US Government Shutdown?

September 30, 2013

The S&P500 lost a little over one percent las week, on modest volume. S&P volatility jumped almost 20%, yet remained at the low end of its 20 year historical range.

Technically, the S&P is rolling over on the daily charts. Another weekly close lower would confirm a new short-term downtrend. On the weekly charts, the topping formation that took shape in late summer is still in effect, and even more so after last week’s decline. Market internals are also weakening. The new highs minus new lows, for example is fast approaching negative figures. Also, the percent of stocks above their 50 day moving averages is not only falling, but the peaks in this index, since the first half of this year, have been successively lower and lower. To sum up market internals, the market advance since the mid-summer months has been led by fewer and fewer stocks. This is not a sign of market strength.

In US macro news, the quarter ended on a weak note. Flash manufacturing PMI disappointed. So did the Case Shiller home price index which is not recording a rapid slowdown in the pace of home price increases. Both consumer confidence and consumer sentiment missed. The Richmond Fed manufacturing index missed. Headline durable goods beat expectations, but the more important ex-transportation figure missed. New home sales missed; and the median price of new homes continues to decline. GDP for the 2nd quarter missed. Pending home sales missed and the Kansas City Fed manufacturing survey plunged. Some of the best results of the week came from personal spending and personal income, which did not beat expectations–they both merely met them.

The big story of the upcoming week is the imminent US federal government shutdown, and the possible repercussion to the US economy and the US capital markets.

The last time this happened (in 1996), it was a short-term event during an otherwise booming period of economic growth. This time, US economic growth is anemic and has been anemic ever since the so-called recovery began in 2009. So the possible impact to the economy if the shutdown actually happens and if it becomes in any way protracted, could be more damaging.

The impact on US markets could be even stronger. Wall Street hates uncertainty and instability and if the shutdown happens, historical analogies may provide a clue to the immediate future.

Back in 2011, when a crisis over the US debt ceiling was boiling over, equities and high yield credit were hit the hardest. Interestingly, and perhaps counter-intuitively, US Treasuries soared. And precious metals soared.

So it seems very possible that something similar might happen with this fiscal crisis. Expect a general risk-off atmosphere where stocks and risky credit gets sold. Money exiting these markets might run short-term and medium-term US Treasuries for a safe harbor. And it may also look to leave the US entirely, in which case the US dollar could get sold off causing other developed market currencies to jump.

Regardless of the exact outcome, there’s a good chance that some asset classes will drop in price, causing them to become more attractive in terms of prospective returns. In other words, this showdown could offer savvy investors a chance to ‘buy low’.


No Taper: Is the Economy that Bad?

September 23, 2013

In a week of ups and downs, the S&P500 closed 1.3% higher on higher volume, But the highest volume day was Friday, the day that the S&P sold off the hardest. Volatility dipped again, this time to the ultra-complacent levels last seen during the summer months.

The major catalyst for the week’s advance was the Federal Reserve’s announcement that it would not taper its monthly $85 billion QE program that is rapidly ballooning its balance sheet to $4 trillion, up from a mere $850 billion in early 2008. Markets were shocked because it was widely expected that the Fed would at cut back its credit creation by a minor $10 billion to $15 billion. With the exception of the US dollar, almost every other asset class jumped on the news—Treasuries, investment grade credit, high yield, equities, metals, and other commodities.

At the same time, US macro news continues to be disappointing. The Empire State manufacturing survey missed expectations badly. Industrial production also missed. Housing starts disappointed, with a big miss. Initial jobless claims have beaten estimates for two straight weeks, but as the BLS has warned, these two reports are tainted by several serious software glitches in key reporting states such as California. On the bright side, existing home sales were stronger than expected. The Philly Fed survey beat expectations, and so did the leading indicators index.

Technically, the S&P500 is becoming very oversold on the daily charts. Several short term breadth indicators, such as the McClellan Oscillator are pointing to the high probability of at least a temporary pullback in stock prices. On the weekly charts, the S&P is still—barely—bearish, primarily because of its failure to follow through on Thursday and Friday, after the Fed’s ‘no taper’ announcement.

