Improving Market Sentiment:
Why You Should Be Leery of It

The bear market is doing an excellent job with investors’ attitude towards the stock market. We can see it in the market’s performance…

So far this year, the S&P 500 has gained 4.6%—its best January start in 15 years! Market sentiment—how investors feel about the stock market—has shown a marked improvement.

The eurozone, through its Long Term Repo Operation (LTRO), has provided liquidity to the eurozone banks, which has improved market sentiment there for now. This solves the eurozone’s short-term liquidity problem (but does nothing to solve the mountain of debt on their balance sheets and on the balance sheets of the countries themselves—a crisis that will resurface in the not-too-distant future).

With the eurozone currently calm, U.S. Treasuries yielding close to zero, and market sentiment turning positive, money has found its way back into the equities market.

It sounds like an attractive proposition: China’s economy is slowing and their central bank has stated that it will ease monetary policy, providing more monetary liquidity. The eurozone is providing monetary liquidity. How could market sentiment not be improving?

Here in the U.S., the Fed is determined to hold rates low until 2013 and there have been no fewer than five Fed governors talking about the need to provide more support to the economy by buying more bonds, specifically, mortgage-backed securities—QE3. Should this occur, it is more money printing—liquidity. This will do wonders for market sentiment!

The problem with this story, as I have been documenting over many months, is that this liquidity hasn’t resulted in growth. In order for equities market to continue to perform well and market sentiment to remain positive, earnings are going to have to grow and, in order for that to occur, consumer demand is going to have to come back to life.

With almost every part of the world currently experiencing slow growth, and with the eurozone already most likely in a recession, I don’t see how consumer spending will improve. (See: 2012 Economic Growth Slashed Across Most Countries.)

Over the last few years, China and India have been the strongest growing economies in the world. However, as 2011 came to a close, their growth rates began to slow noticeably. These countries themselves have slashed their growth forecasts for 2012. Here in the U.S., anemic job growth and stagnant wages continue to pressure consumers.

With the consumer missing in action, and growth a fleeting mirage, investors should tread very carefully with this latest rise in market sentiment and corresponding rise in the equities market.

You shouldn’t see the sign of investors turning bullish on stocks as a positive. On the contrary, I believe the secular bear market is simply achieving its goal of luring more investors back into stocks during this phase of the bear market, a rally often called the “sucker’s rally”. (See: Exactly Where We Are in This Secular Bear Market.)

 Michael’s Personal Notes:

A stronger sign of inflation headed our way…

Late last week, the U.S. Treasury sold $15.0 billion in 10-year Treasury Inflation Protected Securities (more commonly known as “TIPS”) at a negative yield (interest rate), for the first time in its history. Demand for this issue was strong from bond investors.

TIPS are instruments that are purchased by bond investors from the U.S. Treasury as a hedge against inflation.

TIPS are tied to the Consumer Price Index (CPI). This means that, should inflation rise, TIPS would pay the bond investor the interest plus the change in inflation that occurred over the previous year. Should there be deflation, however, the bond investor would lose money on his/her investment.

For the first time, bond investors paid a negative yield, which means bond investors paid extra to purchase these TIPS from the U.S. Treasury.

This, dear reader, tells me two things. On the surface, if we look at this (bond investors buying Treasuries with negative returns), we think investors are finding fewer and fewer places to park their money safely—they are sacrificing profit for the actual return of their money. But there is more to it.

With the eurozone crisis unresolved and global growth slowing significantly around the world, which I’ve been writing a lot about lately, investors are looking for safety. Right now, the safest of currencies to be in is the U.S. dollar…and maybe only because it is the reserve currency of the world.

When bond investors buy TIPS with a negative return, it really tells me that bond investors are worried about inflation. Why pay more for something unless you are fairly confident it will appreciate in value in the future?

As I’ve been writing since the credit crisis started, the Fed is trying desperately to generate inflation. Bond investors are telling the market that they think the Fed will be successful. Combine this with the Fed governors indirectly continually talking about QE3 and the argument for buying TIPS from the U.S. Treasury becomes that more attractive to bond investors.

In my opinion, if you are going to buy an inflation hedge, gold-related investments are really the best plays. TIPS are fine, but not at a negative yield and not when they pay out in dollars. Should the Fed continue to expand the money supply aggressively (i.e. printing money), then the value of those U.S. dollars will continue to fall, which means a bond investor would be paid back in the future with dollars that are worth less than today—evaporating any return earned by the bond investor from higher inflation.

Gold offers protection from currency depreciation, since historically, it rises when currencies depreciate. History has repeated itself over the last 10 years. As the dollar depreciated in value, gold embarked on its bull run.

This is why gold has been a store of value for thousands of years. It can’t be printed, its supply is limited, and it is very difficult to mine.

Inflation is coming. The recent action in the TIPS market is just another sign of that. But if you want to protect yourself against inflation, the best vehicle, in my opinion, is still gold-related investments.

Where the Market Stands; Where it’s Headed:

You have to hand it to this market. Quietly, without much fanfare, January is turning out to be a banner month for the Dow Jones Industrial Average. With seven more trading days in the month still to go, the market is up four percent for 2012 already.

I’ve been writing for months that the bear market rally that started in March of 2009 is alive and well. We’ve been seeing the proof since the beginning of October. But each time the market moves higher, more investors and stock advisors enter the bullish camp. Nothing alarming yet, but once enough people are in the bullish camp, that’s when we will see the bear market rally finally run for the exit gate.

What He Said:

“Prepare for the worst economic period ahead that we have seen in years, my dear reader, as that is what I see coming. I’ve written over the past three years how, in the late 1920s, real estate prices fell first before the stock market and how I felt the same would happen this time. Home prices in the U.S.peaked in 2005 and started falling in 2006. The stock market is following suit here in 2008. Is a depression coming? No. How about a severe deflationary recession? Yes!” Michael Lombardi in PROFIT CONFIDENTIAL, January 21, 2008. Michael started talking about and predicting the economic catastrophe we began experiencing in 2008 long before anyone else.