Fed 1, Global Threats 0

March 26, 2011

The S&P500 bounced, not unexpectedly, a solid 2.7% last week.  But volume plunged, suggesting that once again, this was not a rally fueled by rising investor enthusiasm.  Not surprisingly, the VIX index plunged, bringing back the aura of complacency that accompanied the melt up since September 2010.

There was no unexpectedly good news in the economy last week.  Existing home sales shocked observers when it plunged almost 10% in February (vs. January).  Adding to the pain, median home prices fell over 5% (year over year).  Even worse, new home sales fell off a cliff.  The fell 17% from January and a whopping 28% from last year to notch the lowest ever reading in this statistic.  Durable goods orders fell, when they were expected to rise.  Initial jobless claims met expectations.  GDP for the fourth quarter in 2010 was bumped up to 3.1%, as expected.  And consumer sentiment fell more than predicted.

What’s most shocking about the rise in the stock markets last week was the horrific backdrop of geo-political events around the world.

The nuclear disaster in Japan is getting worse.  Nobody really knows how badly the nation of 125 million will be poisoned by radiation; but the radiation spread is far from contained.  The Japanese stock market crashed–literally.  The Portuguese government fell.  And Portugal’s sovereign debt reached lifetime high yields.  So did Ireland’s sovereign debt.  The Canadian government fell.  Oil prices jumped another 3%, reaching multi-year highs.  The Libyan war (pardon, no fly zone enforcement) is raging.  The dictator of Yemen is teetering.  Bahraini unrest is growing.  The ruling family in Bahrain is killing protestors, and Iran is threatening to defend them.  New unrest is brewing in Syria and Jordan.  And a slew of rockets were fired into Israel.

And there’s more! 

But despite all this turmoil and litany of reasons to sell, the US stock market jumped by a remarkable percentage. 

In fact the battle wasn’t even close.  Last week, the Fed won.  Pure and simple.

The money printing machine—also known as QE2—is still fully operational.  And its effects worked wonders for the risk markets.  Hell and high water were threatening, yet the Fed’s “forces” overcame the global threats, every last one of them.

For now. 

Because the end is near.  The QE2 “forces” are on schedule to be wound down in about two months.  In fact, Fed representatives made several announcements recently to remind all the party goers that they mean it–QE2 will end as originally scheduled.

Then we’ll finally see how the global threats–all of which are raging–will truly affect the stock markets, without the defensive force field of the Fed acting to neutralize them.

Another Down Week. Now What?

March 19, 2011

After the technical breakdown of the charts was noted a week ago, the S&P500 did fall again–as predicted.  The index finished the week down almost 2 percent.  Volume surged, which lends more validity to the price drop.  Also, the VIX index spiked over 20%, which is also a signal that helps confirm the price downward move.

The US economy continues to struggle.  Housing starts are once again collapsing (on a month to month basis), but from already depressed levels.  Permits were also dismally low, falling to the lowest level ever recorded.  Both starts and permits are substantially lower than they were a year ago.  Producer prices wer higher than expected; this will increase corporate costs, which will hurt corporate profits.  Consumer prices were also higher than expected; this will make it harder for consumers to buy more products and services, which will hurt corporate profits.  Initial jobless claims met expectations near the recessionary rate of 400,000.  Industrial production badly missed; it fell, when it was expected to rise.  Leading indicators also badly missed, but the Philly Fed survey beat expectations.

Over the last year or so, this blog has counted numerous ways in which the Fed-engineered stock market rally (now, arguably, a bubble) could be reversed, leading the market into a severe correction and resumption of the secular bear market that began after the 2000 tech bubble burst.

While the Fed, primarily through its money-printing QE programs, has been doing an admirable job of propelling stock prices upward, the argument has been made that the fundamental economic problems (that are behind the secular bear market) have not been fixed.  And until they are fixed, a true secular bull market cannot begin.

