Will Trouble in Europe Spill Over to the US?

May 29, 2018

The S&P500 inched up about 0.3% last week in very light trading. At the same time S&P volatility remained low—the VIX index stayed in the 12.5 to 13.0 range, a range that while not nearly as low as the one investors enjoyed for most of 2017 is a range that suggests investors are far from getting worried about equity market losses in the US.

In terms of technical analysis, the recent strength in the daily charts seems to be abating. Yes, the S&P is still in a short-term uptrend, but the upward momentum, despite last week’s rise in price, is showing signs of slowing down (for example the MACD lines are pinching together). On the weekly charts, the S&P500 has still not repaired the technical damage it incurred in the first four months of 2017. And if the short-term weakness on the daily charts turns into the start of another retreat, then this weakness on the weekly charts will only get reinforced. More importantly, it would demonstrate once again that when it comes to technical analysis, longer-term charts tend to over-rule shorter-term charts.

US macro results were mixed as usual last week. So nothing has changed in terms of the slow-paced growth of the US economy. Also, the Fed’s balance sheet shrank again, this time by less than a billion dollars, bring the total balance sheet reduction up to 123 billion dollars since quantitative tightening began in October 2017.

Finally, in Italy, recent national elections resulted in a proposed government that included several anti-euro cabinet members. The problem, as clearly signaled by pro-euro forces inside and mostly outside Italy (think European Central Bank and Germany) is that such a government would be unacceptable because if the chances of Italy pulling out of the euro were to increase, then the threat to the entire Eurozone would grow materially.

So what can the pro-euro forces do?  Simple. Punish the Italian government financially by allowing its borrowing rate to skyrocket. And skyrocket it did. In only a few days, the Italian 2 year government bond went from yielding almost NEGATIVE 0.3% to a POSITIVE 2.5%. This represents the largest move, upward, in yield for the Italian 2 year note…..ever.

Clearly, if the Italian people continue to challenge the powerful pro-euro forces in Europe, these forces are signalling that Italy will be punished, and this punishment will be especially painful because Italy has one of the highest government debt to GDP ratios in all of Europe.

Meanwhile, the effects of the heightened financial risks in Italy are most definitely spreading to the rest of Europe and into other regions including Asia and the US. This is strong evidence, that like in 2011 when the European sovereign debt crisis first exploded, the risk of financial contagion is real…..and possibly devastating in its force.

S&P500’s Short-Term Uptrend Still in Effect

May 21, 2018

Last week the S&P500 gave back about half a percent. Volume was very light, so there was absolutely no sign of any investor panic. And volatility remained very low; the VIX index stayed in the 13 range, which means that investors were not too worried about the index price drop.

In macro news, it was a quiet week. Core retail sales, housing starts, initial jobless claims and business inventories all disappointed. On the other hand, the Empire State manufacturing index, the housing market index and the Philly Fed survey all beat their respective consensus estimates.  Interestingly the Fed’s balance sheet registered one of its biggest weekly declines since the run-off began—it shrank by almost 21 billion dollars. And since the tightening began in October 2017, the total decline of the balance sheet has now reached $122 billion…..with hundreds of billions more to go.

The technical picture remains virtually unchanged from last week. On the daily charts, the S&P500 is in a short-term uptrend…..despite losing half a percent last week. On the weekly charts, the S&P is still struggling to repair the technical damage incurred over the last 2-4 months, so on this resolution, the index is still in a slightly bearish mode.

So we’ll need to wait another week or two to determine if the daily charts (bullish) or the weekly charts (more bearish) will prevail.


S&P500 Resumes Climbing?

May 14, 2018

The S&P500 jumped over 2.4% last week. Trading volume was light, so this was not the result of a rush of new buyers or money pouring into the market. But volatility continued to back down; last week the VIX index reached a 12 handle, meaning that S&P volatility has retreated almost back to the low levels investors enjoyed for most of 2017.

In US macro news, the big story of the week was US inflation….or lack thereof. Almost all the results (consumer inflation, producer inflation, month-over-month results, and year-over-year results) missed to the downside. This suggests that the Fed is not behind in raising interest rates to curb growing inflation threats. So the Fed has less pressure to raise rates more frequently. And fewer rate increases help investors feel more comfortable buying and owning stocks…..so these inflation results helped push the US stock markets higher last week.

Also, in the background, the Fed’s balance sheet actually grew a bit ($2 billion) last week, instead of shrinking as it has over previous weeks; this also helps to support US equity valuations.

Finally, the technical picture has changed on the daily charts. With last week’s gain. the descending triangle, which is normally bearish, has been broken. This means that many traders who were wary of betting on the long side will now feel more confident building their long positions…..or at the very least, reducing their short positions. This development, again on the daily charts, suggests that there may be even more gains in the next week or two. Also supporting the bullish argument is the fact that the 200 day moving average held—while it was tested for the third time this year, it has done its job and provided strong support each time.

But the weekly charts are still somewhat concerning. The damage done to the MACD has not been erased at all by last week’s gain. So the S&P will need another strong week or two to turn the weekly charts more thoroughly bullish.

S&P500 Tests Support…..Again

May 7, 2018

The S&P500 gave back about a quarter of a percentage point last week. The large cap index took a roller coaster ride, dropping several percent early in the week, but then roaring back on Friday to finish the week down….but only slightly. Volatility continued to drift lower—the VIX index edged downward a bit for the week. And volume was light to moderate; actually volume rose on down days, but fell off on Friday when the S&P jumped higher.

For US economic reports, the big story of the week was payrolls and the latest trend in labor costs. Both disappointed. Payrolls came in well below expectations, and several measures of wages (average hourly earnings, personal income and unit labor costs) all came in lower than predicted. This, perversely, helped the risk asset markets because investors concluded that disappointing wage growth would prevent the Fed from tightening as much as it had originally anticipated. And less Fed tightening leads to greater investor euphoria and hence higher stock prices.

That said, last week the Fed announced a larger than usual balance sheet reduction (16 billion dollars), so as of now, the Fed’s balance sheet has shriveled by about $100 billion from peak.

Finally, the big technical takeaway from last week’s price action had to do with the 200 day moving average. For the third time this year (once in early February, second time in late March, and third time last week), the S&P500 has tested the 200 day moving average. And so far, in all three cases, the S&P has successfully bounced off this moving average. In other words, this hugely important measure of support has held.

So on the one hand, this bodes well for the S&P. Since the 200 day has not been broken, some traders and investors may conclude that it will continue to hold so they should be more comfortable putting more money to work on the long side of the stock market.

On the other hand, the bad sign is that each successive bounce off the 200 day moving average has been weaker than the previous bounce. This creates a descending triangle formation and this type of formation is usually considered to be bearish.

Which direction the market will move should be more clear, in this situation, in about a month or two. This is not something that gets resolved in a few days or just a couple of weeks.