Trouble Ahead?

June 24, 2013

Well, the damage to US equity markets seems to be growing. Instead of continuing to bounce back, as it has for the last nine months, the S&P500 reversed course and dropped 2.1% to log its biggest weekly loss in 2013. Volume jumped. This is not good, because it suggests that there was growing conviction behind the selling. And volatility, as measured by the 30 day VIX, jumped to its highest levels in 2013. Also not good. Complacency seems to be melting away.

Technically, the S&P is now approaching areas where technical damage becomes a greater concern. For the first time in 2013, the S&P500 has decisively fallen below its 50 day moving average. On the other hand, the S&P is still well above the 200 day moving average, and this average is still trending up. Both of these pillars of support would have to break, before we can safely declare that the recent bull market push higher has ended. At the same time breadth indicators are pointing to more trouble ahead. The percent of stocks above their 50 and 150 day moving averages is tumbling badly. Also, in terms of breadth, the new highs less new lows index is collapsing, to levels last seen in the summer of 2011 when the S&P500 lost almost 20%.

At the same time, the US economy is far from reaching a healthy ‘escape velocity’. Most indicators are poor or mixed, at best. While the Empire State Manufacturing Survey jumped, all of the important sub-indicators missed. The sole reason for the beat was a huge spike in hope, hope that things get better in six months! Consumer prices, both headline and core, were subdued, meaning there’s little evidence that inflation is building, which typically happens in a healthy and growing economy. Housing starts missed, but existing home sales beat expectations. Initial jobless claims jumped, above the prior week’s levels and above the consensus forecasts. The Philly Fed beat, but the leading indicators missed. The shocking news of the week came from the Federal Reserve, which announced formally that it is will seriously consider tapering its permanent monthly QE buying program. The news was shocking mostly to the markets which were hit hard.

So now many investors are asking a critical question—should the US stock market be bought on this dip? This investment strategy has worked wonders for not only the last year, but ever since the ┬ámarkets bottomed in 2009 when the Great Recession and the Global Financial Crisis were peaking.

Why not do it again?

Well there happens to be a major difference in this sell-off, and it has little to do (directly) with the stock markets. Yes, the stock markets are showing—so far—the same pattern as we’ve seen over the last four years: a healthy sell-off which offers a good, lower-cost entry point for putting new money to work.

But there’s a difference. This time, other markets are selling off ahead of the stock markets and more severely. US Treasuries, corporate bonds, emerging market debt, non-US sovereign debt, commodities (especially copper), municipal bonds, and others have taken it on the chin far more severely—on a risk adjusted basis—than US stock markets.

When was the last time we witnessed anything similar to this?

In late 2007 and early 2008. And we all know what happened next. The US, and global, equity markets didn’t just ‘dip’ afterward, they crashed.

Will something similar happen this time?

There’s no way to know for sure, but to simply buy the ‘dip’, this time could be very, very dangerous.

Markets and the Fed’s Taper

June 17, 2013

The S&P500 dropped 1 percent last week on light volume. Although this was the third drop in the last four weeks, by no means were investors rushing to get out. Volatility rose by 13% but once again, there was no panic in the markets—the VIX is still, at 17, much closer to levels associated with complacency than levels associated with fear.

Despite the modest pullback over the last four weeks, the S&P500 is still, technically, stretched towards the upper end of its price channel. It never came close to its 200 day moving average, and it never even closed below its 50 day moving average. So the uptrend on the daily and for sure on the weekly charts is still in effect. Internally, the breadth of the advance has weakened somewhat. The percent of stocks above their 50 day moving average has dropped from over 90% to about 60% over the last four weeks. But that’s still fairly strong. And the new highs minus new lows has dropped, but it’s still positive. All in all, the US stock market has not yet broken its bullish surge higher.

As Wall Street continues to cheer, the US economy, or Main Street, continues to struggle. New job openings, as measured in the JOLTS survey, fell instead of rising as expected. Retail sales, when excluding the volatile and government-supported auto sector, rose less than expected. Initial jobless claims came in slightly better than expected. Producer prices were hotter than the consensus forecast; this means that pressure on corporate profits is growing. The big number of the week was industrial production and it disappointed. Instead of growing at 0.2%, it came in at zero growth. Production and capacity utilization in America are stagnating. Finally, consumer sentiment was much weaker than expected.

So if US economic data, week in and week out, disappoint and confound the expert economists who’ve been calling for an organic ‘recovery’ for over three years now (to no avail), why does the US stock market, and virtually all other investment markets, continue to shine?

Why is bad news on Main Street translate into good news for Wall Street?

It’s all about QE and the ‘taper’. Everyone seems to believe that the Federal Reserve will not begin to pare back, or taper, its $85 billion per month printing program if US economic data continue to come in below expectations.

And this means that investors and speculators continue to stay in the game, in the markets, looking for additional returns—on their stocks, their junk bonds, their investment grade bonds, etc.

Wall Street is convinced that weakness on Main Street will prevent the Fed from tapering its QE program, and thus, there’s no reason to sell……just yet. On the contrary, everyone believes that all dips should be bought.

Wall Street is convinced that when the time comes—when US economic data actually does begin to shine, and when the Fed actually decided to taper its QE—it will THEN sell its stocks, its bonds, its real estate—-perfectly timing the market and locking in the magnificent gains provided courtesy of the Fed up until that time.

Since the music is still playing, we’ll keep dancing. We’ll get out when the music stops.

Wall Street is certainly not worried about this simple, but crucial, detail. When millions and millions of stock owners ALL notice that the music is stopping, and they ALL decide that it’s time to get out, WHO will they ALL sell to?

