S&P500 Rally Stalls

March 28, 2016

After several weeks of rallying, the S&P500 finally stalled and actually reversed. The index dropped about 0.7% on light volume due to holiday shortened trading hours. Volatility, while not changing very much, did edge higher which adds to the importance of the price drop.

US macro reports were mostly weak. The Chicago Fed National Activity Index fell into negative territory again; it was expected to climb a bit. Existing home sales rose, but less than predicted. The PMI manufacturing flash index came in weaker than expected. While headline durable goods orders just about met expectations, the core (ex-autos) figure cam in well below consensus estimates. On the positive side, initial jobless claims were slightly better than estimated and new home sales beat expectations ever so slightly.

After highlighting how the most recent multi-week bounce in the S&P was closely echoing the big bounce that also occurred in October last year, we went on to ask if the same final outcome would also occur—namely, that the bounce would end without setting new highs and then the index would turn down to set new post-peak lows.

Well last week’s price drop suggests—at a critically important technical level—suggests that the bounce could be finally coming to an end. Supporting the argument that the bounce may be ending were several reports suggesting that big money funds were net sellers into the recent rally. In other words, professional or “smart” money investors were selling because they were betting that the recent rally was going to reverse itself.

So who was buying on the upside in this rally?  The same huge buyer that’s been buying massive amounts of stocks over the last couple of years—corporations were buying back their stocks,  by using cash from reduced capital expenditures or from increased borrowings.

The problem with this strategy is that it means that corporations have been buying assets (their shares) at high prices (during the rally) and leaving themselves with less in terms of productive investment (bad for future sales and profit growth) or with much more highly leveraged balance sheets (bad for financial risk especially when a recession finally arrives).

Something very similar happened during the run up to the 2008 financial crisis. And the worst part of that story was that after the crisis hit, many of the same companies who were buying their shares at high prices suddenly were forced to de-lever and sell their shares at low prices.

The result—they bought high and sold low, which clearly destroys value for shareholders. And now, sadly, history seems to be repeating itself.

Echoes of late 2015 Bounce in US Equities?

March 21, 2016

The S&P climbed another 1.3% last week to close at 2,049. Volume once again was much lower than it was during the early 2016 weeks when the index was falling significantly. And volatility, as measured by the VIX index, continued to back down, but it hasn’t reached the levels seen during the height of the bounce in the fall of 2015.

In US economic news, the week began with a retail sales report that only met expectations. Retail sales ex-autos fell, but because they fell less than expected, this number was a beat. The Empire State Manufacturing Survey beat consensus estimates, but the housing market index missed. Consumer prices,  both headline and core, came in slightly hotter than expected. Industrial production missed. The current account was far more negative than predicted. Leading indicators missed, and so did consumer sentiment. Both initial jobless claims and the Philly Fed business outlook beat their respective estimates.

Interestingly, the S&P has now returned to levels just above its 200 day moving average. This is about where the S&P recovered to in late 2015, after suffering from a big sell-off in late August. The index then wallowed around (a bit over and a bit below) the 200 day moving average for about two months, and then it reverted to a downtrend as the new year began in early January. Here are some notable differences: First, the index reached a new low (both intra day and daily closing) during its January and February sell-offs….when compared to the August 2015 lows. Second, the 50 day moving average is still well below the 200 day moving average now, as opposed to late December, when the 50 day returned back up to the 200 day. Third, the 200 day moving average is still sloping downward, unlike late November and early December when it leveled off to a neutral slope.

All these differences suggest that the technical damage incurred, first in the August 2015 sell-off and then in the January 2016 sell-off, has not been repaired. Market watchers and analysts do not have an “all clear” signal to jump back into the US equity markets and trade them from the long side.  While many traders who went short have already been squeezed out (and this process itself has helped fuel the recent bounce), there are no signs that investors and traders have wholeheartedly switched to being bullish.

In terms of equity market catalysts, the Fed did put rate hikes on hold, if only for a short while, and the ECB has launched another large QE program. Both of these developments help firm up stock prices, But on the other hand, corporate sales….and more importantly corporate profits….have continued to erode. And this is a very important factor that supports the bearish argument.

So we’ll need to wait another week or two to see if US equity markets can continue to rally in the face of massively disappointing sales and profits reports, or if these markets will reverse course—just like they did at the very end of 2015—and return to their prior downtrend.

