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"Whenever you find yourself on the side of the majority, it is time to pause and reflect."

—Mark Twain

– Enjoy more of our favorite investing quotes –


MARCH 20, 2016




Jump Links:

- Don’t Be Fooled by a Bear-Market Rally in Stocks
- The Market Cheerleaders Continue to Issue Bullish Forecasts
- Business Inventories Rise As Business Sales Plummet
- Fantasy Jobs Report Bolsters Bullish Consensus
- Velocity of Money Now Slower Than Depression Era
- Our Plan for This Week


Most market analysts – and especially the cheerleaders on TV – have been claiming that the bull market is alive and well following the rally over the last five weeks. However, there are some hurdles that market technicals would have to clear and a number of fundamentals that would have to change course for the bull rally to resume. In this newsletter, we will discuss a few of the essential technical and fundamental measures that would have to reverse for the seven-year rally to recommence.


If you are not sure what a bear-market rally looks like, the past month is a first-class example. After a sharp, two-week, 10.8% decline to kick off 2016, the S&P 500 rallied 11.8% from mid-February through last Friday. And not to limit our discussion to the last rally, we have seen four violent moves up and down, each greater than 10%, in the last seven months. Extreme market volatility is a classic hallmark of the beginning of a serious downward move or a bear market as the bulls and bears battle for control of speculative profits.

Four Violent Moves in Seven Months
CHART 1: In the last seven months, the S&P 500 has been subject to four dramatic, violent moves greater than 10%.


These violent swings do not prove that we are in a bear market, of course. However, it also doesn't mean we can conclude that a bull market has resumed just because the market is up almost 12% in the last five weeks, either.

According to James Stack of InvesTech Research, since 1900 rallies during bear markets have averaged six of at least 5%. As an example, during the 2007–2009 bear market there was at least a 5% rally on 12 separate occasions. On four occasions, the gains were more than 10%.

On the assumption that a bear market began at the market highs last May, so far the number of significant rallies is below average and the rally that occurred over the last five weeks was overdue.


Since the market highs last summer, there has been a series of lower highs and lower lows, which is one of the definitions of a bear market. Chart 2 below shows this pattern:

Lower Highs and Lower Lows
CHART 2: The S&P 500 has set a series of lower highs and lower lows since the market top last summer.


For the bull market to resume, we would need to see current prices start to move above the prior highs. Chart 3 below shows four key indices, the S&P 500, the S&P 500 Equal Weight Index, the NASDAQ composite, and the Russell 2000 small-capitalization index. Each window displays the resistance zones that these indices would need to break through for us to begin to consider whether the seven-year bull market is in the process of recommencing.

CHART 3: The S&P 500, the S&P 500 Equal Weight Index, the NASDAQ composite, and the Russell 2000 small-capitalization index are depicted with identification of resistance zones. These zones would need to be pierced for the bull market to resume.

Notice in Chart 3 (above) that the index closest to its all-time highs is the S&P 500, followed by the equal weight S&P 500, then the NASDAQ Composite, and finally the Russell 2000 small-cap index. It is only natural that the largest capitalization stocks would be considered the least risky, and, therefore, be doing best at a time when risk is considerable. The S&P 500 is a capitalization-weighted index, so its components are all the largest stocks traded today, ranked from first to last by the market cap of each company. The $SPXEW is the equal-weighted version of the same group of companies, without ranking assigned to any particular stock.

As we move down the risk ladder towards technology (Nasdaq) and small-cap stocks (Russell 2000), that distance from the prior highs gets much wider. The Nasdaq index includes larger companies, such as Apple, that are not included in the small-cap Russell 2000 index. In fact, the distance of S&P 500 stocks from their all-time high is only about 4%, while Russell 2000 stocks would require a much-larger gain of 18% to re-attain their all-time high.

Regardless of what the distance is for each index, the resistance zones identified above must be pierced to the upside for the bull market to resume. Until that happens, you can ignore what the talking heads on TV are saying (actually, hoping). In fact, it is generally a good idea to always ignore what they are saying, because listening to their schizophrenic psychobabble is proven to be detrimental to your wealth.


As contrarians, we know the market will do whatever it takes to frustrate the greatest number of investors. At the February 11 bottom, the generally-accepted wisdom was that we were indeed in a bear market. Right on schedule, the market staged a powerful rally.

In contrast, today it is discomforting that so many of last month's bears are now bullish. We would be more likely to believe that a bull market had resumed if there weren't so many arguing that the sharp rally is a confirmation that the bull market is continuing. To the contrary, the fundamental drivers of market performance discussed in the next sections instead argue strongly for a continuation of the bear market.



