US Mortgage Rates Soar

December 27, 2016

Very little changed in the S&P500 last week. The large cap index inched up a tiny 5.7 points or just 0.25%. Volumes plunged because the end-of-the-year holiday season had begun. And not surprisingly, the index’s volatility level also declined—-it touched the lowest level of the year, even lower (but only slightly) than the complacent lows reached in the summer months.

So to sum up, stocks are back near all-time highs, and almost all fear in the stock markets has disappeared. Sadly, during these conditions, many mom and pop investors will wade into the stock markets for the first time…..ever or in a long while….and they will often get hurt, because it is during these types of conditions that all serious stock market retreats begin (huge run up in price combined with a big drop off in volatility).

Most of the US economic reports from last week were misses. Except for the core durable goods report, home sales, and the revised 3rd quarter GDP report, all the other reports disappointed. PMI flash services, headline durable goods orders, initial jobless claims, the Chicago Fed National Activity Index, the FHFA house price index, personal income, personal spending, and leading indicators all missed.

Technical analysis is still, strongly, suggesting that the S&P500 is extremely stretched to the upside. The bounce that began the day after Donald Trump was elected President is now almost two months old and has driven the S&P higher by almost 10%.  This is a huge move in a very compressed period of time……and once again, this type of move has historically been followed by some sort of retreat, if only back down to the 50 day moving average which is roughly at 2,185.

Finally it’s worth noting that, as the home sales results have been implying for the last several years, the US housing market has been booming since it bottomed in mid-2012. Clearly, as the Fed drove down interest rates the reduction was passed along to home buyers who bought new and existing homes with record low mortgage rates.

But since Trump’s election, the yield on the US 10 year Treasury rate has risen by about 100 basis points, and not surprisingly the rate on the average 30 year mortgage rate has also risen by roughly the same amount…..from 3.4% to 4.3%. So if record low borrowing rates pushed US home prices back up to bubble levels, will the reversal of these low borrowing rates burst this home price appreciation?

Given that housing naturally remains the average household’s largest expense, it stands to reason that this sudden and massive jump in mortgage rates will hurt the US housing market. But just as the rise in prices took time to kick in, the reversal in home price appreciation will also take time to kick in. Housing—unlike say super liquid stocks—is a slow moving market where deals are negotiated and locked in over many weeks and even months. So changes in the direction of this enormous and very important market will take time to take effect.

But regardless of how long it will take to impact the US housing market, the effects will eventually be felt and they will hurt.


US Equity Market “Internals” are Deteriorating

December 19, 2016

Last week, the S&P500 took a pause from its massive bounce, the bounce that started the day after the US presidential election in early November. The S$P lost less than 0.1% on light volume. Meanwhile, the S&P’s volatility index (the VIX) crept a little higher; that said, it still ended the week only a small amount higher than the super-complacent lows reached in the summer months.

The US macro reports were mixed last week. While retail sales missed badly (and so did retail sales excluding autos), the Philly Fed Business Outlook Survey and the Empire State Manufacturing Survey beat consensus estimates by wide margins. But the rest of the news was weak—industrial production missed. Business inventories missed. Housing starts missed. And producer prices were hotter than expected. The biggest news of the week came from the Federal Reserve which raised the fed funds rates again (the first time since last year), but since this move was widely expected, markets had already priced in the move and the reaction was very muted.

Technically, the S&P500 remains extremely overbought, especially since last week’s tiny pullback did little to change this condition. So the S&P remains super stretched on the daily and the weekly charts—hugging extreme high levels in most price range indicators.

On the other hand, what’s happening beneath the surface—beyond prices—-is not so rosy. While the S&P remains near all-time highs, several “internal” indicators are far less bullish. Leadership for example, as measured by New Highs minus New Lows, is essentially at zero.  Usually, when new highs are reached on the overall price index, the number of new highs far exceeds the number of new lows.

Also of concern is the breadth of the advance, as measured by Advancing issues minus Declining issues. And while this number is positive, it is far below the levels reached during prior index highs. Another breadth measure—the percent of stocks above their 150 day moving average—is also not doing so well: ie. nowhere near the levels reached during prior market highs.

What does this mean?

