Market Summer Debate

There’s been a hot debate raging in the markets this summer, which has probably intensified following last month's sell off in the global markets, concerning the future trajectory of the equity markets. In one camp are the pessimists, the bears, who are adamant that this five and a half year secular bull market has reached its top and that the markets from here on will be entering a new bearish trend. But on the other side of the argument are those who are taking a more optimistic, or bullish view on the equity markets. The bulls believe that this recent correction is healthy and that in actual fact we are midway through a secular bull market, which will keep charging forward and clocking up more gains for probably another five years.

Last month's sell off dragged the DOW and the FTSE slightly into negative territory for the year and the bears are making a compelling case for a 20 percent market correction, which according to them has already commenced with last month's sell off. The crux of their argument is based on all three conditions simultaneously taking place, which has been remarkable in accurately predicting six bear markets within the last 40 years. The signals in question are excessive levels of bullish optimism, significant over-valuations and wide discrepancies in the performances of different market sectors. Indeed, a review of market trends since the early 1970s would indicate that no bear market has come into effect without these three conditions being fully satisfied. So when all the stars align this is the clear signal for a new bear trend, according to Hayes Martin, president of Market Extremes, an investment consulting firm in New York whose research is focused primarily on major market turning points. There have already been six times since 1970 when the market experienced irrational exuberance, dizzy evaluations and a wide variation in the performance of different market sector, according to Hayes Martin.

The first two of these three market conditions, an oversupply of bullish investors, and record overvaluations, have been evident in the markets for the last few months. For example, during December of 2013 the number of advisers who described themselves as bullish rose to above 60 percent, the latest reading on July 30 was 56 percent, nevertheless, still a reading which is in danger territory, according to a market consulting firm. Certainly, it would appear that there’s an element of contrarian investing behind this oversupply of bulls signal. In other words, to be fearful when everyone is greedy and greedy when everyone is fearful. With respect to the latter signal, excessive evaluations, this is also clearly present in the market with the price/earnings PEs ratio for the Russell 2000 index of smaller-cap stocks, after excluding negative earnings, rising in December 2013 to its highest level since the benchmark was created in 1984. The PE ratio at the end of 2013 is higher even than at the October 2007 bull-market high or the March 2000 top of the Internet bubble.

Another signal bears are getting excited over is the waning participation of traders, or lower trading volumes in the market, which has declined rapidly in the last month. One way of gauging this waning participation is by calculating the percentage of stocks trading above their average over a given time. This refers to analyzing the stocks moving average, which is a widely used indicator in technical analysis that helps smooth out price action by filtering out the “noise” from random price fluctuations. For example, the percentage of stocks trading above an average of their prices over the previous four weeks fell from 82% at the beginning of July to just 50% on the day the S&P 500 hit its all-time high. It was one of “the sharpest breakdowns in market breadth that I’ve ever seen in so short a period of time,” said Martin.

But don’t be so confident in your predictions of calling a new bear trend in the markets says Deutsche Bank chief strategist Binky Chadha. The likelihood of a selloff of at least 20 percent, which would define a bear market is unlikely, according to Chadha. Rather, what we are seeing is a secular bull market in mid-cycle. So if we see the market fall by say 10 percent, that is healthy, according to Chadha. But a correction of 20 percent doesn’t seem likely for this analyst, since three-fourths of such corrections happen near recessions and almost never occur when the trend in the unemployment rate is down, chadha concludes.

Nevertheless, there are the black swans to consider, the geopolitical situation in the Middle East, the looming sovereign debt crisis, the EU’s economic and political crisis and tit for tat sanctions over the Baltic crisis could all weigh heavily on the markets.

Whether what we are seeing is a mid cycle secular bull market or the beginning of a bear cycle is hard to gauge, particularly when we analyze the fundamentals and throw into the equation the unknown variables, there are too many in this market. Maybe technical analysis might be a better tool in trying to see through the muddy water, after all the signals are clearer.

British Pay

The stagnation of British pay, and for that matter pretty much most workers pay in developed capitalist economies is concerning. So much so, that the falling real incomes, after factoring in inflation, and the inevitable deteriorating living standards of millions of workers is likely become one of the main electoral issues during Britain’s forthcoming general elections next year. But while Labor politicians will probably stand on their soapbox professing to have a solution to the plight of a growing army of working poor, the problem may be far too entrenched for any erudite politician to solve. 