With respect to the taper, more economic and market analysts are asking the obvious question—-if the Fed thinks it’s too risky to shave just a tiny portion of its monetary stimulus program, just how fragile are things, in the markets and more importantly, in the broader economy?

The answer, as discussed endlessly here, is that the US economy is on thin ice, and that the US financial markets are in even worse shape—they’re in bubble territory, just waiting to burst.

The Fed’s decision this week, it can be reasonably argued, proves this point.

And on a related note, one can wonder—-if, fully five years after starting them, the Fed’s QE programs (all of them) have failed to put the US economy on firm ground, how is it possible that ‘more of the same’ will actually do so? In other words, if the medicine hasn’t cured the disease, is the answer to just up the dose?

Clearly, the Fed’s monetary policy has failed to produce the desired results—put GDP growth on solid ground. And at the same time, this policy has created dangerous distortions and bubbles in many financial markets, with stocks being just one of them.

This will not end well.


Tipping Points in the US Economy?

September 16, 2013

The S&P500 jumped up almost 2% last week on slightly higher volume. Volatility eased down, but not nearly as much as it did during the mid-summer months. So while volatility is still hovering near multi-year lows, it’s slightly elevated levels could be signalling that investors are concerned about the equity markets in the month ahead.

Technically, the US equity markets are now somewhat overbought on the daily charts. And some breadth indicators are also suggesting that markets may be toppy on a short-term basis. The McClellan oscillator, for example, is stretched to the upside, so some sort of pullback should not be surprising. But the weekly charts have yet to turn officially bullish. It would take another week of strong gains for this to happen.

The US economy recorded several disappointing results last week. Job openings (as measured in the JOLTS report) came in far lower than expected. Wholesale trade missed badly. Producer prices came in roughly as expected. But retail sales were a disaster. The headline number missed by 60% and retail sales excluding autos missed by 67%. And in what was the biggest surprise of the week, consumer sentiment plunged in what turned out to be the biggest miss (vs. expectations) in the history of this series.

So fully four years after the so-called US economic recovery began, it seems as though the recent news is pointing to a lackluster recovery, at best. At worst, the US recovery could be headed into another recession.

In  fact, Bloomberg’s Rich Yamarone recently wrote a piece in which he shows that when several key indicators fall below a 2% annual growth threshold, the US economy almost always—based on decades of history—falls into a recession within the following 12 months.

For example, when real final sales of domestic product (which excludes goods piled up in inventory) falls below 2%, the economy usually enters a recession. This figure is now 1.2%.

Also, when real disposable income and real consumer spending fall below 2%,  the economy typically slides into recession. These figures are now 0.8% and 1.7% respectively.

Finally, when real GDP growth itself falls below 2%, a recession normally follows. In the most recent (second) quarter, this figure was running at an annual rate of 1.6%.

Does all of this guarantee that a recession is around the corner? Of course not, but if history is any guide, then the odds of a new recession are certainly more elevated today than they have been since the onset of the Great Recession in 2007.


US Treasuries on Sale?

September 9, 2013

As expected, the S&P500 bounced back last week, gaining almost 1.4% . But the volume was extremely light, even considering that the week was shortened by the Labor Day holiday. So this bounce was certainly not a sign of any meaningful rush back into stocks by investors or traders. Volatility slipped slightly, but not nearly as far down as it had in the weeks during mid-summer.

Technically, the S&P500 will soon approach a test that we alluded to last week. The S&P has consistently over the last year avoided serious damage in the weekly charts, even though it has had many minor bearish pullbacks on the daily charts. For this bullish pattern to repeat, the S&P must re-capture 1,700 fairly soon, say over the next two weeks and then continue on to establish new highs. If this were to happen, then the still bearish signatures in the weekly charts will flip back over to being bullish. But if not, then the S&P could finally enter into a more meaningful downturn, a downturn that has been missing since the summer of 2011.

