US Recession: Overdue But Not Imminent

August 27, 2018

The S&P500 climbed another 0.86% last week. This means that the index has almost returned to its all-time highs, highs set in January, earlier this year. Volume was very light, as would be expected in a trading week in the later weeks of the summer. And volatility dropped off a bit, but interestingly the VIX index did not return to the lows reached in early August; instead, the VIX is still about 20% higher.

In terms of technical analysis, the S&P is now stretched to the upside. Prices are hugging the upper Bollinger band and are therefore far above the 50 day moving average…..and obviously the 200 day moving average as well. So it would not be surprising if from these levels, prices pulled back somewhat, perhaps at least to the 50 day moving average. That said, the bigger bullish factors are still in effect: prices are above the 200 day moving average; the 200 dma is sloping upwards; and our Simply Rule is still solidly bullish.

Despite the S&P’s progress last week, almost all of the US economic results were disappointing. Existing home sales missed. So did the house price index. PMI composite flash also missed. New home sales disappointed. The Kansas City manufacturing index dropped precipitously. And durable goods orders, both headline and ex-autos, missed badly. Only jobless claims came in a little stronger than expected.

But despite the bad week of US economic reports, the overall US economy is still not showing signs of falling into a recession, at least not imminently. Not only is recent GDP growth solidly above zero, but key economic indicators that often coincide with (as oppose to lag) US economic recessions are still all pointing to continued growth, even it means growth at a slower pace.

Considering that the current US recovery began in mid-2009, this recovery is now nine years old, meaning that it’s one of the longest recoveries on record in the US.  And given that most US economic recoveries last between five and seven years, this current recovery due to end sooner than later.

But until the key economic indicators begin to turn down, we can safely claim that the next US recession is not around the corner.

US Stock Markets Still Holding Up

August 20, 2018

Last week, the S&P500 inched up about 0.6%. Volume was light, and volatility eased off–the S&P500 VIX dropped back to the mid-12 level.

Several key economic reports were released last week. Retail sales, both headline and core, beat their respective estimates. The Empire State manufacturing survey came in ahead of consensus estimates. So did industrial production and leading indicators. As usual, there’s always a set of disappointing numbers. The housing market index missed….as did housing starts. The Philly Fed business outlook survey missed. Consumer sentiment also missed.

The Fed’s balance sheet endured one of its largest reductions since quantitative tightening began in October 2017; it shrank by over $29 billion last week alone, bring the total balance sheet reduction to over $231 billion.

And yet US stock markets are still holding up well. Sure they’re off from their all-time highs, highs reached in January this year. This is especially impressive given the fact that many major stock markets around the world—both from developed markets and emerging markets—have been suffering this year. China’s stock market for example has entered an official bear market. The German stock market (the DAX) is well off its highs. The Russian stock market is just about in a bear market. And Japan is also well of its highs.

In part, this is happening because US economic growth is still performing relative well, especially on a year-over-year basis. When most other major economies of the world are starting to slow down notably, US economic performance is holding up…..and this has a lot to do with the late-cycle fiscal stimulus provided by the Trump administration.

And so until US economic activity shows some more serious signs of slowing down—and this can be assessed on a monthly basis—there’s a good chance that US equity markets will continue to hold up relatively well when compared to other equity markets around the world.

Not coincidentally, our Simple Rule is capturing this US market strength and is still giving a signal to stay long US stock market indices.


Turkey and Emerging Market Stress

August 13, 2018

The S&P500 dipped about 0.25% last week. Volume was very light, so this data didn’t suggest that investors were concerned. On the other hand, the VIX index did jump about 20%; while the closing level was still nothing to get worried about, the sudden spike should raise some concern that US equity investors may be getting worried.

In US macro news, the flow was light. The most important reports shed some light on US inflation. Both producer and consumer prices came in very close to expectations. That said, the annual CPI increase of 2.9% is still greater than the annual wage growth. This means that for the first time in many years, US workers are suffering from negative real wage growth. In other words, their paychecks are not keeping up with inflation.

