Word of Wisdom…..from 1929

October 24, 2016

Last week, the S&P500 took a pause from its recent string of retreats and inched back up 0.38% on light volume. Of course, S&P volatility crept back down in sync with the rise in equity prices. That said, the VIX Index is still closed higher than the lows reached during the summer doldrums. Essentially, last week’s action constituted a small reflexive bounce, a tiny bounce that’s very normal even during more extended periods of decline or topping in the markets.

It was a fairly light week in terms of US macro reports. On the negative side, the Empire State manufacturing survey plunged; it was supposed to increase. Industrial production missed badly. Housing starts missed. And jobless claims were worse than expected. On the positive side, existing home sales beat consensus estimates. And the Philly Fed business outlook survey beat expectations. Leading indicators and headline consumer prices met expectations, so no surprises here.

Technical analysis still points to a clear topping pattern on both the daily and the weekly charts—despite last week’s small gain in the S&P500. Upward momentum is still weak or absent, so all signs still point to more downside risk. Last week’s measly 0.38% dip does not qualify as a true retreat.

Finally, in his most recent weekly commentary, investment manager John Hussman posted the following quote:

“The recent collapse is the climax, but not the end, of an exceptionally long, extensive and violent period of inflation in security prices and national, even world-wide, speculative fever. This is the longest period of practically uninterrupted rise in security prices in our history… The psychological illusion upon which it is based, though not essentially new, has been stronger and more widespread than has ever been the case in this country in the past. This illusion is summed up in the phrase ‘the new era.’ The phrase itself is not new. Every period of speculation rediscovers it… During every preceding period of stock speculation and subsequent collapse business conditions have been discussed in the same unrealistic fashion as in recent years. There has been the same widespread idea that in some miraculous way, endlessly elaborated but never actually defined, the fundamental conditions and requirements of progress and prosperity have changed, that old economic principles have been abrogated… and that the expansion of credit can have no end.”


This was published by Business Week in November……..1929.  The point Hussman was making is this—something very similar is happening today, in US equity markets. And no matter what the explanation, the reasoning, or the analysis—the resolution to today’s “exceptionally long, extensive and violent period of inflation in security prices” will not end any differently.

It never has ended differently…..over the history of US equity markets. And it won’t end differently this time either.

And as Hussman points out—to believe that just because a huge market pullback, more accurately a collapse, has not yet happened so therefore it will not ever happen, means one is making a serious mistake. This is the same mistake investors make before every major (and minor) bull market ends…including the one that ended in 1929. And it’s the same mistake investors are making today.

S&P500 Set to Retreat?

October 17, 2016

The S&P500 fell back another 1 percent last week on light volume. Volatility inched higher, as would be expected during a down week. But the VIX Index is still in fairly complacent territory, nowhere near levels associated with fear, much less panic.

Last week’s economic news was mostly disappointing. Jobless claims were a bit better than expected, and business inventories grew slightly more than predicted. But other than that, things were ugly. The labor market conditions index fell …… again. The JOLTS survey missed badly—job openings came in well below expectations. Producer prices, both headline and core, were hotter than predicted. And consumer sentiment crashed; instead of rising as expected, it fell considerably.

So all in all, the same old story for the US economy—very sluggish growth, with no improvement on the horizon.

As far as US equity markets go, the outlook is becoming even more troubling in the near term. As outline here over the last couple of weeks, the S&P500 has been forming a short-term topping pattern, and after last week’s 1 percent retreat in the S&P500, this topping pattern has been reinforced….if not confirmed. First, the uptrend line that began after the big bounce in February 2016 first began has now been violated. Last week’s decline broke this uptrend. Second, almost every major momentum indicator has already diverged bearishly several weeks ago, and now that the S&P has declined for a couple of weeks, this bearish divergence is being confirmed. Third, the most recent significant low point reached in early September (roughly 2,120 on the S&P) was broken last week. All this suggests that some sort of more meaningful retreat in the S&P is now more likely to occur in the near term.

And the lows reached in late June, immediately after the Brexit vote, would become a natural target for an impending downside move. This is roughly around 2,000 on the S&P, which represents a 6% drop from last Friday’s close.

Note that this is still a call for a relatively modest retreat. Given that the latest cyclical bull market is now about six years old (very mature), and given that corporate earnings have been falling for about two years, and given the super-high valuations in the S&P relative to long-term historical standards, a more severe retreat in the S&P would lop off about 50% of its value, which would take the S&P back only to average valuations. Any overshoot to the downside—which almost always occurs in bear markets—-would chop off far more than 50%.

S&P 500 in a Short-Term Topping Pattern?

