Vous êtes sur la page 1sur 42

BELKIN REPORT

belkin@attglobal.net

2012 Belkin Limited All Rights Reserved

Oct 10, 2012

Bear Markets and the Business Cycle - a 110 Year View

tock prices go down in recessions. Although that is an obvious pattern in market history -- business school textbooks and media talking heads seem oblivious of it. The assumption that Fed-engineered rate cuts and credit expansions make stock prices go up is deeply ingrained in market psychology. But the historical pattern is: Corporate earnings slumps in recessions make stock prices plummet.

In the period around the last two business cycle contractions (2001 and 2008-09), S&P500 reported earnings (annual sum) declined 54% (2001, five quarters) and 92% (2009, seven quarters). The S&P500 index declined -49% from its March 2000 peak to its October 2002 low and it declined -57% from its October 2007 peak to its March 2009 low. The peak and trough dates for business cycles, corporate earnings and the S&P500 index do not perfectly coincide. For the purposes of this report and table we use the Dow Jones Industrial Index (DJIA), because it has the best historical data going back 110 years (to 1902 in our table). The National Bureau of Economic Research (NBER) defines US business cycle expansion and recession turning points. Their data extends back 160 years www.nber.org/cycles.html. Well focus on the past 110 years (22 cycles). This is the stock market/recession pattern: The DJIA typically peaks several months before the official start of a business cycle contraction - while the economy still looks OK (average -2.6 months before recession). Then the DJIA slumps (an average -30.6%), bottoming out in the deep, dark depths of the recession - before any economic recovery is evident. Then a new, extended rally starts (an average 3.9 months before the next economic expansion begins). That has been the pattern in virtually every business cycle contraction since 1902 (see table). Percentage DJIA declines have ranged from -6% (ending 1945) to -89% (ending 1933). Please note that the peak (and trough) in the DJIA and economic cycle do not exactly coincide. That is probably why the pattern is not more widely understood. The Belkin model forecast suggests that the US economy will soon tip over into an official recession. That is based on the model forecast for S&P500 earnings, industrial production, durable goods orders, retail sales and employment. Europe is already in a recession and Chinese growth is slowing abruptly. Global economic weakness should infect the US through the international exposure of US corporations (the tech sector has the highest international revenue exposure of about 55%). Business cycle dates are not officially announced until many months after economic turning points. So real-time economic forecasts that accurately anticipate NBER cycle dates are critical. The NBER should eventually proclaim the start of a recession (months or years after it has already started, way too late for investment decisions). The current business cycle expansion is now 40 months old, vs. the average expansion of 45 months (1902-now). That average is skewed by the last three artificially prolonged business cycles of 73, 120 and 92 months. Pre-1990, the average expansion lasted 37 months. Many global stock indexes hit a tentative peak on Sep 14th, 2012. The DJIA went a little higher to 13610.15 last Friday (Oct 5, 2012). Assuming that the DJIA is at (or near) a market top - and applying that -30.6% average bear market decline during a recession - yields a ballpark downside DJIA bear market target of 9,445. Higher-beta tech-heavy indexes (Nasdaq) probably have greater downside risk. We recommend that investors study the following table carefully and apply the lessons it reveals to the unfolding global economic downturn and stock index peak. The oldest lesson in the book is: Sell all your stocks when the news is good right before a recession, go short, cover those short positions in the deepest depths of a recession and buy stocks again when no one wants to touch them and the news is terrible.
RECESSION RECESSION START END LENGTH LENGTH DJIA PEAK RECESSION PREVIOUS BEFORE (MONTHS) EXPANSION RECESSION (MONTHS) 23 21 67.77 13 33 96.37 24 19 100.53 23 12 94.15 7 44 89.07 18 10 119.62 14 22 105.38 13 27 166.64 43 21 381.17 13 50 194.4 8 80 161.5 11 37 190.19 10 45 293.78 8 39 520.76 10 24 685.47 11 106 968.85 16 36 987.06 6 58 903.84 16 12 1024.05 8 92 2999.75 8 120 11722.98 18 73 14164.53 15 45 DATE OF PEAK DJIA PEAK IN MONTHS BEFORE RECESSION -1 -5 -2 -4 1 -3 -2 -3 0 -3 0 -1 -7 -2 -4 -8 -1 -5 -3 0 -3 -2 -2.6 DJIA LOW DURING RECESSION 42.15 53 72.94 53.17 79.15 63.9 85.76 145.66 41.22 98.95 152.27 161.6 255.48 419.78 566.05 631.16 577.6 759.13 776.92 2365.09 8235.81 6547.05 DATE OF LOW % BEAR MARKET DECLINE -37.8% -45.0% -27.4% -43.5% -11.1% -46.6% -18.6% -12.6% -89.2% -49.1% -5.7% -15.0% -13.0% -19.4% -17.4% -34.9% -41.5% -16.0% -24.1% -21.2% -29.7% -53.8% -30.6% DJIA LOW IN MONTHS BEFORE NEXT EXPANSION -9 -7 -3 0 -1 1 -8 -12 -8 -2 -6 -4 3 -5 -3 -5 -3 -2 -3 -5 -1 -3 -3.9

OCT 1902 JUN 1907 FEB 1910 FEB 1913 SEP 1918 FEB 1920 JUN 1923 NOV 1926 SEP 1929 JUN 1937 MAR 1945 DEC 1948 AUG 1953 SEP 1957 MAY 1960 JAN 1970 DEC 1973 FEB 1980 AUG 1981 AUG 1990 APR 2001 DEC 2007

AUG 1904 JUN 1908 JAN 1912 DEC 1914 MAR 1919 JUL 1921 JUL 1924 NOV 1927 MAR 1933 JUN 1938 OCT 1945 OCT 1949 MAY 1954 APR 1958 FEB 1961 NOV 1970 MAR 1975 JUL 1980 NOV 1982 MAR 1991 NOV 2001 JUN 2009 AVERAGE

09-Sep-02 07-Jan-07 19-Nov-09 30-Sep-12 18-Oct-18 03-Nov-19 20-Mar-23 14-Aug-26 03-Sep-29 10-Mar-37 06-Mar-45 23-Oct-48 05-Jan-53 12-Jul-57 05-Jan-60 14-May-69 26-Oct-73 13-Feb-80 27-Apr-81 16-Jul-90 14-Jan-2000 09-Oct-2007

09-Nov-03 15-Nov-07 25-Sep-11 24-Dec-14 08-Feb-19 24-Aug-21 27-Oct-23 19-Oct-26 08-Jul-32 31-Mar-38 26-Mar-45 13-Jun-49 14-Sep-54 22-Oct-57 25-Oct-60 26-May-70 06-Dec-74 21-Apr-80 12-Aug-82 11-Oct-90 21-Sep-2001 09-Mar-2009

Belkin Report Introduction


There have been five major inflection points for the S&P500 and global markets over the past 12 years (risk on/risk off). The following pages provide a look back at Belkin Reports surrounding those inflection points and show what the report and model were forecasting a priori (without the benefit of foresight). Check the dates on the top right corner of each page to keep perspective on where each report appeared in the market cycle and glance back at the chart below for context. This brief, targeted intro does not cover all the detailed sector, group, stock and asset class forecasts included in each weekly report. It is simply a sample of the reports at the major inflection points over the past 12 years. S&P500
Peak: March 2000 Bottom: October 2002 (-49%) Peak: October 2007 (+102%) Bottom: March 2009 (-57%) Peak?: September 2012 (+117%) forecast peak

S&P500 2000-2012
Peak Mar 2000 Peak Oct 2007 +102% Peak Sep 2012? +117%

Bottom Oct 2002 -49% Bottom Mar 2009 -57%

Reports preceding the March 2000 Y2K tech bubble peak

BELKIN REPORT

1999 Belkin Limited All Rights Reserved

Sunday November 14, 1999

US Equities to Soar on Fed Y2K Credit Expansion?

e are switching stance on global equity markets. While we still expect this insane global speculative bubble to end in tears, the timing of that collapse has probably been extended into the new year by the Federal Reserves Y2K related credit expansion. The recovery from the September-October market decline has shifted the model forecast from down to up for most global stock indexes. So we humbly eat our hat with regard to the steep global stock market decline we were forecasting. The probabilities now favor a last surge higher before the bubble bursts.

The Federal Reserve is pulling out all the stops with regard to the year 2000 date problem (Y2K). FEDERAL RESERVE WILL BOOST CURRENCY SUPPLY IN PREPARATION FOR YEAR 2000. The Federal Reserve has devoted significant resources to ensuring that financial systems, including payment systems, will operate without disruption over the century date change. We are confident that our nation's financial system and its key infrastructures will be prepared for the century rollover. Although we do not anticipate that there will be major or prolonged difficulties accessing cash, the public may do its own contingency planning by holding extra cash during the century rollover period. In order to be prepared for such an occurrence, the Federal Reserve will be ready to issue more currency into circulation, when and if demanded by the public. This will be accomplished by asking the U.S. Treasury to print additional currency - just over $50 billion for domestic contingency and $20 billion for international contingency purposes. Under normal circumstances, the Federal Reserve holds approximately $150 billion in reserve, and we estimate that the substantially higher amount of currency available for the century date change will more than adequately meet demand. http://www.frbsf.org/fiservices/cdc/news4/page2.html#supply The Fed has also established an emergency lending facility and has reduced collateral requirements and sold options to financial institutions who might need access to emergency funding. CENTURY DATE CHANGE SPECIAL LIQUIDITY FACILITY. To the Chief Executive Officers of All State Member Banks, Bank Holding Companies, Edge and Agreement Corporations, and Branches and Agencies of Foreign Banks, in the Second Federal Reserve District: The Federal Reserve Board voted on July 20 to establish a Century Date Change Special Liquidity Facility, a program for lending to depository institutions from October 1, 1999, through April 7, 2000. The facility will help ensure that depository institutions have adequate liquidity to meet any unusual demands in the period around the century date change. Among other things, it should help enable institutions to more confidently commit to supplying loans to other financial institutions and businesses through the rollover period. The interest rate charged on loans from the special facility will be 150 basis points higher than the Federal Open Market Committees intended federal funds rate. Although the collateral requirements will be the same as for regular discount window loans, there will be no restrictions on the use and duration of loans from the special facility while it is in operation. Moreover, borrowers will not be required to seek funds elsewhere first. http://www.ny.frb.org/bankinfo/circular/11171.html The Feds Y2K credit expansion is showing up in the monetary aggregates -- while broad money growth is stalling out (M2 & M3), the monetary base is soaring at a 14% annualized rate (see chart). Seasonally, the Fed adds extra reserves in November and December to accommodate the US holiday spending cycle. This year Y2K concerns are causing an extra layer of monetary stimulus to be poured on top of the usual seasonal credit bulge. Fed money pumping has kept stock prices aloft despite their expired sell-by date. The extra year-end monetary stimulus is likely to send US stock indexes galloping higher -- like Mr. Ed on steroids. This projected rally has absolutely nothing to do with the fundamentals of the US economy or of the companies whose share prices could rise. Rather, the expected advance should simply be a knee-jerk reaction to an excessive liquidity injection. Greenspan emerges from this scenario with a multiple-personality disorder. Alan1 warns of stock market exuberance, Alan2 talks of fighting inflation and may even raise rates by 25 basis points this week, while Alan3 is busy pumping up the monetary base so markets float on a year-end ocean of liquidity. Meanwhile, AlanZero wrote 30 years ago of the 1920s Fed The excess credit which the Fed pumped into the economy spilled over into the stock market triggering a fantastic speculative boom ... by 1929 the speculative imbalances had become so overwhelming that ... the American economy collapsed. Alan Greenspan Gold and Economic Freedom 1966 So while Alan1 may soon protest the stock market excesses launched by Alan3, Alan2 can preserve the Greenspan legacy by quoting AlanZero. This guy needs therapy -- and so does the US public after his negligent stewardship of the Fed, which has inflated a crazy speculative casino mentality. While we must acknowledge the probability of a last US market surge, we criticize its author -- the Federal Reserve Chairman and his schizophrenic personality. The man is sick. America needs detoxification from the casino speculative frenzy that Greenspan has worked so hard to cultivate.

