January 26, 2013

The Market Will Never Correct Again

[Special Note: We are migrating to a new backend for the website this weekend. Therefore, to make life a little easier on Eric and Julia, the webmasters extraordinaire that make everything work; this will be a very short technical market update. I appreciate your patience but the effort will be worth it. In this regard we have some ambitious projects scheduled for the next few months including: 1) Conversion to an HTML newsletter which will provide faster downloads, search capability, sharing and more. 2) Podcasts with commercials removed and named by subject and date. 3) 1-2 minute video blogs in addition to the Daily Exchange 4) Web based investment seminars; and much more. All in all, 2013 should provide for a much more robust development of the website to make sure that you are getting the information that you need to manage your money better. Here is the cool part. All of these changes were spurred by you, our loyal members, who submitted comments, criticisms and requests frequently through the website. I read them all, archive them, and when I get enough of the same request I take action to implement them if I am able. The entire www.streettalklive.com website and community has been, and will continue to be, built around your requests. So keep them coming and thank you.] This past week my partner swung by my office and asked me: Lance, do you think this market is ever going to correct again? While the question was asked sarcastically; it summed up the attitude of the average investor who has now plunged face first into the equity risk pool. The problem, of course, is that it is the capitulation by investors who abandon caution out of fear of missing the boat is what leads to their inevitable demise. When will the correction come? That is the topic of todays shortened missive.
DISCLAIMER: The opinions expressed herein are those of the writer and may not reflect those of Streettalk Advisors, LLC, Charles Schwab & Co., Inc., Fidelity Investments, FolioFN or any of its affiliates. The information herein has been obtained from sources believed to be reliable, but we cannot assure its accuracy or completeness. Neither the information nor any opinion expressed constitutes a solicitation for the purchase or sale of any security. Any reference to past performance is not to be implied or construed as a guarantee of future results. See additional disclaimers at the end.

Inside This Issue:

Market Correction Coming? Overbought And Bullish Early Warning Signal Bonds Tell The Story Truth About Investing

Recommended Reading Consumer Deleveraging? LEI Revisions To Growth Visible Hand Of The Fed Economic Policy Uncertain Richmond Fed Survey Real Housing Recovery The Bond Bubble

401k Plan Manager No Change This Week Click Here For Current Model Allocation. Disclaimer & Contact Info.

Over Bought and Extremely Bullish One of the questions I received by email this past week was: Just how overbought is the market currently compared to previous bull market peaks? This is a great question. However, before I can answer it we need provide some basic background for context. Most investors fall into the trap of thinking that the market can move in one direction for an indefinite period of time. When markets are rising it is assumed they will never correct again and vice versa. The reality is that market prices, like the hound dog in the Foghorn Leghorn cartoons, are tied to a stake. The dog could chase Foghorn until he reached the end of his rope and then wham he was yanked back to earth.

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The chart below shows the S&P 500 as it ranges between its run of rope. The boundaries, represented by the blue lines, are where the current price would be 2 standard deviations above, or below, the moving average, solid green line, which is our anchor point.

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For those non-geeks reading this missive when prices reach 2-standard deviations above, or below, the average price, statistically that movement has encapsulated 95% of its normally distributed potential movement in that direction (34.1%+13.6% / 50% = 95.4%).

RECOMMENDED READING
Is The Consumer Deleveraging Really

The balance sheet recession continues. Only mortgage debt is declining.

The light blue shaded areas in the chart of the market above show when the S&P 500 has reached such EXTREMELY overbought levels AND is pushing 2-standard deviations above the mean. At the beginning of these shaded areas the market is pushing higher and exuberance is building in the market. The belief becomes that the market will not correct anytime soon. Of course, it is generally not too terribly long after the onset of such complacency that the market takes away a large bulk of the gains and provides a much better entry opportunity for patient investors. The next chart is the same chart as above but I have overlaid the Volatility Index to illustrate the extreme complacency that sets in just prior to the market correction.

LEI Revisions Show Slower Growth The Conference Board released the LEI index with a full set of backward revisions which showed that LEI has been growing slower than estimated since end of the last financial crisis.

