One More Bounce? Maybe.

May 28, 2011

The S&P500 dipped another 0.2% last week, which was the fourth consecutive week of declines, even though each of these declines was very minor.  Volume was light, but some of that could be explained by the pre-holiday (Memorial Day), pre-summer drop off that’s very normal.  But volatility also dropped off, which suggests that complacency is still very widespread.

As discussed last week, the 2 year “recovery” could be nothing but a government (Fed and Treasury) engineered house of cards.  And this week’s data further supported this claim.  The Richmond Fed survey of economic activity plunged.  Durable goods orders collapsed; both the deadline figure and the ex-transportation figure were well below expectations.  First quarter GDP growth (annualized) was expected to be revised up from 1.8% to 2.1%.  Instead, it came in below expectations at 1.8%, or unchanged.  Initial jobless claims also disappointed; now they’re solidly in the 400 thousand range formerly associated with recessions.  And the stunner for the week was the Pending Home Sales index which fell by a whopping 11.6% (in April vs. March) and 26.5% year over year.  Because this is the spring selling season, it’s normally the strongest time of the year (for home sales).  Instead, sales are collapsing.  This begs the question:  if sales are so bad now, will utter disaster strike residential real estate in the late summer and fall?

The cyclical recovery, the house of cards, looks like it’s falling apart.

Technically, on the daily charts, the downtrend that began in the first week of May is still in effect.  But this is a gradual and low-conviction grind down in stock prices, not a violent downdraft.  The weekly charts are also showing (so far) a gradual erosion in prices.  The negative (or bearish) divergences on the daily and weekly charts are still very much intact.  The US stock markets are stretched in way they haven’t been stretched in a long time.

Could the stock market go higher?

Perhaps.  Actually, after the mild four week sell off, it would not surprise anyone if stock prices melted up in the first few weeks of June.

Why?  Mainly because the Fed’s QE2 pump has a few more weeks of pumping still left.

But such a bounce—even if it were to happen, which is by no means a certainty—will probably be short-lived.

First, a most important known known is fast approaching.  The Fed will shut off its QE pump.  Even a temporary shutdown ought to be enough to take some serious air out of the stock market balloon.  There is little doubt that this deflating moment will arrive and on firm schedule—by the end of June.

Second, the known unknowns are ticking time bombs waiting to go off. For example, the Greek debt tragedy is getting worse by the week. Default is almost 100% certain.  The timing is not—it could happen next week or early next year.  If it happens in June or July, then the Fed’s shut down of QE will only add to the market’s loss of confidence, or possibly panic.

Finally, there are the unknown unknowns.  So much of the global financial system’s asset valuations depend on an extremely fragile and interlocking set of equilibria.  Any one of a series of shocks—from energy, to climate, to geo-political, to food production and distribution, to environmental—are rocks that could break the financial glass house. The risks from these shocks are always present, but today’s exceptionally fragile financial state means that the impact from any one of these shocks would be exceptionally devastating.

There’s very little room for error in today’s stock market valuations. Sure, prices could slowly inch higher.  But they could also collapse in a heartbeat.

House of Cards…on a Foundation of Sand

May 21, 2011

The S&P500 has declined for three weeks in a row.  Last week’s drop, although nothing serious, was 0.3%.  Volume was not heavy; it was as if investors and traders were looking for direction.  Volatility and skew both edged up slightly, meaning that players are starting to worry more about downside risk.

The economic results were bad and recently, getting much worse.  The Empire State survey collapsed by 50%, when it was projected to stay almost unchanged.  Housing starts plunged; they were expected to rise.  Existing home sales fell markedly; they were expected to rise.  It’s now commonly accepted by all (except real estate professionals who never admit to a down market) that housing is double-dipping.  And if these figures keep up, housing will be in a state of collapse.  Industrial production plunged.  Jobless claims were again in the 400,000 range.  The Philly Fed survey also collapsed; instead of rising to 23 as expected, it fell to 3.9.  Finally, the leading indicators printed a negative number, for the first time since October 2010.

