Even Central Bankers are Getting Worried

June 30, 2014

The S&P500 dipped fractionally last week. Volume was extremely light, and volatility—while inching higher—was still close to 10 year lows.

Technically, the picture has not changed. Stock prices are extremely overbought—both on the daily and weekly charts. Yet breadth is not as strong as it was at prior peaks; stock market prices are being led by fewer and fewer “general” while the vast majority of “soldiers” are lagging.

At the same time, there is no material change in the US economy—on Main Street, the struggle for growth and true recovery continues. Last week, The Richmond Fed Manufacturing survey disappointed, as did the Kansas City index. Durable goods orders, both headline and ex-autos, missed badly. Initial jobless claims were a bit worse than expected. The house price index missed expectations. And personal spending also missed. On  the positive side, New home sales were better than estimated, as were existing home sales. Consumer confidence also beat estimates. Overall, no real change in the picture—it’s still not very good, almost five years after the financial and economic crisis supposedly ended.

As financial markets, and especially the equity markets, continue to climb to new record highs, alarms are being sounded from a most surprising source—central bankers around the world.

The reason that warnings from central bankers are surprising is that most experts and even casual observers have now come to understand that these very same central bankers are the ones responsible for the massive levitation in risk asset prices in the first place!

And given that one of the most common concerns raised by market observers, including this one, is that market prices seem to be divorced from the reality on Main Street , it’s very surprising that the Bank of International Settlements (better known as the central banks’ central bank) just issued a report that makes the very same argument.

Here are some key excerpts:

“… it is hard to avoid the sense of a puzzling disconnect between the markets’ buoyancy and underlying economic developments globally….  Despite the euphoria in financial markets, investment remains weak. Instead of adding to productive capacity, large firms prefer to buy back shares or engage in mergers and acquisitions.”


“As history reminds us, there is little appetite for taking the long-term view. Few are ready to curb financial booms that make everyone feel illusively richer.  Or to hold back on quick fixes for output slowdowns, even if such measures threaten to add fuel to unsustainable financial booms. Or to address balance sheet problems head-on during a bust when seemingly easier policies are on offer. The temptation to go for shortcuts is simply too strong, even if these shortcuts lead nowhere in the end.”

So when even the very same central bankers who helped blow the ever-growing bubble in financial assets are warning everyone that current prices are no longer making sense, that real underlying problems in the economy were never fixed, and that bubbles inevitably burst and wipe out paper gains, it’s time to listen and to listen carefully.

Sadly, most people will not. As the central bankers so aptly note—“the temptation to go for shortcuts is simply too strong’—human nature will dominate common sense and historical evidence. And so, the final outcome will not change—people will get hurt, again, after this current bubble also bursts.





Echoes of 2007?

June 23, 2014

The S&P500 bounced back last week with a 1.38% rise on very low volume. Volatility fell back to lows last seen in 2007; complacency has completely taken over the US equity markets. While not a lot of buying is going on (witness the very low volumes in weeks when stock prices rise), there’s also very little selling. The consensus is clearly that stock prices will never go down severely, and any minor dips are merely good buying opportunities.

Technically, the uptrend is clearly intact—on  both the daily and more importantly, the weekly resolutions. While US equity markets are clearly overbought, the strong uptrend suggests to technical traders that there is no reason to sell. In fact, the strong trend is implying that investors should not only hold their positions but even add to them—to continue to ride the trend upward. On the other hand, several breadth indicators are slightly less bullish. For example, the percent of stocks above their 150 day moving averages is high, but not nearly as high as it was at prior peaks over the last four years. This suggests that as stock markets keep rising, more and more of the work is being done by fewer and fewer leaders, rather than the broad population of stocks in the entire market.

US macro data is still not gaining any meaningful strength. Yes, the Empire State Manufacturing Survey beat expectations, as did industrial production and the Philly Fed Survey, but housing starts, leading indicators and consumer prices all disappointed. The US economy—almost five years after beginning to ‘recover’—is still struggling to reach escape velocity.

Also, as discussed last week, the Federal Reserve did further reduce its latest QE program, meaning that it’s looking even more likely that the entire asset buying program should end this fall. And once again, it doesn’t look like the US stock markets have fully digested the implications of this ending. Every time prior QE programs (or similar) have ended since 2009, the US stock markets have corrected significantly. Will this time be different?

