Treading Water

July 28, 2014

The S&P500 ended last week essentially unchanged from its close the prior week. Volume was very light—as one would expect in the middle of the typically quiet summer months. But volatility rose somewhat—not what one would expect with a market that didn’t drop in price or in the middle of a normally quiet summer trading week. That said, the VIX index is still far from showing any signs of fear among investors, as it hovers near decade lows, lows last seen in 2006-2007 close to the prior peak in the S&P500.

There wasn’t a lot of macro economic news reported last week, and most of it was mixed. On the positive side, initial jobless claims dropped below 300,000 and durable goods orders beat expectations—both headline orders and orders ex-transportation. On the negative side, the Chicago Fed National Activity Index fell from its reading the prior month. Flash manufacturing PMI fell more than expected. And new home sales fell far more than expected, with even the prior month seeing a huge downward revision. It looks more and more like the rise in interest rates (and therefore mortgage rates) has started to hurt the housing market, especially in the new construction part of the market.

In terms of technical analysis, the US equity markets remain extremely stretched—on the high side. Despite the lack of forward progress last week, the S&P is still hugging the upper Bollinger band on the daily and the monthly resolutions. Many, many indicators that technicians normally see oscillate between overbought and oversold over the course of a year have remained pinned to the “overbought’ side of the range for not just one full year, or two consecutive years, but now more than two consecutive years. Not that this is unprecedented, but in the last 100 years, the Dow has risen without at least a 10% correction only a couple of times. And of course, this doesn’t mean that the “overdue” correction is just around the corner. But it does mean that astute investors should be on the lookout for one, and that the longer the market avoids one, the greater the subsequent correction that does eventually follow.

Also, astute investors need to be aware that they can’t all—be astute enough—to get out of the market before any serious selling gets started. By definition, if everyone thinks they’re smart enough to exit before big selling starts, who’s going to be the dumb investor who will buy the stock….at the elevated prices….especially when most investors are bullish and solidly long the market already?

So as the summer of 2014 rolls along, it appears that the S&P500 is treading water, looking for some catalyst to push it even higher, or—for the first time in a long time—to push it lower and give it the much needed correction that takes some of the exuberant froth out of it. And even if the wars in Ukraine, the middle east and the current turmoil elsewhere in the world don’t provide the spark for a correction, then everyone needs to be aware of this one simple fact: EVERY time the Fed has ended new buying in prior QE programs, the US equity markets have corrected meaningfully. And the Fed is now only three months away from ending all new buying in its most recent QE program.

Tick, tock? We shall see.

T-Notes: The Gift that Keeps on Giving

July 21, 2014

The S&P500 bounced back about half a percentage point last week in the usual light trading volume. Volatility barely budged….and remained stuck near decade lows. Fear of loss, clearly, is a concept that has completely disappeared from the average investor’s memory.

The technicals still point to an extremely overbought US stock market, especially on the longer term weekly charts. On the daily charts, there appears to be a slight loss of momentum. That said, every time this as happened since mid-2012, the positive momentum was subsequently regained. It’s too early to tell if the same thing will happen again…this time.  Also, the critical 200 day moving average is sloping upward and prices are holding well above it. Nothing really earth-shattering happens in the stock markets until both of these conditions change.

One interesting set of market divergences, however, ought to be noted. First, the Russell 2000 small cap index is down for the year, while the S&P500 is positive on the year. In many prior instances of general equity market declines, the small cap indices sold off first because the smaller firms were seen—correctly—as being more risky. So when investors wanted to sell stocks, they sold small caps first and held on to their large cap holdings because they perceived the larger firms to be less vulnerable to severe declines. Second, the high yield corporate bond market has started to sell off notably. While not showing a loss for the year, the HYG etf has fallen below its 50 day moving average for the first time in twelve months. This is an important signal because high yield bond investors tend to be somewhat more sophisticated that the average stock investor (ie. there are fewer mom-and-pop high yield investors that stock market investors) so when they sell, they tend to sell ahead of the general stock market.

Several times over the last year, we’ve noted how the US Treasury market was one of the few large and liquid asset classes that offered investors and traders some notable value. And while the very strong consensus on Wall Street vehemently disagreed, it has been proven wrong in an almost embarrassing way.

What’s even more interesting is that this trade has continued to work throughout the year. Over and over again, when the US 10 year note has sold off slightly, it—in retrospect—was nothing other than an attractive buying opportunity, because the price has always rebounded back up and provided traders with repetitive profits.  All the while, these traders continued to earn money from the coupon (positive carry) while waiting for the price to rebound.

As of last week, the yield on the 10 year Treasury once again dipped back down (meaning prices rose back up) to the mid 2.4% range. Just a week earlier, investors could have bought that same Treasury with a yield in the mid 2.6% range.

And this trade, or similar, has presented itself at least half a dozen times since the start of the year.

When will it end?

Well given that the Japanese 10 year government bond is currently yielding 0.54% (that’s right, about half a percent, or almost two percentage points LESS than the US 10 year!), and given that the trend in the Japanese government bond market has led the US government bond market by about ten years, then it’s possible that the US 10 year note can soar in price far beyond where it peaked in 2012.

