Technicals….a Warning Sign?

October 28, 2012

The S&P500 lost 1.5% last week on moderate volume. Volatility inched higher, but at 17.8 the VIX index is still far closer to multi-year lows than to multi-year highs. This means that there still has been no panic selling. Is that yet to come?

The macro news in the US is not getting stronger. Both the Richmond Fed and the Kansas City Fed manufacturing surveys badly missed their respective estimates. New home sales just about met expectations, but the pending home sales index missed. Flash manufacturing PMI also missed. Durable goods beat expectations, but this had nothing to do with the private sector; apparently, government purchases soared, and this can hardly be expected to continue. And the first estimate of Q3 GDP came in slightly better than expected, but still it was not a strong number (at only 2.0%) and most recent first estimates have been revised downward; there’s a good chance that this one will be slashed too.

The S&P500 has violated several technical barriers and is now poised to sell off further, barring any surprise intervention or manipulation by the Fed or the other major central banks of the world.

While the S&P could be slightly oversold on a short-term basis, its multi-month climb since June appears to be coming to an end. First, the uptrend that began in early June has been broken. Several commonly followed momentum and oscillator indicators are also pointing to more selling. MACD has moved into negative territory for the first time since late June. RSI is now in a bearish zone.

In terms of breadth, the McClellan oscillator has weakened notably since early September. And the same applies to the summation index. The percent of stocks above the 150 day moving average is turning down, as is the percent of stocks above the 50 day moving average. Also, the new highs minus the new lows is weakening notably.

Next, sentiment is beginning to weaken. The S&P bullish percent index is beginning to fall, and still has a long way to go before becoming too bearish, and thus pointing to a buying period from a contrarian point of view. A similar story is being told among professional traders, who are now starting to raise their Put/Call option ratios, in order to provide more protection for their long positions.

So not only are prices turning lower, but the market internals are breaking down. As more and more firms announce poor 3rd quarter results and issue warnings for the 4th quarter, it’s becoming clear that no amount of money printing by the Fed can magically create stronger corporate sales and earnings.

As a result, stock prices are poised to grind lower. Unless investors accept much higher P/E ratios (as Earnings keep falling), stock prices will have a difficult time maintaining their current levels….even after a 4% sell-off from recent peaks.

 

 


Sales & Earnings Dry Up…As Predicted

October 21, 2012

The S&P500 finished the week up slightly, but the big market story was the meltdown suffered on Friday, with the S&P losing over 24 points, making it the single biggest drop since June. Volume jumped, which unfortunately for bulls is a negative sign–rising volume on big down days means that stock owners were rushing for the exits. And volatility also spiked, rising over 13%. The good news is that the VIX is still in historically calm waters, well under 20. The bad news is that the VIX has a long way to go (up) before entering an overbought area, and one that is usually associated with market bottoms.

US macro news is still in the doldrums. The Empire State Manufacturing survey missed badly. And while retail sales beat expectations, more folks are simply not saving (or worse, draining savings) to keep up their purchases. Consumer prices were higher than predicted. Initial jobless claims roared back close the dreaded 400,000 level. The Philly Fed survey beat expectations, but its two most important sub-components, employment and new orders, both disappointed.

Technically, the S&P seems to be entering a downtrend on the daily charts. In terms of breadth, new highs minus new lows is dropping fast. And the percent of stocks above the 50 and 150 day moving averages seems to be breaking lower. It seems that some more selling, at least from a daily perspective, is very possible.

Back on June 23, we warned that corporate earnings could start to break down. Back then, a few key firms—P&G, Texas Instruments, Ryder Systems, Adobe and Starbucks—began to warn of lower profits. We also noted that the only way stock prices would keep going up is if P/E ratios would start to rise. Well, that’s exactly what happened—P/E ratios did rise over the summer, and stock prices went up with them.

But now, the story with corporate sales and profits is getting scarier. Not only are sales and profits falling further, but more importantly a much broader swath of firms are beginning to suffer. Technology firms have been especially hard hit. Market leaders such as Microsoft, Google, IBM and Oracle have been missing Q3 estimates badly, AND have been guiding much lower for Q4 earnings.

This is setting up an especially risky scenario. Just as in 2008, when the first three quarters were disappointing, most market “experts” were hoping for a huge rebound in Q4 earnings to rescue the year, the same is happening in 2012. And now there’s a greater danger that these hoped for Q4 earnings in 2012 will not materialize.

On top of that, the market impact of the “fiscal cliff” will be hitting in mid-November, just after the elections. This means that the markets could be kicked when they’re already down because of poor sales and earnings.

Yet somehow, equity prices are still hovering near multi-year highs. Why? Once again, because brainwashed investors and traders firmly believe that no matter how bad the fundamental news, then Fed will make everything good.