BELKIN REPORT

1999 Belkin Limited All Rights Reserved

Sunday November 21, 1999

PRINT ME 496 BILLION DOLLARS AND ILL SHOW YOU A GREAT TIME
eve completely revised our 4th quarter outlook -- primarily due to a mind-boggling potential $496 billion Fed credit expansion. We watch Fed policy like a hawk and when the monetary base growth rate took off like a rocket several weeks ago, we investigated and discovered the mechanics of a massive mindless monetary expansion -designed to thwart a mostly non-existent public panic over Y2K. Dont be deceived by last weeks Fed rate hike -- the Fed is currently conducting the most extreme increase in the monetary base in history! This credit expansion utterly discredits the mechanism by which the Fed operates -- Reserve Targeting. In Reserve Targeting, the Fed is supposed to enforce an artificial Fed funds interest rate by monkeying with the supply of credit. A higher Fed funds rate implies a reduction in Fed-supplied credit. So when the Fed raises the Fed funds target while simultaneously increasing the credit supplied to the market -- it is violating the principles by which it operates. This also breaks the fundamental rules of economics -- a higher quantity of money is being supplied at a higher price. Wouldnt corporations love to be able to do that with their products? The increase in credit supplied by the Fed consists of this: $70 billion of new currency and $426 billion of repo options for a current total of $496 billion. Repo options never existed before, they are a new Y2K creation. Those repo options havent been activated yet, so $426 billion of that $496 billion is still in the bullpen. But put yourself in the shoes of a government securities dealer. Youve purchased cheap Fed-supplied financing insurance so you have no year-end rollover risk for your balance sheet. Furthermore, the Fed has loosened collateral requirements for open market operations and discount window borrowing from strictly government securities to investment grade CDs, commercial paper and deposit notes; AAA-rated collateralized bond obligations, collateralized loan obligations, and commercial mortgage backed securities (why not beanie babies and baseball cards?). At the margin, dealers will be breathing easy and reaching for yield rather than deleveraging. This is extremely stimulative to financial markets. The repo options dont appear on the Feds balance sheet so they are an off-balance-sheet derivative monetary boost. This all adds up to the biggest Fed credit expansion ever. This monetary boost is wildly stimulative for the US equity market in the short-term, but will leave equities painfully vulnerable to a crash once the Y2K-related credit expansion is withdrawn in the new year. Greenspan is pumping up the biggest speculative bubble in US history to a higher-altitude bursting point. So far, we are alone in recognizing the magnitude and implications of the Feds Y2K credit expansion. Most money market economists who track Fed policy are oblivious of the equity market impact of credit expansions. And most equity market strategists dont scrutinize the monetary aggregates and Fed policy changes closely enough. The lead story in this weeks Barrons is about declining liquidity threatening the equity market rally. What a joke. The exact opposite is happening. The Fed is pumping up high-powered money at the highest rate ever. That liquidity isnt going into production, it is going into financial market speculation. By freaking out now over Y2K, the Fed is creating a much bigger problem later. So while monetary over-stimulation and our models forecast point higher for stock indexes over the next several months -- the Greenspan-inflated bubble carries the seeds of its own destruction. But first, conservative value investors and short-sellers are likely to be frustrated. Group rotation for the next several months should favor mainly a handful of Internet and Technology stocks -- and a few Financial merger targets such as mid-sized Brokers and Mutual Fund companies. The average US stock should continue to underperform in a narrow speculative bubble advance. But the expanding US bubble should drag up other global markets. The model is now long European equities, emerging markets such as Mexico and Brazil and global bonds. While it may be futile to resist a liquidity-fueled rally over the next several months, investors should keep their perspective -- rather than a healthy, sustainable bull market, this is a dangerous speculative bubble blow-off rally created by misguided monetary over-stimulation. The US equity market is insanely overvalued and the Internet leadership (which we are long) lacks meaningful revenues or earnings. But with the Fed pumping money like a drunken sailor, the probabilities favor a year-end equity market surge. Given that the risk is to the upside into the new year, a reasonable game plan is to participate cynically, keeping one eye on the door. If modern society and the financial system somehow survive the Y2K date rollover without descending into gridlock -- and all the Feds money-pumping turns out to be overkill, then we will have a lifetime selling opportunity in a couple of months when all the excess liquidity begins to drain off. For now, the bubble has afterburners courtesy of the Fed.

You Are Cordially Invited To The

GREENSPAN MILLENNIUM MELTUP Y2K PARTY!


Stardate December 31, 1999
Location: USS Bubblemania -- Broad & Wall St.

US MONETARY BASE GROWTH RATE 1951-99


27%

3 MONTH ANNUALIZED GROWTH RATE

Alan Is The Man With The Plan:


$70 Billion of New Currency Printed Especially for the Bash -So America Doesnt Run Out of Dough When the Lights Go Out on Y2K Who Cares if Theres a Crash Next Year?

Lets See How High We Can Take This Puppy Before She Bursts!
Free IPOs -- Everyone Is On The List Anything Goes in This Cyberspace Mania Everyone Can Be A Billionaire

RSVP: Fed Board of Governors, Washington DC


December 12, 1999 Belkin Limited All Rights Reserved

BELKIN REPORT

1999 Belkin Limited All Rights Reserved

Sunday December 12, 1999

What Is Fueling This Madness? Fed Chairman You-Know-Who.


... we do have a new candidate group for a last blow-off rally. Are you ready for this? Internet leaders ... No, we are not joking. We now cover our short Internet positions and go long those names looking for a final blow-off rally ... No guarantees, but thats what the model says the probabilities favor. Watch out for being short Internet ... What could be a more perfect conclusion to a berserk bubble than a rally in the most speculative segment of the market (that short-sellers love to hate), while the market and broadly-owned groups decline? That is Bubble Dynamics 101. Dont blame us if it happens, we are simply trying to anticipate the process for the benefit of those who must endure the day to day (or quarter to quarter) oscillations in industry group rotation. Belkin Report September 12, 1999 (three months ago)

IIX INTERNET STOCK INDEX 1998-99

What is fueling this madness? Fed Chairman you-knowwho. When news of the Fed Y2K Century Date Change Special Liquidity Facility began appearing in late summer, we assumed the credit expansion was something they would hold in reserve (to respond to any potential future problem). But when the monetary base started going through the roof in early November, we realized that the Fed was pumping money into the system preemptively -- like a fire department pumping water on every house in the city beforehand in case there might be a fire. Such a policy waters the plants. In this case the watered plants are Internet stocks. From that perspective, the entire internet stock mania (which weve been cynically on board) might be interpreted as a knee-jerk reaction in the most speculative sector of the market to an irresponsibly stimulative Federal Reserve credit expansion. The rush to finance unprofitable Net businesses (whose only reason for existence is to cash in on a soaring share price), wouldnt exist if liquidity wasnt being rammed up the financial systems rear end by Greenspan & Company. The revered figure who warned so long ago of irrational exuberance is now hypocritically fanning the flames of wild speculation in the equity market with the biggest credit expansion in the history of the Fed. So while we are still long internet stocks and global stock indexes, it is only because the bubble is still inflating on Fed money pumping and we cant fight City Hall. But the handwriting is on the wall. When this credit bubble deflates sometime early next year -- most 1999 investment stars will become turkeys. The raison dtre of the speculative bubble will vaporize. The only question is when. Some of the Feds Special Liquidity Facility arrangements run through April 7, 2000. We plan on watching Fed Open Market Operations like a hawk starting in January. When the Fed starts draining surplus liquidity, the bubble should quickly deflate. Ultimately, the Fed has made its end-of-cycle tightening job tougher by pumping in all this surplus liquidity now. Economic distortions (wage pressures?) should arrive with a lag (as they always do after excessive credit creation) and force a tighter monetary regime next year than would otherwise be the case. So watch out for the hangover after Greenspans Millennium Meltup Y2K Party.

Go Long Internet Stocks Sep. 12, 1999

The IIX Internet Index has advanced 73% since those comments appeared here and that group began topping our long list. An Internet mega-rally hardly seemed likely at the time -- the group was then snoozing (see chart). We went from short to long at the inflection point indicated on the chart with great trepidation simply because the forecast of our model turned positive. We are not exactly renowned for our boundless optimism with regard to the US equity market -- but the discipline of our model forced us to buy the most ridiculously overvalued sector in a bubble -- just before it almost doubled. We probably dont need to remind you that most bears missed this boat completely and even most prominent bulls are skeptical and totally missed the Internet rally.

Reports (and WSJ article) at the March 2000 Y2K tech bubble peak

The Global Player -- WSJ Interactive Edition

wysiwyg://351/http://interactive.wsj.com/articles/SB955048962134036656.htm

[The Global Player]

April 7, 2000

Bu A who suddenly host of re But whic work? Sp

The Global Player

In this Section: World-Wide Asia Europe The Americas Economy Earnings Focus Politics & Policy Editorial Page Leisure & Arts Voices Weekend Journal.

This Forecaster May Be Brash, But Belkin Is a Model Fellow


By MICHAEL SESIT
Staff Reporter of T HE WALL STREET JOURNAL

Execu spread of for Intern resonates brick-and boardroo companie "special o employee

LONDON -- Michael Belkin sees a lot of "C.R.A.P." out there. He's not just being vulgar; he thinks there are entirely too many listed "companies without revenues and profits." Sounding like the fifth rider of the Four Horsemen of the Apocalypse, Mr. Belkin warns that the Nasdaq 100 index could fall another 60%, Germany's Nemax 50 another 62%, the Dow Jones Stoxx euro-zone tech sector 63% and the U.S. IIX Internet index another 66%.
Ad

Michael who? Mr. Belkin is president of Belkin Ltd., a one-man New York firm that uses quantitative computer models to forecast financial-market trends. George Soros, he isn't. But Mr. Belkin's clients include hedge, mutual and pension funds, proprietary trading desks of investment banks and some very wealthy individuals. What's more, his recent predictions have been on target. "He was looking for a strong rally in Nasdaq in the first quarter and it happened," says John Hickling, a partner at Liberty Square Asset Management in Boston. "He was the first one that I know of to identify the Y2K monetary boom at the end of last year, and it would appear that he's been very right on his call on the technology-sector correction." On March 2, Mr. Belkin spoke at a lunch sponsored by Instinet at the Paris Stock Exchange. His message: Stock markets could halve. His advice: Unload technology shares and buy government bonds. He was two weeks early. "But I'll never get it to the day," says the 46-year-old geek who cut his teeth designing computer-driven strategies for Salomon Brothers' traders.

1 of 3

04/06/2000 10:19 PM

The Global Player -- WSJ Interactive Edition

wysiwyg://351/http://interactive.wsj.com/articles/SB955048962134036656.htm

And it isn't just New Economy stocks that adorn his hit list. Mr. Belkin sees the S&P 500 falling 29%, Finland's HEX index 66% and markets in Germany, France, Italy, Sweden and Spain by 30% to 40%. Behind these dire forecasts sits what insiders call a "threshold" model which, combined with analysis of the 200-week moving average of different financial assets, seeks to identify turning points in stock, bond, currency, commodity and emerging markets. "When a market gets to an extreme deviation from its mean, it tends to revert to that mean," explains Mr. Belkin. "A speculative bubble is an extreme deviation from long-term trend, and a crash or correction is simply a reversion to a mean." Basically, Mr. Belkin tries "to supply a probability matrix that people can factor into their own asset-allocation strategies." Want a history lesson? In 1929, the Dow peaked at 83% above its 200-week average; in 1987, it was 72%. In 1989, Japan's Nikkei peaked at 51%; in 1997 the Hang Seng crested at 57%. The average of the four pre-crash bubbles equals 66%. Now get a load of this: The HEX is 190% over its 200-week average; the Swedish General 78% over; the French CAC-40 is 70% over; and the DAX is 61% above. Oh, it's sectors you want? The Nasdaq 100, IIX and U.S. SOX semiconductor indexes are, respectively, 150%, 195% and 200% over. The STOXX Euro-zone technology sector is 169% over. Its U.K. equivalent is 147% over. Mr. Belkin blames the U.S., Japanese and euro-zone central banks -- which he calls "the three blind mice" -- for these stretched valuations. All three pumped out billions to deal with potential Y2K glitches. "But there was no Y2K problem; so they totally screwed up and printed a bunch of money for no good reason," says Mr. Belkin. "That money spilled over into financial markets and ignited a huge financial boom." What follows? A bash, of course. In December 1999, Mr. Belkin sent clients a mock New Year's Eve invitation: "You are cordially invited to the Greenspan Millennium Meltup Y2K Party!" Location? U.S.S. Bubblemania, Broad and Wall Streets. Trust a guy who once played guitar in Los Angeles bars for a living and whose college graduation speaker was Ivan Boesky? "The weekly Belkin Report provides a valuable, contrarian view of the global equity, debt and currency markets, and very useful macro charts of global markets," says Steven Schoenfeld, head of international equity strategies at Barclays Global Investors. He

2 of 3

04/06/2000 10:19 PM

The Global Player -- WSJ Interactive Edition

wysiwyg://351/http://interactive.wsj.com/articles/SB955048962134036656.htm

thinks the views can be extreme and sometimes quite wrong. "But he has had enough good calls to make his work valuable. When you're inundated with sell-side research, it is vital to get diverse views of the markets as a counterbalance." Yes, there have been times when Mr. Belkin has missed the side of the proverbial barn with a howitzer. His worst call: getting the October 1987 crash wrong. He waxed bearish when the market peaked in August but expected it to rally to new highs after a 10% decline. "Then it crashed in my face," he says. "But I learned something: that I had to develop a model that incorporated risk-controls, which is this model." Believe it or not, the bear does recommend buying a few things, such as Italian, Spanish, French, German and U.S. government bonds. And relative to others, he likes the Irish, Swiss and U.K. stock markets. In Europe, he favors the energy, insurance, health-care, utilities and food and beverage sectors. In the U.S., it's oil, insurance and retail food and discount stores. Right now, it seems, the black-box model has a safety latch. Questions or comments? Send e-mail to michael.sesit@wsj.com

Return to top of page | Format for printing Copyright 2000 Dow Jones & Company, Inc. All Rights Reserved.
&RS\ULJKW DQG UHSULQW LQIRUPDWLRQ

