US Treasuries Poised to Drop in Yield…Again?

October 16, 2017

Last week, the S&P500 essentially closed unchanged from the week before. Actually, it was up a tiny 0.15%. Volume was very light, and dipped—the VIX index closed back under the super low 10 threshold. That said, the VIX has not fallen lower than the multi-year low it set in July last summer.

In terms of US economic reports, the data was mixed…again. The JOLTS jobs survey missed—-job openings were much lower than predicted. Producer prices met expectations, but core PPI came in hotter than expected. The opposite happened with consumer prices—both headline and core CPI was lower than predicted. Retail sales missed, but retail sales excluding autos were slightly better than expected. And finally, consumer sentiment—a very subjective measure—came in better than expected.

In terms of technical analysis, the extremely overstretched status of the S&P500, on both the daily and weekly charts, has not changed much. The closing price from last week, still looks like it’s literally “off the charts”. And this is happening despite a slew of headline risks coming across the wires over the last several weeks, including for example, a nuclear confrontation between the US and North Korea.

Finally, the technicals are suggesting that yields on the US 10 year Treasuries have topped out in the near term. A very distinct topping pattern has emerged using the MACD indicator. This is important because to the extent that this indicator is accurate, falling US 10 year Treasury yields are often associated with—or even precede—risk asset market declines.

So is this impending drop in Treasury yields foreshadowing some sort of upcoming sell-off in US equities and high yield bonds?  We’ll know for sure within a few weeks.


S&P 500 Price vs Aggregate Earnings

October 10, 2017

In a continuation of the super-charged advance in the S&P500, an advance that began the day after election day in November 2016, the S&P added another 1.2% last week. Volume was very light; which again is not surprising as so many investors are simply not participating in this party. And volatility was pushed back down almost to he lows reached in July, as brave investors continue to short volatility with the belief that it simply cannot go up, at least not much or for very long.

In terms of technical analysis, the charts are now as stretched as they’ve ever been, and this includes the periods near the peak of the bubble in 2000. On both the daily and weekly charts, the S&P is not just hugging the upper Bollinger bands, but it’s above them. At the same time, most momentum indicators (eg. MACD, RSI, etc.) are also pressing up against their upper bounds. All technical indicators are screaming that if you buy US stocks now, you are most certainly not “buying the dip”.

At the same time, US macro news was mixed. On the positive side, ISM manufacturing and services both beat their respective consensus estimates. Also, construction spending came in slightly stronger than expected. On the other hand, consumer credit missed badly, and the big number of the week—payrolls—was a disaster, with the headline figure coming in at negative 33,000, instead of the positive 100,000 expected (and this expected number did already factor in the weather related impact). So once again, the US economy is firmly stuck in a low-rate-of-growth growth mode.

Finally, consider this interesting statistic about the S&P500:  The last time aggregate S&P GAAP earnings were at the levels they are at today (early 2015), the price of the S&P500 itself was almost 20% lower. That’s right—in two and a half years, S&P earnings have gone nowhere, but the S&P index has soared to new all-time record highs, and to prices way above those reached in early 2015.

Does this make sense?  Not to most sane market analysts, but apparently these folks have been overruled by all other market participants, who feel that it’s perfectly OK to pay almost 20% more for companies making the exact same amount in earnings as they did several years ago.

But are these optimistic market participants going to be right in the long term? 100 years of history strongly argues that they will lose their shirts—especially since many of them are now heavily buying stocks on margin—but there’s no reason that their temporary victory cannot go on for a while longer. Enjoy it while you can.


Just Because the S&P500 Continues to Rise…..

October 2, 2017

…..Doesn’t mean it’s a good value. But more on that below.

First, to recap last week, the S&P inched up another 0.7% to new record high levels. Volume did not confirm the rise in prices….because volume fell off….but that said, volume has not been rising for several years now, suggesting fewer and fewer investors are participating in this rally. Volatility was hammered back down (the VIX dropping below 10 again) but not quite down to the levels reached in August when the VIX dropped below 9, setting a multi-year low.

Last week’s US macro reports were mostly disappointing. The Chicago Fed national activity index kicked off the week with a big miss. The Case Shiller home price index, while rising, missed expectations. New home sales also missed. Pending home sales dropped a lot. So the US housing market is finally showing signs of cooling, after rising steadily since 2012. Consumer confidence missed. Durable goods orders ex-transportation missed; the headline figure beat estimates. Consumer sentiment also missed. On the bright side, the Dallas Fed manufacturing survey beat consensus estimates. So did the Richmond Fed’s index. International trade was not as bad as predicted. And the Chicago PMI beat expectations.