The Visible Hand Of The Fed There is clear evidence that the recent market push is driven by the Federal Reserve.

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As you can see during these periods of exuberance the Volatility Index has dropped to extremely low levels of fear. Today, the VIX is at the lowest level since 2007.

Early Warning Signal

Back in early 2000 we began writing and warning investors of the crash and the secular bear market that was coming. No one believed me then. In December of 2007 I wrote that we were either in, or about to be in, a recession. No one believed me then. In February of 2009 I wrote an article entitled 8 reasons for a bull market. No one believed me then either. The reason that I wrote these things is simply because of the following chart which has an incredible track record of seeing trend changes in the market long before it is recognized by the media.

RECOMMENDED READING
COTD: Economic Policy Uncertainty The problem is that while market participants have become wildly bullish in recent weeks the economic data has continued to either remain weak or get worse.

COTD: Richmond Fed Survey The latest release of the Richmond Federal Reserve Manufacturing Survey showed little to excited about.

Real Housing Recovery Story While the belief was that the Government, and Fed's, interventions would ignite the housing market creating an self-perpetuating recovery in the economy - it did not turn out that way.

You will notice that the indicator WILL NOT get you out right at the top or in at the bottom. However, it does tell you when the trend has changed for, or against, you. Currently, the market is still on a longer term buy signal and remains a buy the dips market for now. However, it is the top part of the chart that is the most important. When this indicator has reached extreme overbought levels, as it is currently, it has signaled that the market was beginning to reach the potential peak for the current cycle. It doesnt mean that the market is about to imminently crash. This is a monthly chart so these topping processes can several months. Nonetheless, it is a warning sign that is juxtaposed to the many bullish analysts in the market right now predicting that we are entering into a new secular bull market we arent.

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There are many similarities between the current market and previous market peaks. But the chart below shows the greatest similarity yet. This chart was featured in the article this past week entitled The Visible Hand Of The Fed.

As I stated then: It is clear that the visible hand of the Federal Reserve is firmly in control of the markets at the moment as liquidity flows are increased. However, extrapolating the current advance indefinitely into the future becomes somewhat dangerous. Each previous program cycle has ended with a fairly nasty decline, in both the markets and the economy, as the fundamental drivers were being supported solely by artificial interventions. Those declines would have likely been far worse had they not been halted by the next round of liquidity injected goodness. While the Fed programs that we have witnessed since the financial crisis are historically unique - liquidity driven markets are not. We have witnessed the effects of excess liquidity in the bull market cycle prior to the 2008 financial crisis. The only difference during that cycle was that, through government intervention, real estate was turned into an ATM allowing mortgage equity withdrawals to be the liquidity source for the economy and the markets. The chart below shows the extremely high correlation between these two bull market cycles. There are many similarities between the peak of the market in 2008 and today. Investor sentiment is pushing extreme levels, the markets are exceedingly overbought, earnings are weakening, complacency is higher, multiples are expanding, the consumer is beginning to sputter and headlines are beginning to push the boundaries of manic optimism. One doesn't haven't to think back too far to remember that at the peak of the markets in 2008 there was no recession in sight, even though it had already started, as it was a goldilocks economy. Earnings were expected to continue to grow into the coming year and equities were the only investment of choice. Come to think of it - that is what we heard in 1999 as well.

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Bonds Tell The Same Story

If you dont believe any of the analysis above then maybe you will listen to the bond market. When stocks begin to reach extreme levels it is the exuberance that sucks investors out of bonds and into stocks. Therefore, a good indicator to watch is the ratio of stocks to bonds as shown in the chart below.

