‘Holiday Drunk’ and a Litany of Scary

I continue to find myself on the wrong side of the U.S. dollar, which has been soaring.

The Federal Reserve’s much-anticipated rate hike last Wednesday slammed an exclamation point on that, as it helped drive the greenback to a 14-year high.

I just hope it’s an exclamation point. Because that would mean an end to the sentence. An end to the pain.

Gold just can’t find a bottom. Neither can the euro. Nor can the Japanese yen.

Meanwhile, those avoiding direct exposure to the U.S. dollar have been getting drunk on the Trump punch — or is it a Santa Claus rally now? — that’s arguably driving the U.S. stock market to record highs.

I just wonder: Is the U.S. dollar’s strong reaction to the Fed announcement going to turn the holiday party into a hangover soon?

It sure could.

And again, the U.S. dollar may just be the exclamation point that helps put an end to the irrational exuberance in this market.

Are the markets holiday-drunk … or just plain optimistic?

For a moment, indulge me in a little off-the-cuff market psychology about bubbles …

That is, what causes a bubble … and might U.S. stocks be in a bubble?

Let’s, if we can, avoid pointing a finger at the Fed. (That’s been done a billion times too many already.) Let’s instead think about investors’ role.

Sure, easy money and low interest rates naturally create incentives for investors to move further out along the risk curve to realize returns.

But don’t investors bear some responsibility for buying into a frothy market, for example?

Of course.

But why would we voluntarily buy when the market is extremely overvalued … or even just a bit overvalued?

Because we are human.

And we humans are prone to error.

After all, to err is human. To forgive … is something we’d never do if we found out our money managers were piling us into the lowest tranche of mortgage-backed securities in 2005 because recent trends suggested that home prices were only going to keep heading higher in perpetuity.

My point is: Humans screw up.

Even the smart ones who call themselves economists.

And, believe it or not, even I screw up.

But, I do pay careful attention to indicators that suggest markets are priced wrong. Generally speaking, that careful monitoring helps me to do right more often than I screw up.

And what more can we ask for, right?

Don’t answer that.

A Litany of Scary

There will always be the fear-mongers among us.

Some abuse it, others do not. Some use it as a tool for self-preservation. Some use it to sell themselves as grand protectors of health and wealth.

Hopefully I fall closer to the former than the latter.

That said, I’ve recently come across a couple items that I think are worth monitoring —at the very least for the preservation of investment capital — should investors be wrongfully hopeful about stock markets.

The median P/E for the S&P 500 is up over 70% in the last five years.

The demand for call options — bets that profit when the underlying price of the S&P 500 rises — has reached an extreme.

Furthermore, the put/call ratio is at an extreme low level and suggests there is not a lot of worry about potential downside in this market.

And there is this — follow the money:

Barron’s — Dec. 5, 2016

Over 30 days, U.S.-listed ETFs had net inflows of $52.1 billion — more than twice the monthly average of $20.8 billion — and $6 billion for the last week alone. But as (Convergex’s Nick) Colas noted, "every single dollar of inflows (and then some)" went into U.S. equity funds with inflows totaling $54.5 billion for the month and almost $8 billion for the week.

What makes that surprising is the fact that equity funds make up just 56% of all ETF assets.

Last week, in Superman’s Wardrobe Malfunction and Gold, I wrote:

CAPE is the Cyclically-Adjusted Price-to-Earnings ratio covering the last 10 years.

It’s often used as a contrarian indicator …

Now … CAPE is at an extreme. It currently registers 27.9.

Over the last 150 years, instances where CAPE exceeded 27.6 proved the stock market to be a very bad investment.

For good measure, consider another measure of corporate valuations (above chart) as well as household financial asset leverage (below chart):

What to Do, What to Do?

With all that scare, what’s an investor to do?

First, do realize this litany of scare does not mean the market must inevitably collapse.

In the longer run, the likelihood of a major correction is high. But for now, the irrational exuberance can continue if the herd sticks together. Overvaluation does not become a problem … until it does.

In other words, the biggest thing to fear in this environment is fear itself. When a meaningful number of investors opt out of the optimism, the risk of an implosion grows increasingly likely.

Now, if I leave you with one soft recommendation, it is gold.

To be sure, I’ve been wrong on gold for the last several weeks. As I said at the outset, it’s because I’ve generally underestimated the resilience of the U.S. dollar’s rally.

I’ve been looking for the dollar to put in a near-term top. And I’ve been looking for gold to find a bottom.

Same as being wrong, maybe I’ve been early.

So, I leave you with two bars on the charts, then and now …


Gold, December 16 and 17, 2015: the day of and after the FOMC rate hike and guidance …

Gold firmed up after the December 2015 rate hike. But it plunged the next day. And then it rallied 20% over the next two months.


Gold, December 14 and 15, 2016: the day of and after the FOMC rate hike and guidance …

Gold firmed up on Wednesday after the rate hike, presumably because the interest rate factor suddenly became a risk to risk appetite. But gold plunged the next day.

It’s been ugly out there for gold.

Bottoms are ugly.

Tops are scary.

But gold can’t help but look good. Especially when things get ugly and scary elsewhere. And even when they don’t.

Do right,
JR Crooks

Your thoughts on “‘Holiday Drunk’ and a Litany of Scary”

  1. Thanks, J.R. : You have been right on target. I plan to hold my positions that you have suggested. I also follow Larry, E.- I don’t understand how your ,Golden Goose, profits work? How can one be sure that they exist? You don’t own the stock-you just get paid for owning the transaction entry? How does this make any logical sense? I trust you know what works, but until I understand what I am investing into, I just keep investing by buying a good business at the best valued price, as long as they continue to pay increasing dividends annually. The Golden Goose sounds like a ferry tale? I’m sorry to be so uninformed, but I guess I’m getting too old to keep up this hobby of mine. Best Regards, Davis M. Bernier

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“JR” specializes in trading commodities, currencies and options. He has spent nearly 10 years analyzing financial markets and writing about global economics. JR honed his trading techniques and global-macro worldview alongside his father, Jack Crooks, at Black Swan Capital. JR also…