3 of 3

04/06/2000 10:19 PM

BELKIN REPORT

2000 Belkin Limited All Rights Reserved

Sunday March 5, 2000

The Vogue of Reckless Promotions and the Development of Downright Fraud


S economist Irving Fisher described the degeneration of speculative bubble psychology as ... a) the lure of big prospective dividends or gains in income in the remote future; b) the hope of selling at a profit, and realizing a capital gain in the immediate future; c) the vogue of reckless promotions, taking advantage of the habituation of the public to great expectations; d) the development of downright fraud, imposing on a public which had grown credulous and gullible. Econometrica, Journal of the Econometric Society, Volume 1, 1933. Fisher was writing in 1933 about the excesses of the 1929 speculative bubble. But he failed to recognize the speculative excesses before the crash happened -- given his infamous September 1929 declaration of a permanent plateau of prosperity. We suspect that many current market participants will soon undergo a similar involuntary transformation (like Fisher) from wealthy, reckless and complacent bubble people -- to poorer, chastened and revisionist victims of a market collapse. Current financial industry practice is descending deeply into Fishers final phase of downright fraud. Does anyone really believe that the crop of companies now going public will ever be profitable businesses? Even hotshot Merrill Lynch Internet analyst Henry Blodget now predicts that 75% of all Internet companies will disappear within five years (Barrons March 6, 2000). Lets face it -- the marvelous technological development of the Internet has been hijacked by a gold rush mentality. The successful Internet business model consists of taking venture capital and IPO money and getting the hell out of Dodge before the locals wake up and notice they have been swindled. Internet business models depend on burning constant infusions of cash to fund orgies of advertising to establish brands. Its reminiscent of the Japanese or Korean business models of overexpansion and devotion to market share at the expense of profitability -- business models which led to the collapse of the Japanese and Korean markets and economies. Weve seen the cycle turn in other industries that relied on boom-time infusions of capital to support uneconomic endeavors. Ultimately, the spigot of speculative finance runs dry and the companies go broke. Gold exploration companies spring to mind as prime examples of this process. Another great example is Iridium -- the satellite communication provider which is now a hairsbreadth from bankruptcy. Iridium raised billions of dollars to build a clumsy and expensive communications system that customers didnt want. Now the company is running out of operating capital and cant raise new funding. Such is the fate of ill-conceived technological businesses that burn cash and have no realistic prospects of profitability. Iridium is a poster child for the Internet business model. How many other Iridiums are lurking out there in Internet land? Amazon certainly springs to mind. We suggest the entire Internet speculative bubble phenomena should be christened The Iridium Market. Cash burning and insider share awarding business models are irridiating whatever glorious prospects the Internet might provide. Watch for a backlash from the 24/7 generation X crowd when their employee shares and options go up in irridiated smoke. The fraud component of the current speculative mania consists of this: Unprofitable companies are unsuitable investments for all but the most reckless of investors -- and fund management companies which lower their standards and pack their portfolios with the shares of such money-losing companies are violating their fiduciary responsibilities to their shareholders. Thats an easy line to cross when the entire financial industry is urging such behavior and the stock charts of such entities are soaring. But the end of that game is approaching and fund managers will ultimately be left holding such shares in a plunging, no-bid environment. And public sentiment (as it always does after a collapse), will blame the financial industry for improper investments in unprofitable and unproven companies. Such is the glorious future of the Iridium Internet market.

BELKIN REPORT

2000 Belkin Limited All Rights Reserved

Sunday March 12, 2000

Companies without Revenues And Profits -- C.R.A.P.


ust about the only stocks still rising recently in the US and European equity markets have been C.R.A.P. stocks -Companies without Revenues And Profits. In an extraordinarily shrewd and sophisticated asset allocation shift, the public is redeeming its old economy broadly diversified funds and index funds -- and is plopping that money down into the most promising investment sector of the new economy -- C.R.A.P. The effluent from this process is driving the broad market lower, as conservative mutual funds flush out old economy stocks to meet growing redemptions from investors who are switching into C.R.A.P. mutual funds and C.R.A.P. stocks. The new economy portfolio managers who are getting the massive inflows from the investing public, take those funds and buy more of the same C.R.A.P. -thereby pushing up a slim segment of the market. Of course cash-flow, business franchise, products and profitability are handicaps in the world of C.R.A.P. investing -- which prizes multi-billion dollar market cap, minuscule revenues and massive operating losses (growing at a geometric rate) above all else. But new economy investors might be stepping into something soft and squishy that wont wipe off their investment portfolios so easily. Novice investors in financial diapers will no doubt be shocked when the C.R.A.P. hits the fan at the imminent conclusion of this speculative bubble. Because (after all) Companies without Revenues and Profits are simply overvalued C.R.A.P. In all seriousness, industry group rotation in the US, UK, Eurozone and Japan is the most schizophrenic we have ever seen. Most stocks and groups are plummeting, while that small handful of C.R.A.P. stocks levitate. This is absolutely unprecedented. A last burst of frenetic speculative bubble fervor has coaxed hapless investors and portfolio managers into the stocks with the greatest downside risk -- just as markets roll over. While serious money is indeed being made in the worst C.R.A.P. at the moment, our model suggests that window of opportunity will soon slam shut. Lets take several steps back and consider how markets got to this present perilous position. European, US and Japanese central banks conducted an aggressively accommodative monetary policy over the past several years. In the US, the Federal Reserve cut interest rates in late 1998 to massage financial markets after the Russian default and subsequent LTCM Meriwether fiasco. Then in late 1999 the Fed created $100 billion of new high-powered credit to thwart the forecast Y2K computer gridlock meltdown risk -- which never materialized. Examine the record and the Fed has screwed up -- printing a lot of excess money for no good reason and thus fanning the flames of speculation in securities markets (of which Greenspan is fond of criticizing). That Y2K excess credit the Fed provided is now gone (expired tri-party repos) and so is the US markets justification for being at this crazy level. But investor over-confidence is sticky -- easier to stimulate with a round of excessive credit creation than to turn off with a credit tightening. In Europe, European Monetary Union was conducted at the lowest possible interest rate in early 1999 -- and the European Central Bank (ECB) has since dragged its feet at raising interest rates to a more normal level that a free market might set. Not coincidentally, the Euro has weakened and Eurozone equity markets have soared. Meanwhile, Japan has maintained a zero interest rate, BOJ fund surplus monetary policy that has kept Japanese financial markets swimming in liquidity. And Japanese stock prices went up -- surprise, surprise. So all three major global monetary regions have pumped up liquidity (and by extension equity markets) excessively over the past several years. That is where the bubble in front of our faces comes from. The monetary over-stimulation fostered the pathetic parody of capital markets celebrating new economy C.R.A.P. stocks as if they were legitimate businesses. The central bank monetary stimulation propelled US and European stock indexes to record deviations above long-term trend. If a bubble is defined as excessive deviation from long-term trend, then a post-bubble correction can be defined as reversion to the mean. We use the 200 week average as a measure of long-term trend. Previous great bubbles (1929 DJIA, 1987 DJIA, 1989 Nikkei, 1997 Hang Seng) peaked an average 65% over their 200 week averages (range 51% to 83%). The Nasdaq 100 now stands 200% over its 200 week average, Finlands HEX index stands 240% over its 200 week average, for the French CAC40 its 84%, Italian MIB30 its 82% and German DAX its 77% -- all much greater than or equal to maximum deviation from trend at previous great speculative bubble peaks. The 200 week average becomes a downside target when a bubble bursts, since all of the major bubbles weve studied reached the vicinity of that level in the post-bubble correction. The 200 week average gives downside targets 66% below current levels for the Nasdaq and 40% to 70% below current levels for most European stock indexes. While the bubble was still expanding, it was appropriate to participate in the so-called bull market -- and we did. Excessive deviation from trend became more excessive. But now our forecasting model suggests the risk has shifted to the downside. It is mean reversion time. Major equity markets could halve. We recommend that portfolio managers switch out of stocks and into bonds, which now have a rally forecast from our model. Its time to be defensive and not get buried in the collapse of overvalued C.R.A.P.

BELKIN REPORT

2002 Belkin Limited All Rights Reserved

April 7, 2002

Buying Into a Bear Market

ortfolio managers should be extremely cautious. Most information sources are pumping happy tunes about the course of financial markets and the economy -- like insipid elevator music. CNBC has become a showcase of affirmative action -- smiling bimbo faces without a clue of what is going on dissecting and analyzing every twist and turn of the Nasdaq for the benefit of viewers. This would be hilarious if it wasnt so pathetic. The point is not to be optimistic or pessimistic -- it is to analyze the situation correctly and develop a realistic scenario about where the economy and markets are headed. How can you tell where you are going if you dont know your current position? Most investors do not seem to recognize where equity markets now stand. As we have pointed out repeatedly, global stock indexes broke multi-decade uptrends last year. It is not a long-term bull market anymore. That one simple fact seems to escape almost everyones attention. Most stock indexes are now decisively below their 200 week averages. That is the definition of a long-term bear market. This is a real simple and easy-tounderstand way to classify bull and bear markets, developed after studying a century of data. We have previously used the Japanese Nikkei Average example -- the Nikkei remained above its 200 week average for 24 years before 1990, traded below its 200 week average in 1990 and has been below that 200 week average for most of the last 12 years. Using the 200 week average as a reference point would have kept you in the Japanese bull market from 1966 to 1990 and out of the Nikkei bear market from 1990 to the present. Another example is the DJIA during the 1920s and 1930s. The DJIA traded above its 200 week average in March 1922 and remained above it for eight years during the roaring 1920s (+170%). The DJIA crossed below its 200 week average in 1930 and then collapsed 81% from that level. Using the 200 week average as a reference point would have kept you in the US bull market of the 1920s and out of the DJIA bear market 1930-1932 during the Great Depression.

The S&P500 and other global stock indexes are now in a position analogous to that of the DJIA in 1930 or the Nikkei in 1990. The S&P500 was in a long-term bull market for 26 years (1976-2001) while it remained above its 200 week average. Now it is decisively below its 200 week average and is in a long term bear market (as are the DAX, CAC, FTSE, MIB, etc.). Given our analysis of the S&P500 and other global stock indexes, it is bizarre to observe the continued propensity of investors to throw money into the stock market. They obviously dont realize they are enthusiastically buying into a long term bear market (not a rewarding strategy). We hope our clients do not get sucked into the same trap. There are significant 3-4 month rallies within long term bear markets and we are dedicated to spotting those opportunities. There is little chance of any significant rally currently. The S&P500 is at the same level it was last November -- five months of no progress while the Wall Street hype machine has been running full blast. We are adding the S&P500, DJIA and other US stock indexes back as shorts this week. The next significant move should be down -- and since this is now a long-term bear market, downside risk is extreme. Our recommendation is to minimize equity market long exposure and to confine it to value stocks (low price/book ratios) and oil shares. The greatest downside risk remains in tech and growth stocks. Retailers, homebuilders and airlines also appear vulnerable. Elsewhere, the model looks for a further rally in crude oil, a rise in US interest rates and a slump in the US Dollar. Our best sectoral rotation advice remains to be long value and short growth -- globally. As in Japan during the 1990s or the US during the 1930s -- stocks are likely to lead the economy south. The corporate earnings rebound touted by Wall Street should prove to be a pathetic mirage. Stocks are insanely overvalued without that earnings rebound. The excesses of the bubble didnt develop overnight -- and likewise will take years to work through. Strategically, this is a trading market for equities (not a buy and hold market) and the next significant move should be lower.

BELKIN REPORT

2002 Belkin Limited All Rights Reserved

June 23, 2002

Target: 800 level for the S&P500


There is an overhang over the market of distrust ... The business world must clean up its act. People have got to have confidence as to whether or not the assets and liabilities are good numbers." US President George Bush "I don't know why markets are where they are today ... Eventually (stocks) will go back up, perhaps sooner than later. There is an unbelievable movement in the market without what I believe to be substantive information." US Treasury Secretary Paul O'Neill

realistic target for the current US equity market decline is the 800 level for the S&P500 -down 20% from here. The Nasdaq could probably fall twice that much in percentage terms (1000 level for the Nasdaq Composite). European stock indexes and the Nikkei Average could also fall more in percentage terms than the S&P500. This is all with a three month view, although it could happen sooner. If that sounds like an overly harsh and pessimistic outlook, perhaps you have not recognized that global equity markets are in a long term bear market. Classifying long-term bull and bear markets is a simple matter, although no one else seems to do it (cant be bothered to study market history?). The definition of a long-term bull market is: A stock index remains above a rising uptrend (we use 200 week average, regression line also works). During long-term bull markets (decades), shorter-term advances during business cycle expansions (2-4 years duration) rise to moderate deviation from long-term trend (20% to 30% over 200 week average). Then short-term declines during recessions (1-2 years duration) reach the vicinity of the 200 week average. Then the next mini-bull market begins (as long as it is still a long-term bull market). See charts. This pattern repeats for a number of cycles (say 2 decades) and culminates in a bubble -- excessive deviation from trend (65% over 200 week average for the S&P500, 200% over 200 week average for the Nasdaq 100 in March 2000). In the bubble crazy things happen. Fed Chairmen dance jigs and celebrate productivity miracles. Corporate CEOs commit fraud. Auditors cover it up. Capital is directed into crazy unprofitable schemes that go up in smoke. Wall Street analysts issue 99% buy recommendations and 1% sell recommendations. Brokerage house strategists have perpetual 25% higher targets for stock indexes and earnings growth. Investors throw money into the bubble like drunken sailors. Portfolio managers have to buy into the bubble or lose their jobs. Valuations get insane. Brokers concoct ridiculous excuses to justify overvaluation (forward consensus earnings estimates). Then the bubble bursts. The first decline drops to the 200 week average vicinity, like a normal mini-bear market in a long term uptrend. But after a short-bounce on the 200 week average, the post-bubble stock index then drops significantly below the 200 week average, the average rolls over and the long term trend turns down. Instead of leading the 200 week average trend higher, the index leads the average lower. Long term bear markets last for years. Think Nikkei 1990 or DJIA 1930 (see charts). The definition of a long-term bear market is: A stock index remains below a declining downtrend. US and European stock indexes are at such a juncture. The long term trend changed from up to down last year. The two-decade-long uptrend culminated in a massive bubble and the bubble has burst. Now equities are in the liquidation phase.