Virtually all of the brokers and investment banks issue earnings forecasts for the S&P 500 for upcoming quarters and years. They are motivated by self-interest to consistently forecast earnings growth, regardless of the actual economic and market environment. After all, investors don't want to put their money in the market if it is going to decline, so that possibility is never mentioned.

As an example, lets go back a year to see the predictions of a prominent bank and then add its current prediction. The chart below shows a forecast for 2014 through 2018 (click chart to enlarge) from Goldman Sachs, one of the most well-regarded investment banks. As you can see, as of November 2014 the forecast for S&P 500 earnings for 2015 was $122 per share. S&P 500 earnings are now actually at $90.27, 26% less than forecast.

Goldman's current forecast for future years continues to escalate along a beautiful, upward trajectory. Having worked in a two prominent Wall Street investment banks, analyzing stocks as well as the market, and being part of a team making these type of forecasts, I know that the vast majority of these estimates are simply extrapolations of current earnings using best-case scenarios. They are intended to soothe investor's fears and keep the money flowing into the investment bank's coffers.

 IntelligentValue's opinion is that analyst estimates for individual stocks or the market as a whole should never be used by investors. Typically, they are calculated by extrapolating present values into the future using very optimistic assumptions and the possibility of something going awry is never allowed into consideration. This is one of the many reasons I long ago became disillusioned and quit my high-paying, Wall Street investment banking job.

Click to Enlarge
Goldman Sachs Forecast

CHART 4: Goldman Sachs S&P earnings and price targets through 2018. Click to enlarge.

Last week we published a chart of the S&P 500 operating income showing that it started falling off a cliff at the beginning of 2015. It's worth republishing it here to show how wrong Goldman's (and virtually all other bank's and broker's) estimates can be:

S&P 500 Operating Income
CHART 5: Actual S&P 500 Operating Income, 2013-present.

Amazingly, S&P earnings on a GAAP-reported basis peaked last cycle at $85 per share in June 2007 and are currently at just $90.27. That's a cumulative total gain for earnings of only 5.9% in almost nine years!


One of the classic harbingers of a recession is an increase in business inventories accompanied by a decline in corporate revenues. That is a exactly what has been happening for the last four years.

From ZeroHege: Following the recessionary surge in Wholesale Inventories-to-Sales ratio, the March 15 Total Business Inventories-to-Sales Ratio rose to 1.40x - the highest since May 2009. With a 0.4% slump in sales and 0.1% rise in inventories, the smell of recession lays heavy on US businesses.



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Biz Inventories to Sales Ratio

CHART 6: Business Inventories-to-Sales Ratio highest since May 2009.



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CHART 7: Business Sales (YoY) Change


As ZeroHedge puts it, "Do these look like the charts of a "recovering" economy?"

If we were once again living back in the days when stock prices were based on legitimate fundamentals and not Fed-speak, there is no possibility stocks would be at these levels (S&P 500 PE ratio is 23). Instead of improving fundamentals and capital investments made to generate future profit-producing growth, we are now living in an era of Keynesian, debt-driven, central bank money printing.

Stocks go up when a dovish and manipulative Fed announcement is trotted out heralding another delay in interest rate normalization and the continuation of near-ZIRP. This kind of market price growth based on endless money printing and debt creation cannot continue unabated. A day of reckoning is nigh upon us.



Much of the recent stock market rally of the last month is being attributed to strengthening economic conditions. Topping the list of these improvements is the 'seasonally adjusted' Payroll Employment Report, which is released the first Friday of each month by the US Bureau of Labor Statistics (BLS).

On March 4 when the report was released, Economist Steve Liesman of CNBC and his contemporaries at other TV and Internet financial outlets breathlessly reported the 'great news' that payrolls for February increased by 242,000 jobs, beating the consensus forecast of economists surveyed by Reuters of 190,000 jobs expected to be added.

 In actuality, the way this number was derived is quite suspect. The BLS bureaucrats do not go out in the world and actually count 242,000 new jobs. Nor to they do a representative sampling and then extrapolate it using a valid, scientific approach of the Gallup variety. Unfortunately, for decades they have used government-approved shortcuts in order to manufacture these numbers.

The dirty secret of the monthly jobs report is that it quietly excluded 1.8 million people who were available for work and had looked for a job sometime in the prior 12 months but were not counted as unemployed because they had not searched for work in the four weeks preceding the survey. The jobs report also did not mention the 1.555 million phantom, 'seasonally-adjusted' jobs that were systematically added to the February payroll number.

The headline print of 242,000 jobs 'gained' in February is 16% of the of 1.555 million job 'seasonal adjustment.' In January, the difference was even more egregious; a seasonal adjustment of 2.163 million jobs resulted in 172k jobs added, which is 8% of the adjustment figure. Had that arbitrary 'adjustment' been altered a bit one way or the other, the headline number could have unleashed an enthusiastic bull rally or a panicky bear crash in the markets. However, the number seems to come in each month just good enough to keep the trajectory of market prices moving higher.