US economic news continues to be mixed. International trade data slightly missed expectations. The PMI manufacturing index also missed. But the more important ISM manufacturing index beat expectations, and this perversely hurt the markets because it again supported the view that the Fed will begin to taper its QE program this month. Initial jobless claims were also somewhat better than expected, as were factory orders. However the big number of the week—payrolls—did disappoint. Total jobs created were lower than predicted. While the headline unemployment rate fell, this was all due to job-seekers dropping out of the labor force (not good), as opposed to getting new jobs (good). The eroding Labor Force Participation Rate, which fell to a 35 year low, confirms this negative trend. Another problem was that the two prior months of jobs figures were slashed.

So once again, the US economy is limping along. It’s certainly nowhere near reaching the much anticipated ‘escape velocity’ that has eluded it for over four years now.

In the financial markets, interestingly, the US Treasuries continue to sell off. While we have discussed how this trend may signal negative consequences in many risk markets, such as stocks, Treasuries themselves have not sold off so much that they themselves have become one of the few asset classes in the US that are now somewhat cheap.

The US 10 year note which yielded less than 1.5% in the summer of 2012 and reached about 1.6% as recently as May of this year, is now yielding almost 3.0%. In other words, the yield on this note has just about doubled.

But another way of measuring its value as an investment is to compare the difference between the yield on the 10 year note versus the yield on Treasury bills. This ‘spread’ is now nearing all time highs. And to take advantage of this wide spread, investors might want to consider buying the 10 year note in the expectation that the spread will compress by a reduction in the yield of the 10 year, not by an increase in the yield of Treasury bills, which the Fed has shown no signs of raising anytime in the near future.

So while almost every asset class in the US continues to be over-priced by most historical measures, it’s good to see some assets finally going ‘on sale’ even if only slightly.


Taper On—When Good News is Bad News

September 3, 2013

In one of its worst weeks of the past year, the S&P500 lost almost 2% last week. Volatility soared; the VIX index rose by almost 22%. That said, the absolute level of fear is nowhere near panic levels. Volume was light, but that probably had more to do with the season (the last week in August is normally a very light week) than with investor sentiment.

Technically, the S&P’s downtrend is fully intact, especially on the weekly resolution where prices look like they have a lot more room to fall from here. On the daily charts, stocks are somewhat oversold, so some sort of relief rally, or bounce, would not be out of the question. Breadth continues to weaken. The percent of stocks above their 150 day moving average is lower now than it has been for all of 2013. But as in prior multi-week pullbacks this year, the markets are approaching an area where the firm belief in the powers of the Fed has re-established the former uptrend. The next few weeks will tell us if this will happen again.

In the US economy, the news continues to be mixed. While durable goods orders plunged (far more than expected), the Dallas Fed manufacturing survey rose more than expected. Consumer confidence, in the face of high food and energy costs, strengthened. But pending home sales fell more than experts expected. Initial jobless claims have stopped improving. And both personal income and personal spending came in far lower than predicted. Folks are simply earning less money and as a result, spending less money, especially as their ability to borrow (and go into debt) diminishes.

So if the US economic data isn’t imploding, why are equity and other risk markets not happy? The answer it seems is all tied to the Fed’s QE program and the prospects of tapering it.

Over the last couple of years, it appears that stock markets have become so conditioned to more and more monetary easing (as the Fed prints, the markets rejoice) based on weak economic data, that any news that leads to the opposite condition (better economic data means that the Fed has less reason to print) is being greeted with fear and lower prices.

And setting aside other factors, such as the tensions in Syria, that’s exactly what’s been happening in August. US economic data is not getting worse. On some levels, it’s firming. That’s good news.

But that means it’s bad news for the markets. The Fed has more reason to proceed with a tapering of its latest QE program. And this is spooking the markets.

So expect a growing possibility of a bigger sell-off this fall, as the ‘taper’ gets announced formally.

After that, ironically, if markets decline a lot, and if this feeds back, negatively, into the real economy, expect the Fed to resume its prior QE program, or even escalate it. Markets would probably jump for joy, but as always, Main Street and the real economy will only limp along, on life-support, never gaining true escape velocity.