In the long-term uptrend, buy-and-hold was the winning strategy. Academics wrote theories about passive investing and won Nobel prizes for it. Pension funds adopted those theories and positioned accordingly. In a long-term downtrend, buy-and-hold is a ticket to the poor house. The rules are reversed. No more magical compounding of gains into further gains on a larger base. Now it is constant erosion of capital. Companies go bust and their share prices go to zero. A long-term investor should be long the market during the long-term uptrend and completely out of the market (or short) during the long-term downtrend. But the investment industry expanded aggressively during the bubble and most portfolio managers have to manage long exposure in a downtrend -- without having the skill-set to do so. The bull market toolbox didnt include any gadgets for managing downside bear market risk. So most managers (and long-bias hedge funds) could gradually vaporize, as did portfolio managers in Japan over the past decade -- or as did investors in the US during 1930-1932. The alternative is to recognize that the rules of equity market investment have changed. The longterm downtrend can be an excellent trading environment. Timing the market is essential to survival (what academic theory rejects and says is impossible). Bear market declines and advances tend to come in 3-6 month chunks (30%-60% moves up or down). Staying long through a down move of that length and intensity can be a career-ending strategy. Likewise, staying short (or un-invested) through a bounce like that is unbearable. Bear market psychology is brutal -- the pressure is to buy at the top before the next big drop (like semiconductors and autos 2 months ago) -- and to sell because of redemptions at the bottom (2-3 months in the future?). We are dedicated to capturing these bear market rallies and declines. Obviously we wont be perfect, but the model does show the probability of significant and extended market moves up and down. The model forecast now points strongly down, three month view. Markets have shorter swings within extended uptrends or downtrends. With the model forecast pointing down, we recommend taking advantage of any 1-3 day rallies (created by intervention, shortcovering, or simple volatility) as a gift selling opportunity. Selling into panic liquidations should be avoided. If stock indexes are to drop 20%-40% from here (as the model forecast suggests), then selling into brief rallies is the best way to protect yourself. Government officials, central bankers and corporate leaders are following a classic script (see quotes at beginning of this report). It is their role to issue reassuring statements while the market drops and the economy falters. In that light, expect to hear more official statements like: Stock prices have declined more than the fundamentals warrant. A recovery is just ahead. ... The strength of the US economy is intact. The stock market decline will not impact the real economy, which is thriving. ... The underlying fundamentals of the US economy are sound. Production and employment conditions should remain strong, despite this irrational stock market decline. ... The Dollar remains a strong currency and the recent decline is just a little blip in an uptrend. ... Investors have panicked for no reason. Common stocks represent good value at current levels. ... Recent corporate scandals have improved the outlook by removing bad apples from the barrel. Corporate executives are honest citizens and havent abused the system or enriched themselves excessively at the expense of shareholders. ... This stock market decline is senseless. Investors should calm down and accumulate shares in stable, growing businesses -- which represent the strong future of the US economy. ...

Reports near the October 2002 liquidation bottom

BELKIN REPORT

2002 Belkin Limited All Rights Reserved

November 17, 2002

Turnaround
e switch from short to long on global stock indexes this week. Industry group recommendations also reverse -- outperform prospects for the US and Europe are now mainly tech and telecom, while underperform prospects are now mainly banks and cyclicals. This is obviously a big change (hope you dont get whiplash). We have recommended being short stock indexes and tech since April 14th. Our global composite stock index is down 22% since then. We rode out several snapback rallies on the short side in those seven months, but the model forecast has changed. Long term bear markets can have significant rallies. We had thought that this latest rally (starting October 9th, now six weeks old and up an average 13% for global stock indexes) would fade like the July-August rally did. It didnt. That changed the model forecast. Also, the model forecast for industry group rotation has completely reversed over the past several weeks. Conservative groups that have worked so well as outperformers in relative terms are now forecast to be underperformers. Yet the forecast in absolute terms for those groups is up. That suggests a rising market (conservative groups rise less than the index in an uptrend). Meanwhile, the only groups the model can identify as having outperform potential are tech and telecom. The forecast there is up in relative and absolute terms. That is typically bullish for the market (high beta names outperform in an uptrend). Drilling deeper, the stocks within US tech groups with a higher forecast relative to their groups are mostly lower quality names (Sun Microsystems, Rational Software, etc.). Not the Microsofts and Intels of the world. That suggests a miserable market rally for most sensible investors. At this point (2 1/2 years into a bear market), tech has more than halved as a market cap weighting in indexes -- while banks and cyclicals have more than doubled. Our forecast suggests that closet indexers (most portfolio managers) will soon underperform on their largest weightings (financials, cyclicals and consumer products), while they watch lowweighted and low quality tech stocks lead a market rally. Ouch. Hedge funds that short tech companies with lousy fundamentals already feel the pain, but it seems garbage will continue to lead the rally. So most longs and shorts should together be unhappy campers. How could a potential market rally be such a painful experience? Only in a bear market. While it might be possible to make money on the long side in the projected rally -- most conservative funds should underperform and get squeezed into bigger tech positions before the next bear market collapse. Our model rally forecast has a 2-3 month time horizon. We will be watching closely for a signal to close longs and go short again. Positive end-of-the-year seasonal factors are related to Federal Reserve money creation. They expand their balance sheet and create new money so the system is awash in cash during holiday shopping season. That balance sheet expansion just started. It can spill over into financial markets (like the Y2K Fed credit expansion event) and generate irrational stock market rallies. Other big model forecasts currently are: 1) A renewed decline in the US Dollar, 2) A renewed downturn in the US economy. Does it sound weird to forecast an equity market rally in the face of such sick fundamentals? Yes. But we dont run the asylum. We just try to stay out of the path of the stampeding inmates.

BELKIN REPORT

2002 Belkin Limited All Rights Reserved

November 24, 2002

Trend Analysis and Model Forecast Suggest Further Rally Ahead

tock indexes are probably poised for substantial gains over the next 3-6 months. This bear market rally should be bigger than any bounce of the past 2 1/2 years.

Stock indexes are mean reverting processes over the long term. Two examples are the Nikkei Average (1968-1990) and S&P500 (1976-2000). Each index was in a long-term uptrend during those periods. A 200 week moving average is a way to analyze trends. Stock index long term uptrends remain above rising 200 week averages. During long-term uptrends (decades), stock indexes typically begin rallies from the vicinity of the 200 week average, often starting during a recession before any economic rebound is evident. The rally continues for several years, pushing the stock index to a minor deviation from trend (200 week average). After a several-year-long rally, the stock index peaks and declines back to the vicinity of its rising 200 week average (usually during a recession). That pattern repeats over and over during a decades-long uptrend -- up three years, down 1 year, or endless variations of that pattern (see next chart page). What investors perceive as bull markets (3-4 years) are simply upward deviation from trend -- and what investors perceive as bear markets (1-2 years) are simply reversion to mean, during a decades-long uptrend. At the end of a decades-long uptrend, bubbles develop (1929 DJIA, 1989 Nikkei, 2000 Nasdaq). Stock indexes go to greater (and unsustainable) percentage deviation from trend. Market participants get careless. Remembering only the long-term uptrend of the past many years, they throw caution to the wind. Go-go mutual funds advertise 25% annual returns for the past five years. The financial industry prostitutes itself. Stock analysts hype companies they despise for the sake of their year-end bonus. Prominent strategists invent Mickey Mouse valuation models to rationalize the markets overvaluation and feed the bubble frenzy. Companies with half-baked business models are showered with IPO and private equity capital. Governments reap capital gains tax windfalls and think budget surpluses will last forever. Then the bubble bursts. In the first decline, the stock index drops to its 200 week average (just like in the long term uptrend). But this time (after a bounce), the index drops decisively below its 200 week average, for the first time in decades. The 200 week average rolls over, led lower by the index below. Now it is a long-term bear market -- the exact opposite of the previous experience. Trend deviation is to the downside (in market collapse phases) and mean reversion is back up to the declining 200 week average (in bear market rallies). Consider the Nikkei example. After breaking below its 200 week average (in 1990), the Nikkei plunged 46% below the 200 week average when it bottomed (temporarily) in August 1992 (2 1/2 years into its bear market). The level at which the Nikkei ended its initial 2 1/2 year collapse phase was near its 200 month average (see chart -- 14800, August 1992). The principle of trend deviation and mean reversion applies in the much-longer term monthly periodicity as well as the weekly periodicity. When the Nikkei reached its 200 month average, it stabilized and had a 42% rally over the subsequent year. Guess where that rally ultimately reached? The declining 200 week average. Simple concept. Trend deviation gets extreme to the downside in a bear market decline, the index bottoms near its 200 month average -- and the subsequent bear market rally reaches the declining 200 week average. The Nasdaq and European stock indexes reached their 200 month averages in early October (see charts). At that point, The Nasdaq was 56% below its 200 week average and the Dax was 52% below (versus 46% for the Nikkei at its 1992 bottom). That October 2002 low for European and US stock indexes is similar to the Nikkei low of August 1992, which signaled the end of a plunging market and the beginning of a trading range marked by substantial rallies. The model forecast now points up (intermediate and long term) for the Nasdaq, tech industry groups and most global stock indexes. This is a stronger signal than for the Nikkei in August 1992 -- that was a real-time upward forecast made to hedge funds when we first started this business 10 years ago. The declining 200 week average upward target for this rally is far above current levels (Nasdaq 100 NDX +100%, Dax +70%). It took the Nikkei a year or more to reach its 200 week average level, so those are longer term targets. In the meantime, there will certainly be volatility -- but stock indexes should head higher. Markets and industry groups with the biggest upside potential are the ones that have collapsed the most (Dax, Cac, Tech). Defensive positions should underperform in this bear market rally. The fundamentals or valuations arent there to support a bull market. But that doesnt mean a big bear market rally cant happen. We arent like Blodgett or Abby Joe -- telling you to buy crap for the sake of our bonus. We are simply pointing out that normal bear market dynamics could soon produce a rally of bigger proportion than most market participants can currently imagine.

Reports near and following the October 2007 market peak

BELKIN REPORT

2007 Belkin Limited All Rights Reserved

November 11, 2007

The Top is In
he projected year end stock market top has moved forward. It now appears that October 31st was the 2007 peak for speculative indexes like the Nasdaq. So that index is 1 1/2 weeks past its tentative peak. Other speculative global indexes like the Hang Seng also peaked at the end of October. Although emerging markets, the Nasdaq and some internet stocks rallied sharply after we turned temporarily bullish at the end of September, those gains are quickly evaporating and it is turning into a bad call. Sorry. We are completely changing stance this week, closing most long stock index positions and adding shorts. This should turn out to be an important long-term stock market top. So the renewed downward forecast is probably much more significant than the cynical brief upward forecast was. Were hoping our contrary indicator status provides a short-term rally for clients to sell into. The intermediate and long-term downward forecasts are now kicking in together, so we recommend taking advantage of any such remaining bounces (sell). The sector and group rotation forecast was much better than the index forecast at anticipating last weeks market turbulence. Cisco, Freddie Mac and Fannie Mae were on the sell list. The favorite recommended utility sectors outperformed their benchmark indexes by 4% in the US and Europe. The forecast US outperform list (average) beat the S&P500 by 1%, despite having clunkers like Google and Yahoo one week too long. The US stock outperform minus underperform list (average) was +1.6% alpha. So the models sector and group rotation forecast was more intuitive than the index forecast at this market turning point. Sell China The new story is a big sell signal on China. We added the Shanghai C and B share indexes as shorts 2 weeks ago. The downward China signal is picking up intensity. This week we add shorts on the Hang Seng and FXI ETF. It appears that the long-awaited top in the Chinese bubble has arrived. Amusingly, the Chinese authorities coaxed foreigners into Hong Kong equities on the rumor that they would open that market to domestic Chinese buying -- the Hang Seng zoomed 55% from its August lows. Now theyve changed the story. Looks like a case of screw the foreigners. In any event, both domestic Chinese and Hong Kong stock indexes have a big downward forecast starting and the indexes are up in the clouds after a huge rally. The history of emerging markets is full of bubbles and crashes. It looks like China is about to experience the latter. The Chinese equity market has been the backbone of 2007 global stock market strength. But global markets might soon get a backache from China. Utilities The Utility Sector has outperformed the S&P500 by 8% in the past 4 weeks. Weve repeatedly recommended utilities as the antidote to toxic financials in a slowing economic environment. Utilities remain our number one S&P outperform sector prospect. With financial stocks falling like flies on credit worries, order flow is likely to get funneled away from financials into utilities. This looks like a sustainable trend. Its not too late to switch weightings. The tech sector has become a new underperform prospect (previously tech was a mixed bag, short communication equipment and semiconductors, long internet). But the Cisco warning seems to have destroyed the myth of tech invulnerability in an economic downturn. Now the tech sector is a sell. Therefore, one pair trade idea is -- long utilities/short technology. Conclusion Were not dancing anymore. Like Chuck Prince, we attempted to play the game into the final hour. But its easier for the Belkin Report to turn around than Citibank. Some clients will be confused by this change of stance. But last weeks abrupt stock index drop really changed the forecast. Markets are always full of surprises. We hope this switch proves to be more accurate and enduring than the last one.

