US Stock Market Breadth Deteriorating

August 21, 2017

Something very unusual, for the year 2017, happened last week with the S&P500 — it fell for the second consecutive week.  The large cap index dropped 0.65% on modest volume. But volatility, while rising mid-week, failed to close higher than it did the previous week.

The technical picture continued to deteriorate. By Friday’s close, the S&P was firmly below the 50 day moving average. Momentum, as measured by MACD, continued to weaken. That said, the 50 day moving average is still solidly above th 200 day moving average and prices are still well above the 200 day moving average. So the strategy that’s worked well for many years now—buying the dip—has not broken down. If prices approach the 200 day moving average, an entire school of traders and investors may once again jump in with fresh buying. The risk of course is that some day this strategy will fail….and all these dip buyers (which by now means most of the folks and machines in the market today) will be spectacularly wrong; the expected rebound at the 200 day will fail to materialize and a big break—downward—will ensue.

On the US economic front, last week’s reports were mixed. Retail sales, the Empire State manufacturing survey, business inventories, the Philly Fed survey and consumer sentiment all beat expectations. On the other hand, housing starts, industrial production and leading indicators missed or only met expectations. Last week was a bit stronger than usual, but one week’s results don’t make for a trend.

Finally, many market observers are pointing out that while S&P prices (despite the recent decline) are still clinging near all-time highs, market internals are rapidly deteriorating. For example the percent of stocks in the S&P that are trading above their 150 day moving averages has fallen steadily during 2017….at the same time the overall price index has moved higher. Also, the new highs minus new lows is now firmly negative (meaning more stocks are setting new lows than are setting new highs).

All this means that the overall price index is being held up by fewer and fewer large cap market leaders, such as Facebook and Google and Amazon. And in the past 100 years, all major market corrections were preceded by a similar deterioration in market internals. Of course, this deterioration is not a sufficient condition (ie. it’s not the only thing that happens before major market losses ensue), but it’s a necessary condition (ie. it’s one of several key conditions that must be in place for major market losses to happen).

And this condition is now in place.

US Stocks—Dip or Correction?

August 14, 2017

The S&P500 gave back over 1.4% last week. While not a huge loss by any historical standard, this drop was the largest of the year, so far. This demonstrates how narrow the trading range for the S&P has been for so many months; a relatively benign drop of 1.4% makes big headlines. Volume did not spike, however. This suggests that most everyone was not heading for the exits. And while VIX did jump, it moved from a record low sub-10 reading to a still historically benign mid-15 reading by Friday’s close; this implies that true market fear did not materialize among investors and traders. So volume and fear measures suggest that this drop was only a dip.

But what about technical analysis? On the daily charts, the loss of momentum that started several weeks ago, is now very pronounced and the latest price drop is clearly visible as ongoing market weakness. Also the closing price on Friday was just below the 50 day moving average. So there’s some cause for concern on the daily charts—more selling would not be unexpected. That said, on the weekly charts, the recent sell-off is barely visible. While prices are testing the 50 day moving average, both the 50 day and the 200 day are still solidly sloping upwards. And prices are far above the 200 day. So the technicals point to short-term weakness, but with longer-term strength still in place.

Internals are more concerning. While prices are still not too far from all-time highs, several important measures of the US stock market internals have deteriorated notably. For example, New Highs minus New Lows has gone negative for the first time this year. The McClellan Oscillator has dropped to its lowest reading since January 2016. The same is true for the percent of stocks above the 150 day moving average.  So the market internals are sounding a more serious alarm. This doesn’t mean that more substantial selling is about to hit US equity markets. But is does mean that investors can’t automatically assume…as they have for many years now….that last week’s drop is simply just another “dip” that should be bought aggressively.

It’s Not Just Equities that are in a Bubble

August 7, 2017

Once again, the S&P500 barely moved. Last week, the large cap index moved up a tiny 0.18% on low volume. Volatility crept back down, but interestingly not back down to the lows of the year which were set in mid to late July. Are investors starting to hedge a little?

In terms of technical analysis, the S&P500 is still pinned against the upper end of most price ranges. That said, the lack of meaningful movement in price over the last several weeks means that upward momentum has stalled. Still, the big indicators are pointing upward—prices are above the 50 and 200 day moving averages, and the 200 day moving average is comfortably sloping upward. So until this changes, most investors will continue to “buy-the-dip” a strategy that has worked for 8 years in a row.

