The INVESTMENT STRATEGY LETTER
Looking for a Top in the Stock Market/OR/It is OK to be Bearish

While I was having lunch today with a business associate (thanks for lunch) and talking about this blog, I mentioned how much easier it is now, to be bearish and warning about a possible new Bear Market, when you don’t have to worry about panicking your clients. It is one thing to write a philosophical blog (just for the fun of it) and it is quite another to have the fiduciary responsibility of clients on your hands. Therefore, I feel much more at ease, talking about a top in the stock market, than would a money manager. Besides, for those who have a fiduciary responsibility, ‘market timing’, is frowned upon by such regulatory entities as the SEC and FINRA.
The financial industry approves of the Efficient Market Hypothesis Theory (EMHT), which proposes that it is impossible to beat the market by trading in it out and that investors should at all times be fully invested in the market in the aggregate, by owning an allocation of mutual funds, because in the long run the market will go up. The dangerous beauty of this theory is that accordingly, your goals will always be achieved sometime in the future. If you just ‘hang in there’ long enough you will make your money back. This gives investors a false theory of contentment. However, during a very long period between 1997 and 2012, the market was up 50% of the time and down 50% of the time. Also during that period there were two stock market collapses of 50%, one between 2000 and 2003 and the other between 2008 and 2009. The financial industry would have you believe that trying a methodology that uses market timing is an ‘heretical tactic’. Lately, the EMHT methodology, has investors drinking euphorically from the common Kool-Aid trough.

Bear markets do not offer the average investor in mutual funds many alternatives to protecting their portfolio in a Bear Market. Professional investors  easily go short or long with ease. For instance, while Goldman Sachs was selling worthless mortgage-backed securities to Iceland and Ireland, they were shorting the same securities in their own portfolios. It is human nature for most investors to be positive and patriotic and therefore to be bullish. We want the market to go up because it is in our general best interests that the economy prospers, so that our careers and our families can prosper. At one time I use the word ‘good;, when the stock market broke out on the upside and ‘bad’ when a breakout occurred on the downside. This is a bad habit, that we as investors have to break. The outcome for us is only ‘good’ if we are long the security, when the market  goes up or short a security when it goes down. There is a misconception among most investors that they can only make money, if the market goes up. With the use of options, such as puts and the ability to go short a stock as easily as you can go long, investors no longer have to rely solely on mutual funds.

John Maynard Keynes said “markets can stay irrational longer than we can stay solvent.So,”Don’t be stubborn. If the market is topping ,don’t just ‘hang in there’ Your investment decisions have nothing to do with being positive or patriotic.We do not control world events, the economy or the markets. However, we do control our attitude and we can change our old investment habits and follow a strategy of being more flexible.

Be as a cold hearted money player, just as the professionals are. What did the mobster say to his victim in the movie Godfather just before he killed him? “Sorry it’s only business.” That does not mean to be cold hearted in your personnel life. Just making a killing won’t make you happy and the money won’t last long, unless you are in the right frame of mind to be deserving of receiving abundance.

I think tomorrow’s subject will be about five indicators that are showing red flags for a stock market top. For instance, did you know that investor sentiment for people who are bearish is at a nine year low whereas those who are bullish are at a new high? That Kool-Aid flavor of euphoria, sure tastes good.

Carl M. Birkelbach 11/13/14

Is the Market Topping?
This is a continuing dialogue about why I believe the markets are in the ‘process’ of forming a major top.(This is an early warning. It could happen now, or take a year or less.) In the last two current market updates, I have indicated three reasons for my concern. The theme of today’s blog centers around the concerns of two recent best-selling books; This Time Its Different and House of Cards. History has shown us that booms and busts a can occur for a variety of reasons and are somewhat unpredictable across time. However, the one thing that doesn’t change is human nature. In Plato’s Republic in the Allegory of the Cave he describes prisoners that are chained in a cave in such a way that they can only view their shadows on the wall in front of them. In the allegory, Plato has Socrates suggest that the prisoners would believe that their shadows represent reality, not knowing what caused shadows. Socrates further suggests, that if the prisoners are freed and dragged into the sunlight, they would be unable to relate to the new reality and would continue to see things as they thought them to be. We are the prisoners in the cave and we are trapped in the chains of our beliefs.

The recent economic growth has been fueled by government debt, artificially low interest rates and federal reserve buying of bonds. Presently, corporate earnings are high, inflation low, and housing prices are returning to formal levels and the world is in a ‘relatively stable’ period. However, this could change quickly.Housing prices in places like Seattle and New York City are going through the roof. How can a young couple afford an average priced $800,000 house or condo. Because of lower energy prices, inflation appears to be flat. However, four tickets for a basketball game now cost a thousand dollars, college prices are beyond the means of the average person and healthcare costs and basic living expenses are skyrocketing. The average US worker  is not making enough money for a decent living and should be classified as ‘the working poor’.