BELKIN REPORT

2007 Belkin Limited All Rights Reserved

November 25, 2007

The Best Offense is a Good Defense

lobal equity market sector and group rotation has moved in a maximum defensive direction. The games that investors were playing with materials, autos and other cyclical groups appear to be over. Now that most financials have been nuked -- economically sensitive sectors seem to be in the crosshairs for liquidation. The stock price declines in Fannie Mae and Freddie Mac over the past two weeks have been astounding (-35%). These were supposed to be boring, low volatility holdings. Credit market disruption is now spreading again into junk bond and emerging market spreads -- it looks like the next wave of credit convulsion is starting. This should accentuate the downward pressure on the US and global economies. Over-owned global cyclical plays have become good shorting prospects. Disappointing news on the revenue and earnings front should soon surface. The top three S&P outperform sector prospects are consumer staples, utilities and health care. These are strong, early signals (mostly relative to the index, not absolute). So they are simply hideouts for long-only funds, or potentially the long side of long/short pair trades for hedge funds.

Utilities have become the financial sector surrogate. Most financial stocks seem to have that Fannie Mae-like risk of nuclear meltdown. Usually at this point in the falling interest rate cycle, low-beta financials would be outperform candidates. But order flow that would typically be directed toward financials is probably now captured by utilities. The S&P consumer staples and health care sectors also have defensive appeal and an upward model forecast. See S&P group rotation page for specific stock recommendations. The new Eurozone Stoxx sector and stock recommendations have a similar flavor. Food & beverages, health care, utilities and personal goods are top model outperform prospects (see new Stoxx sector page for specific stock recommendations). European telecom is also an outperform prospect. The top European STOXX underperform sector prospect is basic resources. The global boom theme has run its course and left many materials stocks up in the stratosphere. Materials stocks are probably good short prospects on any sharp bounces. Autos and technology groups are also top underperform prospects, both in Europe and the US. The underperform prospects (metals, tech and industrials) also have absolute decline forecasts, so they are recommended as outright shorts on any bounces. Reinforcing the global bust scenario is a model switch on base metals. Long positions were recently closed out and short positions added. A substantial slump in base metals prices should be approaching. China has become our number one short recommendation among equity markets. Chinese companies (which were previously so appealing, partly because they made all the stuff the US was buying) should become increasingly vulnerable as the US economy suffers through the housing finance implosion. The Chinese equity bubble appears to have consumed all its domestic fuel and should enter a classic bubble liquidation phase. Short-term bounces in Chinese and Hong Kong equities should be sold and/or shorted. We have just one long stock index recommendation left -- Saudi Arabia (which has become a negatively correlated market). More to the point, most global stock indexes either have a downward model forecast or have one approaching. We had expected the irrational global rally to last through year-end, but changed position when the speculative stuff topped out in late-October, early-November (Nasdaq, Google, Hang Seng, emerging equity markets). Most stock indexes have given back most of their 2007 gains and the model forecast now points down. We recommend taking advantage of any remaining stock market bounces to close long positions, get short and switch into defensive sectors.

BELKIN REPORT

2008 Belkin Limited All Rights Reserved

January 2, 2008

2008 Outlook: US Recession, Equity Bear Market

he National Bureau of Economic Research (NBER) -- a private research organization -- defines US business cycle expansion and recession turning points. Their data extends back 150 years. (www.nber.org/cycles.html) For this report, well focus on the past 100 years. The Belkin model forecast suggests that the US economy will soon tip over into an official recession. That is based on the model forecast for S&P500 earnings, ECRI Weekly Leading Index, ISM Indexes, employment indicators and consumer sentiment. So the NBER will likely proclaim the start of a recession (months after it has already started). The current business cycle expansion is now 73 months long, 20 months longer than the average expansion of 43 months (1902-now).

Stock prices go down in recessions. Although this is an obvious pattern in market history -- business school textbooks and CNBC talking heads seem oblivious of it. The illusion that Fed-engineered rate cuts make stocks go up is deeply ingrained in mass market psychology -- more so than the reality that earnings slumps in recessions make stocks go down. Portfolio managers can take advantage of that ignorance by selling to the uninformed. This is the stock market/recession pattern: Stocks (we use the DJIA here because it has the best historical data going back 100 years) typically peak several months before the official start of a business cycle contraction (while the economy still looks rosy). The DJIA then slumps (an average -29.5%) -- bottoming out in the deep, dark depths of the recession -- before any economic recovery is evident. Then a new, extended rally starts. This has been the pattern in virtually every business cycle contraction since 1902 (see table). Percentage DJIA declines have ranged from -6% (ending 1945) to -89% (ending 1933). Please note that the peak (and trough) in the DJIA and economic cycle do not exactly coincide. Perhaps that is why the pattern is not more widely understood. Further complicating the issue is that business cycle dates are not officially announced until many months after economic turning points. So real-time economic forecasts that accurately anticipate NBER cycle dates are critical. Where do stocks stand now? The tentative peak in the DJIA for this cycle was three months ago, at 14,164.53 on October 10, 2007. The DJIA is down -6.4% from there. Using that -29.5% average bear market decline provides a ballpark downside DJIA target of 10,000. That is down -24.4% from here. Of course speculative stocks, groups and emerging markets have greater downside risk. We recommend a strategy of closing long positions, selling short-term rallies, overweighting defensive groups, underweighting aggressive groups and having a net short equity market exposure. Longer-term, bulls can look forward to a potential buying opportunity at a much lower level. But the only way to participate would be to have cash -- by not getting destroyed in the bear market.

Bear Markets and the Business Cycle -- a 100 Year View


RECESSION RECESSION LENGTH LENGTH PREV. DJIA HIGH START END RECESSION EXPANSION BEFORE (MONTHS) (MONTHS) RECESSION OCT 1902 AUG 1904 23 21 67.77 JUN 1907 JUN 1908 13 33 96.37 FEB 1910 JAN 1912 24 19 100.53 FEB 1913 DEC 1914 23 12 94.15 SEP 1918 MAR 1919 7 44 89.07 FEB 1920 JUL 1921 18 10 119.62 JUN 1923 JUL 1924 14 22 105.38 NOV 1926 NOV 1927 13 27 166.64 SEP 1929 MAR 1933 43 21 381.17 JUN 1937 JUN 1938 13 50 194.4 MAR 1945 OCT 1945 8 80 161.5 DEC 1948 OCT 1949 11 37 190.19 AUG 1953 MAY 1954 10 45 293.78 SEP 1957 APR 1958 8 39 520.76 MAY 1960 FEB 1961 10 24 685.47 JAN 1970 NOV 1970 11 106 968.85 DEC 1973 MAR 1975 16 36 987.06 FEB 1980 JUL 1980 6 58 903.84 AUG 1981 NOV 1982 16 12 1024.05 AUG 1990 MAR 1991 8 92 2999.75 APR 2001 NOV 2001 8 120 11722.98 AVERAGE 14.4 43.2 DATE OF HIGH 9/9/1902 1/7/1907 11/19/1909 9/30/1912 10/18/1918 11/3/1919 3/20/1923 8/14/1926 9/3/1929 3/10/1937 3/6/1945 10/23/1948 1/5/1953 7/12/1957 1/5/1960 5/14/1969 10/26/1973 2/13/1980 4/27/1981 7/16/1990 1/14/2000 DJIA LOW DURING RECESSION 42.15 53 72.94 53.17 79.15 63.9 85.76 145.66 41.22 98.95 152.27 161.6 255.48 419.78 566.05 631.16 577.6 759.13 776.92 2365.09 8235.81 DATE OF PERCENTAGE LOW BEAR MARKET DECLINE 11/9/1903 -37.8% 11/15/1907 -45.0% 9/25/1911 -27.4% 12/24/1914 -43.5% 2/8/1919 -11.1% 8/24/1921 -46.6% 10/27/1923 -18.6% 10/19/1926 -12.6% 7/8/1932 -89.2% 3/31/1938 -49.1% 3/26/1945 -5.7% 6/13/1949 -15.0% 9/14/1954 -13.0% 10/22/1957 -19.4% 10/25/1960 -17.4% 5/26/1970 -34.9% 12/6/1974 -41.5% 4/21/1980 -16.0% 8/12/1982 -24.1% 10/11/1990 -21.2% 9/21/2001 -29.7% -29.5%

BELKIN REPORT

2008 Belkin Limited All Rights Reserved

January 7, 2008

Bear Market Downside Targets


ast weeks report presented the 2008 economic forecast (recession). The accompanying table portrayed US stock market performance (from index peak to trough) during recessions (-29.5%, DJIA 1902-2001). It is worth repeating that the stock market usually peaks before recessions start -- and usually bottoms before recessions end. With that in mind, lets develop a recommended investment strategy for the forthcoming bear market. Major US stock indexes are down about 10% from their October 2007 peaks (S&P500, Nasdaq, DJIA). Small cap indexes topped earlier (July 2007) and are down about 16% (Russell 2000, Value Line). Major European indexes are down less than 10% from their peaks (FTSE, DAX, IBEX). Technically, most stock indexes have decisively broken their 200 day averages and (from a trend analysis perspective) are in downtrends. The next question is: How far could stock indexes drop in the bear market? Well approach that question from several directions. Using last weeks approach -- the DJIA is about 1/3 of the way through an average recession bear market (down 10%, 1/3 of an average 30% drop). So (from that perspective) US stock market investors might endure 2 more such 10% drops before the extended decline concludes. Broadening the analysis to include 1) The model forecast and 2) Trend analysis provides a different picture. 1) The stock index model forecast now points down strongly in both intermediate-term (3 month) and long-term (12 month) time frames. This is similar to the forecast of late 2000, before the Nasdaq dropped 70%. So the probability of a greater-than-recession-average stock market decline exists. Trend analysis (not model forecast) provides intermediate-term and long-term support levels that become downside targets in bear markets. We use 200 week and 200 month averages. That approach was derived from studies of the DJIA (as far back as recorded data exists). The general pattern is for the DJIA to rise during a business cycle expansion and decline during a business cycle contraction -- usually to the vicinity of its 200 week average. That is during a normal business cycle. Then there are bigger cycles. The DJIA has declined to its 200 month average during three major periods in the past 100 years -- early 1920s (post WW1), 1930s (great depression) and 1970s (stagflation era). Another example of a 200 month average retracement is the Nikkei -- which reached its 200 month average in 1995 (5 years after its bear market started) -- and has remained below its 200 month average most of the time since 1997. Note all these examples were accompanied by severe economic stress. With that in mind -- lets consider levels. The 200 week average for the DJIA is 11406 -- down 11%. The 200 month average is 8091 -- down 37%. That is for the DJIA. More overextended global stock indexes in this cycle have much greater downside risk to reach their 200 month averages -- Hang Seng (-56%), S&P/IFC Emerging Equity Market Composite Index (-63%), DAX (-48%), Spanish IBEX (-50%). Of course those downside targets hinge on whether this is a normal economic contraction or the big one (in direct proportion to the excesses of the previous credit bubble). In either event, we recommend adopting bear market investment strategies. That might include 1) Selling stocks and going net short. 2) Shifting into defensive groups. 3) Shifting out of stocks into government notes and bonds. 4) Selling brief rallies. 5) Steeling yourself for larger daily percentage moves, both up and down. 6) Anticipating company earnings warnings and downgrades by brain-dead brokerage house strategists and analysts. And anything else you can think of to not get hurt in a bear market. Our tentative outlook is for a two-stage global stock market decline in 2008 -- a first decline (already underway) to the 200 week average zone (down another 17% for the average global index, 10% for the average US index, 40% for emerging markets). Then some sort of recovery bounce from around that level (later this year), then another extended decline toward the 200 month average. So our 2008 outlook does include a potential investable long position on global stock indexes -- but not until indexes fall sharply.

