The Fed Continues to Tighten…..

June 19, 2017

Last week, the S&P500 ended essentially unchanged. Volume was very light, and volatility dipped back down to super complacent levels….not quite at the lows of the year, but close.

While the price barely moved for the week, the technical picture for the S&P is still pointing to an extremely overbought market. On both the weekly and the daily charts, prices are hugging the upper Bollinger band and show no imminent signs of backing down. Prices are back above both the 50 and the 200 day moving averages, which themselves are both sloping upwards. The current bull market cycle…while extremely long in the tooth….is not breaking down just yet.

In US macro news, last week’s reports were particularly weak. On the inflation front, the news was very disappointing. Core PPI, core CPI and headline CPI all came in well below expectations. This means that the Fed is not achieving one of its primary objectives—-nudging inflation back up to or just over 2.0% per year. Retail sales missed badly—both headline and ex-autos. Business inventories also missed. Export prices came in below expectations. The housing market index missed. Housing starts missed very badly, and consumer sentiment plunged. On the positive side, initial jobless claims were a bit better than expected, and the Philly Fed business outlook survey beat expectations. That said, the US macro data—both hard and soft measures—are now falling more severely than they have in many years.

But despite the overall weak economic data, and in particular the disappointing inflation data, the Federal Reserve continued its rate-hiking process and bumped up the Fed Funds rate by another 25 basis points. In other words, the Fed is tightening despite clearly not achieving one of its two mandates. What was even more surprising was that in the same rate hike announcement, the Fed outlined a fairly detailed plan and schedule for shrinking its bloated balance sheet by several trillion dollars. Essentially the Fed would stop reinvesting in maturing securities (such as US Treasuries) and when these securities mature, the Fed would remove the comparable amount of base money (money it created electronically to buy these securities several years ago)….so that the Fed’s lower level of liabilities and assets match.

What’s critical to understand about this is that most market experts agree that it was precisely the balance sheet expansion pf the Fed (and those of the other major central banks of the world) that has not only propped up asset prices since the Great Recession ended in 2009, but has also driven these prices to all-time record highs.

So if the primary force behind record high financial asset prices is going into reverse, then how realistic is it to believe that these asset prices can remain so high, or much less, go even higher?


FANG Stocks Breaking Down?

June 12, 2017

The S&P500 inched backwards, but barely, last week. It closed down about 0.3%. But volume was very light, so there was no big rush for the exits. Also, volatility—while inching higher—still ended the week near multi-year lows, which also suggests that investors and traders were not panicking.

In US macro news, the results were mostly poor. While productivity finally beat expectations, it did so by coming in at 0.0% rather than the negative 0.2% that was predicted—this is certainly not some big improvement in the poor productivity trends that began several years ago. The PMI services index missed, as did ISM services. Consumer credit logged a dismal result—its lowest reading since August 2011! Initial jobless claims also missed. Factory orders met expectations, but once again, the hurdle was very low—negative 0.2%. As usual, there are zero signs that the US economy is growing at a healthy rate.

From a technical analysis point of view, last week’s tiny retreat was barely noticeable on the weekly charts. While more visible on the daily charts, there’s no real technical damage to note here too. What hasn’t changed is the fact that the S&P is extremely overstretched to the upside and this condition is showing very few signs of changing anytime soon.

That said, there is one sign that things are not so well beneath the surface of the S&P500. Last Friday, the four famous FANG stocks (Facebook, Amazon, Netflix and Google) all suffered big and some might say crash-like drops. This is important because the significant jump in the S&P500 over the last year, and in particular over the last six months, has not occurred with very broad-based participation. Instead, it’s come about because a few “generals” in the army of stocks have made exceptionally disproportionate gains, which pushed up the price of the index while leaving most of the “soldiers” in the army well behind.

So Friday’s mini-crash in the stock market leaders is notable because if even these stocks are starting to hit a wall and retreat by meaningful percentages, then the odds of a general stock market retreat, a retreat that would be considered significant, go up….a lot.


All News is Good News

June 5, 2017

Despite lots of disastrous economic reports and plunging US Treasury yields, the S&P500 managed to jump up another 0.96% last week. Supporting this bullish move in equities, stock market volatility remained near multi-year lows. While the VIX index crept up early in the week, but Friday’s close it fell right back down to the lows of the year.