Moment of Truth for the S&P 500

March 14, 2016

Even though the week started on a down note, the S&P500 finished the week strongly by recording big gains on Thursday and Friday. The result was a third week of consecutive gains for this large cap index which closed up another 1.1%. Stock market volatility dipped, but only slightly, suggesting that investors and traders are still worried about potential price drops in the near term. And volume, during the week when prices rose, fell back somewhat, and this suggests that investors are not jumping back into the stock market with both feet.

Back in the real world, on Main Street, there wasn’t a lot of news to report. The labor market conditions index fell much more than in the prior month. And export prices also continued to slide backwards, which is bad for corporate profits. On the positive side, wholesale trade came in stronger than expected. And initial jobless claims fell back more than economists had projected. But keep in mind that of all major economic indicators, most job reports are lagging indicators in terms of predicting recessions. They tend to be at their strongest levels just as recessions are about to begin.

In terms of technical analysis, the picture for the S&P500 suddenly becomes very interesting. Now that a big chunk of the losses from January and February have been reversed, the question becomes—will the rally continue further and lead to new all-time highs, or will it sputter now that the traditional resistance levels are being reached (for example, the 200 day moving average is now directly overhead and will be an area where many stock holders look to sell in order to get out of formerly losing positions that were added in December).

So this is it—the big test that everyone will be watching carefully. The stock market’s direction for the following 1-2 months may be determined during the next 4-5 trading days. Stay tuned!

Gold’s Bull Market Resumes

March 7, 2016

The counter-trend bounce in the S&P500 continued last week. The large cap index closed up another 2.7% but since volume on the way up has been far lower than in was on the way down earlier this year, the bounce can be viewed as just that, a bounce that’s driven more by short-covering, not the start of a major leg up to new all time highs. In fact, as well covered in these posts, the S&P500 has further room to bounce before threatening the larger downtrend that started late last year. The S&P can climb well past 2,025 and even up to 2,050 before this larger downtrend can be declared broken….to the upside.

Other technical indicators suggest that now the S&P is becoming very over-bought on the daily charts. And given that the S&P has still not reclaimed the 200 day moving average (which looms at about 2,025) there’s major overhead resistance that lies dead ahead. On the longer term weekly charts, the distribution pattern that began in early 2015 looks very much in tact. And the latest bounce very closely echoes the big bounce that took place in the fall of 2015, a bounce that clearly failed before new all-time highs were reached.

On the ground floor, in the US economy, the news was not good last week. The week kicked off with a disastrous Chicago PMI report, which recorded its worst reading since March 2009. Pending home sales fell. The Dallas Fed manufacturing survey is still in disaster territory, all due to the collapse in the price of oil. ISM manufacturing only met expectations. Construction spending beat expectations, but initial jobless claims, PMI services, and factory orders all disappointed. ISM services beat expectations, but only very slightly. Finally, the big number of the week (payrolls) was deceiving. On the one hand, the headline number of jobs beat consensus estimates. On the other hand, average hourly earnings dropped, instead of rising as expected. In fact, the drop in average hourly earnings was so bad that according to economists it was the equivalent of losing about 700,000 jobs. So while the headline number of jobs was 50,000 above expectations, the total earnings of the workforce actually fell. That suggests that people who are working are making less money because their hours worked and their pay rates are falling. And given that most of the jobs that have been added over the last few years have been of low quality (eg. waiters, bartenders and maids) it’s no surprise that we’re seeing lower total workforce earnings. All this means that the US consumer is earning less money to spend on goods and services and this makes a recession even more likely to occur.

Finally, after peaking in 2011 at an all-time high (in US dollars), gold—one of the most hated asset classes by banks and financial advisors—has quietly entered a new bull market. In gold, both the 50 day moving average has crossed above the 200 day moving average and the 200 day moving average has started to slope upward. This should come as no surprise when the European Central Bank is printing (electronically) currency under its own program of QE and the Japanese central bank has embarked on a negative interest rate policy (or NIRP). To buyers of gold, the trade-off is simple—-own gold and preserve value, or hold cash and lose value. And since these two huge central banks are showing no signs of reversing their policies anytime soon, there’s a good chance that gold’s recent run up has much further to go.