BELKIN REPORT

2008 Belkin Limited All Rights Reserved

April 7, 2008

Panic and Crisis Receding -- Depression Approaching?


even months ago (August 26, 2007 Belkin Report -- Back to Business Cycle Basics) we presented the outlook for a three-stage economic downturn -- Panic, Crisis, Depression. This scenario was based on a survey of economic contractions by Theodore E. Burton Financial Crises and Periods of Industrial and Commercial Depression 1902, D. Appleton & Co. Subsequent events have more or less followed that August 2007 projected pattern. Credit markets have imploded and confidence between counter-parties has been shattered. The Bear Stearns episode may mark the zenith of the panic and crisis stage. Some market participants seem to believe that the Bear Stearns meltdown and JPM takover/bailout is the end of the problem and it is off to the races again for the economic expansion and global equities. Not so fast. The third stage of the historical process described by Burton is something called depression (in the 19th century sense of the word). Depression -- a protracted period in which the activities and profits of industry and trade fall materially below their normal level ... In distinction from a panic or crisis it refers to a prolonged period. It is not a matter of days, but of years. During its continuance the discouraging situation must be recognized and calmly met. p10 The odd feature of this US recession is that it has not (thus far) been a typical inventory liquidation cycle. That aspect tricked many forecasters into sticking with Goldilocks too long (ECRI, Kudlow, UCLA Anderson, Federal Reserve, Wall Street consensus, etc). Now that job losses have arrived -- most of those forecasters have switched positions and acknowledge the existence of a recession (in retrospect). Some even predict the end of the recession that they didnt forecast. How convenient. But their neoKeynesian bias prevents them from appreciating the economic process underway and the potential depression that lies ahead for the broad economy. The obvious transmission mechanism back into the stock market is earnings. The S&P500 P/E ratio is now 25 using official Standard & Poors Q1 and Q2 earnings numbers, which are almost certainly too high ($16/quarter). http://www2.standardandpoors.com/portal/site/sp/en/us/page.topic/indices_500/2,3,2,2,0,0,0,0,0,5,5,0,0,0,0,0.html If final Q1 and Q2 2008 earnings simply equal the 2007 Q4 number ($7.82), the S&P500 P/E is now 36 -- three standard deviations above its long term average (15.8). If the depression lingers and/or intensifies -- S&P quarterly earnings could fall below $5 (as in 2001). Plug four $5 quarters into the current S&P index level of 1,370 and the PE equals 68. Contrast that with the total BS forward earnings consensus quoted as gospel by most long side investors -- and consider the potential for earnings disappointments. So we are not excited about the upside potential for US and global stock indexes. Having said that -- we have been stopped out of most short stock index positions. Fed intervention and the natural inclination of long side investors to believe in fairies is likely to keep indexes supported for several months. The long-term model stock index forecast still points down strongly, but there is a conflict with the intermediate term forecast. So we expect some sort of sideways consolidation for several months. Upside potential seems limited -- so we still recommend that long-term investors take advantage of others enthusiasm by selling into rallies. Stock indexes will probably have an erratic bounce within a sideways range for the next several months. The Burton book quotes from the August 26, 2007 Belkin Report are reproduced below (to save you the trouble of digging through old email files). They help to put the current situation in a historical perspective.

Financial Crises and Periods of Industrial and Commercial Depression 1902, D. Appleton & Co. At intervals ... the blind capital of a country is particularly large and craving; it seeks for some one to devour it; and there is plethora; it finds some one, and there is speculation; it is devoured and there is panic. (Walter Bagehot) P115 The word crisis ... describes a brief period of acute disturbance in the business world, the prevailing features of which are the breakdown of credit and prices and the destruction of confidence ... the word panic describes a different phase of the same general condition or situation, which is essentially mental or psychological ... The word depression ... describes a disturbance having a much longer duration, and which cannot be designated as financial. It pertains rather to industry and commerce ... it is properly described as industrial and commercial. P17 A financial crisis, with its usual sequence, a period of industrial and commercial depression, is invariably preceded by a season of great activity marked by much real or apparent prosperity ... A period of prosperity is thus a necessary prelude to every crisis or period of depression. P54 The usual signal for the beginning of a crisis is a conspicuous banking or mercantile failure, or the exposure of some fraudulent enterprise which attracts wide-spread attention. P57 The essential feature of a panic or crisis is the inability of many debtors to meet their obligations and an apprehensions of many more. The storm center is among the banks and financial institutions P14 In proportion as these enterprises depend on short-term credits rather than upon paid-up capital or permanent loans, are they in danger of failure in time of stress. P263 The effect of a great failure, or of an exposure of fraud in the management of a prominent corporation or banking institution, is paralyzing upon business. Liquidation is hastened and credit for the most commendable enterprises is refused. P98 ... crises occur most frequently where credit is most in use ... Credit is dangerous when out of proportion to available or convertible capital. If prices fall, or enterprises fail, the convertible value of the property of debtors must greatly diminish, and many of them are unable to meet their obligations. As a result, a crisis is probable. P100 .. the cause of the abuse of credit is a spirit of speculation created under the influence of successful operations and large accumulations of capital, or an attempt to keep alive unprofitable enterprises, or the indulgence in extravagance and waste somewhere. P102 Banks have been known to continue in business for years after their rottenness would have been exposed by even a cursory examination. P260 An important fact apparently supporting the theory that a crisis is caused by speculation, is the large quantity of property, both real and personal, which is held in expectation of a rise in price. There is no present demand for such property at the prices asked. When a crisis occurs these values prove entirely fictitious, and sales can only be made at much lower figures. This results in serious loss. P109

Crises and panics are indirectly caused by excessive issues of currency, which stimulate overaction and afford the opportunity for waste and extravagance. P244 It would be difficult to find a crisis traceable to insufficient volume of paper money. Examination of statistics will show that crises occur rather when there is an unusual amount of credit money in circulation ... P110 the volume of money in use or circulation does not depend upon the amount issued. Publish a rumour some morning that a leading bank is in a shaky condition, and before sunset there will be a contraction of available currency greater than any law-making power or finance minister ever accomplished in the same time. P112 ... given a certain quantity of money, there may be two conditions: one, that of universal distrust, where money is kept out of circulation; another, that of general confidence, when borrowers are trusted and money is readily obtained. In the latter event a certain quantity of money may be sufficient to transact the business of a community or a country; in the former, a far greater quantity will not supply the demand. P113 In all depressions prices go down while money is accumulating in banks and rates of interest are going down, so that at the worst of every depression we have a great abundance of money and low rates of interest side by side with low prices. P113 Too much confidence should not be placed in the actions of government. P268 A legislature, for the benefit of debtors, might pass laws staying the collection of debts, or a despot might declare that fifty pieces of money should be regarded as equal to one hundred in payment of obligations theretofore made; but neither of these measures would cure a depression. They might relieve debtors and injure creditors, but could not set the wheels of industry in motion. P106 The central fact in all depressions ... is the condition of capital. These disturbances are due to derangements in its condition which, for the most part, assume the form of waste or excessive loss of capital, or its absorption, to an exceptional degree, in enterprises not immediately remunerative. P68 ... in the period preceding every crisis, there is a notable absence of scrutiny in the examination of the skill and trustworthiness of those to whom capital is intrusted for management. In the buoyant spirit of the time, a desire for increase in activity causes the investor to be less critical, and thus to aid in the creation of unprofitable enterprises and opportunities for fraud. P223 In the relation of shareholders and depositors to corporations under present regulations, crises are promoted by the facilities for speculation afforded to managers and by opportunities for dishonest and irresponsible management. The absence of publicity in the transactions of many great corporations, which control important lines of business, conceals their actual condition, and renders it impossible to obtain accurate information. P260 Panics do not destroy capital; they merely reveal the extent to which it has been previously destroyed by its betrayal into unproductive works. John Mills P20 In other words, a man seeks to obtain wealth by the easiest and quickest way. If he can obtain by speculation larger amounts or quicker accumulations than by the usual plodding way, he is likely to become a speculator. Thus we shall have abnormal buying. We shall have new

enterprises for which there is no call; the abandonment of the work of the producer for the business of the broker or the promoter. P131 Mr. Mills thought the regular recurrence of crises was due to the periodical destruction of belief and hope in the minds of merchants and bankers. To him panic is the destruction of a bundle of beliefs; crisis is not a matter of the purse, but of the mind. P29 ... many of the phenomena of crises remain capable of explanation only as the result of various characteristics of human nature, which cannot be classified according to any established rule, and seem to be more or less capricious, such as the tendency of men to move in a mass; the disposition to alternate moods of hope and discouragement, of trust and distrust; to excessive action and inaction by turns. P130 In the period of expansion preceding a depression, imports will be very large, and will bear an unusually large proportion to exports. With the beginning of the depression, or soon after, there will be a decided change. P89 One of the most significant indications of the approach of a crisis in one country is the existence of a crisis in another ... P242 One thing is certain: in times of excessive expansion, there is too much confidence; in times of depression, too little. Unfortunately, an excess of confidence was our undoing ... unless confidence is rational and rests upon solid foundations, it injures more than it benefits. P99 Bankruptcies: ... if the crisis is relatively the more important event, the maximum of failures occurs in that year, and is followed by a series of years in which bankruptcies are relatively small, as after 1857; while if the depression is relatively the more important event, failures will continue large for a series of years after its beginning, and reach another very large amount in one of the severest years of the depression, as in 1878 after 1873 and 1896 after 1893. P177 The end of the crisis comes after the shock has spent its force and when the true situation is understood. If there are no deep-seated causes for the disturbance, prosperous times will continue as before, though with a considerable degree of abatement. If such causes do exist, a period of depression ensues. P58 The depression is a condition which must be recognized and met; any attempt to ignore it or to indulge in confidence when there is no ground for it will only involve further disaster. Lord Beaconsfield P267

Reports near and following the March 2009 market bottom

BELKIN REPORT

2009 Belkin Limited All Rights Reserved

April 20, 2009

New Bull Market -- or Too Much of a Bear Market Bounce to Miss?


The real money investors are still waiting. I think they are waiting, theyre watching. They want to make sure that what we saw in March is real. And I think once they are convinced you will know it. The market will have a totally different tone to it. Duncan Niederauer (CEO NYSE Euronext) FT Apr 16, 2009

he NYSE CEO probably has a good read on order flow. His comments suggest there is a herd of would-be bulls waiting to stampede. Most global equity markets are up in April as much or more than they were in March. This rally is probably starting to squeeze the big boys back into risky positions. While there seems to be a great deal of skepticism about how much equities have advanced in recent weeks -- those who have missed the rally should soon be compelled to dive back in. This scenario is consistent with the model forecast. Stock indexes are supposed to rally, defensive issues are supposed to underperform, financials and some cyclicals are supposed to outperform and stocks are supposed to outperform bonds. Large portfolio managers who are parked in cash and defensive positions are likely to get squeezed. A forthcoming asset allocation shift out of bonds into global equities should support stock indexes.

Two of the Federal Reserves top policy makers defended the Feds emergency lending, saying the programs wont cause an inflationary surge or create significant risk for taxpayers ... New York Fed Bank President William Dudley, speaking at the same conference, said hes not worried at all that a doubling in the central banks balance sheet to $2.19 trillion will spur inflation. Bloomberg Apr 19, 2009 Central bankers now deny that higher money growth creates inflation. What are they going to say? The excessive credit we are adding will restore the speculative bubble and create an inflation surge with a lag? Of course not. So we will probably have to endure a barrage of happy-talk from Bernanke and Associates about how theyve repealed the laws of monetary physics. Implicit in their assurance that they will remove the excessive monetary stimulus in the future is a guarantee of another big boom-bust cycle. For now the model forecast and Fed monetary stimulus are in uncorrelated agreement. But the Fed is creating another bubble that will ultimately have to be lanced. Bernanke is providing more upside market volatility through his bubble-making policies. New Bull Market? The essential question for the big money institutions waiting to dive into stocks is: Is this the start of a new bull market or just a bounce in a longer-term bear market? While it is too early to be absolutely certain, the pendulum is starting to shift toward the new bull market scenario. The strongest evidence comes from the long-term model forecast (12 month) and the 200 month moving average for global stock indexes. Most indexes recently fell below their 200 month averages for the first time in years (in some cases decades). But the recent recovery is lifting indexes back toward (or above in the case of the DAX) their 200 month averages. So this could potentially become simply a classic bounce near an ultra-long-term (16 year) moving average. In other words, a big dip in the long-term uptrend. The long-term model forecast (12 month) is now moving in agreement with that thesis. The advance during March and April has flipped the long-term stock index forecast from down to up. This model turned negative in August December 2007 (depending on index). With the 12-month forecast now turning up, a sustained market rise is likely. Bull Market or Not, Too Much Upside Potential to Miss From a trend analysis perspective, stock indexes have some hoops to go through to verify a continued uptrend. These are: The 200 day average and the 200 week average. Currently, most stock indexes are about 8 - 10% below their 200 day averages and about 38% - 45% below their 200 week averages (with great variation). These levels are our current two-stage upside targets for stock indexes. The essential point is stock indexes could rally by 10% to 40%. Whether you call it a bear market bounce or a new bull market, is irrelevant -- it should be too much upside potential to miss. So big institutions will probably get squeezed out of defensive positions back into the market while the Fed blows another recovery bubble. With this scenario in mind, we recommend taking advantage of brief market pullbacks (like todays) to establish long positions in global stock indexes and the recommended sectors and groups.

