Stocks Not Out of the Woods

February 29, 2016

The S&P500 recorded a second consecutive week of increases, but this time the rise was about half the prior week’s gain—the S&P closed the week up 1.58%. But volume during this up week was much lower than it was earlier in February when prices fell, which means that investors are far from enthusiastic about this rally. If anything, short covering explains most of the jump over the last two weeks. Volatility did fall back, but only to levels associated with far more uncertain periods; in other words, the complacency we usually see during long periods of price rises did not return. The VIX index closed the week near the 20 level.

US economic news did not get much better last week. The PMI manufacturing index missed expectations. At the same time, it looks like the US housing market is losing steam, and fast, lately; the Case Shiller home price index is no longer showing home price increases. While existing home sales volume beat expectations, new home sales collapsed—-they registered the biggest percentage drop since 2009. Also in housing , the FHFA house price index missed expectations. PMI services not only missed badly, but they moved into contraction (ie. recession) territory. Consumer confidence absolutely collapsed. The Kansas City Fed manufacturing survey notched its worst reading since April 2009. And international trade came in far worse than expected. On the positive side, durable goods orders beat expectations, and both personal income and personal spending were slightly better than predicted. Finally, Q4 2015 GDP revisions were a little better, but only because unsustainable (and soon to be reversed) inventory builds were stronger than expected—final or end sales did not improve.

Now that the S&P500 has bounced for two consecutive weeks, as noted above, the question becomes—is this just a typical bounce within a new bear market decline…..or is this just the resumption of the 3 year bull market rally….first to return to the old highs set in May 2015 and then to set even higher highs after that?

To try to answer this question, we turn to clues in other non-equity markets, but markets that are often correlated to equity markets. And the most important ones to look at are the credit markets. First, the high yield market—which is considered, just as the stock market, to be a riskier asset category, but one dominated by professional investors only—is signalling that more pain lies ahead for US stocks. The reason is that the high yield market, which started selling off well before the dramatic turn down in the stock markets, has not recovered much at all. Spreads are still very wide and they show no signs of compressing. Second, the “safe haven” US Treasury market is also signalling that the coast is not clear. When investors embrace risk, such as stocks, they tend to sell off US Treasuries (which they consider a safe haven) to free up cash to put to work in stocks. When that happens, prices of US Treasuries fall (and their yields go up). Well that hasn’t happened. If anything, the opposite has happened—money has moved into Treasuries and yields are near cycle lows.

So while this stock market bounce has helped relieve some of the pain stock investors have suffered from since the start of the year, it’s far to early to determine if the dramatic downturn in stocks has truly ended and reversed.

Stocks Bounce….Fed Going NIRP?

February 22, 2016

So it looks like we had to wait another week for the bounce in US equity prices to resume, which it did last week when the S&P500 climbed about 2.8%. But since volume was very light, we can infer that this bounce was more about short covering than about investors rushing back into the stock markets to buy new positions. But volatility did drop back, as one would expect during a week when prices rose.

As usual, most of the US economic news was poor last week. The Empire State manufacturing index came in badly negative, when it was expected to improve from the prior month’s reading. The housing market index missed expectations of a rise; instead it fell. Housing starts also missed. Producer prices were hotter than expected; this puts more pressure on the Fed not to halt its rate hikes. The Philly Fed business survey missed. Leading indicators only met expectations. And industrial production beat, but with industrial inventories piling up (relative to sales), productions is overdue for a severe cutback…..which is extremely bad news for future economic growth.

After last week’s stock market advance, the argument for a continuation of the bounce gets stronger. Given the severe damage suffered by the equity markets since the beginning of the year, there’s quite a lot of room for a bounce to blossom. In fact, the S&P could rise almost another full 100 points before the long-term downtrend would become threatened.

And given the severe damage to US equity markets (and even to those abroad), cries for help from Wall Street…..especially from the Fed…..have been growing louder. The idea that’s gaining the most momentum is one recently adopted by the Bank of Japan, which in turn borrowed the idea from several central banks in Europe—lower short-term interest rates below zero. In other words, adopt a negative interest rate policy (or NIRP) to theoretically force anyone or any entity holding cash to be more incline to spend it.

One problem with this is that cash holders will tend to want to pull their electronic deposits from banks and into paper currency in which case, there can be no interest charged by banks.  Sure enough, several influential mouthpieces for the establishment have already begun to argue for the elimination of large denomination notes (eg, the US $100 bill) which would make the withdrawal of large deposits more difficult to do.

But more importantly, the question should be—how have the NIRP policies in these other countries worked out for them. While some would argue that it’s too early to call, so far the results have been disappointing—in all cases, financial markets have not roared back to new highs and more importantly, the real economies in those countries have not started growing robustly; in fact many have tread water at best, and others have slid back down into recession.

US Stocks Stumble….Again

February 16, 2016

Although US stocks had a strong close on Friday, they still managed to drop lower for the week overall. The S&P500 lost just over 0.8% despite the strong Friday. Volume has started to creep higher, which is a bad sign because it means that investors are starting to de-risk not by hedging or insuring their long positions but by exiting their long positions outright. Another bad sign—S&P volatility crept higher so while some investors were simply cutting back on their stock holdings, others did continue to pay up for insuring the exposure they already had.

In economic news, the US economy featured a batch of bad news last week. Sure initial jobless claims were slightly stronger than expected, but most everyone forgets that the labor market is a lagging indicator, not a leading indicator for the US economy. Retail sales barely budged. Export prices plunged. Consumer confidence sank. And worst of all, the inventory to sales ratio for US manufacturers soared to another cyclical high level….a level that almost always signals that a recession is dead ahead (because to bring the ratio back in line, factories must drastically cut back on production).

