August 22, 2016

Another week has gone by and once again, the S&P500 has gone pretty much nowhere. Last week, the large cap index closed virtually unchanged. Volume was extremely light, in large part due to the end-of-August vacation season. And volatility also barely budged; it continued to hold near the lows of 2016.

To mirror the lack of direction in the US equity markets, the economic news flow was also very slow. The Empire State Manufacturing Index missed badly, relative to expectations. Consumer prices met expectations; although consumer prices excluding food and energy rose slightly less than expected. Industrial production came in stronger than expected. Jobless claims were slightly better as well. The Philly Fed business outlook only met expectations and leading indicators beat consensus estimates.

In terms of technical analysis, the picture is as follows—upward price momentum is stalling (a reasonable conclusion after two straight weeks of going nowhere) but prices remained pinned up against or near all-time highs. As mentioned last week, from these lofty, overbought levels, it’s normal to see some sort of modest pullback. But in a world where central banks have pushed short term interest rates down to below zero around the world, what’s been normal over the last 100 years may not be so normal today.

But what remains true, despite the massively overbought and overvalued US equity markets is this simple fact—the more equity markets rise today, the lower the remaining returns will be in the future for anyone who remains in these markets. What this means is that the huge appreciation in equity markets over the last several years has reduced the prospective returns for everyone who invests in equities today.

Clearly, the converse is also true, but for the prospective returns to jump back up even to reasonably normal levels, the equity markets would have to retreat by a meaningful percentage. And by meaningful, we don’t mean just 10% or 20%, but something much more than 30%.

Back in 1929, a nationally known economist from Yale declared that US “stock prices have reached what looks like a permanently high plateau”.  He was proven to be spectacularly wrong, after stocks crashed over the ensuing three to four years.

Nobody knows exactly when, but today’s high plateau will also not endure. And when it breaks, the downside—-as informed by history—-could be depressingly huge.

Treasury Rates vs the S&P 500

August 15, 2016

On very light volume, the S&P500 ended last week virtually unchanged from the week before. Volume was light mainly because of the calendar—peak summer vacation season. And S&P volatility also barely changed; but that’s probably more a function of the fact that the VIX index was already at the lows of the year and had very little room to fall further.

With the lack of movement in the S&P last week, the technical picture remains unchanged—the S&P500 is extremely overbought. On both the daily and weekly charts, the S&P is pushing the upper limits of many commonly followed indicators. Any sort of pullback, from these lofty levels, would be very normal and almost expected.

As far as economic news goes, last week as a big disappointment. Productivity was a total disaster; instead of rising as expected, it fell. And the continued deterioration in labor productivity is important because it will directly impact future corporate earnings….negatively. Initial jobless claims, while still very low, came in a bit higher than expected. Import prices rose instead of falling as predicted; this too will hurt corporate profits. Retail sales were a disaster—both headline and core (excluding autos) sales missed badly. And consumer sentiment also missed. Only wholesale trade and business inventories beat expectations…..and even then, only slightly.

Finally, another major divergence has developed between US Treasury rates and the S&P500. While the S&P ended the week just about at all-time record highs, the US 10 year rate finished the week with a 1.5% yield. And since the 10 year yields (as opposed to 10 year prices) usually move together with the prices on the S&P, this sets up a massive problem—the super low yields on the 10 year suggest that the prices on the S&P500 ought to be much lower. Of course, some would argue that the US Treasury market is wrong and that those yields ought to rise in order to “converge” with the all-time high prices in US equities. But one has to remember that “mom and pop” investors (ie. unsophisticated investors) do not participate in bond market trading nearly to the extent that they do in stock market trading. in other words, the dumb money is far more commonly found in stocks, not bonds. And if that’s the case, then these super low Treasury yields are suggesting that the stock market investors…..sitting on all time high prices…..are super wrong.


Crude Oil Falling …. Again

August 8, 2016

Last week the S&P500 managed to eke out a small gain, rising 0.4% on light volume. Volatility dipped back down, this time down to set new lows for the year; that said, volatility always tends to set yearly lows during the summer months when traders tend to take time off from the markets and take vacations.

So while new, yet marginal, all-time highs have been set in the S&P, the technicals still point to an extremely overbought market. On both the daily and more importantly the weekly charts, the S&P is pressing up against the upper levels of several well-followed ranges, such as the Bollinger Bands. What makes the technical situation even more risky is the fact that on a fundamental basis, the S&P500 is also extremely overvalued. For example, many price to sales and price to earnings measures now show that the S&P500 is more overvalued than at any time (other than in 1929 and 2000) in the last 100 years!

Still none of this means that it can’t rise even further.