Technically,  the three month uptrend is breaking and a new short-term (three week) downtrend has begun.  If the S&P breaks decisively below support at 1325 (its 50 day moving average), then a lot of technical selling could begin.  If so, the next area of support could be at 1250, which was the March 11 low resulting from the Japanese earthquake.  If that doesn’t hold, then the 200 day moving average is down further at about 1238.

What most analysts are starting to debate right now is whether the two year cyclical bull market and the two year economic recovery are in jeopardy.  If so, then we should all be prepared for a strong market correction, before the markets consolidate and form a base, at which time we can jump back in and enjoy another merry bull market.

This is an argument about the market and economic cycle. It’s normal to have it, and in almost any other time, this would be the most important investment timing debate to have.

But what if investors are missing something?  What if there’s something deeper, something secular, that underlies the debate about cycles?  What if the cyclical bull market was actually built on a foundation of sand?  And to add insult to injury, what if the cyclical bull market itself was a house of cards…….sitting on a foundation of sand?

If the underlying rot, the root cancer, that led to the 2008-2009 market and economic collapse has not been fixed, then the foundation is not at all firm.  It will give way.  The question is only when.

And since the central part of the root cancer—the global debt bubble relative to GDP and the financial fraud that helped blow this debt bubble—is still spreading, then the foundation is in fact NOTHING more than a mirage.  It will not hold.

The cyclical bull market and the so-called economic recovery are also fragile, at best.  At worst, they are a mirage……a house of cards. Why? Because they were engineered by the Federal Reserve (through its money creation program) and the cooperation of the Treasury and Congress (which spent and borrowed over 10% of GDP for the last tow years).  This house of cards will collapse simply because the government cannot continue spending (and printing) over 10% of GDP indefinitely….without a catastrophic blow-back.  The question is only when.

So today, the economic house of cards is starting to wobble.  The markets, in turn, are also starting to quiver.  If these two entities do crumble, then we should really worry.


Because there is almost zero chance that the foundation of sand—on which they’re built—will hold.

US Treasuries… Update

May 14, 2011

The S&P500 slipped 0.2% last week on modest volume and declining volatility.  Once again, the most interesting action in the markets was in commodities, not stocks.  And the commodity markets are now suddenly much more volatile and look poised to turn south.  The US dollar, not coincidentally, had its two best back-to-back weeks all year.

The week’s economic news was mixed, but leaning to bearish.  The trade balance for April was worse than expected; this will put more downward pressure on GDP growth.  Retail sales missed slightly; excluding autos and gas, retail sales missed badly.  Producer prices were higher than expected.  Consumer prices just about met expectations.  Weekly jobless claims were again higher than predicted.  But consumer sentiment was slightly better.

Technically, the S&P is at a crossroads on the daily charts.  For the uptrend from the March lows to remain valid, the S&P must close higher next week.  If it doesn’t, then a potentially important turning point may be reached.   With all of the negative divergences building throughout 2011, the break—downward—could be especially severe.  The stock market appears to be very coiled, like a spring, and it could unwind very quickly if the appropriate catalysts hit it.

If a sell off in equities were to occur, then the US Treasury market will be a prime beneficiary.

But how have Treasuries done since we first recommended them back in February?

It turns out that only about a week after the February 5th post, Treasuries hit their lowest price of the year (so far) and have rallied—massively—since then.

Just as predicted.

But this is exactly the opposite of conventional wisdom and some big bond managers were predicting.  The common view was that Treasuries would start selling off badly (interest rates would start soaring) as the end of quantitative easing approached.  Yields, these so-called experts predicted, would spike well above 4.0% on the 10 year note, for example.

What happened instead?

The 10 year rate collapsed from over 3.6% to almost 3.1% as of Friday last week.  Over the last three months, this translates into (roughly) a 13% jump in the value of the note, excluding the accrued coupon, which adds almost another full percentage point of return.

14% return over three months.  Not bad.  Especially compared to the S&P500 which is essentially unchanged since mid February.