US macro news was mixed last week. Chicago PMI fell way below expectations. Personal income disappointed….showing zero growth. Construction spending also missed. ISM services plunged, missing expectations by a mile. But on the positive side of the ledger, pending home sales beat consensus estimates. ISM manufacturing also just barely beat estimates. International trade was not quite as bad as predicted. And the payrolls number beat expectations. But as usual over the course of this multi-year “recovery” in jobs, the bulk of the new job gains came from part-time, low-paying and unbenefited jobs; think bartenders and waitresses. At the same time, the good jobs continue to disappear. Also in the jobs report, both average hourly earnings and the average workweek only met expectations.

As much as all the historical data suggests that US equities are overvalued (on numerous, well-respected measures), it’s important to remember that overvaluation is also plaguing the US corporate debt markets. US corporate leverage has been climbing ever since the Great Recession ended in late 2009. And since much of the net buying of US stocks over the period has come from corporations themselves (not households, not pension funds, not hedge funds, etc.), it makes sense that — especially since the Fed has driven borrow rates to record lows — US corporations have been leveraging themselves to finance this stock buyback process. Operating cash flows alone, after funding capital expenditures, have not been sufficient to pay for all the stock buybacks over these past 8 years.

The result? US corporate balance sheets are as levered as they’ve ever been. And to all those who argue that this is not a problem because rates are so low, it’s important to remember that in almost all market and economic cycles in the past, when there’s a setback in US equities spreads on corporate debt tend to blow out. This means that while base Treasury rates or Fed Fund rates may remain low, the amount that corporations pay over and beyond those base rates usually explodes higher. And when this happens, the price of corporate debt plunges….mainly because debt investors begin to factor in a much higher “refinancing” rate to roll over all the existing corporate debt, which (unlike most US home mortgages) has terms of 0 to 10 years; in other words, interest rates get reset on US corporate debt much faster than they do on US mortgage debt which locks in rates for 15-30 years.

So while today, the spread on high yield debt in the US is near record lows. it’s important to remember that when the economic and market cycles finally turns down, there won’t be a safe place to hide capital in US corporate securities markets. Most likely, both US equity and US corporate debt prices will plunge at the same time.

This means that the most likely destination investors will try to move their money into will be into US Treasury securities or just plain cash accounts……assuming they can sell their corporate equity and debt securities at reasonable prices……to have the cash available to buy these Treasuries!


Pausing at the Highs

July 31, 2017

Last week, the S&P literally paused, closing essentially unchanged from the prior week’s finish. Well, actually, the index slipped a tiny 0.02% but this change is practically meaningless.

Where does this leave us?  The S&P is still pinned up against all-time highs. The same can be said for the NASDAQ and the Dow. Meanwhile, high yield spreads have collapsed back down near five year lows; this means that high yield bonds are extremely over-priced.

Stock market volatility continues to cling to multi-decade lows. The VIX index spent most of last week below 10, a reading seen less than 5% of the time….in other words a very rare occurrence.

So technically, the S&P remains at some of the most extreme overbought levels ever seen in this index—it’s hugging the upper Bollinger bands on the daily, weekly and monthly charts and it’s well above both the 50 day and 200 day moving averages. At the same time, momentum remains favorable, even though it’s not as strong as it has been in many other periods when prices climbed upward so strongly. On the other hand, one of the biggest concerns coming from technical analysis is the fact that the recent surge in prices has come on declining volumes. Almost all market peaks in the past have occurred on declining volume; while declining volumes doesn’t guarantee that big pullbacks must follow, this situation should at least give investors and traders some reason to proceed with caution.

Finally, the US economy continued to stumble forward. Last week’s reports were mixed to weak… has often been the case for the last several years…..and there’s nothing on the horizon to suggest that the economic growth rates are about to accelerate any time soon.

Let’s see what happens next week.


More Signs of a US Equity Bubble

July 24, 2017

Last week, the S&P500 climbed yet again…..this time adding about 0.5% over the previous week’s close. Volume was very light, as one would expect during the middle of the summer. And not surprisingly, the VIX index slipped back down to the lows of 2017. So US equity prices set new all-time highs, with little investor enthusiasm and with record low levels of fear. What could go wrong?

At the same time, US macro news was mixed. The Empire State manufacturing survey missed badly….coming in about 50% below expectations. US export prices were much lower than anticipated; this hurts corporate profits. The housing market index missed, and the Philly Fed business outlook survey also missed. On the bright side, initial jobless claims were a bit stronger than predicted, and leading indicators beat consensus estimates.

