US Equities Stumble

July 27, 2015

The S&P500 lost 2.2% last week, which was one of the biggest weekly losses of the year.  Not since the early winter months has the S&P lost more, in percentage terms. Volume jumped, which as always suggests that many investors were really leaving the stock market party.  Volatility also climbed, but the VIX never reached anything remotely close to panic levels.

The technical picture is interesting in that the S&P has essentially round-tripped since early July when it stopped falling at the 200 day moving average. Then it shot back up in mid-July, back to all-time highs, but it then fell back down and is now approaching the 200 day moving average once again. In the past three years, when the methodical and seemingly inevitable staircase climb occurred, the S&P went on to set clear new highs over a period of several months before retreating back to the 50 day moving average.  This time, the S&P retreated far sooner and from far lower price levels. So some technicians will consider this failure to set new highs as a failed test, and will worry that there may be more substantial downside pressure before the index can resume its climb.

On Main Street, it was a light week for economic news releases. Existing home sales, initial jobless claims and the Chicago Fed National Activity Index all beat expectations. On the other hand, the Kansas City Fed Manufacturing Survey and new home sales both missed. In the upcoming week, we’ll see a much larger—and more normal—volume of economic reports.

Why did the US equity markets sell off?  Well it seems that the carnage in commodities, combined with the meltdown in Chinese equities, was the immediate catalyst. Remember, US stocks—by a vast number of historically proven (eg. market cap to GDP) measures of valuation—are extremely over valued. Using these measures, US stocks were more over valued only once in the last 100 years and that was just before the tech bubble burst in early 2000. The point is that any near-term catalyst can trigger an avalanche caused at root by over valuation, so the specific trigger is less important to causing stock market losses than valuation.

In this case, China’s stock market after almost tripling in about a year, has fallen by about 30% in a matter of weeks; this, as most market observers would agree, is a crash. And what’s more troubling is that the Chinese government is throwing everything including the kitchen sink at the sell-off without much success. Shockingly, the government has made some forms of selling, by certain major market participants illegal. And to add insult to injury, the government has resorted to simply shutting down its stock markets when everything else fails.

But around the world, this is sending shock waves to other financial markets. For one, financial losses in China’s markets can be hedged by selling in other less manipulated and restricted markets. So if you can’t sell in China, you may try to reduce risk by selling something comparable in US or European markets. Thus Chinese selling begets selling around the world. Secondly, the Chinese stock market crash is sending a signal that the Chinese economy is slowing and the last time it did so was in late 2007.  The point being that about 6-12 months later, other markets around the world also crashed. China’s markets, and even economy, therefore, could be providing an early warning signal of what’s to come for the rest of the world. And if so, it’s not going to be pretty.

Commodity Collapse Continues

July 20, 2015

The S&P500 rallied last week by virtue of a “Greece is saved” story line. Was Greece really saved?  Not at all; in fact, it will be taking on another slug of debt to add to the mountain of debt that it’s already burdened with. So the S&P ended the week up about 2.4%. Volume was very light, so once again, this means there was no big in rush of new investors piling into stocks. Also, volatility dropped back, this time to new 2015 lows, which would not be surprising since stock prices almost returned to 2015 highs.

Technically, the oversold condition that we noted over the last two weeks has been corrected as anticipated. The S&P has bounced off the 200 day moving average and is now comfortably above the 50 day moving average. In fact, since it’s almost reached the upper Bollinger band on the daily charts, the index is close to being somewhat overbought. On the weekly charge, last week’s 2.4% advance is barely visible. What is still very clearly visible is the 7 month distribution pattern that began to form at the beginning of the year. Unless new highs on the S&P are achieved and sustained, this distribution pattern will remain in effect.

On Main Street, unlike what happened in US equity markets, there was no “bounce back”. Last week’s data was very weak. Retail sales kicked off the week on a very bad note. Instead of jumping 0.3% as expected, they actually FELL 0.3%. Something similar happened to retail sales excluding autos. Export prices also fell; they were supposed to rise. The Philly Fed survey missed badly. And Consumer sentiment recorded it’s biggest miss (to expectations) since 2006. On the positive side, The Empire State manufacturing survey beat expectations, but just barely. Industrial production also came in just slightly ahead of consensus estimates. All in all, once again, no boom is anywhere in sight for the vast majority of Americans living on Main Street, Americans who by and large do not own a lot, or any, stocks.

Finally, in a story that keeps growing, the commodity complex is witnessing its biggest collapse since early 2008. The Bloomberg Commodity Index has just crashed to 2002 lows, breaking below the low points reached in 2008.

Meanwhile, ironically, US stock prices are still near all-time highs.  How is this possible?  Well, in the long-term, it isn’t. Back in the late 90’s, commodities started crumbling 2-3 years before the stock market started to melt down in 2000.  And in 2008, commodities crashed about six months before the stock market collapsed. In both prior periods, stocks diverged substantially from commodities. And the same is happening again.

So it’s highly unlikely that this time will be different. Stock prices and commodity prices will very likely converge over the next year or so. The only question is—will commodity prices explode higher to catch up with stock prices? Or will stock prices melt down, to meet the already battered commodity prices.

And finally, since commodity prices have already melted down, and by doing so, have scared away huge swaths of investors from this asset class, any value investor will tell you that commodities are now creating attractive long-term buying opportunities. But is it time to jump in with both feet?  From a trading standpoint, no it’s not.  The knife is still falling and buying now may lead to lower prices and short-term paper losses. So just as in the stock markets, it pays to look at the 200 day moving average, and this indicator is still signally to wait to buy—-this moving average is sloping downward with the 50 day moving average solidly below it. A safer time to buy may be when the 200 day stops falling (ie. goes flat) and then starts to rise slightly. Of course this means that an investor will miss the “turn” up in prices, but it will make it less likely that the investor will suffer paper losses by getting in too soon.