Except for one big report, most of the economic news last week was disappointing. ISM manufacturing disappointed. Construction spending reported the weakest annual growth since 2011. Personal income missed expectations; personal spending beat expectations. ISM services also missed consensus estimates. Initial jobless claims came in worse than expected. International trade missed, and consumer credit growth also missed. The big beat of the week was the payrolls number which came in stronger than expected. But as usual, what this report does not specify is the quality of the jobs created. While more and more well-paid and benefited factory jobs continue to disappear, low-paying and unbenefited service jobs are growing. But it takes more than one job as a bartender or waitress to replace one lost factory job. Yet the BLS does not distinguish between the two.

Finally, back in January of this year, crude oil (West Texas) set a multi-year low in the upper $20’s. The problem with such a low oil price is that it virtually destroys the profits and the balance sheets of thousands of important companies in the energy space. And since this sector is so large, relative to the US economy, it’s implosion alone could adversely impact the entire economy. Yet since January, the price of oil has rebounded and in May it touched $50. Unfortunately, since then, it has turned back down, and last week oil fell back under $39.

So it will be interesting to watch what happens to this super important commodity over the next several weeks and months. Because if it drops back down into the low $30’s or worse, into the $20’s, then we will almost certainly see widespread bankruptcies in the energy space, and this could “spill over” to the rest of the US economy.


Gold and Silver Still Rising

August 1, 2016

While this was no major reversal, the S&P500 did at least stop rising. Last week it gave back a tiny 0.07% on moderate volume. Volatility crept back down near the lows of 2016, lows that were set in mid-July. So even though investors have enjoyed a big post-Brexit bounce, it’s worth noting that the S&P500 is still sitting only about 2% above the highs it established in mid-July of 2015, over a year ago. And broader indices such as the NYSE composite are actually below where they were in July 2015. The point is that despite the big move over the last 30 days, the S&P has delivered a very meager return to investors over the last twelve months…..and it’s important to remember that this return has been generated with substantial risk—the S&P is an investment class than can lose (and in the past has lost) over 50% of its value, in a relatively short period of time. By comparison, investors who’ve owned 10 year Treasuries over this same period have not only enjoyed a higher rate of return, but they done so with substantial lower risk of loss.

From a technical analysis perspective, the S&P still sits at extremely overbought levels. And after last week’s slight retreat, the odds of a more material pullback have increased—specifically because the upside momentum indicators have stalled and have even started going into reverse.

In US economic news, there were a lot of disappointments last week. US home prices, as measured by the Case Shiller index, have started to slow their appreciation; while still rising, the rate of the price growth is dropping notably. PMI flash services missed expectations. Durable goods orders were a disaster; both the headline and ex-transportation results missed badly. Pending home sales also missed. Wholesale trade missed. International trade missed. Initial jobless claims were worse than expected. Consumer sentiment missed. The Kansas City Fed manufacturing index missed, and the latest GDP figure missed badly…coming in a less than half the expected growth rate.

As mentioned above, one asset class that’s done very well over the last year is US Treasuries. But another asset class, far smaller and less promoted in the mainstream media, has done even better. Both gold and silver have been booming lately. Since bottoming in December of 2015, gold has jumped over 25%. And silver has soared by about 50% over the same time frame. Why are these precious metals exploding? It’s not quite clear exactly what the reason is. But the last time these two metals made similar moves—off important lows—back in 2008, the both went on to climb much further. Gold peaked after climbing about 150% and silver peaked after skyrocketing about 400%.

So keep an eye on precious metals. Despite the already impressive moves over the last six months, they could both enjoy far more upside over the next 18 months.


Do You Believe in Miracles?

July 25, 2016

After reaching what we described as “nosebleed valuations” the prior week, the S&P500 went on to climb another 0.6% last week. Volume however dropped quite a bit from the prior week, so while new all-time highs were set, the conviction level of investors and traders did not increase. Also, the S&P’s volatility set a new low for the year mid-week, but it began to creep back up by week’s end, so once again, this measure suggests that while investors love the new stock market highs, they’re a bit nervous and keeping an eye on the exit doors.

US macro news was mixed last week. Although the housing market index missed expectations, housing starts beat consensus estimates….but just barely. Initial jobless claims are still clinging to multi-year lows. And PMI flash manufacturing also beat expectations. On the negative side, the Philly Fed business outlook survey missed badly and the FHFA house price index also missed expectations. So once again, there is no real improvement to report for the US economy.

As extremely overbought as the S&P was last week, it’s now even more overbought…..on both the daily and the weekly charts. So from a purely technical perspective, if an investor plows new money into the S&P500 today, he or she would be betting that the extremely overbought conditions would grow to become even more extremely overbought. Good luck with that strategy to anyone who follows it….and unfortunately, there seem to be a lot of investors who are following it.

