Monday, June 29, 2015

"Groups also make people feel safe, letting them take more dangerous courses. When people see others, or even past evidence of others, at a site, they keep to the established path even when they were trained to know better. If other people have done it, or are doing it, it has to be okay." --Esther Inglis-Arkell

THE SECOND HALF OF 2015 WILL INTENSIFY TREND REVERSALS (June 29, 2015): Most investors haven't even noticed that there have been critical changes in primary trends for most assets during the first half of 2015, and those which haven't yet changed direction are likely to do so soon. Among the first sectors to switch direction were numerous assets that pay above-average dividends including utilities (XLU), consumer staples (XLP), real-estate investment trusts or REITs (IYR), and U.S. Treasuries (TLT). All of the above performed extremely well during 2014, so when they appeared near the tops of the lists of best-performing securities, many people who love to own last year's winners bought them at the beginning of January 2015. Since then, all of the above have been in downtrends. Most analysts believe that these are merely intermediate-term corrections, but I believe it is far more likely that these downtrends represent the beginning of bear markets which will continue for two or three more years.

Another key asset which likely reversed direction during the first half of 2015 was the U.S. dollar. The greenback peaked at a 12-year top versus most global currencies during the middle of March, and has since made numerous lower highs as can be seen in a chart of the U.S. dollar index. Most analysts and advisors are continuing to make investment recommendations as though the U.S. dollar is merely suffering a temporary decline and will soon surge to even higher highs, but I think that a much more likely scenario is for it to accelerate its downtrend. If this proves to be the case, then it will explain why most emerging-market currencies, emerging-market equities, and the shares of most commodity producers have been climbing also since the second or third week of March 2015. These uptrends have been even less noticed by most investors than the downtrends for high-dividend securities, partly because they tend to be relatively small in total capitalization and aren't followed as often by the average person. Many of these assets had been in bear markets since April 2011 and didn't bottom until near the end of 2014, in March 2015, or in some cases may not yet have completed their ultimate nadirs for the cycle. While most investors are aware that many popular securities had achieved all-time highs during the first half of 2015, far fewer people realize that most emerging-market and commodity-related assets had slumped to their lowest levels in roughly six years.

One key feature of the financial markets is that perception can often take a very long time to catch up with reality. By Labor Day of 2008, we had already been experiencing a bear market for 15 months for small-cap U.S. equity indices and more than 10 months for the best-known indices, but almost no one believed that the bull market had really ended. By the time investors suffered through the Lehman bankruptcy and a subsequent plunge, it was too late to sell at favorable prices. The same thing will happen again this time, as people keep coming up with excuses not to sell when the S&P 500 is above two thousand and end up once again panicking and selling the next time the S&P 500 is below one thousand. People hate to sell high because they are convinced that there's nothing serious to worry about; when it is time to buy low, they find all kinds of gloomy reasons why they should procrastinate in taking action. We have experienced all of the negative divergences which are typical in the early stages of a bear market for U.S. equity indices, including 1) a dwindling number of new 52-week highs; 2) persistent insider selling except for commodity-related assets and a few other subsectors; 3) an increasing number of U.S. stocks which have begun bear markets; 4) increasingly poor overall market breadth; 5) the most knowledgeable investors have been among the most aggressive sellers while the least experienced participants have been the most eager buyers in recent months. As usual, investors won't pay attention to any of these signs until we have already experienced a sharp correction.

One of the reasons for these reversals in behavior is that, after having been in a nearly deflationary environment for years, we are beginning to experience the early stages of a worldwide inflationary resurgence. Wages are rising in the United States and elsewhere. After having traded near their lowest levels in five to seven years, various commodities have begun to rebound--most recently and dramatically for agricultural products including corn, soybeans, and wheat which have been surging since the middle of June after having slumped to multi-year lows. Crude oil has been moderately rebounding since the middle of January 2015, while most energy-related commodities and the shares of their producers have been especially depressed and represent compelling bargains including natural gas producers (FCG), uranium mining companies (URA), and coal mining shares (KOL). Gold and silver mining companies have been far outperforming gold and silver bullion since March 10-11, 2015, and remain worth buying as they have been forming bullish patterns of numerous higher lows since then.

Tax tip: If you own shares or funds which are trading near six-year bottoms and you are a U.S. resident, you can take advantage of their currently depressed prices if these assets are in your 401(k), 403(b), SEP-IRA, Keogh, traditional IRA, or other non-Roth retirement account. You can convert these shares from your account to a Roth IRA and pay taxes based upon their present low valuations. As these eventually rebound, all future gains will be completely tax free. In the event that these shares don't recover but end up retreating further in price, you can choose to undo your conversion, which is known as a recharacterization. You can then wait at least 30 days, or until the following calendar year--whichever is later--and then convert them again. There is no limit to how many times you can repeat this process and there are no income or other restrictions in making such conversions and recharacterizations, as long as each recharacterization is done on or before October 15 of the year following the date when the conversion had been done. It's like being able to go back in time and "unbuy" something which doesn't go up in price. It's heads you win, and tails you also win. Unfortunately, I do not know of an equivalent strategy which is permitted in any other country besides the United States.

Disclosure: In August-September 2013, and at various points during 2014 through June 2015, I had been buying the shares of emerging-market country funds whenever they had appeared to be most undervalued. Since June 2013, I have added periodically to funds of mining shares--and more recently energy shares--especially following their most extended pullbacks. Prior to the stock market's recent correction, I had also been accumulating HDGE which is an actively managed fund that sells short U.S. equities, because I believe that U.S. assets of almost all kinds have become dangerously overvalued. From my largest to my smallest position, I currently own GDXJ, KOL, XME, HDGE, GDX, SIL, COPX, REMX, EWZ, RSX, IDX, GXG, ECH, GLDX, URA, FCG, VGPMX, BGEIX, VNM, NGE, PLTM, EPU, TUR, SILJ, SOIL, EPHE, and THD. In the late spring of 2014, I sold all of my SCIF which had briefly become my fourth-largest holding, because euphoria over the Indian election was irrationally overdone and this fund had more than doubled. I have reduced my total cash position since June 2013 to less than 4% of my total liquid net worth in order to increase my holdings in the above assets. I sold all of my SLX by acting whenever steel insiders were doing likewise. I also sold all of my FCG but I have been repurchasing it following its recent collapse because there has been intense buying by top corporate insiders of companies which produce natural gas. I expect the S&P 500 to eventually lose about two thirds of its recent peak value, with its next bear-market bottom occurring within several months of October 2017. The Russell 2000 Index and its funds including IWM have only modestly surpassed their highs from the first week of March 2014, while the Russell Microcap Index (IWC) marginally surpassed its zenith from March 6, 2014. The S&P 500 Index set a new all-time high on numerous occasions during the same period, and may have completed its final top for the cycle at 2134.72 on May 20, 2015. This marks a classic negative divergence which previously occurred in years including 1928-1929, 1972-1973, and 2007. Those who have "forgotten" or never learned the lessons of previous bear markets are doomed to repeat their mistakes.