US Stocks vs. Everything Else

December 29, 2014

On extremely low volume, the S&P500 melted up 0.88% last week. Actually, volume was the lowest of the year, lower than the same holiday shortened week in 2013. So the melt-up was just that, a nice rise in prices but one not back by any conviction. Also contradicting the price rise was volatility. Sure it fell back a bit, but far less than it did the last time new highs were reached in early December. So while, prices jumped right back up, investors were somewhat more fearful…..and buying a bit more insurance to protect against the downside.

That said, the percent of investment professionals who stated they were “bears” in the latest Investors Intelligence weekly survey remains near all-time lows, while the percent who declared they were “bulls” remained near all-time highs.

Also, margin debt levels hovered near all-time highs as investors borrowed hundreds of billions of dollars to buy stocks with borrowed money.

Both of these facts suggest that there is no real fear in the US stock markets and that everyone who wants to buy stocks has bought them and that there isn’t a lot of idle cash on the sidelines waiting to buy a lot more.

But many other important markets are singing different tune, namely that something is wrong with growth prospects and risk outlooks.

Let start with the US dollar. It’s been on a tear for the last six months, rising while almost every other major currency in the world has been falling (including the euro, the yen, the pound and the Australian dollar). Usually, a rising dollar is a sign of risk-off when investors sell their overseas investments and convert their capital into the safer US dollar. This is precisely what happened in 2008-2009 during the heights of the financial crisis.

Also, important commodities such as oil and copper have fallen to multi-year lows. Both of these commodities are indicators of global economic strength and when their prices fall, it usually implies that global economic growth is slowing. Again, the same thing happened in 2008-2009.

Other financial markets have not been doing so well. As noted here before, high yield credit markets have been deteriorating for about six months now. And since stocks are a riskier asset class, similar to high yield debt, this divergence usually doesn’t last very long—the divergence in prices usually converges. And unless high yield debt prices spike up, then US equity prices must fall for this to happen.

Finally, US corporate earnings growth has been somewhat of a mirage over the last four years. While sales have been stagnating and overall dollar earnings have been growing at a snail’s pace, earnings per share have been jumping robustly but simply due to financial engineering, as companies have been taking on huge amounts of debt to buy back shares and divide ho-hum earnings by a collapsing number of shares to juice EPS. The same thing happened in 2006-2007 just a year or two before the global financial crisis got underway.

So something isn’t right. Either stock markets—all by themselves—have correctly leaves the global economic and economic tea leaves and all other markets have gotten it terribly wrong, or it’s the other way around, namely it’s stock markets that have gone out on a limb and every other market is right by being more cautious.

Either way, this divergence will not last forever.

Outlook for US Interest Rates

December 22, 2014

Well that didn’t take long—after losing about 3.5% the prior week, the S&P500 roared back to gain about 3.4%.  As one might expect, the volume during this up week was lower than the volume during the down week—sellers always seem to be a bit more committed than buyers. Volatility dropped back down, also as expected, but definitely not back down to the low levels seen before the big sell-off.

So here we go again—the US equity market is completely overbought and overvalued. Prices are hugging the upper Bollinger bands on the daily and the weekly charts and the cyclically adjusted Shiller PE is back up to nose-bleed levels (levels exceeded ONLY during the peaks reached during the dot-com bubble).

Last week’s economic reports were skewed to the downside. To kick things off, the Empire State manufacturing survey missed  badly—by falling into negative territory instead of rising as expected. The housing market index missed. Housing starts also missed, as did PMI flash manufacturing. Consumer prices crashed, with the headline figure dropping far more than experts had predicted. PMI flash services also missed and the Philly Fed Survey came in below expectations. Only industrial production and initial jobless claims came in ahead of expectations.

Looking forward to 2015, one of the biggest areas of interest to investors is the outlook for the US Treasury market. In 2014, when virtually every economics expert predicted that the rate on the 10 year Treasury note would rise—some predicted a huge rise; some predicted a modest rise—the world was stunned to see that the exact opposite happened. The rate on the 10 year fell from about 3.0% at the start of 2014, to about 2.15% by the end of the year…

So what’s the outlook for this key rate for 2015?