Finally, as mentioned above, the VIX index just touched lows last seen in 2007. Interestingly, many other significant indicators reached levels last seen in 2007—-about a year before the stock markets crashed. Margin debt has returned to peaks. Leveraged loan issuance has returned to 2007 peaks. The removal of covenants has reached 2007 peaks. The percent of investors who are bullish has returned to 2007 peaks. And there are many more.

At the same time, the Fed is tightening (by winding down QE)…..just like it was in 2007.

So there are lots of similarities in the markets today to what was happening in 2007. Soon, we will see if history rhymes or, on the other hand, if equity markets have reached a permanently elevated state that is invulnerable to serious corrections.



If You Shouldn’t Fight the Fed…..

June 16, 2014

The S&P500 eased back 0.7% last week on light volume. This was by no means a serious sell-off, in terms of  percent decline or volume. While volatility (VIX) did jump a bit, it still closed near mult-year lows, meaning that even this slight jump in volatility did not chance the fact that the US equity markets are still in a state of complacency.

Technically, equities are very overbought, despite the small price retreat last week. Momentum is still positive, and all trends are still pointing upward. And valuations are still near multi-year highs. The conclusion—yes prices are still clearly rising, but that doesn’t meant that stock prices are a good buy or that they are safe to own.

US macro results mostly disappointed last week. Initial jobless claims were a bit worse (higher) than expected. Retail sales missed badly—both the headline and ex-autos figures came in well below consensus estimates. Producer prices, both headline and core, came in lower than expected, and finally, consumer sentiment registered its biggest miss in almost two years.

Despite the persistent overbought, overvalued and over-bullish state of the US equity markets (a syndrome best described by long-time money manager John Hussman), the equity markets have continued to climb upward to ever higher levels. Over the last 80 years (with the exception of the tech bubble in the late 1990’s), whenever stocks have reached even less extreme overbought, overvalued and over-bullish conditions, markets have always corrected, and usually quite severely.

But this time they haven’t, very much like they didn’t in the late 1990’s when they continued to march higher and higher until certain valuation metrics reached levels never seen before in US equity markets.

Still, even after climbing much higher, and much longer, than many experts thought possible, they ultimately did crash. The S&P fell over 50% and the NASDAQ fell over 70%.

This time around, the main driver of the seemingly unstoppable rise in stock prices is the belief that since the Fed is still printing money (via quantitative easing, or QE), then one should—actually must—be heavily invested in stocks.

And this brings up an important question—if the belief in the Fed…..that you should never fight the Fed—is one key driver of this bull market rally, and since the Fed has long since announced that it will be ENDING its expansionary monetary policy in a few short months, then why are stock market prices still rising?

Is it because investors now no longer really need the Fed watching their backs? Or is it because investors have not yet fully processed the fact that the Fed’s easing is about to end?

Later this week, the Fed will make another policy announcement which most Fed-watchers expect will include another small reduction in the current QE program. Perhaps this latest reduction will finally test the US equity market’s resolve. And if not, then in a few short months, QE is scheduled to fully cease. And then, for sure, we will find out just how much the US stock market valuations depend on the Fed’s electronic printing press.

Deutsche Bank: Markets in “Mania” Phase

June 9, 2014

Once again, the S&P500 crept up for the week, this time by 1.3%. Volume was extremely light; in fact, it was one of the lightest non-holiday shortened weeks of the year. So nobody was really buying into this rally with any convictions; otherwise volume would have been more robust. And volatility remained near multi-year lows, meaning that investors continue to maintain a “what me worry?” attitude toward risk in the US stock markets.

Technically, prices are extremely stretched. On both the daily and weekly resolutions, the S&P is above the upper Bollinger bands. MACD lines are well above the zero line and RSI is above 70. At this point—despite all the nagging concern including declining sales and stagnating profits—stock prices continue to rise because, well, stock prices seem to always be rising. So why not just join the ride?