In terms of technical analysis, the picture remains unchanged from the prior week—the S&P500 remains extremely overbought. Not only is the index well above the 50 day moving average, but it’s bumping up against the upper Bollinger bands on the daily, weekly and the monthly resolutions; this is not something we see very frequently.

In terms of valuation, another milestone was hit last week. The S&P500’s Shiller Price to Earnings ratio reached 30, which is where the index peaked in 1929 before crashing by over 70%. While the Shiller PE exceeded 40 briefly in the run up to the dot-com bubble collapse, the current valuation tells us that investors are now in the second most over-valued stock market environment in US history.

Of course this does not mean that a crash, or even moderate correction, is around the corner. But it does mean that the downside risk to being long the S&P500 is probably greater than the upside opportunity for further price appreciation. As simple as this sounds, and as reasonable as it sounds, most investors will go on their merry way—-staying very much invested in the S&P500—-not worrying much about capital losses because everyone else seems to be fully invested in US stocks and besides, with interest rates still so low, there is really no reasonable alternative to stocks. Right?

Bad News Means Stocks Jump?

July 17, 2017

The S&P500 jumped about 1.4% last week, on very low volume. Volatility, as measured by the VIX Index, dropped back down near the lows of the year.

So the technical picture is now more stretched than ever—on both the daily and weekly charts, the S&P is now hugging the upper Bollinger bands and is well above the 50 day moving average.

At the same time, valuations are more stretched than ever. While aggregate corporate profits remain stagnant, the multiples paid for these earnings are approaching record highs. The Shiller CAPE index for example is now approaching highs last seen in the run up to the dot-com bubble in the year 2000.

So what led to this sudden jump up in US equity prices? Unbelievably, it was a series of extremely bad US economic reports. Retail sales plunged; both headline and ex-transportation results were massive misses relative to expectations. Consumer sentiment missed. Core consumer prices and core producer prices also missed to the downside. Initial jobless claims were worse than predicted and the JOLTS survey also missed.

As a result of all this bad news, market traders and investors reasoned that the Fed would be forced to slow down its hiking program. And any slowdown in interest rate hikes is viewed as an accommodation to the equity markets. So bad news equals good news!

Meanwhile, Blackrock…..the major investment management firm….recently published a study showing that almost all the net purchases in the S&P500 since the 2009 bottom have come from only one source—US corporations buying back their own stock. At the same time, individual and institutional investors have been net sellers over this same time frame!

The catch is that most of these corporate buybacks have been funded not from operating cash flows (much of which have been consumed by normal capital expenditures) but by borrowing, borrowing that’s been facilitated by the Fed’s massive drive to lower interest rates. But now that the Fed is reversing its easing programs, these corporations are still left with their huge levels of debt, debt that will now need to be refinanced at higher rates.

So the ingredients are in place not only for a big stock market pullback in the US, but also for a huge corporate debt crisis. Corporations will find that they’re over-leveraged and that they’re interest rates are surging. This suggests that all risk assets—US debt and equities will suffer in the next financial and economic downturn.

Quiet Week in the Summer

July 9, 2017

While tracing out a small yo-yo pattern during the week, the S&P500 ended on Friday almost unchanged from the previous week’s close. Typical of many summer weeks when many traders and active investors take vacations, the volume of shares traded also fell. And in keeping with the sleepy equity market action, S&P volatility also barely moved—it finished the week near the lows of the year.

US economic reports were mixed. PMI manufacturing and construction spending started the week on down notes; both missed expectations. Factory orders also missed. Initial jobless claims  and international trade both missed as well. On the bright side, ISM manufacturing and ISM services both beat consensus estimates. And the big number of the week, payrolls, also beat expectations. That said, other parts of the payrolls report were disappointing—the unemployment rate ticked higher and average hourly earnings missed. So all in all, there is still no strong evidence that the US economy is anywhere close to accelerating out of its multi-year anemic rate of growth.

In terms of technical analysis, the daily chart is continuing to show a bearish momentum pattern in the S&P500. And now that prices are hugging the 50 day moving average, it wouldn’t take much of a drop for this key level of support to get broken. If that happens then look for support at the 200 day moving average which is about 100 points lower on the S&P.

So with a typical July week in the books, the risk asset markets in the US behaved as expected—they didn’t move a lot in either direction. While valuations remain extremely stretched to the upside, the markets appear to be looking for catalysts to move them meaningfully in any direction, either up or down.