October 11, 2016

After inching up very modestly the prior week, the S&P500 gave back almost 0.7% last week on light volume.  Meanwhile, volatility inched higher—the VIX index rose for the week, but that’s to be expected during a period when prices fell back.

In US economic news, the bad news returned, unsurprisingly to us. The week began with a poor reading from the PMI manufacturing index, which fell from the prior month’s reading. Then construction spending registered a disastrous negative print, instead of a positive one as expected by economists. ADP employment missed badly. International trade was much more negative than predicted; this will hurt the next GDP report. On the positive side, ISM manufacturing was a bit stronger than expected and sow was the ISM services index. But the biggest number of the week—and the biggest disappointment—was the US payrolls report which missed badly. On top of that, the unemployment rate rose; it was supposed to remain unchanged. And worse, average hourly earnings growth disappointed. So while many on Wall Street keep on shouting—as they have for over six years—that the US economy is steadily recovering and growing, the truth, especially on Main Street, is the opposite:  the US economy has never fully recovered from the Great Recession and it’s still….fully seven years after coming out of this recession…..struggling to attain strong, organic growth.

Finally, the picture that technical analysis is painting has just become more ominous….for the S&P500. While last week we pointed out that the S&P has essentially gone nowhere for the last two full years, after last week’s loss, the short-term picture has now become more worrisome. After topping in August, about two months ago, the S&P500 has now been creeping downward slowly but surely ever since. And if it fails to hold at its September lows (roughly around 2,120) then there’s a lot more downside immediately ahead of it.  The next level of support will come into play at roughly 2,000. So because this support level of 2,120 is not that far away from Friday’s close, and if it doesn’t hold, then we’d be looking at roughly a 6% loss from there if 2,000 is reached.

Sure that’s not a huge loss in the long-term history of this index, but over the last couple of years—when the Fed’s support of the US equity markets has become so dominant in levitating stock prices—such a loss would hurt the psyche of many traders who have come to believe that even such minor losses are no longer very possible outcomes in US equity markets.

US Stocks Have Gone Nowhere for Two Years

October 3, 2016

Last week, the S&P500 inched up a very modest 0.17% on light volume. Volatility actually moved up a bit, in contradiction to the slight uptick in prices. While still very low, the rise in the VIX index suggests that investors are somewhat more nervous than they were a week ago.

Last week’s economic news was mixed, but certainly not showing any signs that US economic growth is about to accelerate. The Dallas Fed manufacturing survey came in negative….again. While new home sales beat expectations (slightly), the Case Shiller home price index missed badly, and pending home sales plunged (they were expected to rise). Consumer confidence beat expectations, and so did durable goods orders (but only because they didn’t fall as much as expected!). The Richmond Fed manufacturing index fell again. Wholesale trade also fell again. Personal spending missed; personal income only met expectations. Chicago PMI and international trade both beat expectations.

The technical picture for the S&P500 is not strong. More and more, it resembles a market that’s “hanging on by a thread”. Stunningly, over the past two years, the S&P500 has essentially gone nowhere—it’s now up only a couple of percent from where in was in late 2014. Remember, it’s now late 2016.

As an example of how hard it’s been to make money over this period, Cornell University—which has one of the largest university endowments in the US and some of the best & brightest advisors around—just reported that it LOST 3,3% in its most recent fiscal year. Cornell officials blamed the “low-return environment” for its horrible results.

So when all the pundits on Wall Street, and all the financial news reporters who echo them, scream every week that the US markets are doing well and that everyone should be jumping in with both feet, stop and think about the reality of the situation. The truth is that risk asset markets are very fully valued already, that these markets have gone essentially nowhere over the last couple of years, and that even the smartest and most sophisticated investors are struggling to make money from them.

In short, be careful.

US Treasury Rates Sliding….Again

September 26, 2016

The S&P500 climbed about 1.2% last week on light to moderate volume. Volatility dropped—the VIX index dipped back near, but not quite to, the lows of the year which were established in the summer months. While the S&P rose last week, it’s still not close to setting new highs, highs that were also established in the summer months.

Several key economic reports were announced last week. While the housing market index beat expectations, both housing starts and existing home sales (arguably both more important gauges than the housing market index), missed expectations. Initial jobless claims are still hovering near cycle lows. But the Chicago Fed national activity index, leading indicators and PMI flash manufacturing all missed. The big announcement of the week came from the Fed which decided not to raise rates….again.  Instead, they’re keeping short term rates pinned near zero even longer, all the while arguing that the economy is recovering yet again. The problem with this is that more and more regular American—who know that the economy has never truly recovered after the Great Recession —are beginning to understand that the Fed can’t argue that the economy is getting better while keeping rates so low and for so long. It’s a contradiction. The Fed is beginning to lose credibility not only with Wall Street, but lately even with Main Street.