The single most important problem is the total credit market debt to GDP ratio in the US (and in most of the world, for that matter).  Sadly, this debt load is still sitting near all-time high levels, with the US government–lately– taking on the greatest share of this total debt load (relative to GDP).

So the challenge has been to look for triggers that could overcome the Fed’s powerful monetary BandAid policies (they’re BandAids because they cover up the over-indebtedness without doing anything to lower it; ie. actually fix the problem).

This list of triggers has included global sovereign debt crises, currency crises, trade crises, US state fiscal crises, Chinese bubble risk, and geo-political crises.  But the key takeaway was that the one trigger event that would actually cause markets to sell off would most likely not be on this list; in other words, it would be an unknown risk.

And sure enough, last week’s sell off was triggered by a massive earthquake in Japan, an earthquake that led to a disastrous tsunami and a still ongoing nuclear meltdown crisis.

But most importantly, for the stock markets, this is only a scratch.  It is not–yet–a sure thing that the secular bear market has resumed.  For that to happen, a cyclical bear market must first get established.  And we are still far away from the 20% sell-off (from the February 18 peak) that would ring the bell announcing the arrival of a bear market.

So what’s next?

The uptrend line, broken two weeks ago, is still broken.  And the stock markets are even slightly oversold, so that a bounce would not be surprising.  After this bounce (and even if no strong bounce emerges), the S&P must resume its decline for the newly established downtrend to remain intact.

This will be a challenge, primarily because the Fed’s QE2 program will continue for another two months or so.  But the Fed, last week, confirmed that it WILL be ending this QE program cold turkey in a couple of months, as originally planned.

So if this downtrend does not hold over the next 30 days, it’s highly likely that it will re-establish itself as equity investors head for the exits in advance of the end of QE2.  They will certainly not wait until it actually ends to leave the stock market party.  Because the last ones to leave, may not be able to get out without getting crushed.

So continue to enjoy the party, even if it manages to keep going over the next week or two.  But start putting your jackets on, locate your car keys, and head closer to the exit doors.  Because when the punchbowl finally runs out, you don’t want to be the last person standing on the dance floor.

Technically, the Charts are Broken

March 12, 2011

Last week, the S&P500 slid 1.3% on moderate volume.  The VIX (or fear) index rose about 5% for the week, adding validity to the price decline. 

The economic news was mostly negative.  Although consumer credit rose more than expected, all of the rise (and then some) happened only because of a huge spike in Federally backed student debt; without this change in student loans, consumer credit would have plunged.  International trade results were horrible;  the trade deficit was much worse than expected.  Initial jobless claims soared back to almost 400,000–also far worse than expected.  Retail sales met expectations, but only because prices (think gasoline) shot higher; real sales were poor.  Finally, consumer sentiment plummeted, when it was expected to dip only slightly.

Last week was a bad one for the Federal Reserve–the forces for lower stock price overcame the Fed’s best efforts to keep prices going higher.

The technical implications though are important.  Since September 2010, the S&P500 has closed each trading day well above its 50 day moving average (dma).  And in the world of technical analysis, whenever the stock market closes above the 50 dma, many traders and investors gain greater confidence in putting more money to work buying stocks.

Last week, for the first time in over six months, the 50 dma was broken–and not just on the S&P500 charts, but also on the Dow, the Nasdaq and the Russell 2000. 

Why is this important?

Because the same traders and investors who put money to work on the basis of the 50 dma being intact will now be more apt to reverse this decision.   This means that many stock market participants will move up stops and become very aggressive sellers should the stock market continue to fall further.

They’re naturally trying to protect their six month gains, and technically, they’re assuming that other traders will also look at the break in the 50 dma and become trigger-happy sellers.  These traders are staring intently at the exit doors and will stampede through the door at the next sign of trouble.

The first sign has already flashed–the violation of the 50 dma.  To many traders, the stock market charts are now broken.  They’re on stand-by.