The technical picture shows an S&P500 even more stretched to the upside than it was last week. On both the daily and weekly resolutions, prices are hugging the upper Bollinger bands, they way they often have for most of 2017.

And this brings us back to the logic many investors are using today to stay fully invested in US stocks—they buy or continue to hold because prices “just keep going higher”. And interestingly, technical analysis supports this type of reasoning because a rising 200 day moving average usual captures this type of behavior, and when the 200 day is rising (and prices remain above the 200 day) then technical analysis suggests that the correct decision is to be long.

The problem with this type of decision making is that it completely ignores fundamental valuation logic, which will also have a big say in how long and how stock prices can rise. And today, valuations are—using many long-term and highly respected measures such as price-to-sales or cyclically adjusted price to earnings—sky high. More specifically, they are about 150% (or 2 and a half times) above their long-term historical averages. Clearly this implies that if prices were to simply revert to their means (as opposed to overshooting to the downside as they often do), then the S&P500 should drop by around 60%, or more than it did in the tech crash or the global financial crisis.

There were many market analysts who predicted that big prices drops would occur back then too—also based on the same general market valuation metrics—and they were all dismissed back then too. Many were laughed at. But in the end, they were right. Many of these same analysts are predicting another major US equity market retreat. Will they be right again?

The Fed Begins to Unwind QE…Finally

September 25, 2017

The S&P500 barely budged last week, closing on Friday essentially unchanged from the prior week’s close. Volume dropped, and volatility inched downward—but still, the VIX index did not close at or below the levels reached during the summer.

In US macro news, the results were mostly negative. The housing market index fell more than expected. The current account missed. Existing home sales missed. FHFA house prices also missed, and so did PMI composite flash. On the positive side of the ledger, housing starts beat expectations. Leading indicators and the Philly Fed business outlook survey also beat consensus estimates. Once again, there are no indications that the US economic is about to break out with a robust rate of growth. Instead, it’s still stuck at a rate that’s close to (and often under) 2.0%.

Last week’s lack of price movement on the S&P500 means that upward price momentum declined….for both the weekly and daily charts. But the overall patterns remain bullish for both time resolutions. Prices remain well above the 50 day and 200 day moving averages, and both of these averages are comfortably sloping upwards.

One of last week’s biggest announcements in the US financial world was the fact that the Federal Reserve has officially declared a specific timetable for unwinding its massive and almost decade-long Quantitative Easing program. Beginning in October, the Fed will begin to reduce its balance sheet by about $10 billion per month and will increase this amount to about $50 billion per month sometime next year.

Why is this important? Because of all the factors that have driven the S&P500 higher over the last 9 years, none has had a more accurate correlation that the size of the Fed’s balance sheet. And since almost all market analysts accept that the Fed’s QE has driven stock prices (and most other financial asset prices) higher, then it’s perfectly reasonable to assume and predict that when QE goes into reverse, that these prices could suffer. Starting in a few short weeks, we will know for sure.


Today’s Stock Valuations Will Drive Future Returns

September 18, 2017

Once again, in spite of many economic and global-macro concerns, the S&P500 powered forward with a 1.6% gain last week. In the process, it set new all-time high records.

Volume, while still low, did move higher. And volatility, as expected, backed down….close but not all the way back down to the multi-year lows reached in the summer.

As mentioned, US economic news took a turn for the worse last week. Producer prices came in much lower than expected—this is usually a sign of weaker than expected industrial production. Jobless claims were still high, in part due to the flooding in Texas several weeks ago. Retail sales were a disaster—both headline and core results missed by a mile. Industrial production plunged…also very bad. And consumer sentiment missed expectations. All in all, the US economy took a turn for the worse last week.

In terms of technical analysis, the daily charts show a stock market that’s stretched to the sky—prices are once again hugging the upper Bollinger bands. On the weekly charts, interestingly however, the bearish momentum signal that appeared several months ago has not been erased by last week’s gains. And since most technicians put greater weight on longer terms charts (over shorter term charts), this continued bearish signal bears watching.

While all-time highs—in prices—have just been set again, it’s important to remember that when valuations (as opposed to prices) reach all time highs, future returns will be lower than the returns achieved prior to the time that valuations peak. Simply put, record high valuations today, always lead to much lower returns tomorrow. But are valuations stretched today? Absolutely, and many blue chip firms on Wall Street are agreeing with this assessment. For example, the Shiller PE of the S&P500 is now as high as it was in 1929, just before the crash, and exceeded only at the peak of the dot-com bubble. In other words, this very important measure of market valuation has been higher only one time in the last 100 years!

