Do You Believe in Miracles?

July 25, 2016

After reaching what we described as “nosebleed valuations” the prior week, the S&P500 went on to climb another 0.6% last week. Volume however dropped quite a bit from the prior week, so while new all-time highs were set, the conviction level of investors and traders did not increase. Also, the S&P’s volatility set a new low for the year mid-week, but it began to creep back up by week’s end, so once again, this measure suggests that while investors love the new stock market highs, they’re a bit nervous and keeping an eye on the exit doors.

US macro news was mixed last week. Although the housing market index missed expectations, housing starts beat consensus estimates….but just barely. Initial jobless claims are still clinging to multi-year lows. And PMI flash manufacturing also beat expectations. On the negative side, the Philly Fed business outlook survey missed badly and the FHFA house price index also missed expectations. So once again, there is no real improvement to report for the US economy.

As extremely overbought as the S&P was last week, it’s now even more overbought…..on both the daily and the weekly charts. So from a purely technical perspective, if an investor plows new money into the S&P500 today, he or she would be betting that the extremely overbought conditions would grow to become even more extremely overbought. Good luck with that strategy to anyone who follows it….and unfortunately, there seem to be a lot of investors who are following it.

From a valuation standpoint, money manager and PhD economist John Hussman, in his most recent bulletin, pointed out that there has been only one time in US history when the S&P500 has been more overvalued…back in 2000 just before the tech bubble burst and took down all the US stock markets and pushed them into bear market territory. So for an investor to do the same today—give currently “obscene” valuations, then that investor would essentially have to believe in miracles……that something that’s never happened before would happen this time—that stock prices would materially and sustainably advance from today’s nosebleed levels.  As Mr. Hussman notes, this does not mean that prices can’t go even higher in the short-run, but any such increases would be given back, and then some, in the brutal price retreat that will almost inevitably ensue.


S&P500 at Nosebleed Valuations

July 18, 2016

Last week saw another melt up in US stock prices with the S&P500 registering a 1.49% increase by the end of trading on Friday. Volume was light, a reflection of the normally slower summer trading season as well as the fact that new investors are still not rushing in to chase this market higher. Volatility, as measured by the VIX index, dropped back down to the lows of the year. So the entire Brexit fall-out has been entirely ignored as far as US equity prices go. Not only does the S&P think Brexit will not hurt equity prices, but judging by the new all-time highs set last week, the S&P believes that it will be a positive for risk asset markets. How? Once again, the S&P500 is anticipating that any bad news from Brexit will be met with good news from central banks, in the form of even more expansionary monetary policies. So bad news is good news.

In the real economy, the labor market conditions index fell once again. Job openings, as measured by the JOLTS report, also fell. Wholesale trade missed. Initial jobless claims were better than expected. While producer prices were a bit hotter than predicted, consumer prices were lower. Retail sales and industrial production beat consensus estimates. But the Empire State manufacturing survey and consumer sentiment both missed. So once again, there is no notable uptick in the pace of growth in the US economy; it continues to muddle along.

Technically, the S&P500 is now extremely overbought. Both on the daily and the weekly charts, prices are hugging the upper Bollinger bands. And prices are now far above—stretched above—the 200 day moving average.

More importantly, some highly respected Wall Street firms are starting to voice concerns about more fundamental valuation measures. Goldman Sachs, for example, has just issued a report where is notes that “Valuations are already at historical extremes. The S&P500 trades at a forward P/E of 17.6x, ranking in the 89th percentile since 1976. At 18.4, the median constituent ranks in the 99th percentile. Most other metrics such as P/B, EV/EBITDA, and EV/Sales paint a similar picture.”

So here is one of Wall Street’s most respected firms, a firm that normally champions rising stock markets because they’re good for business, now expressing deep concerns.

So anyone who decides to cast aside such simple, historically informed data and put new money into US stock markets should understand that they will be picking up nickels in front of a steam roller. It’s good while it lasts, but when it ends, the effects will be catastrophic.


US Treasury Rates Fall to Record Lows

July 11, 2016

The S&P500 continued to grind upward, despite the initial Brexit setback, and last week it registered another solid gain. This time is was up 1.28%. Volume however was very light, and this implies that the average mom and pop investor was not participating in the rally. In other words, new money did not rush in to buy. Instead, the usual drivers—corporate buybacks and short covering explain most of the gain. Volatility dipped back down, almost to the lows of the year, as measured by the VIX index.