And speaking of losing credibility, the US Treasury market rates have started to slide back down recently. After touching 1.75%, the 10 year Treasury yield has now fallen back below 1.60% and shows no signs of rising soon.

The reason this matters is that rising Treasury rates are typically associated with an improving economy, and therefore falling rates are associates with a deteriorating economy. After the 10 year rates jumped up from about 1.35% in late June (immediately after the Brexit vote was cast), the world took a breadth and realized that everything was not about to fall apart. So rates crept higher for most of the summer.

And it’s not just that lower rates are associated with lower prospects for economic growth; it’s also the case that falling rates are associated with lower prices for risk assets, such as stocks. When owners of stocks sell, they tend to buy up Treasuries to park their capital in a safe harbor.  This lowers yields.  And this is precisely what may be happening now as someone seems to be pushing the prices of US Treasuries higher…..in anticipation of a market decline.

US Stocks on a Precipice?

September 19, 2016

After skidding the prior week, the S&P500 inched back up about 0.5% the last week….on slightly higher volume. Volatility, as usual during a week when prices rise, crept back down. But the VIX index has not returned back down anywhere close to the lows seen during the summer months. Investors are much less complacent now.

Most of the US economic reports were released at the end of the week, and most of them were bad. Initial jobless claims rose instead of falling as expected. Retail sales were a disaster—both the headline number and the ex-autos number came in well below expectations. The Empire State manufacturing survey missed. Industrial production also missed. Business inventories missed. And consumer sentiment…..you guessed it…..missed. By all accounts, the US economy is not doing very well.

A very interesting technical picture is emerging for the S&P500. Over the last two years, a long-term topping formation has been forming, but this formation has been challenged lately, especially as earlier this year, the S&P rose above 2,100.

But more recently, the S&P500 has begun forming a short-term topping formation. After dropping for a couple of days in June after the Brexit vote, the S&P recovered all those losses and rose almost all the way up to 2,200 in July. But since then, the index has gone nowhere. More importantly, several key momentum indicators have turned down notably. MACD, for example, had turned bearish since late July. RSI has been deteriorating since mid July. And many others have done the same.

A week ago, the price of the index dropped below the 50 day moving average and has not recovered. Unless, this happens, a very reasonable downside target—and test—will be the 200 day moving average. This lies at around 2,058 or 4% below current prices.

Sure, a 4% drop would not be a huge loss  in the context of the massive run up over the last several years, but the S&& has not seen any type of similar losses since Brexit in late June and since the somewhat larger losses in late January.

So a 4% loss, in today’s world, would be noteworthy.

US Stocks Skid

September 12, 2016

After going almost nowhere for several weeks, the S&P500 slipped badly last week. The index lost 2.5%, with most of that loss coming on Friday alone. Volume for the week was light, but that’s mostly because of the Labor Day holiday. Volume on Friday, when the market sold off badly, was stronger. And volatility also spiked on Friday, but with the VIX reaching only the mid-teens, this “fear index” never reached the levels associated with panic sell-offs in the past.

There wasn’t much in the way of economic reports last week. PMI services missed expectations slightly. ISM services was the biggest story of the week—it missed badly. And this miss echoes the big miss in ISM manufacturing. Together, the two poor ISM results strongly suggest that the US economy is in a soft patch…..again. On the brighter side, initial jobless claims were a bit stronger than expected.

The technical picture changed dramatically. As discussed here last week, the S&P was poised to take a turn, up or down. And with the big sell-off in the books, it’s looking like the turn will be for the worse. That said, it will take much more than a one-day 2.5% drop to change the longer-term direction of the US equity markets. While prices did close below the 50 day moving average, this average is still well above the 200 day moving average. So the “golden cross” is still in effect. And therefore the short-term outlook has not really turned bearish….at least not yet.

Finally, well-known money manager and PhD economist John Hussman noted in his weekly newsletter that it takes a lot of discipline to sit out and miss the temporary gains that come with a bubble in equity markets. And he suggested that this is a lot easier to do, when one understands the consequences of participating in a bubble, falsely believing that this time is different, or just as badly, mistakenly believing that one will be able to sell at high prices when the bubble does in fact burst. He reminded readers that must:

Understand that valuation levels similar to the present have never been observed without the stock market losing half of its value, or more, over the completion of the market cycle.

So unless one is willing to endure such a huge setback in portfolio values, one must be willing to sit out the bubble and protect one’s assets from huge drops by investing more in cash and near-cash securities.

Unfortunately, most investors, amateur and professional, will not be so wise.