The last banking crisis occurred because banks were too big to fail and were caught with derivatives that wound up to be close to worthless. Then, the 10 largest banks had approximately 30% of all US deposits, now they have above 55% of all deposits and 75% of total assets and they own more derivatives than there were in 2008. The most dangerous derivatives are in Europe (Greece and Spain for instance) and emerging nations. Also banks are holding bonds at prevailing lower interest rates, which was caused by the Fed’s stimulus buying. The Fed is no longer buying. Interest rates could easily double and once again crippled bank balance sheets. What will happen the next time banks need a federal bailout with a Conservative Republican dominated Congress? I don’t think they would approve a trillion dollar stimulus (like the democratic congress approved in last crisis), that would increase the deficit. Then what?

Carl M. Birkelbach

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INTRODUCING THE NEW INVESTMENT STRATEGY LETTER BLOG

LOOKING FOR A TOP IN THE MARKETS
Since 1978 I have written 573 market letters. This BLOG is a continuation of that tradition, to speak out for the individual investors and to give them an independent view of investing that has become dominated by market commentators that drink from one Kool Aid fountain of the large bank dominated financial industry. Just as I was one of the first in my Lone Bull Letters in the 1980’s and 1990’s to forecast a market (DJIA), that would rise from 1,000 to over 10,000. I now see STOCK AND BOND MARKETS THAT APPEARS TO BE READY FOR A TOPPING PROCESS.  I have been asked, why am I looking for a top in the stock market, when it keeps on making new highs? Good question. But, it deserves a long answer. Some of my reasoning is in the below section INVESTMENT STRATEGY with two of my concerns 1) the inequality of economic growth and wealth is confined to the top 1% and is sucking the air out of the economy. 2) high-yielding (junk) bonds are not liquid enough should investors holding mutual fund shares in high-yielding bonds decide to sell.
There are a lot of other reasons for my caution. One of them, of course, is the euphoria that investors now seem to have, as they are trained like Pavlov’s dog to not to worry about market setbacks. So, rather than trying to do this (explain my concerns), all at once. I will do this a little at a time on a daily basis

Today’s Subject: Investing Locally
When I was a kid, there were brokerage firms on every corner similar to the way you see Starbucks coffeehouses now. Due to pressure from above (probably from the banks, the SEC and FINRA), brokers have gone from about 10,000 entities to only 3000 entities, most of which are owned by banks. In the past, local brokers and investment bankers, helped small businesses go public. Here I defined small businesses as having 500 or fewer employees. They make up 99% of the businesses in the United States and account for 45% of US revenue and three out of every four jobs. The $26 trillion invested in stocks, bonds and mutual funds, goes mostly to multi national and international conglomerates. Less than 1% of money raised by banks (formerly investment banks, which were separate from the banking industry) goes to local productive use, which hires people and develops new products. Now the banks not only control the brokerage, and mutual fund industry, they also control the investment banking industry. Small companies (those with less than 500 employees) have been cut off by the banking industry from loans and investment banking alternatives. That’s because, the system is set up to help large companies only, those that are only interested in the national and international markets and many of which have corporate headquarters outside of the United States. Just as the top 1% and the 80 people who own 50% of the wealth in the world are sucking the air out of consumers’ pockets, the conglomerates are sucking the air out of small US companies. On a short-term basis, this has been good for the stock market and is corporations. However, the long-term effect could be devastating both the economy and stock market. For further references check out the book LOCAL DOLLARS, LOCAL SENSE by Michael Shuman (who has commented on this subject in the New York Times editorial section)
Tomorrow Subject; House of Cards. Reference book: THIS TIME IT’S DIFFERENT /Eight Centuries of Financial Folly by Renhart/Rogoff