It turns out that many of the same factors that drove rates lower in 2014 are still in effect. For example, the decreased supply of Treasuries from a declining US federal deficit will continue in 2015 where the budget deficit is on track to shrink, again, even more. Also, the need for major financial institutions to beef up their low-risk investment holding is also going to continue—many banks around the world are being forced by new financial regulations to reduce their holdings of risky assets and to replace them with safer assets, and there’s no safer asset in the world than a US Treasury security. Also, the super low rates on other sovereign debt securities (for example, Spain’s—yes Spain’s!—10 year bond is yielding far LESS than the US 10 year note) will pull down the rates on US government debt securities.

How low can rates go?

Well at the very least, they can simply return to the lows reached in 2012, when the US 10 year dropped to the 1.4% range. And that would represent another major move higher in price.

At the extreme, US rates can eventually fall to the levels reached by Germany and Japan. And these rates are ultra-low:  Germany’s 10 year rate us under 0.6% and Japan’s is under 0.4%.

Will such moves down happen quickly and in a straight line? Most likely not. But unless many of the long-term trends, trends that have been in place for several years now, reverse, US Treasury rates can still fall a lot more.

Some Markets Crash, While Stocks Hang on to Dear Life

December 15, 2014

In one of its worst performances of the year, the S&P500 lost over 3.5% last week. Volume rose, but not by much; this means that the sell-off was not a true “rush to the exits” panic where most investors look to get out. Instead it was fairly orderly where some investors and traders reduced their long positions. As expected, volatility increased, but once again, not to true panic levels.

Still, the percentage drop was notable, if only because many, if not most investors, have been conditioned to expect losses (on the rare occasions when they’ve been occurring) to be much smaller, and even then, such losses are to be welcomed as buying opportunities. On the first count, the loss was much greater than usual over the last two years. So this was a new experience. On the second count, the next two weeks will tell if this sell-off will be bought and followed by the usual bounce, or if it will be followed by even subsequent losses that could add up to a real correction.

Technically, the S&P500 closed just at its 50 day moving average. So this moving average has still held as support. Unlike in October, when the S&P500 sliced through both the 50 and 200 day moving averages, last week’s loss is but a minor scratch. At the end of the day, the 50 day moving average is still in no danger of crossing below the 200 day, and the 200 day is rising robustly. We’d need to see at least 2 or 3 weeks of such losses before either one of these bull market indicators to fall apart. In fact, on the weekly charts, last week’s loss is barely even visible. The S&P is still overbought and it’s still overvalued, as measured by the Shiller (CAPE) price to earnings ratio.

On the economic front, things didn’t get much better last week. Initial jobless claims came in as expected. Yes, retail sales beat expectations, but business inventories and export prices missed. Also, producer price inflation came in far lower than expected.

While US equities are just a bit off their all-time highs, other markets are—for all intents and purposes—crashing. Crude oil, for example, by Friday’s close, was down almost 50% its highs of the year, highs reached just a few months ago. Several foreign currencies have also crashed, most notably the Russian Ruble. Sure this drop is related to the drop in the price of oil, but Russia’s geo-political prominence in the world means that there can be serious repercussions in the global financial system if Russian finances come under further stress. US energy and base materials firms are under severe stress—both equity and credit prices of these firms have been cratering. For example, Goodrich Petroleum’s stock price is down almost 90% since June! The Canadian dollar is falling and many other entities (such as credit providers to the energy and base materials sectors) are under severe pressure.

For the first time in several years, the “everything is fine in the markets” meme is starting to fall apart. Sure, many firms’ credit and stock prices are hanging on to, or near, all time high prices. But if a huge percentage of the US economy (and together, energy and base materials are very large) start to crumble, this can and will affect the rest of the credit and equity markets.

The Truth Behind the Latest Jobs Report

December 8, 2014

The bounce from the mid-October lows continues. Last week the S&P500 added another 0.38% to push the index price even further into record high territory. Volume, of course, was low and certainly suggest that there was no in-rush of new investors or new money into the US stock markets. At the same time, volatility eased back almost to the lows reached during the mid-summer doldrums. At this point, volatility is about as low as it normally goes.

Technically, the S&P500 is back to an extremely overbought condition—both on the daily and the weekly charts. That said, there is no reason to make big bets against this market—the 50 day moving average never crossed below the 200 day at the October lows, and just as importantly, the 200 day moving average is still sloping upward….comfortably.