We will soon find out if this is true.


Return Free Risk

October 14, 2012

The S&P500 dropped 2.2% last week, it’s largest weekly loss in 2012 since July. Volume did not surge, suggesting that this was not some sort of rush to sell by long-term holders of stocks. And volatility, while rising 12.6% (the VIX), remained at low–and therefore still complacent–levels.

Technically, there were more signs of a breakdown of the uptrend in price….which is still in effect. The new highs less the new lows in the NYSE tumbled badly, and are very close to entering levels associated with more severe corrections. The percent of stocks above the 50 day moving average (in the S&P) also broke down, yet still not to levels associated with bear markets. Finally, the NYSE Summation Index made a substantial turn for the worse and it’s pointing to more selling ahead.

In macro news, international trade disappointed, and that means that the US economic growth in the 3rd quarter is weakening even further from it’s already dismal performance in Q2. Producer prices surged last month, suggesting that corporate profits will be under pressure from rising input costs. That said, excluding food and energy, the core PPI did not rise at all, meaning that if you don’t eat or drive, you’re not feeling any negative effects from inflation.

Citigroup’s credit strategy team, via ZeroHedge, just released a paper in which they argue that the Fed’s liquidity injections have been the driving force behind the levitation in asset prices over the last three years.

But the argue that the prices have now reached levels that are so lofty that prospective returns are huge and prospective risk are also high.

In other words, by driving “market” interest rates down to zero, the Fed has been forcing investors to dump low risk securities such as money market funds, and Treasury bills and notes and reach for yield in far riskier assets such as junk bonds and equities.

And now that the prices of these risky securities have jumped so high, anyone buying them now—or just holding them—is looking at essentially minimal returns going forward, but with super high risk of capital loss.

What could cause ¬†these risky assets to lose a lot of value? Well, the same “tail risk” catalysts that we’ve been harping on for months: among others, these include a Greek exit from the euro, political crises in Spain or Italy, or social unrest in any number of states and regions.

According to Citi, these “tail risks” are “bound to resurface in our view”.

And in our view too.


Don’t Forget High Frequency Trading

October 7, 2012

After two weeks of modest losses, the S&P500 reversed course and rose 1.4% last week. Volume was modest. But volatility dropped; the VIX index dropped back down to multi-year lows, suggesting that once again, investors are setting all worrying aside and putting all their faith into the central banks of the world.

The primary drivers of last week’s rally, aside from technical reasons (the market was over sold on a short-term basis), were a couple of upside surprises in the economy. But there were caveats with each. First, the ISM indices beat expectations. However key components within these indices were still quite ¬†bearish. For example, prices paid rose within the ISM’s—pushing the indices higher—but the reality is that higher prices lead to lower corporate profits or lower wages, which could hurt the economy in the longer run.

Then the unemployment rate surprised everyone by plunging to 7.8% from 8.1% just in time to boost the president’s election chances. However, key problems remain in effect. Almost all of the improvement in the headline rate came from a historic surge in part-time workers, who seemingly came from nowhere to suddenly take on sub-optimal employment. So the most broad measure of unemployment, U-6, remained stuck at an dismally high rate of 14.7%. Meanwhile, factory orders kept on plunging and construction spending fell, instead of rising as expected.

After all the focus on the open manipulation of the equity markets (up), the bond markets (yields down) and the dollar market (down) by the Federal Reserve, it’s easy to forget that there are other major risks lurking beneath the surface of the capital markets.

One of the most sinister, yet still perfectly legal, forces of market manipulation comes from high frequency trading. And now over two years after the Flash Crash in May 2010, this industry has just kept on growing. Today, it’s responsible for 70% of all transactions on US stock exchanges.

Computer algorithms, or machines, have virtually taken over the US stock markets. And this presents several problems. One is that these programs cheat everyday individual and institutional investors out of money. Algos, for example, due to their speed advantage, can front run normal traders and take money away from them.

A second problem is that their supposed liquidity tends to vanish when it’s need most—eg. times of market stress. Instead of supplying liquidity when normal “human” investors get stressed, computers simply shut off, usually in a flash, leaving the markets they were formerly trading vulnerable to massive plunges.

Luckily, regulators outside the US are beginning to rein in these predators. And hopefully this will set an example for the SEC in the US, where they have still not conclusively demonstrated how and why the Flash Crash occurred in 2010.

While, according to the NY Times, the SEC is beginning to invest in research to better track computer trading, it’s still a long way away from doing anything about it.

And this means that in addition to all the other major risk factors already threatening risk markets, it’s important not to forget that algorithmic trading is another home-grown risk that we face every single day.