BELKIN REPORT

2009 Belkin Limited All Rights Reserved

April 13, 2009

Cinderella Financials
ts probably safe to say that not many prominent investors have recently had banks and financials as their top holding or long recommendation. With the fundamental news seemingly still so bad, financials are like Cinderella -- the scorned family member no one wants to invite to the ball. Meanwhile, the BKX bank index has outperformed the S&P500 by 45% over the past seven weeks (gaining 56% vs the S&P500s 11% advance). This is a Cinderella performance, the sector not invited is turning out to be the star of the ball. Banks and financials remain our top long portfolio position and group outperform recommendation. How much more could financials rally? Although it sounds outlandish, the BKX 200 day average is 42% higher and its 200 week average is 171% higher. Financial stocks were absolutely demolished in the previous liquidation and now have the greatest sector rebound potential. Cinderella Stock Market Rally Recent comments by prominent investors and talking heads suggest a consensus skepticism about the current stock market advance: Pimco says stock rally vulnerable given data, Soros Says Gain in U.S. Stocks Is Bear-Market Rally, Roubini Says Stocks Will Drop as Banks Go Belly Up. Since the fundamental news hasnt improved, it is natural for investors to extrapolate a continuation of economic and market weakness. But the danger in that assumption is missing a major market bottom. Lord knows this six-month long range is stock indexes has been frustrating and confusing. But this current rally is probably designed to punish the doubters, the shorts and those who are waiting for an earnings recovery before plunging in again. Stocks are usually the first to move at major business cycle inflection points -- heading higher before the green shoots of economic spring arrive. The model forecasts a forthcoming rebound in the US economy, presaged by a continuing global stock market rally. Squeeze This projected recovery rally will probably squeeze portfolio managers out of cash, back into the market. It should also squeeze investors out of defensive sectors (health care, utilities, energy and consumer staples) into financials, consumer discretionary and industrial groups. This sector rotation forecast jives with the approaching economic rebound forecast. A move back into depressed financial and cyclical issues would be a natural development before an economic inflection point. Shortsellers should beware of a rising market trend affecting the beta of their positions. The models best short ideas are currently defensive groups (in relative terms only). Thus, a recommended long/short pair trade in this environment would be long XLF/short XLV (or short XLU). Another pair trade example would be long CYC/short CMR (added this week). Japanese Equity Market Bottom The Nikkei Average remains right up there with financials as a recommended long position. The Japanese market appears to be making an intermediate term and long term bottom (3 month and 12 month view). For those who have suffered through the interminable Japanese bear market, there is some light at the end of the tunnel -- and it is probably not a Japanese bullet train heading in your direction. We urge global portfolio managers to take a look at the Japanese equity market. This is probably a good entry point for a sustainable rally. As in the US, Japanese financials are the models top outperform recommendation. More European Equity Markets Added as Longs Although European markets are less appealing from an outperformance perspective than markets in the US or Japan, the model does have an absolute rally forecast kicking in. Depressed European stock indexes with stand-out rebound potential are the Irish ISEQ, Austrian ATX, Dutch AEX and Italian MIB30. These indexes are still relatively close to their bear market lows, have a fresh upward model forecast and high double-digit percentage rebound potential to their 200 week averages. Conclusion The long trading range has probably dulled consensus expectations of an economic and market recovery. A rising trend is likely to squeeze investors back into stocks, financials and cyclicals. Japan is appealing from a long-term investment perspective. Like Cinderella, downtrodden markets are likely to surprise the doubters.

BELKIN REPORT

2010 Belkin Limited All Rights Reserved

Sep 27, 2010

Fourth Quarter Outlook

s markets head into the fourth quarter of 2010, the model forecast is changing. All stock index short positions were covered last week, some new longs are established this week. The sector and group forecast has flipped around (2-3 month view). Most defensive sectors and groups have shifted into underperform prospects. Technology and some industrial and consumer discretionary groups probably have bounce potential. Emerging and frontier equity markets also seem to have upside potential. The US dollar is a short, most commodities are longs and US bonds seem like a very stale bubble. Stock Indexes Most indexes have been locked in a trading range for many months. Astute short-term traders may have milked this range for short-term moves, but we (and seemingly many hedge funds) have obviously been less successful at positioning for extended moves (which havent happened). But we must stick to our knitting, it has worked well over the years. The model has a fresh, intermediate-term upward forecast for most US stock indexes. The S&P500 just popped above its 200 day average, which has been an obstacle to upside progress. With the US election approaching and pressure on the Fed to expand credit, the odds favor a market rally (2-3 month view). We would temper that statement with an observation that the Nasdaq has just had a three-week nonstop rally and is likely to pull back for a few days or a week. So we would not chase short term rallies, but would use brief market corrections to raise long exposure and reduce shorts. Internationally, the Nikkei has a strong upward forecast, but Europe does not (yet). So we recommend sticking to Japan and the US for now. Frontier markets also have an upward forecast, some of these developing markets remain really depressed and havent come into full-scale fashion yet. So they have upside potential (see list for names). Some emerging markets are in the same boat, specifically eastern European equity markets have a fresh upward forecast. Sector and Group Rotation Change The model has favored defensive sectors and groups and has panned tech groups for months. The S&P consumer staples sector outperformed the index by >8% from late April through the end of August. That forecast has now reversed, staples groups have become underperform prospects. Conversely, tech was a recent model underperform prospect -- the S&P tech sector underperformed the index by >5% from June 4th through September 10th. That signal has now reversed and tech groups are becoming outperform candidates. If all this makes you dizzy, it boils down to: Sector and group rotation has probably reached an inflection point and the market now seems to have an appetite for jamming up higher beta groups at the expense of defensive groups until year end. Retailers and some industrial groups have also just flipped into outperform prospects, while banks and brokers have the opposite forecast. Ultra-long term investors can probably afford to ride out potential quarter-long rotation swings like this, but mere mortals who get measured in quarterly performance installments need to swing with the punches. It looks like the next rotational thrust should be beta up. Currencies, Commodities and Bonds The US dollar has a fresh downward forecast and most commodities remain longs. In the race to the bottom of currency debasement, it appears the US has a competitive advantage. Things that are cosmetically-enhanced by dollar weakness (like commodities, emerging market indices and US exporters) probably have a built-in lipstick applicator. Agriculture commodities (especially grains) stand out as long prospects. US bonds (on the other hand) seem vulnerable to this scourge of dollar weakness. Looking back at previous Fed bubble cycles: Nasdaq and tech stocks represented the bubble excesses at the early 2000 market top (after the Feds Y2K credit expansion). Houses, CDOs and subprime mortgages, etc. represented the bubble excesses after the Feds 2003-2004 period of 1% interest rates. Bonds got the big inflows of buying in this lengthy Fed 0.25% interest rate bubble and are probably now comparable to the position of the Nasdaq in early 2000 or to CDOs in 2007. This bond bubble is becoming obvious to market participants, who must be wondering when the game of musical chairs will commence. Our general scenario goes: Dollar drops, Fed pumps, bonds roll over, stocks rally for awhile, beta groups outperform, bonds eventually get spooked enough by currency weakness and end the party on capital outflows. So we are long stocks for a trade, with an eye on a potential turning point around year-end.

BELKIN REPORT

2010 Belkin Limited All Rights Reserved

Oct 4, 2010

Year End Squeeze Potential


he perspective emanating from the model forecast suggests the potential for a year-end squeeze higher in US, Japanese, emerging and frontier equity markets. The six-month stock index trading range has probably been frustrating for all but the most nimble short-term traders. US indexes appear poised to break out above this range, led by small caps (Russell 2000, Value Line), midcaps (S&P400) and tech (SOX Index, SMH ETF). Tech stocks and retailers that sold off during the summer appear to have 2-3 month bounce potential (LSI, WDC, STX, NOK, ODP, BBY, JCP, CA, RIMM, etc.). Notice these are mostly not the mega-cap Apples of the world, more second-tier names. Portfolio managers might start sifting through some recent laggards in a typical end-of-year bottom-fishing expedition. The upside rally is likely to squeeze participants out of defensive positions. Consequently, there is a fresh 23 month underperform forecast for defensive sectors and groups (consumer staples, utilities -- names likes PG, KO, MO and DIS). At this juncture, the potential appears to be for only a 2-3 month market rally, until somewhere around year end. So this scenario is strictly for a trade, based on a switch in the model forecast for group rotation and stock indexes. We wouldnt get married to long positions. Another turning point appears likely around year end (market top). This is simply a calculated trade to participate in a forecast market rally up to a potential top in several months time. The Feds new obsession with QE2 (quantitative easing) should have a positive impact on equity prices and market psychology. The Squids forecast of $500 billion in fixed income securities purchases represents a 22% increase in the Feds balance sheet. That is significant. That much currency debasement would obviously tend to damage the dollar, unless other global central banks followed suit. This QE boondoggle dovetails with the current model forecast for the dollar (lower) and commodities (higher). A recent addition to the stronger commodity and global sector forecast is energy. A rotation in commodities seems to be moving through grains and metals into energy prices. Energy producers must be getting antsy about receiving depreciating dollar revenue, particularly with the Feds single-minded focus on domestic demand. Also, energy stocks in the US and Europe have been laggards. It now may be time for investors to consider increasing physical energy and energy sector weightings. Another indication of upside market potential exists in the forecast for emerging and frontier equity markets. The BRICs have snuck back onto the long list recently. Depressed Eastern European emerging markets such as Hungary, Poland and the Czech Republic are also fresh longs. Frontier markets are a special case, many of these are still severely depressed (notably, gulf markets). This asset class should be on your radar screen, capital flows will probably glue frontier markets more into mainstream markets over the next several years. Many of the ones on our recommended long list have not yet been inflated by foreign inflows. The investment appeal of Bulgaria, Bahrain, Kazakhstan, Jordan, Slovenia, Kuwait, Nigeria and Vietnam is as yet undiscovered. SocGens recent hedge fund position report suggested hedge funds (in aggregate) are long bonds and short stocks. We anticipate that QE2 will backfire for bonds, driving longer term US Treasury yields higher (as occurred in August during Fed bond purchases). In that case (if SocGen is correct on hedge fund positions), funds could be squeezed out of the obvious trade (long bonds). Combine that with the models upward forecast for US stock indexes (which hedge funds are supposedly short in aggregate) -and you get the potential for a significant involuntary asset shift (out of bonds into equities) -- hence the title of this weeks report: Year End Squeeze Potential.

BELKIN REPORT

2011 Belkin Limited All Rights Reserved

Mar 7, 2011

Risk Off

his week we close all remaining long stock index positions and go short. Most of these US longs date to the September 27th, 2010 Belkin Report. The S&P500 has gained 15% since then, the Nasdaq a few percent more than that. This change shouldnt be a shock, we gave ample warning that a switch was approaching. It arrived a little bit sooner than anticipated. What really tipped the scales in our weekend analysis was an across-the-board shift in the model forecast for sector and industry group rotation. Defensive is In, Cyclical is Out The forecast has switched for the S&P consumer staples, health care and utilities sectors. These are new outperform prospects. These sectors have been on the forecast underperform list and have lagged index performance significantly since September 24th (utilities -14%, consumer staples -10% and health care -7.6% vs. the index). These were the wrong places to be long during the rally but the model forecast suggests they have just become the right place to be for the projected forthcoming decline (in relative terms). Conversely, the materials and industrials sectors are fresh underperform candidates. These were longstanding model outperform recommendations (until recently). These sectors did outperform the index significantly (by about 4% at their peak), but the forecast has changed. We now suggest closing out long materials and industrials sector positions and going short (see list for recommended groups and stocks). US financials are removed as an outperform prospect. US financials have been a disappointment this quarter. The model looked for financial and energy sector outperformance in the Jan 3rd 2011 outlook report. Since then, the S&P500 is up 5%, the financial sector is up 3.4% and the energy sector is up 14.4%. So energy has worked exceedingly well, but financials have underperformed moderately. The financial signal is now over, so we are officially out of US banks and brokers. It is time to move on. Sell Rallies Our change in outlook calls for lightening up on long positions, getting defensive in sector positioning, raising cash and reducing long market exposure through buying puts, etc. The obvious implication is to sell into any remaining short-term rallies. The S&P500 is within 2% of its peak for the post-September rally. Inflows into equity funds continue, providing a potential window of selling opportunity as last-gasp buyers provide liquidity. We wouldnt rule out another slightly higher high for stock indexes, that wouldnt change the new bearish forecast. Indeed, we hope such a selling opportunity arrives, since it is always less pleasant liquidating into a declining market. Emerging Markets Resource-linked emerging markets have a strong downward intermediate and long-term forecast (Chile, Peru, etc.). Middle East frontier markets have an obvious catalyst for a decline. The model forecast has been unfriendly to most emerging markets for awhile, there has been a stealth emerging equity market decline going on while US and European indexes reached new recovery highs. The switch in outlook for frontier markets casts a shadow on the whole junior global equity market universe. We advise closing longs and shorted still-elevated markets like Chile, Peru and Mexico. Conclusion Strong rear-view mirror economic statistics and a residue of fund inflows may provide an ideal backdrop for opportunistic portfolio rebalancing -- aka: selling and shorting. Fed money pumping may prevent an absolute market collapse for the next several months, but the sector forecast change suggests that a market top has arrived anyway. Emerging and European equity markets do not have artificial Federal reserve life support and are probably vulnerable. The energy price rise (which the model anticipated) has probably reached the point of crimping the global economic expansion. We recommend harvesting the gains of the six-month rally and getting defensive.

BELKIN REPORT

2011 Belkin Limited All Rights Reserved

October 17, 2011

Inflection Point - Switch on Sectors and Markets

he Belkin Report has been Risk Off since March 7, 2011. Everyone should be familiar with the course of markets since that date. The S&P500 is down 8.3%, cyclical sectors down 14%-25%, emerging markets down 17%, continental European indexes down 18% to 28%, the Hang Seng down 19%, etc.
Performance Mar 7 - Oct 17 2011 S&P Utilities Sector S&P Cons Staples Sector S&P Health Care Sector S&P500 Index S&P Materials Sector S&P Industrials Sector S&P Financials Sector EEM Emerging Markets G3 bond future (avg) G3 stock index (avg) Dax Italian Ftse/Mib Dutch Aex Hang Seng Absolute +6.0% +3.8% -1.3% -8.3% -14.5% -14.4% -25.6% -17.3% +7.6% -13.9% -18.2% -28.1% -18.3% -19.0% -6.2% -6.1% -17.2% -8.9% +15.9% -5.6% -9.8% -19.8% -9.9% -10.7% Relative to S&P500 +14.3% +12.2% +7.0%

The model forecast just switched for sectors, stock indexes and many risk trades (2-3 month view). We are reversing the defensive trades established seven months ago and now look for a bounce into year end. We had expected a further sell-off in October, when it didnt happen our model flipped around into an intermediate-term upward forecast. This is our discipline, when the model forecast changes we change. This intermediate term signal goes against our models long-term forecast (12 month view, which remains down for stock indexes and the economy) so this should be a tug-of-war between a deteriorating long-term outlook and markets propensity to have a rebound - in other words, a bounce in a downtrend. Portfolio managers are probably now overweight the type of defensive positions we have advocated for seven months and markets could deviously squeeze managers back in the cyclical beta direction. Psychologically, a waltz though October without a crash could provide encouragement to portfolio managers to get back to the serious business of ramping up stock prices through year-end.

