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Five Things You Need to Know: A Confederacy of Dunces, The ECB, Narrow Escape, Capitalization-weighted? Equal-weighted? What?, Audbile


What you need to know (and what it means)!


Minyanville's Five Things You Need to Know to stay ahead of the pack on Wall Street:

1. A Confederacy of Dunces

The Organization for the Petroleum Exporting Countries (OPEC) has informally agreed to take at least 1 million barrels (or 4% of world supplies) out of the market.

  • An OPEC delegate said the producer group will cut output by 1 million barrels per day as soon as possible to prop up prices, Reuters reported.
  • Saudi Arabia will lower production by 300,000 bpd from September as part of the plan.
  • The voluntary reductions are most likely to be formalized at the cartel's Abuja meeting, the Financial Times reported.
  • US oil inventories rose by 3.3 million barrels last week, the Energy Department reported yesterday.
  • So what does this all mean?
  • Look at it like this: If OPEC was powerless, by their own admission completely powerless, to halt the surge in oil prices on the way up...

    ...why on earth would anyone believe they are capable of "tweaking" the price of crude to hold above their "floor" on the way down?
  • By the way, it may be worth considering the forward-looking budget forecasts based on crude oil prices well above $70/bbl for countries such as Venezuela and Indonesia.... countries which, we are now led to believe, will be content to settle for selling less crude oil at far lower prices.
  • "When a true genius appears in the world, you may know him by this sign, that the dunces are all in confederacy against him." - Jonathan Swift

2. The ECB

The European Central Bank on Thursday raised eurozone interest rates by another quarter percentage point to 3.25 percent.

  • The interest rate hike, the ECB's fifth in less than a year, takes rates to their highest level in nearly four years.
  • The ECB sets interest rates in the 12 euro currency-based countries.
  • The decision by the ECB was unanimous and widely expected despite the recent downturn in energy prices which pulled the consumer price index below 2% in September for the first time in 21 months.
  • The ECB has recently expressed concern about a wave of increased household borrowing (hey, that sounds familiar!) across the eurozone.
  • Meanwhile, European money supply is expanding at an 8.2% clip, which we know because the ECB, unlike the U.S. Federal Reserve, believes M3 tracking and reporting is an important part of monetary policy.

3. Narrow Escape

In a separate article written yesterday afternoon we looked at narrowing breadth in the S&P 500. It's interesting to take that a step further and consider what the consequences of that narrowing breadth are in terms of portfolio management, equity allocations and overall strategies.

  • One way to gather a picture of market breadth is with a bullish percent index.
  • A bullish percent index is calculated by simply dividing the number of stocks in a given group (that group can be an index or even an industry) that are currently on point and figure buy signals, by the total number of stocks in that group.
  • For more information about the bullish percent concept see this series of Minyanville articles: NYSE Bullish Percent Primer and NYSE Bullish Percent Primer, Part Two.
  • The last time we saw this kind of narrowing breadth occur on the S&P 500 in bullish percent index terms was between April 1998 (when the bullish percent index for the S&P 500 peaked at 84%) and April 2000 when the bullish percent index for the S&P 500 "broke out" suggesting an expansion in breadth.
    - From April 1998 to April 2000 the S&P 500 (SPX) capitalization-weighted index returned 35%.
    - The S&P 500 Equal-Weight Index (.SPXEW) (using back data) gained a miserly 6.6%.
  • The breadth on the S&P 500 as measured by the S&P 500 bullish percent index expanded dramatically from April 2000, reaching a new peak of 88% in January 2004.
    - From April 2000 to January 2004 the S&P 500 Equal-Weight Index (using back data) gained 19.2%.
    - The S&P 500 lost 25.8%.
  • Accompanying this most recent increasing narrowness of breadth for the S&P 500 is a narrowing of the spread between the outperformance of the S&P Equal-Weight Index and the S&P 500.
  • Year-to-date the SPX is up 6.8% while the SPXEWI is up 6.6%.

  • What does this all mean? Well, the 1998-2000 period was a grim one for many managers and especially for investors with diversified portfolios.
  • Those using the S&P 500 as a benchmark found they simply could not keep pace with that index's performance as a consequence of the narrowing breadth as the news reported powerful index movement led by only a small number of stocks.
  • The same thing may be happening once again.

4. Capitalization-weighted? Equal-weighted? What?

Wait, what is this talk of capitalization-weighted versus equal-weighted? What are you talking about and why should I care?