So either as an investment, or as a trade, or both, keep your eye on the US Treasury market. It’s the gift that keeps on giving.



Mom, Pop and the Stock Market

July 14, 2014

In a very minor way, the S&P500 retreated last week on extremely light volume. The index fell only 0.9% and the lack of volume means that the selling had very little conviction behind it. Sure the VIX (or volatility) index jumped a bit, but since it ended the week at around 12, it was still hovering near decade lows. By no means did any real fear enter the US stock markets.

Technically, the extreme overbought condition of the S&P, on both the daily and weekly resolutions, has not been resolved by the minor dip in the price last week. Far from it—the index is still stretched to nosebleed levels. At the same time, the trend is still fully upward sloping. This means that making major directional (non-hedging) bets on a decline in the stock market would be dangerous to do. Until the index falls below the 200 day moving average (and stays below this moving average) and until the 200 day moving average turns down and becomes clearly downward sloping, then the bull market rally cannot be declared over.

Meanwhile, in terms of US economic news, the small business optimism index fell when it was expected to rise. Wholesales trade also fell more than expected. On the other hand, initial jobless claims were slightly better than expected, and the same happened with job openings. It was a light week for economic reporting; next week will bring a slew of new numbers.

While there have been many historically tested signs that the US equity markets are overvalued or overbought (for example, margin debt used to buy stocks through borrowing has already exceeded the peaks reached in 2007), one sign had not materialized until now.

What is this sign of a market top?

Retail, or mom and pop, investors piling into stocks while—at the same time—professional, institutional, investors rush for the exits.

For most of the first few years of the bull market rally (after the 2009 peak), retail investors did the opposite—they pulled money out of the stock market and plowed it into bonds. mostly corporate bonds and some government bonds. Institutional investors, on the other hand, were net buyers of stocks during that entire time.

Until now.

This year, for the first time since before the prior peak was reached in late 2007, retail, or mom and pop, investors are piling into stocks like crazy. Here’s how Bloomberg described this development:

“Individual investors are plowing money back into the U.S. stock market just as professional strategists say gains for this year are over. About $100 billion has been added to equity mutual funds and exchange-traded funds in the past year, 10 times more than the previous 12 months…”

But so what? What does this mean?  Here’s Bloomberg again:

“While the strategists have a mixed record of being right, history shows the bull market has already lasted longer than average and individuals tend to pile in at the end of the rally.

Professional investors, such as Nick Skiming of Ashburton Ltd., say that individuals investors are attracted to stocks after seeing others getting rich from a big rally, a time when equities are usually overpriced. The bursting of the technology bubble in March 2000 was marked by mutual funds absorbing a record $102 billion in the first quarter.”

Oops. Not a good sign. It makes sense and historical evidence proves that this signal works.

Does this mean that the rally is about to end? Nope. But one should add to the ever growing list of warning signs that the US equity market is overdue…..extremely overdue…..for a notable correction.

When mom and pop jump in with both feet, it’s time to get worried.


Even the NY Times is Catching On

July 7, 2014

In a week shortened by the July 4th holiday, the S&P500 still managed to creep up 0.55% on very low volume. Volatility fell to another post-2007 low.

The technicals point to an extremely overstretched market. For example, the S&P closed above–not just near–its upper Bollinger band. With such conditions, even minor pullbacks become far more likely to occur. But setting record high prices aside, breadth is not doing nearly as well. New highs minus new lows, for example, fell notably last week. So it’s becoming increasingly clear that this stock market rally may be ripe for a correction. How serious such a correction would be is an open question, but any type of  pullback, from here, would be very much not unexpected.

US macro data was dominated by the jobs report released near the end of the week. While on the surface, the report beat expectations (almost 300 thousand jobs were created),  beneath the surface, the reality was not so rosy. With respect to the jobs created, about 800,000 part-time jobs were created and 500,ooo full-time jobs were lost, netting out in to a 300,ooo reported gain. The problem, obviously, is that while half a million good (high paying , with benefits) jobs were lost, 800,000 bad (low paying, without benefits) jobs were gained. That’s not good news. In addition, the labor force participation rate remained stuck at 30 year lows. Beyond the jobs report, the Chicago PMI missed badly. ISM manufacturing and construction spending also missed. Factory orders missed. ISM services also missed. On the brighter side, pending home sales beat expectations.

Finally, the NY Times just published a front page story titled: “Welcome to the Everything Boom, or the Everything Bubble”. In it, the author argues:

Around the world, nearly every asset class is expensive by historical standards. Stocks and bonds; emerging markets and advanced economies; urban office towers and Iowa farmland; you name it, and it is trading at prices that are high by historical standards relative to fundamentals. The inverse of that is relatively low returns for investors.

Imagine that—most risk assets are over-priced, are not priced according to long-term historical averages that are rooted in fundamentals, and are poised to disappoint all investors who hold them today.

What’s worse, the author dares to suggest that we may be witnessing a “bubble”.

Where have we heard all this before, week after week, month after month?

Coincidentally, we also heard similar warnings in late 2006, most of 2007 and even early 2008. Did those warnings prevent the global financial meltdown and the huge investor losses that followed? Nope.

And it’s doubtful that this warning  from the NY Times will do anything different.