How bad were the US economic reports? Pretty bad, especially considering the fact that US economic growth over the last 9 years has been very poor already (fun fact—US economic growth from 2007-2016 averaged 1.3% per year; growth from 1930-1939, during the Great Depression, ALSO averaged 1.3% per year!). While personal spending and personal income met expectations (ie. no beat, but also no miss), almost every other report was a miss. Consumer confidence missed. Mortgage applications missed. Chicago PMI missed. Pending home sales missed. Initial jobless claims missed. PMI manufacturing missed. Construction spending missed. International trade missed. And the biggest number of the week, May payrolls, registered a disastrous miss.

But no matter, US stock markets rallied on the week.

So now (once again) US equities are extremely overstretched from a technical analysis point of view…. using daily, weekly and monthly charts. Also US equities are extremely overvalued from a fundamental point of view…..both aggregate price to sales and aggregate price to GDP are near 100 year highs.

At the same time, oil prices (and other commodity prices) have resumed their retreats. And US Treasury yields have fallen back down to levels last seen when the S&P500 was more than 10% lower than it is today.

But again, nothing seems to matter.

It’s getting to the point where not only the average person on the street is convinced, utterly convinced that there is no alternative to buying stocks ….. but lately top Wall Street strategists are doing the same.  A few days ago, for example, Bank of America Merrill Lynch published report with a headline: “All News is Good News”.

In it, they stated: “clearly, equities continue to respond well to both positive and negative economic data….”

Some day, this insanity will end, but in the meantime, the easiest and surest path for US stocks is to the upside.


May is Almost Over, and Nobody is Selling

May 29, 2017

Amazingly, the S&P500 continued to climb higher. Last week, it added another 1.4% and in the process, it set another new all-time high. As usual, volume was light—so this jump in prices did not happen because investors poured new money into the equity markets. Very likely, some of the last remaining short sellers covered their losing bets, leaving most investors and traders—once again—almost all invested on the long side. And supporting this theory is the VIX Index which obediently retreated back down to its multi-year lows.

If you’re a US equity investor, everything looks just fine.

In macro news, the story of course is not so rosy. Last week, the Chicago Fed national activity index registered a stronger than expected result. Also, the FHFA house price index beat expectations. Durable goods orders looked better on the surface, but core orders (excluding transportation) they plunged, missing badly. Other bad news came from new home sales, which also plunged and missed consensus estimates. The Richmond Fed manufacturing index missed badly. Existing home sales also missed. International trade missed as well. So continuing the pattern of the last couple of years—while Main Street USA struggles to progress, Wall Street is enjoying a raging party.

In terms of technical analysis, the S&P500 is now is as overbought as it’s ever been. Prices on the daily, weekly and monthly resolutions are hugging the upper Bollinger Band, something that we don’t usually see simultaneously on all three time frames. Also, the S&P has jumped back well above the 50 day moving average, and the 200 day is sloping comfortably in an upward direction.

Finally, what makes this most recent all-time high more interesting is that it’s happening just as the month of May is ending. Seasonal data shows a historical pattern where equity index prices typically tend to give back some gains by the end of May; that’s where the old saying “sell in May and go away” comes from.

But this May, with June starting just a couple of days from now, the S&P500 is still setting records. Once again, this is confounding market experts who continue to be amazed that nothing, truly nothing, seems to be able to faze this US equity bull market.

 


Mini-Panic in US Equities

May 22, 2017

The S&P500 lost 0.38% last week on slightly higher volume. Volatility, as measured by the VIX index, closed higher on the week.

US macro news flow was light. The Empire State manufacturing index missed expectations—badly, by falling when it was projected to rise. Housing starts also missed. On the other hand, the housing market index, industrial production and the Philly Fed survey all beat consensus expectations. And initial jobless claims continued to hover near multi-decade lows.

The technical picture got uglier last week, not so much because of the modest weekly drop, but more because of the one-day panic sell off that approached two percent. While two percent, on the surface, shouldn’t be such a big deal, it did become a big deal last week because the S&P500 hadn’t had such a large drop in many months. In other words, investors had grown accustomed to unusually minor day-to-day variations in the S&P, so when a slightly larger sell-off occurred, a lot of investors got caught off guard.

More importantly, many investors got re-acquainted with risk, specifically risk to the downside in US equity prices.

With the big one-day sell-off (and despite the fact that a great deal of the one-day loss had been recouped by week’s end), many technical indicators suddenly grew more bearish. Most momentum indicators got pushed downward, and if they were already pointing down, they became even more bearish. Also, the 50 day moving average was not only broken, but the average itself stopped sloping upwards.

That said, this is still a relatively short-term moving average. Longer, and arguably more important moving averages such as the 200 day, are still solidly sloping upward…..and prices never even came close to falling below it.

