Economic And Financial Outlook (Part II)

Stock Market Forecast

I turned formally bearish near the end of 2013 for the first time since the 2006-08 period.  I was early then too.  I was also early in 1999.  The bearish signals aren’t perfect.  The decline in oil prices could still be taken in a bullish light. I agree with the bulk of the evidence that it is a net negative to the boom, and may signal its impending collapse.  We may see that in the job market soon.  The economic data has softened too lately.

What’s missing (in my model)?

• Q/Q downturn in S&P500 profits
• Technical break (i.e., Dow theory confirm)
• A more pronounced slowdown in money growth

However, I am settling for the less perfect sell signal for the following reasons,

1.   Valuations are extreme in financial assets (both stocks AND bonds)

2.   Sentiment is overly bullish now

3.   Boom is long in the tooth, historically

4.   Oil and emerging market troubles appear to be canaries

5.   Markets are too far out in front of ECB (and BOJ) QE

I’m looking for European government bond markets to trigger the dominoes.

In the last cycle (2003-07) the Fed started to tighten in 2004, but when it did its allies overseas began to inflate heavily: China, ECB, emerging countries, etc. What this did was to extend the global boom.

The housing boom started in the US thereby morphed into a global housing and commodity boom.

But this time the Chinese have been very tight, the ECB has been hesitant, and the BOJ most clever.

The US has been inflating money faster than all of them, even throughout the tapering!

Think about that the next time you hear pundits talk about what the Japanese or Europeans are doing.

It is a genuine delusion, and I believe it will be an unfortunate one for dollar assets very soon.

Up to now I’ve believed that the Treasury bond would unravel before equities on the premise that the rising stock market would continue to suck capital out of the safehaven trade, and especially T-bonds.  That may still happen.  But while I continue to see the collapse starting in the Euro bund market, I believe that the greater risk in the short term lies in US equities over Treasuries -as the latter might continue to attract safehaven flows in the short run...at least until the central bank reacts to the accident.  There may be room for euro shares on the upside at first, and they are already on fire.  This might even give the currency some respite in the short term.  But US equities are not priced for a significant back up in yield.  Even so, your best strategy might be to wait for the initial rally in Europe to peter out before shorting equities in the US.

If you’re trading futures just keep your stops tight.

I like the idea of shorting the Canadian banks for their exposure to the oil sector and a real estate bubble in Canada.  Plus, they have largely given us a break in the charts.  The two banks with most real estate exposure on their books are Royal Bank of Canada (RY:TSX) and Toronto-Dominion (TD:TSX),

Technically premature but potential double tops in both cases.  Some of the other Canadian banks have given off a more bearish sell signal by already breaking below their October lows this month, but these make more sense if you want to stay on the real estate theme -Canadian real estate has yet to turn down.

Finally, you might consider buying put options on the stock market averages, or buying ETF’s like DOG or SH (unleveraged shorts against Dow 30 and S&P 500 respectively) or if you want leverage (more volatility) consider QID (NASDAQ 100 short), DXD (Dow short) or SDS (S&P 500 short) - all with twice the leverage.

Remember not to own ETF’s, just trade them; there is too much value leak in buying and holding them.

We expect to see Dow 12000 to 15000 within the next year or two if our fundamental outlook is right.

Currency Forecast

We see a major reversal in the US dollar ahead, and it may start within days.

Here’s how i see it,

• bullish sentiment on USD hit extremes this month
• fundamental basis of move is US-EU yield spreads -but not likely to grow anymore
• recovery story is an untenable distraction and may be in its final inning
• ECB policy likely to fire up EU shares and yields, and drive euro/dollar higher at first
• US equities priced for perfection, weakness could undermine USD
• Yen reversal likely to correct for misperceptions
• Gold in strong position to rally (which could also undermine USD f/x)

Our view has a couple of blind spots in the short term.

The first is that it is also possible that the situation in Greece gets out of hand, wars break out, Germany pulls out, or any one of a number of political events that put the focus on the ECB instead of share values.

That is, the USD might thrive if my hunch about the short term effects of the ECB policy is incorrect, or if there is any large scale flight from risk in search of a safehaven, even if we expect the pm’s to outperform.

I see the strong likelihood of a financial market upset in 2015 primarily because of how far ahead of the policy the market’s expectations appear to be.  Did investors front running the ECB news calculate correctly?  I dunno, but I know that it can mean the difference between easing too late or not.  It was too late when the Fed started easing in 2001 and 2007.  This situation is different.  All we can draw from the other instances i think is that there is a point at which the policy can be too late.  i don’t know that point. 

If it is ‘too late’ and we are right about a downturn in financial markets this year the US dollar may still fall if only because it has been a great draw to foreign investment in the last few years, and because stocks in the US have the most short to medium term downside i believe.  Also, perhaps because of the Fed’s reaction.

The second is the chart.  It’s a pretty standard textbook 5-6 yr triangular bottom that started in 2008.

I hate to fight such a pretty looking chart.  But chart signals are not 100% and i can’t buy the premise for this move - i.e., I do not see it as evidence that the US economy is actually recovering or improving, or is in any better position than any of its peer western economies.  The reasons it has rallied so strongly is that (1) the euro and yen have collapsed on speculation that they are and will be printing more (they have not so far), (2) the US has stopped inflating (it has not -the commercial banks are keeping the engine running), and (3) the anticipation of the ECB decision drove euro yields to nothing (widening the US-EU spread).

Not one of those factors has anything to do with proof that the US economy is strong or healthy.

Moreover, all of them are either in the market or reversing, or simply erroneous.

Definitely the move is rooted in the destruction of markets across Europe that Stockman noted.

We have to short such a move.  You can’t talk about real interest rates in this kind of environment because they mean nothing.  Both the interest rate and the price indexes are manipulated.  The former is abolished.

Precious Metals Forecast

We are not wrong about any of the fundamental aspects of our outlook.

Gold is not down because our fundamental story is wrong.  It is down because the bulls got ahead of themselves on the one hand, and on the other because central banks produced a distraction in financial assets through a massive coordinated interest rate suppression by central banks around the world today - punishing savers and productive people while fooling investors, entrepreneurs and business owners.

Financial assets have as a result been priced out of the capital preservation trade and imply too much risk today.  The trends are still against gold and silver but they have been pushing through resistance points.

Here is what i like in the charts,

1. Gold bulls recovered above neckline (~1185) of bearish descending triangle, refusing bears
2. October break in gold below 1185 saw big volume but bulls held in
3. Silver completed downside target at 14.5 and now challenging $18 neckline following gold
4. That these things are happening on massive run up in USD index

We’d like to see gold fly through 1350 and silver push through $22 for a confirmation that bottom has arrived.  I don’t like buying after a rally like this and just below resistance though so if you are not long yet then wait for another bearish raid or a break out through that resistance just above the market today.

However, i think it will continue, especially if we’re right about the USD and stock market, but is likely to stop at around 1450 gold and/or $25 silver for a revisit or retest of support underlying the move.

Nevertheless, my forecast for the year is for gold to print a $1700 high and silver to see the high 20’s but for the year to average around $1450 gold and $25 silver.

Gold / Silver Equities

We’re looking for gold stocks to double in 2015 on average and they are a third of the way there now.

Given their extremely cheap valuations - relative to what we see - we believe they should be over weighted in your portfolio at this juncture, but we expect to lighten that up as the rally gains enough momentum.

I strongly recommend the purchase of all the gold stocks in my portfolio - next page - with emphasis on the eleven that are NOT highlighted. I’ve written about these positions many times, and have absolutely no reservations in recommending them as part of a core portfolio going into the next golden bull leg.

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