Our boss at Salomon Brothers (the Vice Chairman) had a trading floor slogan: Nothing goes straight down except a limp XXX (you get the idea). In that spirit, a lot of groups and stocks that we have recommended as shorts (or underweights) are down big since March 7 and are close to their lows (building products -38%, electronic equipment -33%, auto components -23%, electrical equipment -22%, machinery -20%). Our weekend study of the model forecast suggests the potential for an extended trading recovery in these groups and member stocks, in that old profane Salomon Brothers trading floor tradition. The shift in outlook for defensive sectors could be painful for worrywarts. Since March 7th, the utilities sector is up 6% and the consumer staples sector is up 3.8% (versus -8.3% for the S&P500) - they have been successful hiding places during the bear market (+12% to + 14% relative outperformance). But with the forecast changing, those sectors could get squeezed. Another potential squeeze play is the #1 asset allocation position, stocks vs. bonds. Our long G3 bond future/short G3 stock index asset allocation spread (added in that March 7th report) has gained 21.5% (7.6% long bonds and 13.9% short stocks). But we now recommend putting that spread on in the opposite direction (long stocks/short bonds). So pension funds and insurance companies should re-evaluate bond market and stock market exposure, 2-3 month view. All long bond positions are closed out and new bond future short positions are added (sorry Bill Gross). Stock shortsellers should also beware of bounce potential in depressed names. The two S&P sectors with the strongest relative forecast currently are industrials and technology: Industrials for a bounce from a depressed level and technology for a blow-off rally to a peak. Three industrials sector groups with a stronger forecast are electrical equipment, building products and industrial conglomerates. Three tech sector groups with a stronger forecast are semiconductors, communication equipment and software. Defensive food, beverage, tobacco, health care and utilities groups have a fresh model underperform forecast in the US, Europe and Japan. Emerging markets shorts are covered and new longs are added for the EEM index and countries such as Turkey, India, Brazil, Korea and Eastern Europe (see list). This is another case of bounce-in-a-downtrend potential. The short positions on junk and emerging market debt are covered, as well as the credit spread widening positions. These have worked, but well step aside for a few months with a view toward re-entering positions at a better level. The fundamental view of an end to the business cycle expansion hasnt changed. Were just looking for an interlude in which most risk markets have a 2-3 month bounce. This could be encouraged by several developments: 1) EU bank bailout package #99 (the Stoxx bank sector is probably several weeks from a model buy signal). 2) The possibility of a Fed drift in the QE3 direction at their early-November meeting. Were obviously not fans of bailouts and central bank credit expansions, but the new upward model forecast for risk markets suggests asset prices might receive something from that direction. See following page for a peek at the March 7th, 2011 Belkin Report Risk Off.

Recent reports forecasting a major 2012 top in global asset prices

BELKIN REPORT

2012 Belkin Limited All Rights Reserved

August 27, 2012

S&P500 vs. Interest Rates - a 4 Standard Deviation Event


ne inter-market relationship we follow is the ratio of the S&P500 to the 10Yr TNote yield. This obscure ratio shows the relationship between stock prices and interest rates. The ratio can rise when interest rates are falling, to a certain point which we label the breaking point. The widely-accepted notion that lower rates are positive for stock prices holds true until the S&P500/10Yr yield ratio reaches a major extreme - as it did in Mar 2008, April 2000 or July 1990. Bull markets (or bubbles) depend on this ratio expanding. When it reaches an extreme level (as in 2008, 2000 or 1990) and stops rising, a major stock index decline can occur. In other words: There is a limit to a lower-interest rate boost for stock prices. S&P500/10Yr TNote Yield Ratio 2000-Now
Avg + 4 standard deviations = 833 841 ?

The S&P500/10Yr yield ratio hit 4.8 standard deviations above its 12 year average (320) on July 20th. It now stands at 4.1 standard deviations above its average (841). That is way beyond the range of the past 12 years (see chart). Breaking it out by decade, there is nothing approaching a 4 standard deviation event like this on record. Bernanke gets a gold medal for ultimate warping of the S&P500/TNote yield ratio. What is the significance? As mentioned, bulls would prefer that this ratio keep rising, as a proverbial return to the mean would require a 62% decline in the S&P500 to the 536 level (holding the 10Yr yield constant). What recently caught our eye is an apparent late-July top in this ratio, with a new downward model forecast. We now have a situation where the S&P500/TNote yield ratio is extremely overextended and potentially rolling over.

Avg = 320

2001-02 bear market

2008-09 bear market

Avg minus 4 standard deviations = -195

Our interpretation goes like this: The Fed has pulled out every trick in the book to artificially depress interest rates (QE1, QE2, Operation Twist, Portfolio Balance Channel, etc.). Operation Twist specifically targeted intermediate and longer term yields such as the 10Yr. These Fed shenanigans have contorted the S&P500/10Yr yield ratio to a preposterous extreme (smaller denominator). In order to continue a further march upward into absurdity, stocks need a big surge in earnings to justify a further rally (earnings are not reflected in this simple ratio). But our forecasting models economic and earnings prediction points down - stocks are likely to get a big earnings collapse, not upsurge. Bottom line: The S&P500 is already stretched to the breaking point vs. interest rates and those who are waiting breathlessly for more QE or Twist to emerge out of Jackson Hole or autumn Fed meetings may find that stock prices actually DECLINE on rate cuts or credit expansions. If that sounds improbable in the current environment, take a glance at China. The Chinese stock market keeps grinding lower, despite numerous rate cuts, bank reserve cuts, etc. The link that supposedly guarantees higher stock prices from lower interest rates is broken in China. Economic Scorecard A glut of unsold goods is piling up in China. This is a classic lower sales/higher inventory bulge that necessitates production and employment cutbacks. The Eurozone mess is compounding the global economic slowdown. It is showing up in plunging Japanese exports to Europe (-25%) and China (-10%). The latest August China manufacturing PMI was 47.8, down from 49.3. Eurozone consumer confidence (-3 points) and IFO business sentiment (-1 point) are falling. The Bloomberg Weekly US Consumer Comfort Index has fallen 9 points in the last 5 weeks, this huge slump should soon show up in monthly US consumer confidence surveys. US new orders of capital goods x-aircraft just collapsed, falling 5.5% yoy. These are not normal variations in an ongoing expansion. They are early warning signs of a major global economic contraction. Sectors, Groups, Stocks Most stock indexes seem to reflect the optimistic view that there will be no global recession. China seems to be the only major market that is acting rationally, it is down 5% on the year (Shanghai Composite). Emerging equity markets are next least crazy, up only 4% ytd (EEM in $US). The average European stock index is up 5% ytd and the S&P500 is up 12% ytd. Looking at sectors, the EuroStoxx Industrial Goods and Services sector is up 12% ytd and the S&P industrials sector is up 9% ytd, even the S&P materials sector is up 7% ytd. These are the most cyclically sensitive sectors of the market that are likely to be most impacted by the looming global economic downturn. What are they doing up on the year? The S&P tech (+20% ytd) and consumer discretionary (+16%) sectors stand out like sore thumbs. They are economically sensitive and will feel the pain of falling revenues and earnings. The drumbeat of individual stock earnings warnings should continue, it has recently included UPS, Fedex, Applied Materials, Big Lots, Lowes, Priceline, Chipotle, etc. Conclusion Stock prices are probably stretched about as far as possible relative to interest rates. Mean reversion from a 4 standard deviation event implies significant downside market risk. Stock indexes and individual stocks do not at all reflect the reality of the gathering economic global contraction. Selling short-term rallies and shorting cyclicals is recommended.

BELKIN REPORT

2012 Belkin Limited All Rights Reserved

September 24, 2012

Whats Going to Pop This Bubble? Earnings

nvestors are merrily following Pied Piper Bernanke as he leads the S&P500 into an fanatic divergence above 10Yr TNote yields (see chart and Belkin Report Aug 27, 2012 S&P500 vs. Interest Rates - a 4 Standard Deviation Event). Those who drink Kool-Aid from Bernankes punchbowl assume the mantra of dont fight the Fed is a valid investment strategy, but the bubbles Achilles Heel is earnings.

For those who bother to track such things, S&P500 Q2 2012 reported earnings ($21.62) were down 6.1% from Q1s $23.03 and also down 2.8% from Q2 2011s $22.24. Quarterly reported earnings are down sequentially and annually. That was for the second quarter, before the profound global economic slump really kicked in. Who cares? Not those who focus solely on operating earnings, which Factset calls earnings. That measure rose 4.9% sequentially and 2.3% annually in Q2 2012. Are investors safe and bulletproof because operating earnings performed better than reported earnings in Q2? No. Operating earnings always fall less than reported earnings during recessions, because of the big write-offs from closing plants, employee layoffs, etc. Those recession costs appear in reported but not operating earnings. The key concept is RECESSION. Both measures of earnings slump during recessions. Our economic forecast calls for a recession. You really need a blindfold on to believe that the world isnt slipping into a recession. The recession dividing line for PMI indexes is below 50 and these are current levels of global PMIs: China 47.8, Japan 47.7, Germany 44.7, France 46.0, Italy 43.6, Switzerland 46.7, Spain, 44.0, Sweden 45.1, Netherlands 49.7, UK 49.5, US 49.6. Stock prices follow earnings down during recessions. The S&P500 has declined an average 53% in the past two recessions (-49% 2002, -53% 2009). Its a fact of life. Stock prices decline sharply during recessions. The Fed is doing everything in its power to deny the facts of life. It isnt going to work. They cannot prevent the corporate earnings collapse that always occurs during recessions (-54% 2002, -92% 2009 - S&P reported earnings annual sum). The transmission mechanism of the forthcoming stock market selloff should be straightforward: Companies are going to miss Wall Streets revenue and earnings expectations by a mile. When companies miss expectations, airhead analysts (i.e. Goldman) who didnt see it coming will downgrade the stock from their conviction buy list - and sleepwalking portfolio managers will dutifully dump the shares, driving the stock price down. Of course we are already seeing this process unfold with the likes of Intel, Fedex, Norfolk Southern, Dell, Hewlett Packard, Burberry, etc. But as they say in the movies, you aint seen nothin yet. Earnings expectations for Q3 are way too high (+8% QoQ for reported earnings from S&P, -2% QoQ for operating earnings, Factset). Consensus forward estimates dropped during July and have held sideways at $25 for two months (Q3 operating, Factset) - while the global economy has spiraled downward. Sell side analysts must be on drugs, the bad kind (PCP) that gives them delusions of grandeur. The enormous gap between economic reality (the accelerating global down cycle) and the utterly complacent earnings outlook is about to be shattered. Non-US economies (Europe, Japan, China) are obviously in worse shape at this point than the US. Therefore, US companies that are most exposed to global economic conditions should be most vulnerable in this earnings reporting season. Technology stands out like a sore thumb, with about 55% of revenues coming from abroad (the most of any sector). Tech is also very elevated and overextended relative to the index. These are tech names that the model has as short recommendations: AMAT, INTC, KLAC, NVDA, LLTC, ADI, DELL, HPQ, STX, NCR, IBM, CIEN, ERIC, CSCO, BIDU, PCLN, VRSN, BMC and AAPL. Industrials (at about 40% of revenues from abroad) also stand out as vulnerable. These industrials names are recommended model shorts: FDX, UPS, UNP, CSX, CNW, NSC, JBHT, LUV, LCC, GWW, GPC, DHR, DE, CMI, CAT, AG. Consumer discretionary (at about 30% of revenues from abroad) is very overextended. Stocks in that sector with a model short recommendation are SBUX, NKE, RL, YUM, WMS, LYV, ZUMZ, TJX, HOTT, SHW, BKS, AZO, ARO, FDO, PETM, CMG, BWLD. Finally, recommended European shorts are ASML Holding Nv, Burberry, Christian Dior, LVMH Moet Hennessy, Rolls Royce Grp, Atlas Copco A, EADS, Smiths Grp, SSAB Svenskt Stal Ab A, Anglo American, Compass Grp, Sodexho Alliance, Daimler Ag, Vivendi, British Sky Broadcasting, Next and Hennes & Mauritz B. To summarize: There is a major disconnect between earnings expectations and a deterioration in the global business cycle. A Dont Fight the Fed mentality is warping portfolio managers perceptions of individual company business risk. Corporate managers are about to wrap up the books on a quarter that will be heavily influenced by a negative global economic trend. The aggregate impact of many individual company revenue and earnings misses should be a massive de-rating of the equity market, despite the best efforts of Bernanke the market manipulator. The opportunity should be on the short side of stocks with big international exposure and stupid earnings expectations.