INVESTMENT STRATEGY: Lighten up during rallies
The markets have steadily risen since 2009 and investors have been trained like Pavlov’s dog to not worry about setbacks. Stock markets tops and the beginning of a Bear Market happen when it is least expected. I tend to be suspicious when euphoria and hubris reach high levels ( I just got back from NY City and the euphoria is unbelievably high.) That happened in 2000 and 2008 after which the market corrected 50% of its gains in a very short period of time.
So what could go wrong? There are two bubbles that I am concerned about. 1) All economic growth in last 20 years has gone to the top 1% in the US and to the top 80 people who control 50% of the wealth in the world. There is nothing wrong with accumulating wealth; however its effect on the general economy could make future economic growth unsustainable. How many bars of soap and how many cars can each of the wealthy people buy? These excessive conditions have taken the breath out of the economy for consumers and sooner or later will affect the entire economy negatively. 2) The FED has stopped its stimulus package of buying bonds. Investors who have high-yielding bond mutual funds have immediate liquidity. However, the managers that hold these funds in high-yield bonds, have much less liquidity. PIMCO owns close to 50% of many foreign bonds and controls over 40% of the debt issued by the Bank of China, 40% of the State Bank of India and close to 30% of some Spanish banks. This is not a problem during the good times like now and when the stock market shows higher highs. However if the Fed starts raising interest rates and the stock market starts to fall, this could cause a problem with high-yielding bonds that are not very liquid, which could cause a precipitous drop in in high yield bond prices. ‘Junk bonds’ can suddenly become a new name for these high yielding bonds. Markets hate lack of liquidity!

As always, I will let the market tell me what to do, using my technical methodology outlined in Investment Strategy Handbook for Volatile Markets.(My book). If we start seeing new highs, the Dow could go up to about 18,000 by year end. To me,the market looks like it is running out of breath for 2015. If the market starts making new lows, there isn’t any Intermediate down side support until around the 15,000 area. Stay tuned!

Carl M. Birkelbach 11/11/14

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THE INVESTMENT STRATEGY LETTER
In my opinion the market continues to look as though it is topping.

So what could go wrong? There are two bubbles that I am concerned about. 1) All economic growth in last 20 years has gone to the top 1% in the US and to the top 80 people who control 50% of the wealth in the world. There is nothing wrong with accumulating wealth; however its effect on the general economy could make future economic growth unsustainable. How many bars of soap and how many cars can each of the wealthy people buy? These excessive conditions have taken the breath out of the economy for consumers and sooner or later will affect the entire economy negatively.  2) The FED has stopped its stimulus package of buying bonds.  Investors who have high-yielding bond mutual funds have immediate liquidity. However, the managers that hold these funds in high-yield bonds, have much less liquidity. PIMCO owns close to 50% of many foreign bonds and controls over 40% of the debt issued by the Bank of China, 40% of the State Bank of India and close to 30% of some Spanish banks. This is not a problem during the good times like now and when the stock market shows higher highs. However if the Fed starts raising interest rates and the stock market starts to fall, this could cause a problem with high-yielding bonds that are not very liquid, which could cause a precipitous drop in in high yield bond prices. ‘Junk bonds’ can suddenly become a new name for these high yielding bonds. Markets hate lack of liquidity!

As always, I will let the market tell me what to do, using my technical methodology outlined in Investment Strategy Handbook for Volatile Markets.(My book). If we start seeing new highs, the Dow could go up to about 18,000 by year end. To me,the market looks like it is running out of breath for 2015. If the market starts making new lows, there isn’t any intermediate down side support until around the 15,000 area. Stay tuned!

Carl M. Birkelbach

So what could go wrong? There are two bubbles that I am concerned about. 1) All economic growth in last 20 years has gone to the top 1% in the US and to the top 80 people who control 50% of the wealth in the world. There is nothing wrong with accumulating wealth; however its effect on the general economy could make future economic growth unsustainable. How many bars of soap and how many cars can each of the wealthy people buy? These excessive conditions have taken the breath out of the economy for consumers and sooner or later will affect the entire economy negatively.  2) The FED has stopped its stimulus package of buying bonds.  Investors who have high-yielding bond mutual funds have immediate liquidity. However, the managers that hold these funds in high-yield bonds, have much less liquidity. PIMCO owns close to 50% of many foreign bonds and controls over 40% of the debt issued by the Bank of China, 40% of the State Bank of India and close to 30% of some Spanish banks. This is not a problem during the good times like now and when the stock market shows higher highs. However if the Fed starts raising interest rates and the stock market starts to fall, this could cause a problem with high-yielding bonds that are not very liquid, which could cause a precipitous drop in in high yield bond prices. ‘Junk bonds’ can suddenly become a new name for these high yielding bonds. Markets hate lack of liquidity!

As always, I will let the market tell me what to do, using my technical methodology outlined in Investment Strategy Handbook for Volatile Markets.(My book). If we start seeing new highs, the Dow could go up to about 18,000 by year end. To me,the market looks like it is running out of breath for 2015. If the market starts making new lows, there isn’t any intermediate down side support until around the 15,000 area. Stay tuned!

Carl M. Birkelbach