2015 Change in S&P 500 Just About Zero

Finally, the S&P 500 enjoyed a reasonable bounce—last week it closed higher by almost 2.8%. But in the holiday shortened week, volume was very light, and the index moved higher on the back of even fewer market leaders; in other words, market breadth was very thin and this makes the large rise in price look not so impressive. Volatility, as would be expected in a week when prices jumped, dropped back down; that said, the VIX index is nowhere near the super low levels seen during the complacent summer months. The upcoming week, the final week in December and in 2015, will tell us if last week’s “Santa Claus Rally” will continue.

While the US stock markets rallied, there was no “Santa Claus Rally” in the US economic data last week. The Chicago Fed National Activity Index got the week started on at down note: instead of rising as expected, it fell. Existing home sales disappointed badly. New home sales also missed. Headline durable goods orders beat expectations slightly, but that was all due to airplane orders; when those volatile orders were removed, durable goods ex-transportation showed a disappointing drop. And finally, personal income only met expectations.

The technical picture for the S&P is one of a continuing distribution and therefore topping pattern. This pattern began early in the year, and has gotten even more strong as the months ticked by. The last two times we saw something similar was in 2007 and in 2011.  In 2007, the intra-year 20% drop was reversed by the end of the year and, with the help of huge QE programs from the Fed, the S&P went on to climb strongly in 2012, 2013 and 2014. But as we all remember, in 2007 there was no reversal. The topping pattern formed by the end of that year set the stage for a huge loss, approximately 55%, that took more than a year to achieve (March 2009).

The problem with hoping for a repeat of the 2012-2014 performance is that valuations this time around are far higher than they were in 2012. In fact, they’re stretched to levels last seen in 2007. Also, unlike in 2012-2104, corporate sales and profits are falling…..also last seen around the end of 2007. And finally, unlike 2012-2014, the Fed is not injecting monetary easing into the financial markets; on the contrary, the Fed has commenced a process of removing monetary easing, with the first of several rate hikes just completed.

So as 2015 winds down, not only is the S&P 500 looking like it could suffer its first loss in about eight years (it just about broke even in 2011), but more importantly, it could be entering a phase in which it could easily—and finally—retreat by a very meaningful percentage.

High Yield Bonds on Sale?

After cratering the prior week, the S&P500 began to rebound early last week, only to close the week with two days of big losses. This caused the index to close down for the week, but only slightly….down 0.34%. Volume was not high, but this may have had something to do with the holiday season which is just around the corner. Also, volatility fell a bit for the week. That said, the VIX index has been trending higher since late October.

The technical picture for the S&P continues to become more grim. Instead of retaining the early week bounce, the S&P gave it all back after the Federal Reserve announced its first rate hike in 8 years. This inability to hold onto a bounce suggests that some more selling lies directly ahead. Add to this the fact that the S&P closed the week well below its 50 and 200 day moving average and you have a lot of reasons for traders to become concerned about being fully long this market. Next week, if the selling resumes, you may see more bears coming out of the woods and start to argue that we could retest the lows of August and October.  If these don’t hold then, some experts will argue that the long overdue “bear market” may be imminent.

In economic news, the reports were particularly poor. the week started off with a “less bad” than expected Empire State manufacturing survey (it was still bad though), and things went downhill from there. The housing market missed estimates. Industrial production missed badly. PMI manufacturing also missed. The Philly Fed business survey disappointed. The PMI services index missed very badly, and the Kansas City Fed manufacturing survey cratered.

It’s been a while, but after the multi-year meltdown in commodities (which drove, for example, oil and copper down 75% and 55% respectively). While we pointed to these major asset categories more as signals of upcoming economic weakness, they will also become serious investment opportunities for the long-term, once their prices stabilize.

Another major asset category has also recently come onto our radar screen—high yield bonds. While this asset category is still falling in price, and because of this, it’s not yet ready to be bought, it’s been falling far more than the overal US equity indices which are not too far off from their all-time highs. Also, high yield bonds are being disproportionately affected by losses in the energy and commodities sectors. That said, this investment bucket is starting to approach prices last seen in early 2008. And once the full effects of the slowdown in the US economy are fully expressed in terms of corporate defaults and once the effects of the Fed’s hiking cycle fully sink in to the markets, we may find ourselves approaching high yield prices last seen in late 2008, when it offered a huge investment and income upside—at those prices, yields were in the mid-double digit area, and prices eventually rose by 40-50%.