Historically, when this ratio has reached the extreme levels that are currently present it has been coincident with a market peak. Currently, as shown with the stock market above, the ratio is pushing 2-standard deviations of its mean as investors sell bonds to buy stocks. Of course, this is exactly the emotionally driven behavior that you would expect to see for average individuals that get sucked into to panic buying market peaks and selling market bottoms. The chart on the next page inverts the ratio above to bonds versus stocks. This creates a clearer buy/sell indicator. When the lower indicator reaches extremely oversold conditions the SELL indication is given when it turns sharply up. While the indicator would have gotten you out very early in 2011, leaving you to be regularly chastised for such stupidity by the media for next several months, it would have saved you from the near 20% plunge that following summer. The same held true this past September as QE3 was introduced. Conversely, when this indicator peaks and turns back down that has given a clear buy indication as well.
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The Truth About Stocks And Investing

Despite all of the ink spilled on value based investing, fundamentals, earnings, etc. in todays world of high frequency trading, position seeking algorithms and programmed trading, fundamental analysis now takes a back seat to price analysis. Today, 90% of the price movement in any stock is dictated by the overall movement of the stock market. While fundamental analysis still serves a valued purpose in helping to avoid potential bankruptcy issues in the long run it is price analysis that rules in the short term. This is important to understand, comprehend, accept and adopt because investors are no longer long term oriented. The markets, overall, are focused on the next day, week and month and buy/sell decisions are evaluated as success, or failure, within minutes of the transaction. This is why we spend so much time focused on the price movements of the market in this weekly missive to evaluate our buy/sell recommendations accordingly. However, the management of risk, through understanding price movement is essential for long term success. Here are some real stats for you: Fact: 3 out of 4 stocks eventually decline 75% or more from their IPO prices before they go bankrupt. While underperforming the indexes, all of them spend a lot of time on the 52-week low list. Rule: Dont buy 52-week lows because you think they are cheapthey arent.
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Fact: Yes, occasionally, a stock will have a massive comeback from its 52-week lows. These are the exceptions and not the rule. Rule: Dont buy bounces of bottoms until trends confirm a return to sustained positive price action. This will be when they hit a new 52week high following a proper basing process. Fact: Only 1 in 4 stocks outperform the S & P 500 during their life time. The biggest winners spend the majority of their time on the 52week high list. Rule: These are the stocks that you generally want to focus on buying. However, all trends end and generally when there seems to be nothing in the world to stop it. AAPL is the most recent example. Fact: Tops are clear only in hindsight. Rule: As shown in the charts above the market usually gives plenty of signs of a trend change and enough time to exit. You just have to be willing to pay attention and set aside the greed factor. Fact: Not every breakout to a new 52-week high is a valid buy signal. Only the ones from proper technical setups are. Rule: Pay attention to the details and not the media hype. Successful trading, you are not an investor, requires attention to details and the flexibility to move when necessary.

STREETTALK ADVISORS
What makes us different? Its really pretty simple. We believe that managing risk is the key to long term success. Conserve the principal and the rest will take care of itself. Risk = Loss Seems like a simple concept yet most people take way too much risk in their portfolio which is fine as long as the market goes up. The problem comes when it doesnt. Managed Risk = Returns By applying varying levels of risk management to a portfolio of assets the potential for large drawdowns of capital is reduced thereby allowing the portfolio to accumulate returns over time. Total Return Investing We believe that portfolio should be designed for more than just capital appreciation. There are times when markets do not rise. During those periods we want income from dividends and interest to be supporting the portfolio. If you are ready for something different then you are ready for common sense approach to investing.

Let me repeat that last part. Despite what you think, or what you are told, you are NOT AN INVESTOR. You are a speculator, a trader, who buys electronic pieces of paper in a company that you neither have control or real knowledge in order to sell those electronic pieces of paper at a higher price than where you bought them. Thats it. Everything else is Wall Street marketing machine enticing you to keep you money invested for the long term while they trade all around you at your expense. If you dont believe that previous paragraph look at your annual profits versus those of the major banks. The Wall Street Casino is a huge business, and very much like going to Las Vegas, you either learn to play by the rules or you become part of the profit margin. The market is extremely over bought, extremely bullish and much overvalued. A correction is coming. It is just a matter of time and will likely be bigger than you can currently imagine. While I am NOT recommending that you sell everything you own on Monday and go hide into cash I am suggesting that the risk is rising. As stated above the market will give us plenty of time to liquidate our positions and move to cash the only question is whether, or not, you will be paying attention. Have a great weekend. Lance Roberts

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401K Plan Manager

The ongoing rally since the end of December continued this past week. Earnings season has been less than positive and on a comparative basis is the second weakest since 2011. However, earnings expectations are extremely low and the Fed pumping $85 billion a month into the markets the overbought nature of the market can continue for a while longer. However, as stated in this weeks missive above a correction will come and will likely be sooner than most expect. We continue to recommend holding current allocations but not increasing exposure to equities at this time. If you need help after reading the alert; dont hesitate to contact me.