With respect to technical analysis, the S&P500 is still enjoying a bullish set-up on the weekly charts. The bad news is that on the daily charts, the signs are pointing to the possibility of a short-term drop in prices. From an overstretched position (at the upper Bollinger band), the MACD indicator turned bearish, suggesting that some more near term selling may lie ahead.

All that said, our Simple Rule is still solidly bullish, which means “stay long” the S&P500 index.

Finally, we may see the currency crisis in Turkey become the spark that leads to the short term sell-off in US equities. In part due to US political pressures, the Turkish Lira has fallen to near record lows against the US dollar. This in turn has helped to cause other emerging market economies to suffer currency stress of their own. The Brazilian Real, for example is falling to multi-year lows. The same is happened to the Argentinian Peso….and several other emerging market currencies.

The resulting problem is that these nations will have trouble servicing their respective dollar-based debts……which could lead to severe stress or even failure for the banks that made these dollar loans. And if this happens then other banks, even ones that do not hold large amounts of EM debt on their balance sheets could get stressed. This in turn could lead to general global credit stress and spill over to global equity markets.

As mentioned many times over the years, US equity markets remain over-valued by historical standards….and as we have seen, they can remain over-valued, or become even more over-valued, for many years after first becoming over-valued.

So the trigger to reverse investor psychology can come from anywhere, whether it’s a currency crisis in Turkey or some other financial or geo-political event anywhere in the world.

So let’s see if Turkey actually becomes a trigger for a meaningful sell-off. As of now, it’s still too early to tell.

A Glance at US Corporate Bonds

August 6, 2018

Over the last two weeks, the S&P 500 has crept higher. Two weeks ago, the S&P moved higher by 0.61%. Last week, the large cap index closed higher by 0.76%. Not only are these moves consistent with our long term Simple Rule signal (bullish) but they were consistent with our bullish signal from our analysis of the weekly charts on 7/23/18.

Volume over these last couple of weeks has been light to moderate, which is consistent with a market that’s creeping higher and with normal activity during summer trading months.  The same factors are associated with a dropping VIX index—markets moving higher and diminished summer trading activity.

Going forward, the daily charts are pointing to a US equity market that’s still a bit overbought. The weekly charts are bullish….again. And our longer term Simple Rule is still solidly bullish.

Keep in mind that all the bullish signals coming from technical analysis do not factor in the extremely overvalued state of the US equity markets—the Shiller PE ratio for the S&P 500 continues to hover near record high levels, levels formerly reached just before the dot-com collapse and the late 1920’s.

On the US economic front, the most there were two interesting developments. The first was a pronounced slowdown in many hard data indicators over the last couple of weeks. Many of these results were simply misses to more optimistic consensus estimates, but still there were many more misses than usual. The other major economic story was the miss in the July payrolls report. Not only were fewer jobs created (vs consensus estimates) but the average hourly wage growth figure—2.7% year over year—came in BELOW the latest consumer inflation figure—2.8% year over year. This means that REAL annual wage growth is now negative, a development that we haven’t seen in several years. Simply put, US wages of US workers are NOT keeping up with inflation….and this is bad for the US economy in many ways.

Finally, as much as we discuss US equity prices from a fundamental and technical perspective, it’s worth noting what’s going on in the US corporate bond markets. One of the best ways to assess value or lack of value in corporate bonds is to examine spreads over comparable US Treasuries. And over the last year or so, spreads for both investment grade (IG) and high yield (HY) corporate bonds have been hovering near record tight levels. This means that now is NOT the time to increase allocations to US corporate bonds. Instead, this is the time to either lighten up on holdings or simply to hold existing allocations steady. The last time spreads blew out:  late 2015 and early 2016. And this was a much better time to buy or to increase allocations…to both HY and IG credit.

But just as prices in the US equity markets swing up and down over long time horizons, something very similar happens in the corporate bond markets yet often not at the exact same times.

And just as our Simple Rule captures these major swings in US equity prices, an analysis of corporate spreads can do something similar for swings in US corporate bond prices.

Stay tuned.