At the same time, the cross-market divergences are still pronounced. Oil and copper prices are plunging—-this does not happen when global growth is strong and conducive to rising corporate profits and stock prices. The high yield markets are still falling—this also does not happen when investors are bullish about profit outlooks for corporations. High yield credit is a risky asset, like stocks, and it normally moves in tandem with stocks.

US economic data continues to paint a picture of weakness. Last week, PMI manufacturing missed expectations. Productivity also missed……as did initial jobless claims. Factory orders fell far more than expected. International trade also missed. On the other hand ISM services and manufacturing numbers beat expectations.

And on the surface, the big number of the week—payrolls—also beat expectations. Instead of creating 230,000 new jobs as predicted, the US economy created about 320,000 which led to a lot of celebration among the US equity market cheerleaders claiming that not only were stocks fairly valued but that if these job gains continued, that the US stock markets could and should rise even further—so go ahead and buy more at the all-time highs.

But beneath the surface, the US jobs story is not nearly as rosy as it first appears. The household survey (the one used to establish the unemployment rate) showed that full-time jobs (you know the good ones that actually pay a decent salary or wage) actually declined by about 150,000. This means that the vast majority of the reported job gains came from part-time jobs, jobs that pay poorly and don’t come with benefits—but are counted as jobs nevertheless.

At the same time, the labor force participation rate did not increase. At 62.8%, it remains stuck at multi-decade lows.

Also, the workforce aged 16-24, in other words the newer entrants into the US work force, declined by almost 170,000. Instead, the over 55 category grew, meaning that folks who would normally begin to prepare for retirement are coming back into the workforce because they can’t afford to retire; this leaves fewer jobs for America’s youth, the future of the country.

So while the Wall Street pundits cried tears of joy when the payrolls number blew away expectations, what they didn’t tell you is that most of these new “jobs” were secretaries, waiters, store clerks, teacher aides, and bartenders.

The truth is clearly not so pretty.

US Equity Bears are Gone….Again

December 1, 2014

The S&P500 inched up a fraction last week on volume that was shortened by the Thanksgiving holiday. Contradicting the move up in price was the increase in volatility—the VIX index closed higher for the week.

Also contradicting the move up in US equity prices, was the slew of US economic reports from last week, reports that were thoroughly poor. Starting with the Chicago Fed national activity index and ending with the Chicago PMI, the results were very disappointing, missing consensus estimates by meaningful margins. In between, PMI flash services, FHFA housing prices, consumer confidence, the Richmond Fed manufacturing index, personal income, personal spending, durable good orders (ex-transportation). jobless claims, consumer sentiment, new home sales and pending home sales ALL missed! Only the Dallas Fed manufacturing survey beat expectations and even then by only the slimmest of margins.

Around the world, China is continuing to slow down sharply. Japan has entered a recession—again. And Germany, plus much of the rest of western Europe is slowing down notably.

Oil prices are collapsing and Dr Copper is down to 2010 lows.

Yet US stocks are at all-time highs.

And interestingly, the percent of bears among professional advisors has hit another bull market low. According to the Investor Intelligence weekly survey, the ratio of bears has fallen to 13%. At the same time, the percent of bulls, among professionals, has risen to almost 57%.

This begs the question—-if only 13% of advisors are bearish on US stocks, then WHO is left to buy more equities and drive the markets much higher?

Sure, money trickles into the markets monthly from withholding from peoples’ paychecks, but the big shift into stocks has already happened. The “fuel” to power additional big moves higher has been spent.

And now that the Fed—at least for now—has suspended its latest money printing program, there isn’t another large supply of cash that’s available anywhere else.

Finally, corporate stock buybacks are slowing—partly because the cost of borrowing is rising and partly because the corporations are already so levered. So even this tactic looks like it will no longer be working.

So we will wait and see if John Hussman is right by arguing that US stock market indices are over 100% above their “historically-informed” fair values and that when markets get stretched to the degree that they are now, they tend to correct in abrupt and dramatic lurches, now in gradual and steady retreats.

If so, then “monetizing” all the paper gains that investors have enjoyed over the last four years will be a challenge because WHO will buy everyone’s stock—at the all-time high prices—when everyone already owns them and nobody is left to buy?