In economic news in the US last week, factory orders dropped, but they dropped by exactly as much as economists predicted. Our international trade deficit came in a bit worse than expected. ISM services, on the other hand, beat consensus estimates. The big news of the week was US payrolls, which beat estimates with as much of a shock as it missed estimates the month before. But while the number of bartender and waitressing jobs continues to soar, the actual unemployment rate ticked higher (bad), and average hourly earnings missed expectations (also bad). That said, the payrolls beat was the big driver of the US equity price jump last week.

The technical picture for the S&P500 is becoming murky: the two-year topping formation is now in jeopardy of being weakened,  because the S&P is now very close to setting new all-time highs. Of course, for this topping formation to be completely nullified, not only do new highs have to be set, but they have to hold and then the market would have to continue to grind higher. As of last Friday, new highs had not been set.

All that said, in the short term, the S&P is now somewhat overbought. And a pullback, even a modest one, would be perfectly normal at these high levels.

Finally, as described last week, while the S&P500 has been grinding higher, the US Treasury rates have been grinding lower. Remember, this is not supposed to happen. Normally, when US stocks are bought, buyers sell US Treasuries, in part, to fund the purchase of US stocks, and as a result of the Treasury selling, Treasury rates normally would rise.

Instead, last week, the US 10 year Treasury rate set the lowest rate in the history of the United States…..1.33%.  This is not supposed to happen. It seems that while US equity prices march higher, big money is running for cover and buying US Treasuries (at record low yields). So this is a HUGE divergence from normal historical patterns. One of these markets is most likely very wrong—either US stock prices are too high and will come down, or US Treasury rates are too low, and will go back up.

Although this divergence will probably not resolve itself in a week or so, it will very likely end sometime this year….over the next few months.

 


US Treasury Yields Approach Lowest Levels….Ever

July 5, 2016

Unsurprisingly to us at least, the S&P500 roared back last week….despite all the doom and gloom predictions by pundits in the media…..to close up 3.2%, which was one of the largest percentage gains on the year. Volume was moderate, and volatility plunged, as would be expected in a week when prices rose. The VIX index fell back close to the lows of the year.

In US economic news, the results were mostly disappointing. To kick off the week, international trade missed. The Dallas Fed manufacturing survey came in with a deeply negative reading. Case Shiller home prices missed badly, suggesting that the multi-year recovery in home prices may be slowing down. The Richmond Fed manufacturing survey also registered a deeply negative result. Personal income missed; personal spending only met expectations. Pending home sales logged their biggest drop since May 2010. Initial jobless claims were a bit worse than expected. Construction spending missed badly. On the positive side of the ledger, Chicago PMI beat estimates. And ISM manufacturing also came in better than expected.

The technical charts now suggest that, in the short-term, the oversold condition from the previous week has been reversed—all in one week, last week. Importantly, however, during last week’s rally, the S&P did not recover above recent tops set in June. Instead, it stopped short off those levels. This sets up a simple test for the upcoming week—if those recent tops from June are not eclipsed, then the S&P could resume its recent downturn. On the other hand, if these recent tops are taken out, then a new all-time high could be established. On the long-term weekly charts however, the two-year topping formation is still fully in effect.

For the last several years, we have been recommending that investors trade US Treasuries from the long side…..which means that one should own them not only to earn interest but to also benefit from price appreciation. In other words, we were betting that rates would come down.

Back in the fall of 2013, when we first introduced this trade, the US 10 year was yielding roughly 3.0%.  And as of last, the yield had dipped below 1.4%.

Amazingly, almost all professional analysts and economists have been arguing that rates would be RISING during this entire three-year period. So all these so-called “experts” have been dead wrong….for three years now and running.

This brings us to the next logical step—where could rates move to next?  While Treasuries are somewhat overbought in the short-term, and rates could back up a bit (the market could take a “breather”), it now is entirely possible that the US 10 year yield could fall to 1.25% over the next several months. What’s more interesting is that when (not if…but when) risk assets finally crash in the US, then the 10 year yield could even approach….or take out…..1.0%.