Why such seemingly arbitrary 'adjustments?' Because these figures are manufactured by the BLS computers to include birth/death factors, seasonal employment 'adjustments,' estimated population increases, immigration rates, revisions of prior estimates, and just enough additional statistical shenanigans to achieve the desired number.

As an example of these manipulations, is it really possible that 'educational service' jobs, which includes everything from exclusive private schools to fly-by-night, for-profit tuition mills, has seen jobs increasing at the precise rate of 62,000 per year since 2006? That is just one example in a multitudinous list of similar 'adjustments' that the BLS uses to manufacture their highly-questionable payroll numbers.


The total seasonal adjustment for February this year was 1.555 million jobs. For February last year, it was 1.545 million and the year before that it was 1.512 million. That's a nice, smooth upward progression, isn't it? In fact, it is so smooth it does not come close to reflecting reality. Nevertheless, millions of investors are affected by these fabricated numbers that border on deceitful charlatanism.

If a seasonal adjustment must be added, it is absurd that the numbers would show such a uniform sequence. After all, the phase of the business cycle would have an enormous influence on jobs numbers with a larger effect in early recovery bounce-back periods and a lesser effect on more normalized periods and a downward effect during contractions. Additionally, actual weather variations each month of the year would affect jobs far greater than implied by these sequential figures.

Capitalism is about the ceaseless apportionment of economic resources to profitable usefulness. In recent years, globalized flows of economic activity have punctuated the fervor of these adaptations. Accurate adjustments reflecting reality could be made in real-time, doing away with the easy and unsound shortcuts used by the BLS to add a gradually escalating dollop of phantom jobs each and every month.

In addition, the jobs report does not provide insight into the kinds of jobs being created. In an eye-opening article about the manipulation that goes into the jobs reports, former Reagan-era Office of Management and Budget (OMB) Director David Stockman noted,

The truth is that the big numbers in job creation do not reflect healthy economic growth but a fundamental shift in the labor force away from high-paying, full-time jobs to low-paying, part-time jobs. The February “household” survey of job creation shows that 78% of the jobs created were part-time, and 82% of those were in the low-paying service industries such as food service and retail. This partially explains February’s data that shows exports at the lowest level in almost five years. It’s hard to export the things created by bartenders and waiters.

There are a number of other influences that could be factored in scientifically if the BLS desired more accuracy in creating comparative year-over-year/month-over-month figures. These variations and accurate adjustments for them could be built into the BLS system, but apparently a budget of $600 million per year in taxpayer dollars allocated to the Payroll Employment Report somehow isn't enough to cover a much-needed improvement such as this.

Of course, I'm being facetious. However, what the BLS is creating now is nothing more than statistical noise and 'happy numbers' for the politicians, investment banks, and brokers to use to manipulate the masses. The losers are everyday investors, who must deal with seemingly illogical market movements.

We are getting nowhere near the economic improvement represented by the US government. In fact, David Stockman says, " can look at years of seasonal adjustment factors for January (or any other month) and not find any consistent, objective formula. They make it up, as needed."

In any other situation, this manipulation of data might be considered investor fraud and the perpetrators summarily shackled, duck-walked, and prosecuted. However, in the case of the BLS, it is viewed as very beneficial by whichever party of government bureaucrats is currently in office and the investment houses that ultimately make money from the glowing, growing jobs reports. There is no one to call them out on this steaming pile of manipulative BS except honest, independent analysts.


One of the more obscure reports that doesn't get the attention it deserves provides a clearer picture of the true jobs situation: The Labor Market Conditions Index, published by the Federal Reserve Board:

  Click to Enlarge
Chart 8: A monthly view of the Fed's Labor Market Conditions Index


According to Haver Analytics: "The Labor Market Conditions Index from the Federal Reserve Board includes 19 indicators of labor market activity, covering the broad categories of unemployment and underemployment. These include jobs, workweeks, wages, vacancies, hiring, layoffs, quits and surveys of consumers and businesses. Because the trends in the index are slow-moving, Haver presents only the changes in the index.

During February, the index deteriorated to the greatest degree since June 2009, the last month of the recession. Last month's weakening runs counter to the improvement in payroll employment reported March 4 because it also reflects other weaker indicators in the report, including the unemployment rate, the decline in hours worked, the drop in average hourly earnings and the rise in the average duration of unemployment. During all of the last year, the index rose moderately following a stronger performance in 2014."

