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OCTOBER 2013 INVESTMENT JOURNAL: NORMAL PARANOIA
  • US Government re-opens as Congress kicks the can
  • The Fed meets and stays on cruise control
  • Stocks widen their lead over bonds everywhere

 

 October saw stock markets rally, while bonds, commodities, and precious metals were flat:      
    
    
    
 Stocks have decisively re-claimed the three year performance crown from all other categories with this year's impressive run:
  
             
   
The amount of paranoia among investors was palpable as October began, for good reason. The last US budget crisis in August 2011 produced a significant swoon in the stock market. Historically, the really epic stock market crashes have also occurred in October (the "seasonality" effect). We received many inquiries from friends and clients about whether it was time to lay low and wait for the storm to pass.
   
The evidence told us to stay constructive (invested). As you can see from the charts below, the price momentum of the stock market was fading into August of 2011, but not so now:
        
         
   
These unbiased "signals" are not perfect, but are very useful for guiding month to month and longer term positioning.
       
By contrast, shorter term indicators would suggest that it is not time to make large new commitments to stocks until we get a "breather". The graph below is of the "McClellan Oscillator", a widely recognized "breadth" (advance vs. decline) indicator:
  
   
   
The green circles highlight the two very brief periods this year when selling pressure overwhelmed buying, which is usually a good time to invest.

The political drama in the U.S. and "compromise" produced yet another "kick the can" maneuver that means we can all re-visit Gridlock Central sometime early next year. Meanwhile, the roll-out of the new government website has given both sides of the aisle something they both can agree on: Obama goofed, and it better get fixed pronto.  (And market observers have a whole new sub-industry to talk about, namely who wins and who loses under Obamacare.) Throw in a little disgust over more reports of NSA eavesdropping on foreign governments and leaders, and you've got all-time lows in public trust in government. But not to worry, Election 2014 is just around the corner, so we'll get a chance to "throw the bums out", right? (There is a lot being written about the rise of a third party to counter ongoing DC dysfunctionality, which could meaningfully change policies and thus impact investors. It's another "trend" worth following.)
   
The Federal Reserve's Open Market Committee (FOMC) met again in October and announced no changes. As we have highlighted before, the Fed introduced a radical shift in policy this year by targeting the Unemployment Rate to guide "tightening" or "easing", in addition to the existing inflation rate watch. In Fed-speak: "The Committee will closely monitor incoming information on economic and financial developments in coming months and will continue its purchases of Treasury and agency mortgage-backed securities, and employ its other policy tools as appropriate, until the outlook for the labor market has improved substantially in a context of price stability. " (Our highlights). We don't know why everyone is trying to guess when the "tapering" is going to start, when they have flat out said "not until the unemployment rate improves substantially".  Here's a look at the latest reading; we'll leave it to you to gauge whether this meets the Fed's criteria (hint: 5% is a magic number).
   
  
   
Overseas, European economies continue in belt-tightening mode, as the recent German election results leave Angela Merkel struggling to build a ruling coalition that dovetails with her austere views. In what has become a continuing farce, Greece was called on the carpet by the "Troika" (EU, ECB, IMF) for "looming budget gaps" coming in 2014, but Greek officials say they can't implement any more wage and pension cuts as "the social pressures are unsustainable" (but the Athens stock market was up over 17% in October).
       
Meanwhile, the European Central Bank warned its member banks that they better start cleaning up their balance sheets to meet the new international standards (i.e. start thinking about new depositor fees and shift your taxpayer funded bailout strategies into higher gear). 
   

The ECB "heads up" coincided with a widely heralded report by Price Waterhouse Coopers that described how troubled ("non-performing") European bank loans had doubled in the last four years, reaching just north of €1 trillion. The report predicted it would take many more years to unwind these bad debts, which is consistent with the idea the enormous debt bubble that has built up over the last generation is of the "epic" variety that is not going away soon. The full story from the Financial Times is here:

     

 http://www.ft.com/intl/cms/s/0/9f429f6a-3ff4-11e3-a890-00144feabdc0.html#axzz2jPsL2iXA 

      

As we head into November, markets seem to have taken the U.S. budget impasse in stride, and will be looking to year end and beyond. Is there more room for stocks to go up, and are there other groups that are set to take center stage? Will commodities and gold reverse their slide, and are yields on bonds going to rise? For these and other questions, our answer is "the fundamentals inform but the evidence rules".

    
Have a great month, and let's all make like Pilgrims (Happy Thanksgiving)!

 

 

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