Sesame Street Memories Offer a Clue to the Stock Market
Everybody knows that Audrey is still too young to really understand Sesame Street, but I’m not. Since she has come into my life my interest has been piqued again. I love that show, and a new one called Baby Einstein. They are teaching babies things I didn’t learn about till college—or so it seems.
But, one thing that I remember clearly from Sesame Street are the scenes in which they show several objects that are somehow related, and in which they always include one that is totally unrelated. All the while they are singing ‘one of these things doesn’t belong here’ and they end with the question, “do you know which one”?
That is exactly how I have been feeling about the financial markets for the past several weeks. Gold is going up, interest rates are going up, energy prices are going up, and stocks are going up. One of these things doesn’t belong here—do you know which one?
The answer, for those who don’t know, has to be stocks. It is both mystifying and amusing that major U.S. stock averages are carving out new 5 year highs in the face of rising interest rates, rising gold prices and $67.00 per barrel oil. I can’t say I’m not enjoying it, but I have my eye on the exit door of the stock market at all times these days. It seems like something is too good to be true.
We acknowledge that the U.S. economy is doing quite well. In fact it is doing better than many forecasters expected this year, and that is one of the drivers for higher stock prices. But lots of economic growth in the U.S. is fueled by factors that we find suspect, like the huge household debt load that continues to support consumer spending. That keeps us worrying.
We have made it very clear that we believe the globe is in the midst of a long term bull market for precious metals and commodities and nothing has happened to change our minds. We have made it very clear in two previous major newsletters that we believe the path of energy prices is relentlessly upward. The Fed is making it extremely clear that they are not yet done raising rates—although we can’t imagine why. Therefore, if all of the aforementioned trends stay intact, the stock market has but one choice—that is to top out and start back downward. That is not a matter of “if”, it is a matter of when, and by how much.
Since trying to predict the movement of the markets has been hazardous to our financial health, from time to time, we will not attempt to do so. We will simply wait and watch the charts of each of these components of the financial markets. They will tell us all we need to know about the timing of that expected turnaround.
We are also watching other financial markets that can influence, and/or shed light on the direction of all the markets previously mentioned.
For example, we watch the fortunes of the U.S. dollar on a daily basis, and the trading action is very interesting. Check out the chart below which is by Richard Russell at Dow Theory Letters.
Focus on the middle section first, he one labeled $USD Daily in the upper left hand corner. See the symmetrical triangle that is forming to the right side of the chart. It is highlighted by the converging blue lines. Notice how the volatility is decreasing and that the magnitude of the up and down price movement is getting smaller and smaller.
Symmetrical triangle patterns like this usually mark a holding period or continuation period, during which the price and volatility range are squeezing down into the point of the symmetrical triangle. When they get to that point the holding pattern will usually break distinctively in one direction or another. We have thought for some time that the dollar will eventually have to correct significantly against other major currencies. That point may be getting closer. If the trend line breaks downward, we will have arrived at the appointed moment.
Most pundits agree that gold and the dollar tend to move in opposite directions. So if the dollar continues to drop it is likely that gold will continue to rise in price. At K&A we believe that the current bull market for gold is only partially explained by the correlation to the dollar. But that is a subject for another newsletter.
Assuming that the dollar does resume its downward path, we may arrive at a point at which the FED will have to keep raising rates to higher levels than they might have otherwise. Rising rates tend to act as a defense for the dollar. However, it is very unlikely that continuously rising rates would be good for stocks.
We have already pointed out in several previous reports that the FED and the Treasury can also “defend” the dollar simply by continuing to flood the global economic marketplace with more dollars. It is simply a function of hitting the “print” key. After all it is a fiat currency. Since the FED has chosen to discontinue reporting growth in M3 money supply it is difficult for us to keep track of total global supply of dollars. But one way to keep raising rates while dampening the effect is to keep liquidity related to the dollar flowing. In other words, print a lot of them.
Now take a look at a second interesting chart that is also from Richard Russell at Dow Theory Letters.
The $USB Weekly portion of this chart displays that price change of the 30 year Treasury bond. Focus on the portion above the blue line. That formation is called a Head and Shoulders formation. More often it is called a “Head and Shoulders Top”. It is very commonly the formation that depicts the top in price movement.
You can see the first top under the red arrow on the left which formed the first shoulder. You can see the second top that goes higher, under the center arrow, that forms the head And, finally, the third top forms up under the arrow on the right, giving us the right shoulder. You can see the pattern breaking down on the far right side of the chart, as the “head and shoulders” is complete. Assuming this chart develops further along predictable lines, the price of the 30 year bond will continue downward. That means that the yield on the thirty year bond will continue upward. That is probably not good for stocks.
So for now we see the potential for significant headwinds to be forming against the U.S. stock market. It is either that, or economic conditions shift to kill the upward pressure on the prices of gold, commodities, including energy, and interest rates. Then stocks would be “good to go” to new record highs. Somehow we just don’t see it unfolding that way.
We’ll keep you posted.
All the best,
Paul Krsek
For K&A Asset Management, LLC
P.S.
I have never written a “post script” to one of our newsletters before. But this could be an important communication of an “after thought”. I was surfing many of my usual research websites tonight when something came to my attention. Evidently the total dollars in all commodities related mutual funds is only $190 billion. Only $190 billion, you say? Believe it or not that is a tiny number in the big scheme of things, and I just read that tonight on the Bloomberg website.
Total up the assets in three or four of American Funds largest mutual funds and you will have $190 billon. Never mind their remaining 25 or so funds, or all of Fidelity’s funds, or Vanguard’s, or Schwab’s, or Strong’s, or Dodge and Cox, let alone the approximately 10,000 other mutual funds out there.
My point is simple. The commodity markets, including gold and silver are SO small compared to other financial markets that if this commodities bull market actually catches on with the general public— well watch out.
You have to ask yourself what might happen if everyone decided all of a sudden that they wanted to own some gold, or silver or other commodities. Where and how would they buy the limited supply that is available.
Just a thought.