Stay Long US Stocks….For Now

July 16, 2018

The S&P500 closed higher last week; it rose 1.5% which added to the gains from the prior week. As we noted in last week’s note, this gain was completely expected–it was a continuation of the bounce that began several weeks ago, and it was building on the positive technical signals that grew even stronger on both the daily and weekly charts.

On the downside, volume was extremely light, so by no means were investors rushing into the stock market with new money to buy more shares. In fact, all the evidence from analysis of funds flow suggests that the largest marginal buyer of US stocks over the last couple of years has been the corporate sector itself. Cheap money (cheap in large part due to the Fed’s stimulative monetary policies) acquired by corporations that sell bonds has been used by these same corporations to buy back their own shares. In the process, corporate debt to GDP ratios have reached all-time highs, highs that in the past have always been associated with the onset of credit crunches as the massive volumes of newly issued debt crash in price, leaving corporations to face much higher costs to re-finance this debt. This causes cash flows to suffer, and this in turn leads to corporate lay-offs and big reductions in capital spending.

But to be fair, this hasn’t happened yet.

In terms of US macro reports, last week’s news was neutral to negative. Headline inflation figures, both CPI and PPI, came in higher than expected. For wage earners, the higher CPI figure means that their real earnings are dropping, because their nominal wages are not keeping up with inflation. Job openings, in the JOLTS survey, also missed. On the positive side of the ledger, initial jobless claims were better than expected.

Now that the S&P500 has rallied for several weeks in a row, it’s time to look at the bigger technical picture. As noted last week, the weekly charts have now returned to being bullish, especially with the most important momentum indicators. That said, the S&P500 has still not returned to its highs of the year, highs reached in late January. Finally, our Simply Rule is still delivering a bullish signal, the same signal that it’s delivered all year—and in retrospect, properly so.  This means that investors should remain long the basket of the entire S&P500; in other words, investors should continue to own S&P500 ETF’s such as the SPY.

At least for now.


S&P500 Bounces

July 9, 2018

After a fitful start to the week, the S&P500 closed on Friday to register an impressive 1.5% gain on the week. Volume was light, but this was pushed down in part due to the July 4th holiday on Wednesday. Supporting the bounce, the VIX index moved back down to the mid-12 levels. So volatility is now approaching the lows of the year; that said, the VIX is still almost 30% higher than the lows reached for much of the 2017 calendar year.

In US macro news, the ISM manufacturing index. factory orders, and ISM services all beat their respective consensus estimates. Construction spending, initial jobless claims, and ADP employment all missed. The big report of the week, June payrolls, was a mixed bag. The headline number of jobs created and the labor force participation rate beat their estimates; but the headline unemployment rate and average hourly earnings both missed. It’s important to remember that six months into 2018, that annualized hourly earnings at 2.7% are exceeded by annualized consumer price inflation at 2.8%. This means that in the first half of this year–fully nine years after the so-called recovery began in 2009–that real wage growth is actually negative. Unlike Wall Street investors, that is people with excess capital, capital that can be invested in stocks and bonds, most people on Main Street who do not have such capital are not only not benefiting from Wall Street’s gains, but they’re falling behind in incomes, because their inflation is eclipsing their wage gains.

Also, the Fed’s balance sheet just registered one of its largest weekly reductions since it initiated quantitative tightening—the balance sheet dropped by almost $16 billion, bringing the total shrinkage since October 2017 up close to $170 billion.

But the S&P500, so far seems to be ignoring the reduction in base money, which is not unusual because US equity investors back when the US stock markets first started eroding in late 2007 did not immediately respond to Fed easing either. They spent more than a full year falling, in the face of Fed easing.

With respect to technical analysis, this most recent bounce is impressive because it took place without even challenging the 200 day moving average. In other words, the big support that would normally be found at the 200dma was not needed to turn the most recent sell-off around. So now both the daily and the weekly charts are signalling that there may be some more upside ahead for the S&P500.

DM and EM Bear Markets?

July 2, 2018

Just as we outlined here last week, the S&P500 did in fact retreat in the short-term, specifically over the last week, when it gave back 1.33%. But since volume was light, it can’t be claimed that investors were rushing for the exits. On the other hand, investors did express their greater caution by taking out more insurance against further losses—the VIX index rose to the mid-teens for the first time since late May.

US macro reports were mixed as usual, with no signs that US economic growth is accelerating. In fact, the latest revision to Q1 growth missed expectations—it came in at 2.0% (annualized) instead of the 2.2% that was expected. While 2% growth is better than no growth, this rate of growth is well below levels that were reached in prior recoveries, when they were typically above 3% per year.

In terms of technical analysis, the charts are still bearish on the dailies. That said, the S&P500 did manage to hold near the 50 day moving average, and if this level can be held next week, then a short-term rally may ensue.

The weekly charts are still bullish, but only barely, after last week’s losses.

More importantly, our Simply Rule for the S&P500 is still bullish, so investors can stay long the entire index (in other words, this analysis does not apply to any particular company in the S&P500, but it does apply to the index as a whole).

Finally, this same Simple Rule, when applied to the developed market (DM) equities and to emerging market (EM) equities generates an entirely different conclusion. For both DM and EM equities, a new bear market cycle has begun. So that means if we owed DM or EM ETF’s such as EFA or EEM, we’d have exited these positions by now, and would have allocated those funds to other investments. As the situation in DM and EM equities evolves, we’ll look to our Simply Rule to give us a signal that we should re-enter these asset classes. But this buy signal is not around the corner—it will most likely take several months to register.

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.