From a valuation standpoint, money manager and PhD economist John Hussman, in his most recent bulletin, pointed out that there has been only one time in US history when the S&P500 has been more overvalued…back in 2000 just before the tech bubble burst and took down all the US stock markets and pushed them into bear market territory. So for an investor to do the same today—give currently “obscene” valuations, then that investor would essentially have to believe in miracles……that something that’s never happened before would happen this time—that stock prices would materially and sustainably advance from today’s nosebleed levels.  As Mr. Hussman notes, this does not mean that prices can’t go even higher in the short-run, but any such increases would be given back, and then some, in the brutal price retreat that will almost inevitably ensue.

S&P500 at Nosebleed Valuations

July 18, 2016

Last week saw another melt up in US stock prices with the S&P500 registering a 1.49% increase by the end of trading on Friday. Volume was light, a reflection of the normally slower summer trading season as well as the fact that new investors are still not rushing in to chase this market higher. Volatility, as measured by the VIX index, dropped back down to the lows of the year. So the entire Brexit fall-out has been entirely ignored as far as US equity prices go. Not only does the S&P think Brexit will not hurt equity prices, but judging by the new all-time highs set last week, the S&P believes that it will be a positive for risk asset markets. How? Once again, the S&P500 is anticipating that any bad news from Brexit will be met with good news from central banks, in the form of even more expansionary monetary policies. So bad news is good news.

In the real economy, the labor market conditions index fell once again. Job openings, as measured by the JOLTS report, also fell. Wholesale trade missed. Initial jobless claims were better than expected. While producer prices were a bit hotter than predicted, consumer prices were lower. Retail sales and industrial production beat consensus estimates. But the Empire State manufacturing survey and consumer sentiment both missed. So once again, there is no notable uptick in the pace of growth in the US economy; it continues to muddle along.

Technically, the S&P500 is now extremely overbought. Both on the daily and the weekly charts, prices are hugging the upper Bollinger bands. And prices are now far above—stretched above—the 200 day moving average.

More importantly, some highly respected Wall Street firms are starting to voice concerns about more fundamental valuation measures. Goldman Sachs, for example, has just issued a report where is notes that “Valuations are already at historical extremes. The S&P500 trades at a forward P/E of 17.6x, ranking in the 89th percentile since 1976. At 18.4, the median constituent ranks in the 99th percentile. Most other metrics such as P/B, EV/EBITDA, and EV/Sales paint a similar picture.”

So here is one of Wall Street’s most respected firms, a firm that normally champions rising stock markets because they’re good for business, now expressing deep concerns.

So anyone who decides to cast aside such simple, historically informed data and put new money into US stock markets should understand that they will be picking up nickels in front of a steam roller. It’s good while it lasts, but when it ends, the effects will be catastrophic.

US Treasury Rates Fall to Record Lows

July 11, 2016

The S&P500 continued to grind upward, despite the initial Brexit setback, and last week it registered another solid gain. This time is was up 1.28%. Volume however was very light, and this implies that the average mom and pop investor was not participating in the rally. In other words, new money did not rush in to buy. Instead, the usual drivers—corporate buybacks and short covering explain most of the gain. Volatility dipped back down, almost to the lows of the year, as measured by the VIX index.

In economic news in the US last week, factory orders dropped, but they dropped by exactly as much as economists predicted. Our international trade deficit came in a bit worse than expected. ISM services, on the other hand, beat consensus estimates. The big news of the week was US payrolls, which beat estimates with as much of a shock as it missed estimates the month before. But while the number of bartender and waitressing jobs continues to soar, the actual unemployment rate ticked higher (bad), and average hourly earnings missed expectations (also bad). That said, the payrolls beat was the big driver of the US equity price jump last week.

The technical picture for the S&P500 is becoming murky: the two-year topping formation is now in jeopardy of being weakened,  because the S&P is now very close to setting new all-time highs. Of course, for this topping formation to be completely nullified, not only do new highs have to be set, but they have to hold and then the market would have to continue to grind higher. As of last Friday, new highs had not been set.

All that said, in the short term, the S&P is now somewhat overbought. And a pullback, even a modest one, would be perfectly normal at these high levels.

Finally, as described last week, while the S&P500 has been grinding higher, the US Treasury rates have been grinding lower. Remember, this is not supposed to happen. Normally, when US stocks are bought, buyers sell US Treasuries, in part, to fund the purchase of US stocks, and as a result of the Treasury selling, Treasury rates normally would rise.

Instead, last week, the US 10 year Treasury rate set the lowest rate in the history of the United States…..1.33%.  This is not supposed to happen. It seems that while US equity prices march higher, big money is running for cover and buying US Treasuries (at record low yields). So this is a HUGE divergence from normal historical patterns. One of these markets is most likely very wrong—either US stock prices are too high and will come down, or US Treasury rates are too low, and will go back up.

Although this divergence will probably not resolve itself in a week or so, it will very likely end sometime this year….over the next few months.



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