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Disclaimer & Contact Information

Disclaimer The opinions expressed herein are those of the writer and may not reflect those of Streettalk Advisors, LLC., Charles Schwab & Co, Inc., Fidelity Investments, FolioFN, or any of its affiliates. The information herein has been obtained from sources believed to be reliable, but we do not guarantee its accuracy or completeness. Neither the information nor any opinion expressed constitutes a solicitation for the purchase or sale of any security. Past performance is not a guarantee of future results. Any models, sample portfolios, historical performance records, or any analysis relating to investments in particular or as a whole, is for illustrative and informational purposes only and should in no way be construed, either explicitly or implicitly, that such information is for the purposes of presenting a performance track record, solicitation or offer to purchase or sell any security, or that Streettalk Advisors, LLC or any of its members or affiliates have achieved such results in the past. ALL INFORMATION PROVIDED HEREIN IS FOR EDCUATIONAL PURPOSES ONLY USE ONLY AT YOUR OWN RISK AND PERIL. Registration Streettalk Advisors, LLC is an SEC Registered Investment Advisor located in Houston, Texas. Streettalk Advisors, LLC and its representatives are current in their registration and/or notice filing requirements imposed upon United States Securities & Exchange and State of Texas Registered Investment Advisors and by those states in which Streettalk Advisors, LLC maintains clients. Streettalk Advisors, LLC may only transact business in those states in which it is registered, or qualifies for an exemption or exclusion from registration requirements. Performance Disclosures Past performance may not be indicative of future results. Therefore, no current or prospective client should assume that the future performance of any specific investment, investment strategy (including the investments and/or investment strategies recommended and/or purchased by adviser), or product made reference to directly or indirectly on this Website, or indirectly via link to any unaffiliated third-party Website, will be profitable or equal to corresponding indicated performance levels. Different types of investment involve varying degrees of risk, and there can be no assurance that any specific investment will either be suitable or profitable for a clients investment portfolio. No client or prospective client should assume that any information presented and/or made available on this Website serves as the receipt of, or a substitute for, personalized individual advice from the adviser or any other investment professional. Historical performance results for investment indexes and/or categories generally do not reflect the deduction of transaction and/or custodial charges or the deduction of an investment-management fee, the incurrence of which would have [the] effect of decreasing historical performance results. Disclaimer of Warranty and Limitation of Liability The information on this site is provided AS IS. Streettalk Advisors, LLC does not warrant the accuracy of the materials provided herein, either expressly or impliedly, for any particular purpose and expressly disclaims any warranties of merchantability or fitness for a particular purpose. Streettalk Advisors, LLC will not be responsible for any loss or damage that could result from interception by third parties of any information made available to you via this site. Although the information provided to you on this site is obtained or compiled from sources we believe to be reliable, Streettalk Advisors, LLC cannot and does not guarantee the accuracy, validity, timeliness or completeness of any information or data made available to you for any particular purpose. Copyright or Other Notices If you download any information or software from this site, you agree that you will not copy it or remove or obscure any copyright or other notices or legends contained in any such information. All investments have risks so be sure to read all material provided before investing.

STREETTALK ADVISORS
Lance Roberts Director of Fundamental & Economic Analysis Michael Smith Director of Alternative Investments Luke Patterson Chief Investment Officer Hope Edick Compliance Officer Leah Miller Operations Manager Lynette Lalanne General Partner Streettalk Insurance Office Location One CityCentre 800 Town & Country Blvd. Suite 410 Houston, TX 77024 Tel: 281-822-8800 Web Sites www.streettalkadvisors.com

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