Welcome to 2014

After a year that saw an incredible rally across the board, we all have to collect our thoughts and analyze how we as investors choose to proceed in this continuously uncertain market. That being said, last year was one filled with immense economic uncertainty, however there was a decidedly bullish roar to the markets. Because it is not prudent analysis to pinpoint exact causes of market movement, we will recognize forces that drove the market to new highs seemingly every week and brought us to where we are. To begin with, operation Fed to the rescue has ensured that interest rates remained at rock bottom for most of the year. While arguable, it is almost certain that the bond buying program and accommodating monetary policy nudged the market higher and precipitated most, if not all, of the other reasons being discussed today. Interest rates have been the driver for the resurgence in US housing recovery and the increased consumer confidence accompanying and its affects have spread to company's bottom lines and stock prices.

The fundamentalists approach to stock valuations give weight to earnings capacity and growth, by most accounts we have seen such growth and potential in the stock market in 2013 causing the major indexes to rise by double digits. Further market growth was fueled by easy comps from an environment with tepid growth in 2012, and continued expense and cost cutting measures by companies. In short, it looks like we hit the stride of this bull market in 2013. In many respects, if you let the uncertainty that was rampant in the economy deter you from pushing that buy button, then you missed out on some serious coin. But few would blame you, the US at times looked like the politicians were out to destroy an already feeble economy, Chinese growth was still a big question mark and the Euro Zone had more than its share of economic woes. Needless to say, investors came out of the year alive, and stronger than they've been in the last five years. Economies returned to growth and all was well in the world, or so it would seem. If nothing, this year should strengthen everyone's belief in the stock market as the greatest wealth creator in the world.

But that was then, perhaps investors who have been apprehensive should remain so, at least for the near term. Signs of an exhausted market are afoot. Perhaps we have reached a point where the economy needs to catch up to the capital markets, or maybe this bull of a market is gearing up before it begins to charge onto the next rally. But consider one simple metric that historians and analysts have used to determine market exhaustion for decades. Today January 22 2014, the S&P 500 index has a Price to Earnings ratio of 18.91 compared to a historic average of less than 16. Perhaps not incredible expensive, but it should be cause for reconsideration. the market is known to have inflection points and mild corrections around these PE ratios. It is by no means an indicator of a reversal of this great bull market, rather I consider it to be a sign of market fatigue which will give the real economy a chance to catch up with the market, i.e job creation, top line growth and long term capital investments.

Of course all future considerations will have to be viewed with the consideration of the Federal reserves interest rate manipulation. It is market consensus that this recovery should take stride this year and be accompanied by rising interest rates. This gives way to a weaker bond market and perhaps a hum drum stock market.

There are always bargain opportunities in any markets, look for cheap stocks with a solid balance sheet and a viable business strategy. exercise patience as the market takes a breather, then pounce once the timing is right.

If there's one thing I learnt from 2013 it's that there has been a shift in paradigm, we are now investing in an economy that is in a permanent state of uncertainty, apprehensiveness will never get results, rather patience and conviction in execution will serve the best investors.

Stay tuned for more
Till then - Trade Well-
F.

News Letter.

Going forward, I will make an endeavour to frequently create and upload a newsletter. However, logistically I do not think this blog is the appropriate medium to share the news letter. In the interim it will have to do until we are able to develop a solution.

The link below contains MyTrading Books first news letter, be advised that it is a beta test and frequent updates to style and formats are to come in the following days.

The gist of this letter is to update you on daily macro and micro news that have a bearing on the markets and are reflected in my other blog entries.

Today we have a look at the effects the "taper" discussion is having on the market, world banks revised world GDP forecast and various acquisition and micro news. Please enjoy in the link below

Download

Pull Back in the Markets, Over Exhausted Rally

Recent Market activity has brought on the realization that the market has overextended its recent rally. Current market conditions lack a catalyst in either direction for the immediate future, therefore investors need to weigh the probabilities of a decided bearish pull back or continued rally in the $SPY. Below are arguments for and against a significant 5-10% pull back in current indexes ($SPY, $DIA, $QQQ)

PULL BACK 

The Fed signaled a need to revise the longevity of its asset purchase program in its latest FOMC meeting, citing inflation, asset bubbles and possible complications to withdrawing stimulus as material risks of ongoing easing. Gold, crude oil and stock futures are down on the news, while the VIX, a measure of market volatility, is up 20%. The market has rallied despite a lack of indication that the economy is improving materially, with 4th quarter GDP down 0.1% and the unemployment rate holding at 7.9%. While corporate profitability has risen, it has been more a result of cost cutting programs than revenue growth, which strengthens the notion that the market has improved faster than the overall economy, which is growing at a steadier pace.

With the S&P 500 near an all time high, there seems to be no real catalyst driving traders to buy in further, especially as the primary catalyst, QE 3, and Bernanke's recent promise to continue to buy $85 billion of securities a month until employment and the overall economy improves come into doubt. And while equity inflows started off the year positively, recent data shows an net outflow in February as investors started to lock in profits and get more defensive in anticipation of a pullback that it this point seems inevitable. Market sentiment is becoming increasingly negative and more investors are taking the short side of the trade. Hedge fund manager David Einhorn reduced his long positions and increased his short positions. His reason, an advancing market without the presence of an advancing economy to support current valuations. The truth of the matter is, we are not yet out of the wood works. The European situation has improved and is relatively stable but downside risks remain and improvements in the European economy have yet to materialize, with recent economic gauges coming in less than expected. The U.S economy is stronger and optimism is up, but the market has gotten ahead of its self. While there is room for growth, especially as 2013 rolls forward, a pull back in equities to a level that makes valuations more in line with current business and economic conditions is inevitable and near. This market leaves no room for material gains on the long side and investors are paying a lofty price for earnings. A pull back of 5 - 10% in the near term is a more probable occurrence than a 5 - 10% near term rise, which makes taking the short side a better bet especially as global economic readings are coming in less than expected and will compound to trigger sell offs in equities. 

Continued Rally 

While recent developments from the Fed signaled a need to revise its asset purchase program, the need for continuous asset purchases was never questioned. The underlying factors causing the Fed to continue its asset purchase program is the pace at which the economy is recovering. Economic growth is being threatened by increasing interest rates, therefore as long as 10 year treasuries continue to increase there will be a growing threat to the recovery that was spurred by Bernanke's aggressive monetary policy. An increase in household and business debt costs as a result of increasing rates could serve to derail an already sluggish economic recovery, therefore as 10 year treasuries creep over 2% in the short to medium term there will be added pressure on the Fed to keep policies intact in order to keep rates relatively low and protect this slow recovery from derailing.

While increasing rates threaten the Bernanke "recovery" thus forcing the Fed to leave its asset purchase program as is, the market is also supported in large part by higher than expected corporate earnings; recent earnings reports show that 65% of the 433 companies in the S&P 500 have reported better than estimate revenue. Furthermore, the stock market valuation is still not overbought with a price to earnings ratio just less than 14 which is well below an historic overbought valuation of 16.

The markets show signs of normal fatigue that will not amount to more than a 2-3% correction from its current levels. Having rallied 6% this year and already pulled back 1%, short term fatigue and some profit taking may occur, but longer term investors can rest assured that the breadth of this rally is still intact. The impressive earnings and Bernanke's need to bolster the economic recovery will serve as support for this market and protect it from an excessive or elongated correction.

 Disclosure: We have no current position in any stocks listed above, however we may decide to enter one within 72hours of this article.

 This blog post was written in collaboration with Samer Sweidan