
why any investor should own gold now.
The great bull market for gold is continuing. The fundamentals are in
force to push gold prices higher, and the technical analysis supports higher
gold prices from here.
First, the fundamental case. It all boils down to central bank policy.
The Fed, the ECB and BOJ are all maintaining accommodative monetary policies.
That is, they will keep interest rates artificially low and continue to add
liquidity by various forms of Quantitative Easing. QE itself debases the
currency and drives commodity prices higher.
Loss of confidence in the Dollar, the world’s reserve currency, is also
reflected in the price of gold. Political instability in sensitive regions of
the world affects the price of gold (and oil). We are seeing the war premium
boosting oil prices as tensions rise over nuclear weapons development in Iran
and North Korea. Even central banks are buying gold. That’s because unlike fiat
currency, gold has intrinsic value. Gold is recognized as the ultimate global
currency and store of value.
Second, the technical case. QE is
weakening the Dollar. As the Dollar weakens the price of gold increases. The
traditional inverse relationship between the Dollar and gold is present in
today’s market. Global QE and US economic policy is keeping the Dollar weak.
The weak Dollar supports higher commodity prices in general and higher gold
prices in particular.
We can see this dynamic play out in the chart of gold vs Dollar below.
Technical indicators on the daily and weekly basis charts are bearish for the
Dollar. On the weekly basis charts, resistance is now 80.74 with support at
77.44. The Dollar is headed lower form here. A move down to the 78 level would
command a gold price of 1800, a key resistance level.
What would cause the gold price to drop significantly? Well, if the Federal Reserve were to cease
buying bonds (QE), the price of gold would drop. But Chairman Ben has
reiterated his commitment to buying bonds at the rate of $85 Billion per month
until unemployment is reduced to 6.5%. The January 2013 unemployment rate is
14.4% and the current regime has no pro-growth economic plan. The price of gold
would drop if peace broke out in the Middle East and Iran, North Korea and
China dismantled their nuclear weapons. Recent events in these tinderbox areas
demonstrate there’s not much chance of that happening, particularly when the US
is reducing its military strength to the point it can no longer fight in two
theaters of operation at once. Gold
would fall if real estate became a safe investment asset again. But it will
take 10 years to work through the housing overhang of 5 million foreclosed
properties that is weighing down home prices. And gold would fall, as it did in
the Reagan years, if pro-growth tax reform, and a plan to balance the budget
within ten years, which would include entitlement reform, were adopted now. As
we saw in yesterday’s State of the Union address, the president is campaigning
for higher taxes, more spending and more Federal regulation. No pro-growth
agenda there.
So now is a good time to buy and hold gold. Buy gold to protect your
wealth against the corrosive effect of ultra-easy monetary policy. Buy gold to
maintain a store of value that is recognized universally. Buy gold to diversify
your investment portfolio. Buy gold for peace of mind in uncertain times. Buy
gold to secure yourself and your family.
Responsible citizens and prudent investors protect
themselves and their wealth against the ambitions of over-reaching government
authority and debasement of the currency by owning gold. Gold is honest money.
Investors from around the world benefit from timely
market analysis on gold and silver and portfolio recommendations contained in The
Gold Speculator investment newsletter, which is based on the principles
of free markets, private property, sound money and Austrian School economics.
The question for you to consider is how are you going to
protect yourself from the vagaries of the fiat money and economic uncertainty? We publish
The Gold Speculator to help people make better decisions about
their money. Our Model Conservative Portfolio has outperformed the DJIA and the
S&P 500 by more than 3:1 over the last several years.
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