Is the Trump Trade Over?

March 27, 2017

While not a massive drop, last week’s 1.44% fall in the S&P500 was the largest….in percentage terms….in many months. Volume was on the lighter side, but volatility did jump—the VIX index rose to the highest levels of the year. That said, there was still not signs of panic, which would require the VIX to jump well over 20. The last time we’ve the VIX over 20 was around election day in November 2016.

Last week was quiet in terms of the number of economic reports that were released. On the positive side of the ledger, the current account wasn’t as bad as forecast. New home sales beat consensus estimates, and headline durable goods orders beat expectations slightly. On the negative side, the FHFA house price index missed badly…coming in well below expectations. Existing home sales also missed. Initial jobless claims were much higher than expected. Durable goods orders excluding the volatile transportation component were far lower than predicted, and finally, PMI composite flash also missed.

Technical analysis, after last week’s loss, is suggesting that the S&P500 is on the verge of a breakdown. At Friday’s close, it came back down to the 50 day moving average, which means that for the Trump rally to continue, it would need to bounce off this support level and continue to move higher from there.

The problem with this test is that after Friday’s close, the Trump administration announced that at least for now, it would give up on repealing and replacing Obamacare. This means that one of Trump’s key election promises failed to become reality due to the inability to get all Republican legislators on board. So naturally, everyone will now ask this simple question—if repealing and replacing Obamacare failed miserably, how can we expect the other major promises to come to fruition, especially the promise about lowering corporate and individual tax rates? And if these two pledges also fail to become reality, then most of the reason for the Trump rally, the rally that began the day after Trump was elected, could disappear.

So US stock investors must suddenly worry about giving up major gains and must decide if they should ride out the probably drop…and perhaps buy more stocks on the “dip”…..or if they should sell now….to lock in gains….and wait for another day to re-enter the market.

Not an easy decision to make!

Something’s Gotta Give

March 20, 2017

The S&P500 ended last week up a fraction—it closed on Friday up 0.24% for the week. Volume was very light. And volatility drifted lower, close to the lows reached in February. Essentially, the S&P500 was treading water and looking for some sort of signal to find a direction for its next meaningful move.

US economic reports were mixed so these provided no clear direction for US financial markets. On the positive side, the housing market index, housing starts, consumer sentiment, and leading indicators all beat expectations. On the negative side, labor market conditions, initial jobless claims and industrial production all missed. At the same time, many reports (including consumer prices, retail sales, and business inventories) came in exactly as expected.

In terms of technical analysis, the S&P remains extremely stretched….obviously to the upside….on both the daily and weekly charts. The short-term parabolic jump that began after Donald Trump won the presidential election is still in effect.

Last week, we discussed how arguably the world’s most important commodity—oil—was diverging from US stock prices. Specifically, as stock prices remain near record highs, the price of oil, which originally crashed in 2014, has resumed its decline by dropping almost 10%. And it continued to creep downward—again—last week.

This week, we’d like highlight how S&P500 aggregate earnings have started to diverge significantly from the overall price of the S&P500. While the correlation over the last 10 years has —- for obvious reasons —- been positive (ie when corporate earnings rose each quarter, the price of the S&P500 rose in tandem with those earnings). But starting in early 2016, the reverse has happened:  GAAP earnings have not recovered; they’ve stayed flat. At the same time, the S&P500 has soared.  This is another very important divergence, arguably even more important than the divergence from the price of oil,that must be resolved on way or another. Either GAAP earnings must rise sharply to match the lofty prices of the S&P500 or the S&P500 must drop precipitously to match the depressed level of corporate earnings.

Once again, we need to wait and see how this convergence plays out exactly.

Oil Price Collapsing

March 13, 2017

The S&P500 dipped about half a percent last week, on very light volume. S&P volatility meanwhile, crept up… would be expected during a week when prices fell.

So does the slight pullback in prices change the technical picture? Not at all. On both the daily and the longer-term weekly charts, the S&P is extremely overstretched to the upside. It’s almost parabolic spurt—-starting the day after Trump won the election—-is still in effect.

