Weekend August 10, 2014

 

The Eleventh Hour

The world is a mess.

Former Secretary of State Madeline Allbright, this past month

The markets have not registered a final high, yet. But as our title suggests evidence mounts that a final high in both oil and stock prices  is likely to occur this fall. Remember that while talking heads on television bemoan high gasoline prices,  high oil and gas prices always move in lock step with a bullish stock market.  One breeds confidence in the other. However there are numerous warnings (the gathering storm) that the markets are over extended and likely to hit final highs this fall. Let’s take a look.

The first clue lies in the existence of cycles. The Dow Jones registered its first trip to the 1,000 mark in 1966. Eight years later it bottomed in December, 1974 at 577, retracing about 50% of the 1,000 mark. This fall will mark a two generational anniversary. Markets tend to alternate so this time we may record a forty year high from the low years ago. Amazingly, the Dow’s high in 1929 was at 390. The low in 1974 was a mere 187 points or about 50% higher in thirty-seven years. In addition we are five years out from the 2009 low.

Adjusted for inflation, the Dow Jones has made no progress since Year 2000. Which is to say that if the Dow Industrials  divided by the Producer Price Index, or the price of gold, it is at the same level now that was then. This suggests that the rise has not been as a result of any new productivity but as a result of the three trillion dollars the FED has injected into the economy. This resulted in new nominal highs in stock prices rather than raising the level of full time employment. By the way, a mere 47% of Americans now hold full time jobs.

Short term both stock indexes and the energy prices appear to have put in intermediate lows in early August. This should set the stage for a final push higher amid glowing reports of expanding auto and truck sales. That latter indicator is also a warning given where the car market was five years ago.  Already tractor and auto manufacturers are offering zero down payment and zero percent financing deals to clear out existing inventory.

Energy prices remain in an uptrend but like stock prices have just undergone a correction. Crude oil dropped ten dollars to the $97 area. Gasoline has dropped to $2.70. After spiking to $6.50 earlier this year, natural gas has apparently bottomed at $3.70.   The refining industry did not anticipate the production of abundant ‘lighter’ crude in the US. That coupled with the inability to ship the new production over seas and the lack of the Keystone Pipeline has kept West Texas Intermediate trading below the price of Brent North Sea crude.   Brent is trading at $105.44. The fact that crude is not trading at new highs is a further divergence in stocks and energy prices.

Junk bond prices are another indicator of market tops and bottoms. The leading Junk fund JNK bottomed at $16.15 in 2009. It topped in June at $41.42. Investors pulled a record $7.1 billion form junk bond funds this past week. Yields hit new lows under 5% this past month for junk funds. Money is moving out of junk in anticipation of the FED exiting bond purchases in October.  After a 2.4x rise in price, junk looks toppy.

Luxury goods makers are falling in price. Coach COH has fallen from $50 to $34.  Ralph Lauren RL has been stair stepping down from its high at $190 last year. One luxury stock in particular reflects the strength of the stock market and that is Sotheby’s BID. When investors feel confident, they bid up auction prices for collectibles. This is reflected in a strong price for BID. Sotheby’s topped just over $50 earlier this year. As I write Friday, August 8, 2014, BID is down a whopping 9.2% (just today!) to a new low for the year at $36.92.   Market tops are a process, not a simultaneous event. All these events taken together suggest the topping process has begun.

The Dow Industrials has pulled back from well above its moving averages at 17,133. It is now testing the longer term 200 day moving average around  16,348. That should set the stage for a final run up over 18,000.