S&P500 Turning Down in the Short-Term?

June 25, 2018

After the previous week’s stall, the most recent week saw the S&P drop almost 0.9% Volume was light, but volatility crept higher suggesting that investors were getting worried and as a result they started buy more downside protection.

In US macro news, the results deteriorated. The housing market index, existing home sales, the Philly Fed business outlook, leading indicators and the PMI composite flash report all missed their respective expectations. Only housing starts and initial jobless claims beat their estimates. And the Fed’s balance sheet took another notable step down in size; last week it rolled off $9 billion in assets. This brings the total, since October 2017, to almost $145 billion.

The signals from technical analysis have now diverged. On the one hand, the weekly charts of the S&P500 are now bullish, especially since most of the damage from the losses earlier this year have been recovered. But the daily charts have—due to the loss last week—have now turned bearish. Specifically, MACD on the dailies are pointing to more selling in the near-term. And that may mean only another few days of selling. Why? Because the index price is still well above the 50 day moving average, and the 50 day moving average itself is still well above the 200 day moving average (dma). Plus the 200 dma is comfortably sloping upwards. Finally, despite last week’s pullback, our Simply Rule is also still comfortably signalling that investors should remain long the S&P500 index as a whole.

So let’s see if the predicted selling in the S&P500 actually materializes and if so, let’s see if it’s going to respect the longer-term indicators which remain—for now—still bullish.

Yield Curve Flashing Red

June 18, 2018

The S&P500 finished the week essentially unchanged. Volume was moderate and volatility inched lower.

In terms of technical analysis, the S&P is still in its recently reinstated uptrend…on the weekly charts. And on the daily charts. the S&P while showing signs of stalling in the short-term is also in an uptrend. Prices are well above the 50 day moving average. The 50 day moving average is comfortable above the 200 day, and the 200 day is sloping upwards.

Needless to say, our Simple Rule is still signalling that long-term investors should be long the S&P500 index.

All that said, a very important development has occurred in the US yield curve. While it’s been gradually in the making, the curve is coming very close to being flat. That means that shorter term Treasuries, such as the 2 year, are yielding almost as much as longer dated Treasuries such as the 10 year.

Why is this important? Because the shape of the yield curve affects lending in the entire country. And when the yield curve flattens, or worse, inverts (when short dated UST’s yield more than long dated UST’s), lending in the US slows substantially. This happens because all banks borrow in short dated credit markets and then lend in longer dated credit markets (ie. business loans), but when the cost of funds rises in the short dated credit markets….as is happening now….then it becomes less profitable to make business loans.

So credit contracts…..and when that happens in banking system based on fractional reserve lending, then the overall money supply contracts.

The key point is that contracting money supply almost always precedes economic recessions and financial market contractions. And a flattening…followed by an inverted….yield curve is always a good signal of an impending credit contraction cycle.

The good news is that recessions and financial corrections don’t follow immediately after a yield curve inverts…..but the delay is usually only a matter of months.

And since the last time the yield curve inverted was in 2007 about a year before the global financial crisis began, this recent development in the US yield curve bears close watching.

S&P500 Bounces Again

June 11, 2018

Last week, we concluded in our technical analysis language that:

Last week’s gain the in the S&P500 was fully anticipated by the prior upturn in the daily technical indicators for this index. And with another week of gains in the books, the bullish pattern on the daily charts has become even more reinforced.

And in fact the bullish move in the S&P500 did continue. Last week, the S&P moved up a solid 1.5%. Volume was light to moderate, and volatility remained stuck near the lows of 2018; the VIX index closed near 12. However this is still notably higher than the lows enjoyed for most of 2017.

It was a quiet week for US economic reports. Factory orders, productivity gains, and consumer credit all disappointed. But PMI services, ISM services, international trade, and initial jobless claims all beat consensus expectations.

The Fed’s balance sheet continued to shrink. Since quantitative tightening began in October 2017, the balance sheet has diminished by 141 billion dollars….with a lot more reduction on the way later this year and next year.

In terms of technical analysis, last week’s bullish pattern on the daily charts has only been further reinforced. Unless something out-of-the-blue hits the US equity markets, the near-term outlook is again bullish.  On the weekly charts, the damage from the February sell-off has now largely been repaired. For the first time since the winter months, the MACD has turned bullish on the S&P500. So the next big test on the weekly charts is to see if the old highs from January can be overtaken.

And finally, with respect to our Simple Rule, it’s no surprise that with last week’s additional gains, the bullish signal, the signal that had never been violated this year (despite the big sell-off earlier this year), remains in place. Remember, this is a signal to stay long the entire S&P500 index, not any one or group of selective stocks in the S&P.

Finally, there are a lot of cracks developing outside the world of US equities. Specifically, several important emerging market currencies are crashing. The Brazilian Real is falling close to a dangerous level of 4 to the US dollar. And many emerging market sovereign bonds are also crashing.  All of this is related to the reduction of US dollars in global markets due primarily from the reduction of the Fed’s balance sheet, but also from the increasing supply of US Treasuries (to fund the Trump fiscal stimulus) that also absorb US dollars.

Financial historians are on a state of alert because almost all US financial market corrections were preceded by cracks in EM bond markets and FX markets. Soon we’ll know if the same is happening today.


Bullish Move in S&P500 Continues

June 4, 2018

The S&P500 added almost 0.5% last week.  Volume was very light, so the price movement cannot be explained by a large inflow of new investor capital. And volatility crept higher, so even though the large cap index closed higher on the week, many investors became more nervous.

In US macro news, last week’s results were slightly stronger than usual. On the downside, consumer confidence, wholesale inventories, pending home sales and the PMI manufacturing index all disappointed. But more results exceeded expectations—the Case-Shiller home price index, the Dallas Fed manufacturing survey, international trade in goods, initial jobless claims, Chicago PMI, ISM manufacturing, and the May payrolls report all beat their respective consensus estimates. That said, one week’s worth of better-than-expected results does not make for an economic turnaround story; until and unless these types of results continue for several months (never mind weeks) in a row, then the story of continual sluggish growth in the US has not changed.

Last week’s gain the in the S&P500 was fully anticipated by the prior upturn in the daily technical indicators for this index. And with another week of gains in the books, the bullish pattern on the daily charts has become even more reinforced.

On the weekly charts, the technical damage suffered over the last 4+ months has not quite been reversed. But it wouldn’t take many more even moderate weekly gains to accomplish this reversal.

Also, our simple rule is still bullish. This super long-term indicator has never turned bearish this year, despite all the damage incurred on the weekly and daily charts starting in February.

So for the next week or two, most technical signals are pointing to the strong possibility of more modest gains in the S&P500.