The big economic news last week was the US payrolls report which showed a higher than anticipated increase in new jobs for the month of February. The downside of this report was the average hourly earnings figure, which disappointingly rose less than predicted. So more jobs, but less pay. In other economic news, wholesale trade, productivity, consumer credit and initial jobless claims all disappointed. On the positive side, only factory orders beat expectations.

So while the march higher in US equity prices continues, something more worrisome is happening in the global oil markets—the price of oil is collapsing, again.  This is important because oil is not only a large industry in the economy but it also functions as a signal of overall economic activity, much like the price of copper. Since oil plunged about 9 percent last week, back down to levels first seen in late 2014, the concern is that the global economy can’t truly be doing very well….as least as well as advertised. Of course, higher supplies can contribute to a glut in oil inventory and hence a lower price, but if the world’s economies were doing well, they would absorb this extra supply with greater demand and at least maintain the price of oil, if not push it higher.

Meanwhile, the price of copper is also turning down lately.

And high yield bond prices are turning down.

At the same time, this week the Federal Reserve is almost 100% certain to raise interest rates, which would be the third increase in this latest hiking cycle, which started in late 2015.

Could the Fed be hitting the brakes just as the US economy is about to slow down anyway?  If so, then the US stock market could get jolted and the Fed could be looking at a very short interest rate hiking cycle….one that stops and even gets reversed after only a handful of increases.

US Stock Market Valuations Nearing Highest Point in History

March 6, 2017

While the S&P500 did not rise every day last week, it did close higher for the entire week. The index rose another 0.67% to set yet another all-time high. Once again, volume was very light, which doesn’t support the rally. But volatility retreated—the VIX index fell back and this movement does mesh with the rise in prices.

The week’s economic reports were mixed as usual—-with roughly half missing expectations and the other half beating expectations. So no change in the anemic pace of US economic growth, growth that’s been anemic ever since the Summer of Recovery began in mid-2009.

The technical picture is beginning to look like the S&P has entered a short-term parabolic blow-off top formation. Ever since Donald Trump won the election, the hopes and expectations of lower taxes and lower corporate regulations have driven stock prices higher at a rate that has been steeper than most other bursts since this market bottomed in early 2009. And all this, despite any concrete plans or details to support the hopes that these Trump initiatives will actually take effect anytime in the near future. So the S&P500 is now even more over-stretched than it’s been in many years.

More importantly, valuations—the driver of long term returns in stock markets—continue to move higher into nosebleed levels. Long time money manager John Hussman describes the situation this way:

“…the consensus of the most reliable equity market valuation measures we identify (those most tightly correlated with actual subsequent S&P 500 total returns in market cycles across history) advanced within 5% of the extreme registered in March 2000. Recall that following that peak, the S&P 500 did indeed lose half of its value, the Nasdaq Composite lost 80% of its value, and the tech-heavy Nasdaq 100 Index lost an oddly precise 83% of its value. With historically reliable valuation measures beyond those of 1929 and lesser peaks, capitalization-weighted measures are essentially tied with the most offensive levels in history. Meanwhile, the valuation of the median component of the S&P 500 is already far beyond the median valuations observed at the peaks of 2000, 2007 and prior market cycles, while our estimate for 10-12 year returns on a conventional 60/30/10 mix of stocks, bonds, and T-bills fell to a record low last week, making this the most broadly overvalued moment in market history”

Think carefully about what he just pointed out. the S&P500 is nearing 2000 bubble highs, the most overvalued point in the history of the S&P! The S&P is already more overvalued than it was in 1929, before the crash that preceded the Great Depression. And you use median valuations, then the S&P is already way more overvalued than it was in the 2000 peak when the overvaluation was driven by relatively few tech firms.

And now interest rates are rising and the Fed has signaled that it will hike rates three times this year.

Super high valuations and rising rates have ALWAYS preceded major (not minor ) stock market corrections. Perhaps this time will be different.