If they see any more signs that the house is actually on fire, the markets could easily see a replay of the fireworks last seen on May 6, 2010…..a flash crash.

Given how over-bought and over-stretched the stock markets have become, things could get really ugly, really fast.

The Fed vs. The World: A Draw, for Now

March 5, 2011

The S&P500 finished the week almost unchanged.  Again, volume signalled that there’s more selling pressure than buying pressure; on the two days when the S&P fell, average volume was higher than it was on the three days when prices rose.  Volatility was also unchanged for the week, but it spiked on the two sell-off days.

The macro data was mixed to weak.  Personal income beat expectations; spending missed.  But personal income missed, badly, when the effects from the one-time late 2010 tax relief are removed.  Pending home sales missed.  ISM manufacturing and services beat expectations, but both are at levels that are almost always associated with cycle peaks; it’s highly likely they will fall in the near future.  Initial jobless claims were lower than expected.  Nonfarm payrolls missed, slightly.  Just as importantly, the average workweek did not increase as expected, and average hourly earnings did not grow at all (they were expected to rise).  The headline unemployment rate dropped to just below 9 percent, but shockingly the labor force participation rate remained at multi-decade lows (64.2%).  This means that the job conditions are so bad that a record number of unemployed folks are just no longer even looking.  If the labor force participation rate simply returned to its 25 year average of 66.1%, the headline unemployment rate would be a depressing 11.6%.

Technically, the S&P has not broken its uptrend line on the daily charts.  Just as importantly, it has not broken (and closed) below the 50 day moving average.  Some technicians have declared the uptrend broken because a rising wedge pattern (that began in August 2010) has been broken.  But until the S&P closes below about 1295, the Fed-induced melt-up is still in effect.  The weekly charts support this argument.  As overbought and overstretched as the stock market is, it has still not technically broken.

Last week we commented on the non-financial forces that could overcome the massive power unleashed by the Fed in pushing up stock prices.  And last week’s action in the oil market supported this argument.

On the two days when (in this case primarily due to Libyan unrest) oil prices rose the most, the stock markets fell the most.  The high (and the threat of even higher) price of oil swamped the Fed’s stated goal of boosting stock prices.

What ironic is that the Fed’s actions (primarily its quantitative easing) have been one of the most important drivers behind the rise of oil prices.  First, the Fed’s creation of billions of additional dollars has spilled into the hard commodity markets (like oil), thereby boosting their prices.  Second, the Fed’s QE has helped stimulate general demand in the global economy (even if much of it spilled over to developing nations such as China); this additional global economic demand naturally pushed up the cost of oil, which is used to satisfy this new demand (for raw material in making products and for fuel in transporting products).  Third, the increased prices in fuel oil and food commodities exploded into social stress in developing countries all over the Middle East and North Africa (MENA).  The generally poor people there suddenly found it much more difficult to eat.  And since so much of the population is young, it expressed this hunger-driven stress through protests and rioting, leading to revolutions in Tunisia and Egypt, so far.  This social and political turmoil has reduced oil production in MENA and threatens to slash it much more, should the unrest explode in Saudi Arabia, for example.

The Fed, in many ways, shot itself in the foot.  While it temporarily “solved” one problem (by boosting stock prices), it created another massive set of problems, problems that are only now beginning to boomerang back to the Fed.

So last week ended in a draw.  While oil prices shot up again, the stock market—thanks directly to the continuing QE2 program—did not change, for the week.

Once again, we are left to ponder: what happens when QE2 winds down over the next two months? 

It’s very possible that the stock market benefits will disappear, and that alone would give stocks a strong reason to pull back. 

But it’s also possible that—in addition to the elimination of the stock market support—the “massive set of problems” will remain:  high oil prices, high food prices, global social and political stress. 

So if the benefits of QE disappear, and all the nasty side-effects remain, that would give stocks a stronger reason to pull back.

Scratch that.  That would give stocks a reason to crash.