Where does this leave us now?

The best is yet to come.  The bulk of the bullish effect laid out in the February 5 post has yet to be fully expressed.  Since QE2 will be winding down in about a month, the big money movement into Treasuries hasn’t even occurred….yet.

Much of the current rally has happened because the folks who were betting against Treasuries—and losing—have begun to stop their losses.  This alone drives the price up further.

But when the big—long awaited—“risk off” phase commences, after the loss of QE2 liquidity slams the markets, a tsunami of scared money could rush into Treasuries.

The recent downturn in the commodity markets was the first sign that this (selling of one asset and movement into Treasuries) rotation may have begun.

But when the big selling begins—in stocks, in high yield corporate bonds, and in investment grade corporate bonds—the yield on the US 10 year Treasury could move down much further.

Depending on the severity of the sell off, it would not be surprising if the 10 year note fell to under 3.0%.  And if things get really ugly, the 10 year could dip to 2.5% or lower.

If, or when, that happens, we’ll discuss the next logical step: SHORTING the 10 year note.

The Pressure Mounts

May 7, 2011

The S&P500 slipped 1.7% last week despite widely held expectations that the equity markets would rally after the death of Osama bin Laden.  Volume edged higher, adding validity to the sell-off.  And volatility also spiked almost 25%.

What overcame the buoyant expectations was the gloomy economic data.  Specifically, there were growing signs that the US economy is headed for a serious slowdown……as predicted here for a long time.  In a manner resembling the mid-year slowdown in 2010, the economic numbers are suddenly crumbling.  For example, the ISM services index collapsed from 57.3 to 52.8.  Also, initial claims rocketed up to 474,000…..much closer to 500,000 (bad recession territory) than 400,000 (minor recession territory) where they’ve been for several months.  Although the government payrolls report showed that over 200,000 jobs were created in April, the household survey showed that almost 200,000 jobs were LOST.  The headline unemployment rate jumped back up to 9.0%; the broadest (and more meaningful) measure [U-6] jumped up to 15.9%.  Average hourly earnings disappointed, and the average workweek stagnated.  Also grim were the broad measures:  the employment-to-population ratio FELL to 58.4%, and the labor force participation rate stagnated at 64.2%—both measures are near 30 year lows.

Technically, the S&P has returned to a bearish phase on the daily charts, but possibly only for the very short-term.  As of yet, this is not a very strong signal.  But on both the daily and the weekly perspectives, the S&P remains extremely overbought and looking like it’s pinned near its highs by some supernatural force.  In fact, this force is nothing but the Federal Reserve’s money pumping, pumping that is firmly scheduled to end next month.

Several additional pressure points are building and possibly getting closer to breaking.

The global credit markets are pricing Greek government bonds at prices that imply a default is imminent.  The 2 year government bond, for example, is offered at about 50 cents on the dollar, to yield about 25% annually.

Rumors are starting to circulate that Greece is close to throwing in the towel:  admitting that it can’t credibly service its massive debt load and default.  There were rumors that Greece was even preparing to dump the Euro and re-issue its own currency, obviously at a severely lower value relative to the Euro.

Also, Japan’s post-earthquake economic data have begun to roll in and the results are horrible.  Industrial production dropped 15% in March.  Retail sales dropped 8%.  Barron’s is estimating that first quarter GDP will drop by up to 3% (from the previous quarter).  What’s worse is that production has continued plunging in April and May.  Barron’s estimates that total production will fall 25% by summer, which will be 35% below levels seen in 2008 (before Lehman failed).  GDP could drop 10% before the 2008 peak.

Yikes!  Japan is putting up Depression-style numbers, as its fiscal debt woes keep growing—gross government debt is now about 220% of GDP.  Double yikes!

Either one of these time bombs could set off another Lehman-style global financial crisis.  And they both seem to be on short fuses.

Meanwhile, the Fed is about to shut down the QE free money party and Europe’s central bank is already tightening.

Things are about to get very interesting, very soon.