Indeed, the falling real incomes for households on middle to low income, which amounts to over a third of the nation’s population, is more than just a passing storm, or a shift from one economic paradigm to another, but in the words of Former US Treasury Secretary Larry Summers, “a long-term, “secular” stagnation of the developed capitalist economies.”

The slowing growth of British wages had started well before the financial crisis of 2008. A recent think tank report, titled “Growth without Gains,” revealed that the general population’s living standards had deteriorated long before the onset of the previous recession. The report showed that despite Gross Domestic Product (GDP) growth of 11 percent between 2003 and 2008. Median wages were stagnant and per capita disposable income fell at the household level in every region outside London. Moreover, there has been a rapid shift in the way income has been distributed from wages to profits. Just 12p of every £1 created by the UK economy finds its way to the wages of workers in the bottom half of the earnings distribution, a drop of one quarter over the past 30 years, according to the report. 

While, this helps explain income inequality there are other fundamental reasons at play which could explain the slow growth of pay of workers in the low-middle income bracket. They are as follows; Globalization. While there are many upsides to globalization and free trade, such as competitively priced goods and fewer wars as nations seek to trade rather than wage wars on each other, there have also been some downsides. Without doubt, free trade has undermined the real wages of blue collar workers, countless examples can be cited of workshops being setup in low wage regions, thereby displacing factory, process workers in the UK, or forcing them to accept lower wages. Furthermore, there is growing evidence of white collar incomes being adversely affected by increasing competition from a new generation of young educated workers in developing nations. For example, Deutsche Bank cost-cutting in New York and London has been brutal in recent years. But the bank has increased its employee head count in India to 6,000 and has recently employed 125 analysts in Mumbai.

Capital’s obsession with returning greater shareholder value at the expense of rewards from ordinary workers has also contributed to lower pay rises for medium to low income workers.

Despite the fact that Technology has raised productivity in every sector it has also replaced the tasks undertaken by many other low skilled workers. Certainly, we are living in times when the digital technological revolution is evolving beyond that of the last decade. The fusion of nanotechnology, information technology and mechanics is propelling robotics to new heights. Drones are becoming more sophisticated, resulting in pilotless aircraft, which are currently being deployed by the military for surveillance and aerial combat missions. So drones can now do the job of piloted military jet at a fraction of the cost, which logically means less demand for pilots. On the civilian front, Amazon is currently requesting permission from the authorities to use drones for parcel deliveries and robots will soon probably replace people in their dispatch warehouses. Put simply, robots do the work more efficiently than humans, they are cheaper, they work 24/7 and they don’t require a pay rise. Then there is the autonomous vehicle, driverless vehicle, which is now a technical reality, apparently this will mean no more human error road accidents, which could cut the road mortality rate and insurance premiums. But it also means putting the professional driver out of business. Technology is revolutionizing education; predictions are that within next few decades half the universities won’t exist. Workers will require education and skills more than ever in the brave new world, but they will acquire it online, at a fraction of the cost. This could mean less work, or lower paid work for education workers.

So labor’s bargaining power will continue to erode, as the true supply of labor exceeds its demand, thereby keeping wages low.

Perhaps we are moving towards what Jeremy Rifkin describes in his book, “The zero marginal cost society,” like Marx, Rifkin thinks capitalism will consume itself. The argument runs something like this: increasingly intelligent machines will generate products at nearly zero marginal cost—in other words; the cost of producing each additional unit falls to essentially nothing. And when that happens, everything becomes free, profits disappear and… capitalism eats itself. 

What this could imply is dwindling income for governments, as their tax revenue continues to shrink. Less public finance means eroding public services in health, education and defense. So a gentle slow march into poverty for millions.

But people are resourceful and when they start realizing that the market economy is declining, along with the public sector there is likely to be a growth in the third sector, voluntary and community based jobs and self-employment. The downside is that this type of employment often pays less. 

With regards to trading, the world’s most sophisticated form of gambling, as a means of escaping the sinking ship; it could be for those who have a strong constitution, a healthy sense of cynicism, able to manage risk, numerate, literate analytical and cunning. But you need to keep in mind that trading is a zero sum game with more losers than winners and the house always wins. Mrs. Jones might be best suited to baking cakes for the local raffle. However, a trader’s academy for people who believe they already have the material to work with might be a winner.