In US macro news, ISM services slightly missed expectations, but only after being revised not once, but twice to make the miss a modest one. Construction spending suffered its biggest miss in 14 months. International trade badly missed expectations: this will hurt the GDP results in the current quarter. Productivity also fell much more than expected. Initial jobless claims also slightly missed. On the positive side, factory orders beat consensus estimates. ISM manufacturing also beat. The big news release of the week, the jobs report, was pretty much on target. New jobs created, average hourly earnings and the average workweek all basically met expectations. The unemployment rate fell slightly. But the labor force participation rate did not improve, and remained stuck at multi-decade lows.

Recently, Deutsche Bank and one of its top market analysts (David Bianco) released a simple analysis that compares the US market VIX, as a measure of complacency, to the US market P/E ratio, as a measure of valuation. Going back to 1990, they looked at this ratio of PE / VIX and searched for times when the ratio peaked, reasoning that a high PE relative to a low VIX would suggest that markets were in a dangerous condition and ripe of a serious correction.

They found that in the early 1990’s, this ratio hit 1.5 just before stocks entered a serious bear market. In 2000, before the dot-cum bust, this ratio hit 1.3. And in 2007, the ratio touched 1.5 just before the Global Financial Crisis got underway, leading to a 55% drop in the S&P by March 2009.

So where does this ratio stand today?

Answer: at 1.66, which is higher than it was at every other prior peak in this analysis!

The led Deutsche’s Bianco to conclude that this “sentiment measure has never been higher and is in an extreme ‘Mania’ phase. And his advice to all would-be stock investors: “wait for a better entry” point.

So it’s not just some ‘crazy’ bloggers hammering home the message that this is a dangerous time to buy stocks and to be fully invested in stocks, but it’s an established mainstream analyst from an established global bank who is now sounding the alarms.

Go ahead and ignore the bloggers, but ignore the warnings from Wall Street at your own risk.

The Lack of Volatility

June 2, 2014

The S&P500 climbed another 1.2% last week, but on ultra-low volume, which was partly due to the holiday shortened week. Volatility in equity markets, as measured by the VIX index, closed almost unchanged for the week.

Technically, the S&P500 is now as overstretched than as it has been in about 100 years (using a proxy for the S&P500 in the first part of this 100 years). This includes the peak periods just prior to the 1929 collapse, the post-2000 meltdown, and the 2008 crash. John Hussman and Jeremy Grantham both estimate negative stock market returns for all time horizons under 8 years for everyone holding stocks at these prices. Both of these long-time market analysts correctly called the bubble peaks of 2000 and 2007. What’s worrisome, technically, is that many measures of market internals are not matching the peaks in current prices. New highs minus new lows, for example, are far lower than they were at lower highs on the S&P. The same applies to the percent of stocks above their 150 day moving average. What this means is that while overall index prices are rising led by strong performance of some key stock leaders, fewer and fewer of the average stocks are participating in the rally. Almost always, such a breakdown of market internals leads to bad outcomes for the overall market down the road.

US macro results continue to disappoint. Both the Richmond Fed and Dallas Fed manufacturing surveys missed. Pending home sales missed, as did both personal spending and personal income. Consumer sentiment disappointed. And the big surprise result of the week was the revised 1st quarter 2014 GDP result, which plunged from positive 0.1% to negative 1.0%, meaning that the economy registered its first contraction since 2011. Sure, durable goods orders beat expectations, as did initial jobless claims, but that doesn’t change the picture of the US economy—since first “recovering” in 2009, it has never reached escape velocity. or growth fast enough to put back to work the millions of jobless folks who’ve left the workforce because there are not enough jobs for them.

Meanwhile, another interesting development is taking place in the world of volatility. We’ve already mentioned that stock market volatility is near decade lows (2007 to be more precise), but what we haven’t yet mentioned is that volatility for most major asset classes has also collapsed over the last several months. This includes volatility for Treasuries, corporate bonds, foreign exchange and even commodities.

Why does this matter?

Because when this situation developed in the past (and yes this is not the first time), it has tended to coincide with peaks in prices for those asset classes—especially equities and corporate bonds. And that’s exactly where equities and corporate bonds are priced right now…..at or near peaks.

What usually happens after volatility bottoms and asset prices peak?

Simple—volatility usually spikes, and asset prices retreat.

So let’s add this to the long list of measures that suggest that key asset prices are stretched, and that when they’re stretched, they are prone to serious snap-back corrections.