The mistake that almost all investors are making is simple….and always made near market highs—they erroneously assume that gains in valuations leading up to big stock price moves will repeat in the future. They completely ignore the fact that market history shows that the exact opposite happens—that market valuations are mean-reverting. So while investors are enjoying today’s bubble valuations, almost all these investors will end up giving back their big gains because they will fail to sell near these valuations; instead, they will ride the equity markets down, to more historically normal valuations, all the while lamenting that “nobody saw it coming”.

US Stocks Stuck Near All-Time Highs

September 11, 2017

The S&P500 gave back about 0.6% last week on low volume. S&P volatility climbed a bit, as would be expected in a down week, but the VIX ended the week not too far above the lows reached in the summer months. In other words, no real signs of fear came entered the US stock markets.

In US macro news, it was a light week in terms of the number of reports released. Factory orders came in slightly weaker than expected. PMI services also missed expectations. ISM services missed as well. Initial jobless claims spiked. On the positive side, US productivity climbed more than expected and wholesale trade beat expectations.

In terms of technical analysis, last week’s slight drop wasn’t strong enough to reverse the short-term bullish impulse that we highlighted here last week. Prices still closed above the 50 day moving average, which in turn is solidly above the 200 day moving average. So from a shorter-term trading perspective, going long may still work. On the weekly charts, the loss of momentum—as a prelude to a bigger drop in prices—remains in effect. And last week’s loss on the S&P500 only added to the deteriorating momentum.

But there’s another interesting observation, on the S&P, that can be made. Since June, the index has been stuck between 2,400 and 2,500. That’s about three months of going nowhere. Granted, prices are still near all-time highs, and this is a bullish signal in and of itself. On the other hand, when prices are stuck in a range for a long time, especially near the all-time highs, it’s very common to see distribution happening. Distribution means that one set of investors sells its equity holdings while another set of investors buys roughly the same amount of equity holdings. And at stock market highs, distribution tends to go from the smart money to the dumber retail money.

Does this process guarantee some sort of meaningful sell-off? As usual, the answer is no. But in all major sell-offs in the past, smart money has gotten out of equities with less damage than the dumb money which has always been the bag holder.

When the next major sell-off occurs, something similar will most likely happen again.

Gold and Treasuries Contradict Stocks

September 5, 2017

US stocks bounced back last week, despite continuing fears related to North Korea’s nuclear weapons programs and actions. The S&P500 jumped almost 1.4% by Friday’s close. Volume on the other hand did not go up—so this rise in price looked more like it came from short covering than it did from a rush of new money or investors into the stock markets. That said, volatility did ease down, which confirms the rise in prices.

With last week’s stock market rise, the technical picture did change somewhat. On the daily charts, the weakness that we’ve seen in August has been reduced; now, with prices back well above the 50 day moving average, traders can start looking for the traditional buy-the-dip opportunities…..pursuing the same strategy that’s been working for many years already. On the other hand, the weekly charts have not returned to a bullish phase. And because these charts are often more meaningful that the shorter-term daily charts, traders must still be careful going long stocks until, or unless, the weekly charts confirm the daily charts.

Back on Main Street, the US economic picture took a turn for the worse last week. International trade, retail inventories, wholesale inventories, Case Shiller home prices, pending home sales, personal spending, construction spending and consumer sentiment all disappointed. Even worse, the US payrolls report for August was a disaster—fewer jobs were created; the unemployment rate rose; average hourly earnings, and the average workweek both missed expectations. On the positive side of the ledger, consumer confidence, 2nd quarter GDP, Chicago PMI and ISM manufacturing all beat expectations. Still, after a couple of weeks of mixed results, the majority of results last week were decidedly negative.

So as US stocks return back near their all-time highs, two important asset classes are moving the other way—they’re both sending bearish signals while stocks rally. First, US Treasury prices have been creeping higher for many weeks now; this has sent the yield on the 10 year Treasury back down to the lows of the year. At the same time, the price of gold has risen over $100 per ounce in the last six weeks; in fact, gold has risen so much in 2017 that’s its beating the Dow Jones Industrial Average.

Both of these developments contradict the high stock prices in the US. When Treasury prices and gold prices spike, it usually means that investors are worried about risk assets and are selling them to free up capital to hide in Treasuries and gold.

So this contradiction must be resolved—clearly, either Treasury prices and gold prices need to come back down, substantially, or US equity prices need to do the same, drop off meaningfully.