But that’ll be a problem for another day. Right now, it’s still party time!


Credit Markets: More Bad News

June 10, 2013

The S&P500 bounced back lightly last week, rising by about 0.8% on moderate volume. Volatility slipped back down into ultra-complacent territory; the 30 day VIX for example, fell over 7% last week. Breadth, while still fairly strong, is showing signs of deterioration. The latest leg of the stock market’s advance is being led by a narrowing group of stocks. This is not what a strong bull market looks like.

US macro data continues to come in on the weak side. The ISM manufacturing index, a very important indicator, fell to 49 instead of increasing to 51. Anything under 50 means that US manufacturing is contracting; this is what we see during recessions. Also, this was the weakest reading since June 2009. Construction spending rose much less than expected, as did factory orders. ISM services, while still over 50, came in less than the consensus estimate. Initial jobless claims were slightly weaker than expected. Finally, the big report of the week was payrolls. While May was slightly better than expected, April and March were revised lower….largely offsetting the entire beat in May. The headline unemployment rate rose to 7.6%; it was supposed to stay steady at 7.5%. Average hourly earnings were expected to grow; instead, they stagnated (ie. showed zero growth). At the same time, the employment-to-population ratio and the labor force participation rate are both hovering near 30 year lows. The US labor market is suffering. It has been suffering for over 5 years, and most importantly, it’s not showing any signs of improving in a meaningful way.

Technically, the S&P downtrend, on the daily charts, is still in effect. The uptrend on the weekly resolution, however, has not been broken. Very soon, either the weekly uptrend will be broken, or the downtrend on the daily charts will reverse and rejoin the uptrend on the weekly charts.

Last week, we touched on the ominous sign that prices in fixed income markets are falling (ie. yields are rising) and that this if often a precursor, or leading indicator, of a drop in prices in equity markets.

This time, a closer look at the US Treasury market is warranted. At the end of last week, yields on the US 10 year Treasury shifted into positive territory for the first time in almost two years, as prices of Treasuries continued to sell off.

To the extent that buyers of (or investors in) mortgage debt need to hedge against rises in interest rates (because suddenly they will be more likely to be stuck with lower yields as homeowners reduce the amount of refinancing they’d otherwise conduct), these folks will need to sell more Treasuries to maintain their hedges. This in turn will drive down Treasury prices even more, which will cause rates to rise even further, creating ┬áthe possibility of a Treasury selling vortex.

Why does this matter?

Because one of the strongest indicators of an imminent correction in stock prices is the falling of Treasury prices, leading to a rise in real yields, especially during conditions where the stock market is relatively over-valued and over-bullish.

This is exactly what is happening now…..for the first time in almost two years.


Are Credit Markets Leading Equity Markets…..Down?

June 3, 2013

The S&P500 dipped another 1.1% last week. Notably, this was the first back-to-back weekly decline since late 2012. Volume was light. In other words, investors weren’t all rushing out the door. At least not yet. Volatility, as measured by the VIX, jumped over 16%. That said, it is still nowhere near the levels associated with fearful, or chaotic selling. Investor complacency has not disappeared. Also not yet.

The US macro picture has not improved materially. The Case-Shiller home price index beat expectations. Sure, the government engineered housing price ‘recovery’ continues, but as soon as normal mortgage rates return (there is no way to argue that 3.5% 30 year mortgages are normal or that they will continue indefinitely), then demand from buyers will plunge,taking price back down to more normal market-driven levels. Meanwhile, the Dallas Fed manufacturing survey imploded. First quarter GDP growth missed expectations. Initial jobless claims jumped; they were supposed to remain unchanged. Personal incomes did not grow; consensus estimates called for a rise. And Personal spending fell; it was supposed to remain unchanged. Finally, yes, Chicago PMI was stronger than expected. But given the preponderance of other data points (all pointing south), this result looks like an outlier. A reversion back down wouldn’t be surprising next month.

Technically, despite the two-week sell-off, the S&P remains in an extremely over-bought range, especially at the weekly resolution. The index is still hugging all-time highs and remains well above its 200 day moving average. In fact, the S&P is still comfortably above its 50 day moving average. So it’s still far from breaking down in terms of price. Breadth, while also still strong, is showing signs of turning down. The percent of stocks above their 50 day moving average is weakening. And the summation index, derived from the McClellan oscillator is turned down strongly. The next couple of weeks will answer this simple question—are stocks dipping while not breaking their long uptrend, or are they finally breaking down and correcting in a more serious fashion?

Outside the US stock markets, an interesting story is developing in the fixed income markets. It seems that virtually all the major classes of bonds (corporate investment grade, high yield, US Treasuries, and municipal debt) are selling off notably. Long term government bonds (as represented by the TLT), are well below their 200 day moving average and more importantly, have turned the 200 day moving average down, so that they’re now in a downtrend. High yield bonds (using HYG) have crashed through 50 moving average support and are threatening the 200 day line, for the first time since 2011. LQD, the investment grade ETF, has decisively crashed below the 200 day moving average, for the first time since 2008. Finally, municipal bonds (using the fund MUB) have broken down below 200 day support, for the first time since late 2010.

Why does this matter?

Because there’s an old saying on Wall Street that bond often markets lead stock markets, because the ‘Dumb Money’ is mostly in stocks, while the ‘Smart Money’ dominates credit markets.

And today, the Smart Money is heading for the exits, for the first time in years. This is a very ominous signal. Let’s see if stock markets follow.