More on Greece

July 13, 2015

After a several big up and down days, the S&P500 ended the week down a very small fraction of one percent. Volume perked up a bit, but this was mostly due to the greater uncertainty in Greece as many traders sold down some risk in case negotiations collapsed in the Mediterranean state. The Vix index jumped back up to about 20, which was its highest level since February of this year.

The oversold condition we noted last week in the daily charts looks like it’s poised to correct itself over the upcoming week. Any sort of modest bounce back in equity prices would remove this condition, and bring the index back to its usual crossroads—does it turn up and resume its march higher to new all time highs, or does it resume its distribution or sell-off and continue backing away from the highs reached in May? If the latter happens, then there could be a substantial risk that the 50 day moving average could pinch into the 200 day moving average. And if this were to happen, then a vast army of technical traders would be poised to turn bearish on the S&P for the first time in four years, or since 2011, when the S&P lost almost 20%.

Not too many US economic reports were announced last week. PMI services came in lighter than expected. Consumer credit missed expectations. Initial jobless claims jumped way above consensus predictions and almost touched 300,000 for the first time in many months. On the positive side, international trade results showed a deficit that wasn’t as bad as expected. And wholesale trade came in stronger than expected. All in all, there’s no change in the US economic picture, which is growing anemically, at best.

Finally, the Greece saga has returned to the front pages of most news outlets around the world. After holding a referendum on a proposed bailout in early July, and witnessing an outcome in which 61% of the people rejected the proposed bailout, the Greek prime minister just announced that he will ignore the will of the people and instead accept a draconian set of measures (or more accurately labeled as punishments) in order to secure even more billions of euros in debt, debt that will be used primarily to service the lenders on even older debt.

Shockingly, the Greek prime minister has just thrown his country under the bus, all with the supposed intention of keeping his country in the euro.  And even if he’s able to pass all the laws required of him by Germany and Brussels over the next week, there’s no guarantee that Greece will even then remain in the euro.

Many non-Greek experts are already arguing that defaulting on the European debt, abandoning the euro and suffering another short-term recession would be less punishing than the new tax hikes and pension cuts agreed to by the prime minister.

And others still are claiming that the next government (because it’s highly unlikely that a government that so openly ignores the will of the people will  be able to survive) will be tempted to abandon this latest “bailout” anyway.

Either way, Greece looks like it just kicked the can down the road, again. Nothing has been solved in Greece or in the other PIIGS states, and the euro zone came as close as ever to ejecting a member, something that was unthinkable as recently as one year ago.

Meanwhile in China……

July 6, 2015

After rallying slightly the prior week, US equities resumed their recent retreat, with the S&P500 falling 1.2% last week. While volume for the week was light, the day that the S&P dropped the most was the day that volume was the heaviest. And at the same time, volatility jumped, which is unsurprising during a week when prices fell. That said, the VIX is still well below panic levels, so investors are more complacent than they are fearful.

The technical picture suggesting a distribution pattern continues to become clearer. After last week’s mild loss, the S&P500 is now slightly down for the entire first half of the year. The last time this happened was in 2011, when the S&P500 proceeded to drop almost 20% before resuming its climb. As of now however, it’s down only about 3%. So even a run-of-the-mill correction, which is extremely overdue, would imply a drop of another 17% from peak.

On a short-term, say daily, basis, the S&P is no longer overbought.  And arguably, it’s somewhat oversold and due for an near-term bounce.  On a longer term, weekly basis, the S&P is still looking strong, but the broad distribution pattern is now beginning to become very clear.  This is important because all major corrections typically don’t come out of nowhere; instead the usually begin after the smart money has had some time to unload some of their shares onto the dumber money, sadly referred to as “retail”. This doesn’t mean that the long overdue sell-off is imminent, but that the conditions are very ripe for one.

In the real economy last week, we saw pending home sales, consume confidence and ISM manufacturing all beat consensus estimates. The bad news is that far more reports missed.  The Dallas Fed manufacturing survey, Chicago PMI, PMI manufacturing, factory orders and initial jobless claims all missed expectations. Even worse, the big number of the week—June payrolls—also missed.  Not only were fewer jobs created than experts had predicted, but average hourly earnings collapsed. Employees may not be losing jobs, but the ones they’re getting—often as bartenders and cashiers—-are part-time, with no benefits and with low pay. Also, the labor force participation rate dropped to 62.6% (from 62.9% the month before). This is the lowest level since 1977, or 38 years!  So as the US population continues to grow, a smaller and smaller percentage of it is actually working. This is not good.

While the world has been fixated on the massive problems in Greece over the last several weeks, another interesting bearish development has been developing in China. Since peaking well over 5,000 in early June, the Shanghai Stock Exchange has plunged about 30% in the last four weeks. Not only is this a bear market correction, but if it doesn’t stop soon, it has the potential for turning into a huge crash.

But why does this matter to anyone in the US?  Well, because the last time this happened was in 2007 when the Shanghai index rocketed from about 1,500 to about 6,000 in only a year. Then starting in late 2007 and continuing in the first half of 2008, the Chinese stock market crashed all the way back down to almost 1,500 again, losing about 70%.

So it’s not the fact that the Chinese stock market soared and crashed, it’s the fact that it crashed about six months before US stocks crashed. In other words, the Chinese stock market was a leading indicator. And if there’s any reason to think that history may rhyme again in the future, then US stock investors have plenty of time to de-risk.

The number of high-quality “warning signs” is growing by the month.