  • In what we consider the "regular" S&P 500, the one quoted by financial media, the index is "weighted" by stock according to each stock's market capitalization relative to the total index.
  • Market capitalization is calculated by multiplying the total number of shares by the market price.
  • So, in the S&P 500, a capitalization-weighted index, the stocks with the largest market capitalization have the most say over the movement of the index.
  • In the equal-weighted S&P 500 index, each stock has equal say.
  • Obviously, since most investors and portfolio managers do not construct a capitalization-weighted portfolio, that, in a nutshell, is why a market with narrowing breadth becomes increasingly difficult to navigate.
  • Another view of this is to look at the S&P 500 Capitalization-weighted Index ETF (SPY) versus the S&P 500 Equal-weighted Index ETF (RSP).
  • If we plot these ETFs relative to one another on a single chart, we can get a view of how they are behaving.
  • Below is the SPY vs. RSP on a point and figure chart. If this chart is trending downward then it shows that the RSP is outperforming the SPY.
  • The column of Xs in green illustrates a point and figure buy signal. Also note the downtrend has been broken.
  • This suggests the period of outperformance for the average stock (represented by the RSP) has ended and a period of outperformance by a select number of large-capitalization stocks is beginning.

5. Audible

I was going to use this fifth "Thing You Need to Know" to do a brief satire of the fact that, according to a recent survey from an outfit called "Transparency International," Russia tops the survey list of "international bribers." The U.S. ranks way down in ninth. Apparently, in addition to Overall Global Competitiveness, we're no longer even in the top five in international bribery, which is something we actually invented. As sad as that fact may be, however, there's actually something far more serious that keeps resurfacing in my mind since I ran across it yesterday. So I'm calling an audible.

  • Gene Callahan is the author of a great introductory book to Austrian economics, titled Economics for Real People. He is also an adjunct scholar of the Mises Institute.
  • Yesterday Minyanville Professor Scott Reamer forwarded to me a piece Callahan had written which appeared at, called "Welcome to Fascist America!"
  • On the face of it, the title sounds hysterical and ridiculous. America? A Fascist state?
  • Callahan admits the word "fascist" is often thrown around lightly:
    "Now, the term "fascist" has been thrown around over the last fifty years in a loose way that has drained it of much of its meaning. If someone wanted to cut 5% off of a leftist professor's favourite welfare programme, the professor would call his opponent a "fascist."
  • Sadly, he's not using it in the "loose sense."
    "I'm not using the word like that. I mean honest-to-goodness, old-fashioned, 1930s style fascism, featuring such old favourites as:
    - Secret prisons – they're back!
    - Torture – we're doing it.
    - Spying on all citizens.
    - Arrests and indefinite imprisonment without trial.
    - Rampant militarism.
    - Secret detention.
    - Enforced disappearance.
    - Denial and restriction of habeas corpus.
    - Prolonged incommunicado detention.
    - Unfair trial procedures
  • Of course, that list of "1930s style fascism" is just one man's opinion, right? It hysteria, right?
  • Maybe, but consider what kind of "hysteria" that same list would have engendered to a German in 1934.
    "America is full of decent people, who could never believe their own government could become fascist. So were Germany and Italy in the 1920s. But they became fascist anyway."
  • Perhaps the reason Callahan's impassioned article resonated so strongly with me is because I wrote virtually the same thing on the Buzz and Banter exactly one year ago today on October 5, 2005:

    "The conditions that lead to the erosion of freedoms and the rise of totalitarianism are grounded in social mood and its corresponding economic influence. No one in an open society wakes up one day to find a dictator in charge and all their freedoms gone.

    The erosion happens subtly, over time, as conditions shift from valuing freedom and economic choice to valuing the perception of safety as handed down from a centralized state. This has been demonstrated time and time again throughout history, even within the past 100 years.

    A great book that is not directly related to the loss of freedom, but which tangentially outlines the slow, almost imperceptible process by which it dissolves, is "Wittgenstein's Poker," by David Edmonds and John Eidnow.

    The story is ostensibly about a philosophical argument between Karl Popper and Ludwig Wittgenstein. In the course of covering their lives, however, the authors describe the slow, methodical course of events that led to the loss of freedoms in Vienna and ultimately to the horror of the Holocaust.

    A popular perception (delusion is more like it) is that the loss of freedom is something that happens overnight. But in open societies, the loss of freedom is a prison built brick-by-brick by the very people it will contain when it is finished. There is no such thing as "minor threat" to freedom."
  • But this time is different. It can't happen here.
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