So all in all, last week’s price action suggests that beneath the calm surface, the US equity markets are fragile and susceptible to sudden and meaningful drops….at least on a short term basis.

 


The China Factor

May 15, 2017

The S&P500 slipped about 0.35% last week on light volume. S&P volatility didn’t change much—it remained near multi-year lows. In other words, investors are still extremely complacent and not fearing any significant equity market drop.

At the same time, confirming this market complacency is the fact that market prices, despite last week’s tiny pullback, remain near record highs. While the upward momentum on the daily charts is slowing, the technicals point to the possibility of more gains. On the weekly charts, the recent downturn in momentum looks like it’s on the verge of reversing to the upside. So the technicals are saying that while prices are stretched to the upside, even more gains are possible…..at least in the near term.

In terms of US economic data, the story has not gotten better—US macro data is still coming in on the weak side of average. Job openings from the JOLTS survey are not growing much. Retail sales disappointed—at both the headline and core levels. Consumer prices shocked everyone because the core figure on a month to month basis came in at half the expected rate. Even worse, on the year over year basis, the rate dropped below 2.0%, which is the Fed’s important threshold for monetary stimulus; if inflation is below 2.0%, then the Fed usually favors more stimulus. The problem now is that the Fed has started a tightening program but inflation has fallen below its minimum target. On the positive side, business inventories came in stronger than expected and so did consumer sentiment.

Finally, most investors are not aware of the huge role that China has played in the global recovery from the great recession of 2008-2009.  Both its fiscal and monetary stimulus were massively increased, unleashing a powerful reflationary impulse that pushed not only corporate profits around the world upwards, but also many other factors including commodity prices and financial asset prices.

The downside to all this is twofold. First, China financed this huge multi-year stimulus primarily by issuing trillions of dollars (or dollar equivalents) of debt, debt which has now reached such high levels that additional future borrowing has become more difficult to accomplish. Second, the entire policy decision to undertake this stimulus rests with the Chinese government, not the US and not Europe (our allies). So the decision to pull back on such huge stimulus would clearly rest with this same entity, the Chinese government.

Why is this important? Because the Chinese government has recently begun taking measures to reign in its debt growth and as a result, the world could be in for a shock…..because the same stimulus that has propelled the world to recovery over the last eight years may go into reverse and become a deflationary impulse, which could unwind many of the benefits achieved since the stimulus began.

So it will pay investors to watch China closely!


Are Economic, and Market, Cycles Obsolete?

May 8, 2017

The S&P500 gained about 0.6% last week, in very light trading. And volatility remained very low—the VIX index continues to hover near multi-decade lows. The risk here is that a big reason behind the super low level of volatility is the fact that many investors have begun to sell put options on stocks, as a way of supplementing their low returns. The problem of course is that while this strategy may work well in the short term, it may someday blow up in everyone’s face if or when stocks decline by a meaningful percentage. These investors are betting that the stock market will not decline in the near to intermediate future.

In macro news, the week got off to a poor start. Personal spending missed, and so did personal income. Also core PCE, year-over-year (one of the Fed’s preferred measures of inflation), also missed to the downside. In other words, inflation has not risen to the 2.0% threshold desired by the Fed, so its tightening cycle seems to be in conflict with one of its two key mandates. ISM manufacturing also missed. Construction spending missed very badly. On the other hand, ISM services beat estimates. So did international trade and initial jobless claims, which hit a multi-decade low (implying that jobless claims don’t have much more room to fall). Factory orders missed, and productivity missed by a mile (this means that unit labor costs are rising more than expected, and this will hurt corporate profits in the near future). Finally, payrolls beat expectations, and so did the headline unemployment rate. But average hourly earnings only met expectations and the labor force participation rate moved the wrong way—it ticked down.

The technical picture for the S&P has not changed much in the last week. On the daily charts, the S&P is in an upswing. But on the weekly charts, the damage that was done in April has not yet been erased.

Finally, there’s a lot of talk among market pundits that stocks are still a great place to invest most of one’s money and that we shouldn’t worry about a big decline in stock prices; on the contrary, investors should use a dip in prices only to buy more stocks.

One, among many, of the problems with this argument is that implicitly, these stock market bulls are arguing that US economic cycles and US financial market cycles are no longer a threat. In other words, they are implicitly saying that recessions and bear markets have become obsolete….mainly due to the way that the Fed has seemingly prevented any of these threats from materializing over the last 8 years.

So if you buy into the argument that now is still a great time to be massively long the US stock market, then you are also buying into the implicit assumption that US economic and market cycles are obsolete. And if you do, then good luck; you’re going to need it.