Is this Sell Off Meaningful?

January 27, 2014

The S&P500 2.6% last week. Amazingly, this was the largest weekly fall in the index since 2012. Volume surged on the largest down day, Friday. Volume for the week was light but only because Monday was a federal holiday. Volatility surged, as one would expect. The VIX index spiked by almost 50%, but that said, it still closed the week under 20, which is not a level historically associated with market panics. It would take a VIX surge above 30 for that to happen, and the VIX has not jumped above 30 since 2011, or almost three years.

Technically, the S&P is still very over bought. The drop over last two weeks has pulled back the index only slightly from its upper Bollinger band. In terms of breadth, the percent of stocks above their 150 day moving average is still close to 70%. And the Summation Index has not turned down. So breadth, while not as strong as it was a couple of weeks ago, has not collapsed.

Away from Wall Street in the real economy, things are still not looking good. The Chicago Fed National Activity Index fell substantially from its prior reading. The PMI manufacturing index, while still in expansionary mode, missed expectations. Both existing home sales and the FHFA house price index also missed. Initial jobless claims and leading indicators only met expectations. So while the number of reports was light during the holiday shortened week, the overall picture remains the same—one of an economy limping along, without strong growth.

So while last week’s drop in the S&P was notable, is it necessarily the start of something more serious? Is this the big turn that a lot of bears have been warning about?

The answer is simply—we don’t know. It’s far too early to tell if this is it. Yes the 50 day moving average has been broken, and decisively so. But over the last three years, ever since the 19% sell off in mid 2011, any and all dips below the 50 day moving average have been met with strong buying which then went on to take the S&P to new highs. On the two occasions since 2011 when the S&P cracked the 200 day moving average (both in 2012), the same thing happened—the buy-the-dip forces jumped in with both feet and not only recovered all the losses but propelled the index to new highs.

So until, or unless, the S&P500 closes below its 200 day moving average, we can’t even begin to discuss a major change in trend. And even when that happens, it a bear market will be called only after the S&P climbs back up to the 200 day from beneath and fails to move above it decisively. If this were to happen, the slope of the 200 day will start to shift down (it’s still firmly upward sloping), and when it becomes firmly downward sloping, the bears will very likely take control of the US equity markets.

After last week’s drop, we are a long way from calling a new bear market.

Gold Miners Bottoming?

January 21, 2014

The S&P500 ended the week down very slightly….about 0.2% on slightly higher volume. Volatility, as one would expect in a losing week, rose, but it only inched a little higher and still ended the week at levels that are associated with extreme complacency. In other words, not much happened in US equity markets over the last five trading days.

Technically, the S&P500 is still very over-stretched. Not only have prices been hugging the upper Bollinger band for the last year, but they have now started to trace out a parabolic pattern, a pattern that usually ends in disaster—when the strong and final upswing in the parabola is followed by an equally strong downswing. Sentiment is still extremely bullish; in fact it’s almost off the charts. And bearishness has almost vanished. Valuations are also off the charts….if one understands that earnings are near record levels. Why? Since earnings always revert to historically normal levels relative to sales and GDP, today’s stock market price-to-earnings ratio is far above normal levels. And if earnings simply revert back to normal, instead of dipping below normal, then the market is about 50% over-valued.

The US economy is showing no signs of strong growth. While retail sales beat expectations, much of that came from auto and gas sales. Producer and consumer inflation, as reported by the government, is not picking up. The Philly Fed survey beat expectations, as did the Empire State manufacturing survey. But the consumer sentiment reading registered its biggest miss in eight years. Once again, as Wall Street cheers, Main Street struggles.

And while the party on Wall Street rages on, there are a few sectors that have not only been dismally under performing,  but also have recently shown signs of rebounding.

Two of the most hated sectors in the investment world over the last two years are gold and gold miners.

Gold miners in particular, have  been hit hard. The gold miners index, or GDX, lost about 70% of its value between its highs in 2011 and its lows last month, in December. But while Wall Street has all but written off gold miners, GDX has started to trace out a classic technical bottoming pattern on the weekly charts, which are more important to long-term investors than the daily charts. As GDX touched new cyclical lows in December, several technical momentum indicators (such as MACD and RSI) failed to hit new lows. Technical analysts call this a bullish divergence, and it could form the foundation of a meaningful rebound.

GDX has yet to pass some more conservative tests, namely trading above its 200 day moving average, and more definitively, changing the slope of the 200 day moving average from a downward sloping line to an upward sloping line.

So gold and gold miners should be watched more closely.  As most of the rest of the stock market traces out a huge topping pattern, these two smaller markets could be at the beginning stages of a meaningful bull run.

Week of Complacency

January 13, 2014

Another week has gone by, and once again, the S&P500 didn’t do much of anything. Although it inched up 0.6% by week’s end, it traded in an extremely narrow range every day. Volume was light, and volatility retreated back down near the lows set in 2013. This has the feel of a ‘wait and see’ atmosphere, even in the face of some ugly economic news. Nothing much changed in the equity markets last week.