The market “internals” are diverging — bearishly — from the overall S&P500. And in the past, as in over the last 100 years, all major declines in the overall price index were preceded by deteriorating market internals.

This is clearly happening today. But while this divergence does not portend an immediate market sell off, it does set off alarms, alarms that should tell us that big sell offs are far more likely to occur now….as opposed to times when market internals are not diverging from the overall price index.

Warning from Robert Shiller

December 12, 2016

After stalling the prior week, the S&P500 resumed its partying ways by climbing a massive 3% last week. Volume was moderate (lower than in the prior week when the index retreated). And volatility was essentially flat—the VIX index dipped slightly but since it was already near yearly lows, it didn’t have much room to fall.

US economic reports were mostly poor last week. PMI services fell from the prior month’s reading. International trade missed expectations by being more negative than economists had predicted. Productivity rose less than expected; this is very important because productivity growth is a critical determinant of long-term economic growth (ie GDP growth). Also related to poor productivity growth (lower productivity growth translates to higher unit labor costs) is unit labor cost which rose far more than expected; this clearly hurts corporate profits. Consumer credit rose less than expected. Initial jobless claims once again disappointed. On the positive side, ISM services beat consensus estimates. And consumer sentiment also rose more than predicted.

Technical analysis of the S&P500 still points to a market that extremely overbought. This is true both on the daily and the weekly charts which makes the technical argument stronger than if the overbought condition existed only on one time resolution (eg. the daily charts but not the weekly charts).

Speaking of overbought conditions in the US stock market, last week Nobel prize winner and Yale professor Robert Shiller commented on CNBC that his famed Shiller PE Ratio (current price of the S&P divided by the average of the last 10 years of S&P earnings) was reaching the levels last seen in 1929 and 2007……both times when the US stock markets went on to crash in spectacular fashion. While the Shiller PE today is still lower that it was in early 2000 at the height of the dotcom bubble, Shiller is suggesting based on 100 years of data with his indicator that buying stocks now may not generate much, if any, returns to stock investors over the next 10 years.

Shiller is the first to admit that his indicator cannot predict the timing of a major equity market retreat, and that the US stock market may move even higher in the short run (especially in investor “animal spirits” drive them higher). But he is reminding everyone who will listen, that the evidence is simple yet blunt—that if investors buy stocks when prices are extremely high, then they should not expect to make a lot of money in the long run.


Still—Treasuries Oversold and Stocks Overbought

December 5, 2016

The S&P500 breathed a little, after roaring higher in the aftermath of the Trump presidential election. Last week, the index retreated just under 1 percent. Volume was much higher than it was in the prior holiday-shortened week, and equity volatility inched higher, but it remained near the low end of its multi-year range.

In US macro news, the big story was the November jobs report. On the one hand, the total jobs figure beat expectations……but only very slightly. Also, the headline unemployment rate dropped even further… down to 4.6%.  But the real picture is not so rosy. Most of the new jobs created—as has been typical for the last several years—were low-paying, un-benefited, and low-skill jobs such as bartenders and waitresses. Meanwhile, good jobs that come with benefits and higher pay, such as manufacturing jobs, continued to disappear. Also, the headline unemployment rate fell but it fell mainly because people without jobs stopped looking for jobs. How do we know this? Among other data points. the labor force participation rate fell. Also on the negative side, average hourly earnings fell, instead of rising as expected. So the US jobs picture is great if you think like an economy with more bartenders and Walmart greeters who need to work two jobs now—since getting laid off from their old manufacturing jobs—to make ends meet.

In other macro news, the US housing market is showing signs of slowing down—the Case Shiller un-adjusted numbers showed that house price appreciation across 20 major cities has slowed almost to a standstill……far worse than expected. Pending home sales also collapsed. Also, initial jobless claims came in worse than expected. On the bright side, the Chicago PMI report, ISM manufacturing and consumer confidence all beat expectations.

Finally, the technical picture has hardly changed from the prior week. While US stocks eased off ever so slightly, US Treasury prices dipped a bit more last week!  This means that US stocks are still extremely overbought and that US Treasuries are still extremely oversold (remember, the 10 year Treasury yield has risen about 100 basis points from its late June lows….only FIVE months ago!). The natural trade—at least over the next week or two—would be to get long US Treasuries and to short US stocks. Let’s see how this works out.