Over the next couple of months, something similar may happen again in high yield. And this would be an exciting opportunity.

Will the Fed’s Rate Hike Matter?

After two consecutive weeks of treading water, the US stock markets made a decisive move last week—down.  The S&P500 dropped almost 4%, to record one of its worst weekly losses of 2015. Volume was moderate, and volatility spiked….but still not anywhere near panic levels last seen in August of 2015.

The technical charts for the S&P just got a lot uglier. Now that prices have broken down, there isn’t a lot of support beneath the market until the August lows (which were retested in late September) are reached. And that’s about 7% lower than the close on Friday on the S&P. And if that level…about 1,875…doesn’t hold, then the next step down is the October 2014 low of about 1,815.

And this bearish technical development appears to be equally relevant on the daily and the weekly charts. Also, after last week, the 200 day moving average resumed, even if only slightly, sloping downward. And remember, the 50 day is still below the 200 day. Both of these situations are distinctly bearish.

In US economic news, almost all of last week’s reports were disappointing. Labor market conditions, consumer credit and wholesale trade all missed expectations. Initial jobless claims jumped more than predicted. Producer prices, both headline and core, were hotter than expected. Retail sales missed; but retail sales excluding autos beat slightly. Finally, business inventories and consumer sentiment both  missed. In short, we recorded another week of weak data, data that suggests the US economy, which never recovered in the traditional sense of US economic recoveries, is now headed for another recession; the only major questions are exactly when the recession will start and how severe will it be?

Finally, this week, almost everyone is predicting that for the first time since 2007, the Federal Reserve will finally bump up short-term interest rates. And while the Fed has—for a long time—been signalling that this move is coming, and while the markets have supposedly already “priced in” this interest rate increase, there’s a possibility that the markets are underestimating the impact of this seemingly minor increase in rates. Why? Because the Fed’s balance sheet has ballooned by several trillion dollars over the last seven years by electronically printing money (ie. QE), Fed analysts estimate that the Fed will have to remove a lot of money from the rate markets in order to make the itsy bitsy 0.25% rate hike happen.  How much will they have to remove? Estimates range from $300 billion to $800 billion. And the real problem with this removal of liquidity is the speed with which it must happen—virtually overnight.  Remember, the Fed—when conducting its various QE programs—would create and inject several hundred billion dollars over many months.  And this would gradually, but steadily, push up asset prices over that period.

So what happens when the Fed conducts QE in reverse….and in a day, rather than over six months?  Nobody really knows.  But there’s a good chance that even if asset markets have priced in the amount of liquidity withdrawal, they have not fully processed the speed with which it will be withdrawn—overnight, or cold turkey.

On Wednesday December 16, we will find out for sure!

US Stocks Tread Water—Two Weeks in a Row

Amazingly, the S&P500 finished another consecutive week with almost no change in price. That doesn’t mean that during the week there wasn’t any significant movement in price. There was. But it does mean that when the closing bell rang on Friday afternoon, the index finished the week just about where it started. Volatility rose—when prices fell—but then fell—when prices rose….to end the week also with little net change. Volume rose a bit, but that was mainly due to the fact that last week’s trading days returned to normal when compared to the prior week’s holiday-shortened schedule.

The volume of US economic reports also returned back to normal.  The week began with a very weak Chicago PMI result; instead of rising as expected, it fell by a lot—most meaningfully, below the important 50 level. Pending home sales also missed badly. Then, the ISM manufacturing index registered a disastrous sub-50 reading, also far below expectations. And to add insult to injury, the ISM services index also badly missed consensus estimates. On the positive side, factory orders beat expectations, but only barely. And the big number of the week—payrolls—was slightly better than expected:  more new jobs were created than economists predicted. The problem though is that most of these jobs, such as bartenders, waitstaff, and landscapers, pay ultra-low wages and usually don’t offer benefits. At the same time, the jobs that are lost are more often traditional high-paying jobs that offered healthy benefits.

Finally, as already touched on, the S&P500 continued to give no clear signal over the past five days. Early in the week, rose. Then midweek, they fell fairly hard, but by Friday, they rallied so vigorously that the index finished the week pretty much unchanged. This means, we’ll need another week or two, with some clear direction, to be able to conclude that this market is header up and poised to set fresh all-time highs, or on the other hand, it’s going to finally break down and true to it’s year-long distribution pattern, finally sell off and stay down for a while.

Once again, the next week or two will  be telling. Unless of course, the index finishes unchanged again!