Technically, the slight bounce pushed the S&P back toward over-bought levels on the daily, weekly and monthly resolutions. This has been the case for quite a bit of the last half of 2013, and as of the beginning of 2014, it’s still the case. Bullishness is also off the charts, as has also been the case for a while. And valuations are nearing 25 year highs, when the stock market was blowing a tech bubble in the late 1990’s.

Economic data flow was light, but mostly negative. While factory orders slightly beat expectations, the ISM Services Index missed badly. Consumer credit growth also disappointed. But the big story, and number, of the week was the jobs report. In a word, it was ugly. Instead of growing by 200,000 jobs as expected, payrolls inched up by only 74,000. This is a huge miss. Headline unemployment fell, but this happened only because hundreds of thousands of folks found the labor market so discouraging that they simply stopped looking, and by doing so, they no longer count as being unemployed, according to the Bureau of Labor Statistics. Piling on to the bad news, the average work week fell and average hourly earnings also disappointed. But once again, this really ugly part of this story is the labor force participation rate, which at 62.8%, fell to the lowest level in 35 years.

So what did the US stock markets do after this shockingly bad news? One would think that they would have sold off, at least a bit. But that’s not what happened. Instead, the S&P actually closed up on the day of the bad payrolls report (Friday). And as mentioned already, the S&P gained 0.6% on the week. This is clearly evidence that complacency has taken over the US equity markets.

Interestingly, and more logically, US Treasuries rallied, as we expected the might a few weeks ago. This was partly because they were very oversold (and offered a comparably attractive return) and partly because investors were reacting to the reality that the US economy is more troubled than the public believed, or wanted to believe.

So while some markets are starting to accept the reality that the US economy is weak, has been weak, and is likely to continue being weak, the US equity markets are still closing their eyes and ears to this reality. Stock markets are extremely complacent.

Let’s see how long this complacency lasts.

Global Risks…Where We Stand

January 6, 2014

The week ended on a down note, with the S&P registering a 0.5% loss for the week. Volume was low, as would be expected for the holiday shortened week. And volatility inched up, also as would be expected for a week that ended with a loss. What was most surprising was the fact that for the first time in five straight years, the S&P did not jump on the first day of trading of the new year. The last time that happened was when the global financial crisis was about to unfold.

Technically, the slight dip from last week did very little to change the fact that the S&P is extremely over-bought. At this point, it would take almost 100 S&P points to reverse this condition and make it somewhat, but still not extremely, over-sold. The S&P is now officially more over-bullish than it has ever been in recorded history; the difference between bulls and bears has never been higher. And there are almost no bears left out there. Since almost everyone is a bull, almost everyone who wants to be ‘in’ this market is now in it. And valuations, as measured by the Shiller PE ratio (now almost 26), have never been higher except for a brief period during the tech bubble and 1929, just before the stock market crashed.

Economically, the story for the US economy is still unchanged—it’s limping along, without generating strong growth. Last week, pending home sales disappointed. The Dallas Fed manufacturing survey missed, as did the Chicago PMI report. Consumer confidence was better than expected. ISM manufacturing only met expectations, as did consumer spending. It was a short week, and nothing really new emerged among the economic data to suggest that the economic picture is changing in any way.

Meanwhile, around the world, the reality on the ground is still fairly somber as opposed to the prices of stocks and bonds which have been soaring. It seems that the Wall Street vs Main Street dichotomy has been spreading globally.

In Europe, most of the peripheral states are stuck in a mild depression. Unemployment rates are sky-high, and economic growth has been abysmal….much worse than in the US. Sure the ECB has helped prevent sovereign debt crisis (for now) from flaring up, but the fact is that European debt is still soaring (vs. GDP) and there has been no economic recovery for most of the continent.

In Asia, China continues to slow in terms of growth. But the bigger story is that it’s government debts have ballooned over the past five years and are now starting to cause problems for the economy. It’s looking like it will be more difficult for China to artificially boost growth going forward by pumping more credit into its economy and it may even become difficult for China to manage the trillions of dollars of debts that it has already accumulated.

Japan, meanwhile, has succeeded in boosting goods inflation—via Abenomics—but it hasn’t been able to boost wages. This means that its people are now struggling even more to pay for most costly goods and services with incomes that are no longer keeping pace. All the while, Japanese government debt is still soaring; soon it will hit 250% of GDP, a shockingly high ratio, rarely seen in history, and even then always related to fighting major wars.

With a slowdown in Asia, Australian and Brazilian exports have been hit hard, and this has been reflected in the drop in the currencies of these two states.

With the rising threat of the Fed tapering, gradually at first, beneficiaries of hot money flows are suffering from capital flight. One of the hardest hit major markets is India, which has suffered from a collapse in its currency and all the pressures associated with that (eg. soaring costs of energy imports).

The middle east is still a simmering pot of instability. The Iran problem (nuclear weapons) has not been solved. Syria has not been solved. And recently, the Egyptian problem has re-emerged.

Behind the scenes, the global financial system is as fragile as ever. In a recent article, the former prime minister of the UK, Gordon Brown, argued that almost all of the problems that led to the global financial crisis in 2007-2008 have NOT been solved.

So while the last 12 months have been relatively calm, it seems that a repeat of this ‘smooth sailing’ over the next 12 months would be nothing short of a miracle.