The technical picture suggests that on the one hand, the S&P 500 is still quite oversold, especially on the daily charts. And a bounce, a real one that lasts for a week or two (not just a day or two) would be very normal to see right about now. On the other hand, the longer term weekly charts are still very bearish. They’re still pointing to the same risk that we’ve pointed out over the last couple of weeks here—that the entire US stock market is sitting on the edge of a cliff. And if the stock market doesn’t firm up by decisively backing away from this edge, then it risks dropping more…..a lot more.

The charts literally show nothing but air between current prices in the S&P, and prices that are 15-20% lower, where real support may finally kick in. So the bottom line is this—the risk for US stock markets is much more serious today than it has been for many years.

It’s Do or Die for US Stocks

February 8, 2016

Well the bounce didn’t last very long. After two weeks of modest gains, the S&P500 gave it all back—and then some—by plummeting 3.1% last week, with most of the damage coming on the psychologically important last day of the week: Friday.

Volume was moderate, which suggests that there was no serious capitulation selling. And volatility, while jumping 15%, was also nowhere near the panic levels reached in August 2015; the VIX index closed the week in the low 20s. Back in August last year, it jumped over 50, so when panic selling finally arrives, expect to see the VIX spike well over 30.

There was one huge economic report last week—payrolls. But first let’s touch on all the rest, which were mostly disappointing. Personal spending missed; personal income only met expectations. PMI manufacturing disappointed. ISM manufacturing also disappointed. Construction spending badly missed. PMI services missed,  ISM services missed badly. Initial jobless claims were worse than expected. Productivity fell. Factory orders fell, but more than expected. Finally, the payrolls number was a disaster. Only 151,000 jobs were created instead of the nearly 190,000 expected. While the unemployment rate looked good on the surface, it actually masked the ugly reality that millions of unemployed workers have quit searching for jobs making them no longer counted as part of the workforce. If these people were counted, the rate would be around 10% which is a very ugly number, especially since it’s almost seven years since the last official recession ended. The other reason the jobs number was a lot uglier than reported was because while 151,000 new jobs were created, most of these were waitressing and bartending jobs, jobs with low pay and near-zero benefits. At the same time, more traditional high-paying manufacturing jobs have been seemingly permanently eliminated and shifted overseas.

To put it bluntly, the US stock market is on the edge of a more severe retreat in prices. Since the already feeble bounce lasted only about two weeks and then was followed by a big retreat in prices immediately afterwards, the US stock market must now either immediately bounce back—and more accurately, it must roar back—-or it will face a slew of scared stock owners who will look to get out before they lose any more money. Keep in mind that the S&P has now fallen back to levels last seen in 2014, and with just a little more retreat, it will be back down to 2013 levels. So a sea of recent stock buyers are extremely unhappy and increasingly becoming more fearful. If stock prices don’t roar back up immediately, they will begin to ignore their financial advisors’ pleas for calm and patience and will instead demand that they “get out” of stocks and quickly.

When this happens, it will fuel the big and sudden push lower in prices. This will be the catalyst that will drive the S&P500 down to a 20% loss, the level associated with bear markets, for the first time since mid-2011.

Back in 2011, the Fed came to the stock market’s rescue and not only prevented further losses, but drove the US stock market indices to all-time record highs.

The huge question asked by all Wall Street experts is this—will the Fed be able to pull another rabbit out of its hat this time, given that Fed funds rates are still near zero and that the Fed balance sheet is still ballooned to massive levels.

Many of these experts are concerned that this time the Fed will not be so effective.

And the Bounce Arrives

February 1, 2016

Just as expected….if not actually predicted….here last week, the S&P500 bounced back up from an extremely oversold condition on the shorter-term daily charts. The S&P ended the week up 1.75% with an especially strong Friday that generated all of the gains for the week. Volume was moderate, just a touch lower than it was during the prior week when the S&P fell. And volatility inched back down, as one would expect in a week that showed price gains.

Last week’s economic reports were mostly disappointing….with signs of an oncoming recession growing even stronger. The week kicked off with a dismal Dallas Fed manufacturing survey, which continued to register deeply negative results. The Richmond Fed also fell notably. Durable goods orders collapsed. Both headline orders and orders excluding transportation were disastrous. Pending home sales also disappointed. Fourth quarter GDP results came in weaker than expected. And consumer sentiment missed. On the positive side, new home sales beat consensus estimates, and the Chicago PMI surprisingly beat expectations; but let’s see what the next month’s Chicago PMI looks like because this number is often very volatile.

The technical picture is—as noted in the opening—showing a very predictable pattern:  a large multi-week loss in the S&P is followed by a modest bounce. The question, as also mentioned last week, is this—will the bounce continue, or will it we sold. On the positive side, last week’s bounce is very minor compared to the huge losses suffered earlier in the month of January. That means that the bounce could still be just that—a temporary bounce—before more selling resumes afterwards. There’s a lot more room for the S&P500 to rise before it runs into very strong resistance at the underside of the 200 day moving average. So it can continue “bouncing” for another 100 S&P points….all the way up to about 2,040 before the downtrend would come into play.

This doesn’t mean that such a huge bounce must happen, but only that if it did, it would be entirely within the definition of a short-term counter rally.

The big question everyone is asking is whether or not the big selling we saw in January will continue, and given the severe technical damage done to the US equity markets in that month, the evidence favors a continuation of this selling in the upcoming months.

But once again, only time will tell for sure.