According to this report, labor conditions in 2016 started out negative in January and increased further downward in February (to levels not seen since 2009). This is a far more accurate picture than the fabrications emanating from the offices of the Bureau of Labor Statistics (BLS) in Washington.


As shown in the chart below from the St. Louis Federal Reserve, the velocity of money is now extremely low. In fact, it is now lower than the Great Depression/World War II era!

According to the St. Louis Fed, "The velocity of money (also called the circulation of money) refers to how fast money passes from one holder to the next. It refers to the frequency at which the average unit of currency is used to purchase newly domestically-produced goods and services within a given period. In other words, it is the number of times one dollar is spent to buy goods and services per unit of time.

As shown by the chart, the velocity of money was once as high as 22.5/year in 1981, but is now below 5/year. That means the turnover of the average dollar is less than five times per year. Comparatively, in the depths of the Great Depression, the velocity of money was about 8/year. This is a somber indication that the underlying economy has entered a period of extreme stagnation, largely caused by the zero-interest rate policies of central banks.

Click to Enlarge
CHART 9: The velocity of money has dropped to an all-time low – less than the period during the Great Depression and WWII.

In its infinite wisdom, the Federal Reserve has attempted to negate this near-economic standstill by flooding the financial system with new money. Instead, this wrong-minded effort has created enormous asset bubbles but has not addressed what is fundamentally and structurally wrong with our economy.

On a very basic level, the amount of real economic activity we are witnessing is nowhere near what it should be, and the anemic flow of money through our economy is proof certain of this seemingly endless dilemma.

Why is this hyper-low turnover of money occurring? Ostensively for two reasons:

1) Economic activity is not being driven from the bottom up by self-sustaining, productive economic activity at the meat-and-potatoes, Main Street level. Instead, is being generated in an aberrant way; from the top down through endless ZIRP/QE in an effort promote debt-induced purchases. However, Americans (and apparently other nation's citizens) are not interested in taking on new debt to buy things – regardless of low interest rates. The emphasis in America is on deleveraging, which is appropriate following a balance-sheet recession.

Furthermore, unable to generate actual earnings growth, America's businesses seem interested not in taking out loans to make capital investments, but instead to buy back their own stock in a financial-engineering effort to lower their P/E ratios and prop up their stock price.

2) The largest capital market of them all, the US bond market, has been stopped in its tracks by the Fed's Keynesian money manipulators. Near-zero interest rates have created a dormant US Treasury market and idled savers who are unable to get a reasonable return on an interest-bearing account or CD. The malignant effect of ZIRP has been to stifle the economic flows generated from legitimate savings.

These flows of money, constructively created by genuine economic activity, i.e., people going to work every day, vastly outweighs the economic benefits of Wall Street speculation. This speculation is the apparent aim of the Fed's endless effort to create a 'wealth effect,' as enunciated as the Fed's objective by the father of ZIRP and QE, former Fed Chairman Alan Greenspan. Instead of economic improvement, what we have is the third great financial bubble in the last 18 years, destined to crash just as the prior two did, wreaking havoc across the economic landscape and pummeling the average, hard-working 401(k) holder yet again.


Because of the reasons addressed in the section titled, "Don’t Be Fooled by a Bear-Market Rally in Stocks," we will make no changes to our two model portfolios this week. Should the indices discussed in that section close above the resistance levels identified, we will presume the bull market is continuing and change course with the addition of profitable, undervalued equities to our model portfolios.

On the other hand, if the market reverses course downward, with confirmation, following its robust, five-week counter-trend rally, we will purchase inverse ETFs to profit from the most overbought and overpriced industries and sectors created by the recent rally.

We will send an email to IntelligentValue members with specific details of our purchases when either event occurs.

Best Wishes for Another Week of Intelligent Value Investing,


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Opinions expressed herein by the author are not an investment recommendation and are not meant to be relied upon in investment decisions. The author is not acting in an investment advisor capacity. This is not an investment research report. The author's opinions expressed herein address only select aspects of potential investment in securities of the companies mentioned and cannot be a substitute for comprehensive investment analysis. Any analysis presented herein is illustrative in nature, limited in scope, based on an incomplete set of information, and has limitations to its accuracy. The author recommends that potential and existing investors conduct thorough investment research of their own, including detailed review of the subjects discussed, market environment, company or ETF SEC filings. Investors may wish to consult a qualified investment advisor. The information in this material was obtained from sources believed to be reliable, but were not been independently verified. Therefore, the author cannot guarantee its accuracy. Any opinions or estimates constitute the author's best judgment as of the date of publication, and are subject to change without notice. Shareholders, employees, and writers associated with IntelligentValue, Inc. may hold positions in the securities that are discussed. Neither, nor any of its employees or affiliates are responsible for losses you may incur.