Market Comment

June Gloom

June 3, 2012

“You don’t look for reasons to trade. You look for reasons not to trade. By having that mindset, you eventually reach a point that when you do pull the trigger the emotion is gone and you have confidence in what you are doing.”

— James Hearndon

 

Shares rolled over pitifully last week, nullifying a six-day attempted rally off the May 18 lows.

 

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The wilting labor market that was exposed by Friday’s jobs data sends a sobering message. If the most ambitious monetary accommodation in history cannot produce a bona fide expansion, then the next phase may mean deflation, as even “dollar bills being dropped from helicopters” may have the effect of pushing on a string.

We will digress for a moment or two.

Like a forest that every so often needs a fire to destroy the deadwood that has accumulated on its floor, so a free market economy needs for its failures to face consequences. However, the current system bails out those that don’t succeed, such as world governments that allow banks to sit on mountains of bad debt for fear of reducing banks’ capital bases and hobbling their ability to make loans. This merely encourages more greed.

Politicians, whose ability to put food on their tables at night hinges on their ability to get re-elected, have no incentive but to do things that please the most number of their constituents. This is why every fiat currency in history has died. Governments cannot say “no” to doing whatever it takes to bail out their economy, even when it involves printing ever-increasing sums of money.

The excess capacity in various industries needs to be reduced by continued de-leveraging of the economy – not by further money printing in an attempt to stimulate aggregate demand. A drug addict at some point must wean himself off the drug before the ever-increasing use of the drug causes his organs to freeze up, causing death.

A forest must be allowed to rejuvenate itself by the natural fires that occur every so often, and which clear itself of the deadwood and kindling. However, if left unchecked, a forest will accumulate so much deadwood that the potential exists for an even greater disaster that threatens to destroy the entire forest. Yet mankind views any kind of naturally-occurring forest fire as something that must be micro-managed. Thus, the forests are managed by mankind in ways that nature never intended.

If one takes a risk and succeeds, one gets a reward. If one takes a risk and fails, one must face consequences. If there are no consequences for failure, as in the current system, then the distinction between greed and fear blurs. This encourages more malinvestment and never allows the system to clean itself up.

This results in the stimulus that is provided by a government in one economic cycle being layered on top of the stimuli of prior cycles, such that every cycle requires more and more stimulus – i.e. money printing (debt) – to achieve the necessary effect of stimulating aggregate demand. At some point, there will either be hyperinflation, which ultimately destroys the currency, or deflation.

To sum up the above, the view here is that the real problem is not who is in the White House or who controls Congress. The real problem is that the fiat currency fractional reserve central bank system used by Western nations is inherently flawed and doomed to failure because it places a printing press in the hands of governments. And politicians, whose survival depends upon pleasing the masses, have a hard time saying “no” to spending money.

Otherwise, the yield on 10s dropped a gaping 28 bps on the week to a 200-year low of 1.46%, gilts fell to a 309-year low of 1.43%, and bunds also recorded a record low.

As we noted here a week ago, “There has not been enough improvement in the averages to indicate a playable rally is at hand.”

The action of the past week adds an exclamation point.

Gold (GLD) was the star attraction. The second test of the Dec. 29 low was noted here last week and was followed by Wednesday’s test and Friday’s breakout. As the chart below shows, the breakout was accompanied by a powerful gap, the heaviest volume in over four months, and a good close. Historically, gold has performed best between September and January. The view here is that the Wednesday low of 148.53 in GLD holds. A speculator could consider initiating a junior position which, assuming it was entered around Friday’s closing level, would be 5.7% from Wednesday’s low, which would make a suitable stop-loss if proven incorrect. This would equate to a risk of less than 3% of a normal-sized position if the stop was hit, and represents a reasonable way of limiting risk while putting one in position to capitalize from any new trend up in gold.

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Among the names, Monster Beverage (MNST)
continued to act well last week and could be expected to resume its leadership mantle if and when the averages firm up. It has acted about as well as any glamour since this correction began. A possible entry for the aggressive speculator who wants to pre-empt firming in the averages might be above the May 10 high of 74.92, as shown below. A less-aggressive participant would wait until the averages show strength before initiating new positions.

 

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Pharmacyclics (PCYC), Petsmart (PETM), and Foot Locker (FL) were three of the first breakouts. FL broke down and failed last week. As such, we are watching PCYC and PETM for sentiment clues in coming sessions/weeks.

Tractor Supply (TSCO) and Ulta Salon (ULTA) were noted last week as having potential assuming they crossed certain points, but these broke down since then and will need to put in more time before meriting consideration again.

 

 

In summation, things went from bad to worse last week. Despite this, it is always a good idea to be prepared for anything in the market. This includes a jolt higher, perhaps driven by a Federal Reserve announcement or something similar. A few names discussed in recent reports are worth watching, such as MNST, for breakout potential. Cash remains king for most speculators.

Kevin Marder

Gil Morales & Company, LLC (“GMC”), 8033 Sunset Boulevard, Suite 830, Los Angeles, California, 90046. GMC is a Registered Investment Adviser. This information is issued solely for informational purposes and does not constitute an offer to sell or a solicitation of an offer to buy securities. Information contained herein is based on sources which we believe to be reliable but is not guaranteed by us as being accurate and does not purport to be a complete statement or summary of available data. Past performance is not a guarantee, nor is it necessarily indicative, of future results. Opinions expressed herein are statements of our judgment as of the publication date and are subject to change without notice. Entities including but not limited to GMC, its members, officers, directors, employees, customers, agents, and affiliates may have a position, long or short, in the securities referred to herein, and/or other related securities, and may increase or decrease such position or take a contra position. Additional information is available upon written request. This publication is for clients of Gil Morales & Company, LLC. Reproduction without written permission is strictly prohibited and will be prosecuted to the full extent of the law. ©2008-2018 Gil Morales & Company, LLC. All rights reserved.