S&P500 Valuations Remain Obscenely High

May 1, 2017

The S&P500 jumped another 1.5% last week, but volume was very light so once again, buyer conviction was not all that strong. At the same time, S&P volatility plunged back down close to multi-year lows, where it was back in February of this year.

The technical picture is now showing some divergence between the daily and weekly resolutions.  On the daily charts, the S&P has broken to the upside. The recent, short-term downtrend has been broken and it now looks possible that the S&P could set new record highs, which were last set in February, when the VIX index bottomed. On the other hand, when looking at the S&P on the weekly charts, the breakdown that began in late February looks like it’s still in effect. Momentum, as measured by MACD, is waning and the MACD lines have crossed over into a bearish direction. Of course, if the S&P500 rises another week or two, then this bearish condition in the weekly charts will flip over to a bullish signal and match the daily charts. On the other hand, many technicians….when assessing a divergence between daily and weekly chart signals….tend to favor the longer-term weekly signal because it tends to be more accurate than the shorter-term daily signal.

US macro news was particularly negative last week. The Chicago Fed National Activity Index plunged. The Dallas Fed manufacturing survey missed expectations. Consumer confidence also missed. Durable goods orders, both headline and ex-autos, missed…..with the core reading missing very badly. Pending home sales missed. The Kansas City Fed manufacturing index plummeted. First quarter GDP came in lower than expected. The employment cost index rose more than predicted (this will hurt corporate profits). And consumer sentiment also missed. Only new home sales, international trade, and the Chicago PMI beat estimates. All in all, it seems that both hard and now soft measures of US economic health have started to deteriorate more in the recent month.

Finally, it’s worth noting that valuations in the S&P500 still remain obscenely high. Prices are just a fraction lower than they were at the all-time highs set only a couple of months ago. And extremely reliable measures, measures that have been valid over the last 100+ years of market history, are portraying a US stock market that’s extremely overvalued. How overvalued? Using price-to-sales and price-to-GDP (some of the most reliable metrics available), the S&P500 would need to fall by about 50% JUST to revert back to historical averages. If prices were to overshoot on the downside—which they almost always have done in bear market cycles over the last 100+ years—then the S&P500 would need to fall by about 75%. It sounds crazy, but that’s what history teaches us, and history has always been relevant in predicting and explaining future market outcomes.

Commodities Crumbling

April 24, 2017

The S&P500 bounced about 0.85% last week. Volume was light and volatility, as measured by the VIX index, inched back down slightly.

US macro news was mostly disappointing last week. The Empire State manufacturing survey missed badly. The housing market index also missed. Housing starts came in lower than predicted. Initial jobless claims were worse than expected. The Philly Fed business outlook survey missed. And PMI composite flash also missed. On the positive side of the ledger, industrial production beat slightly. Leading indicators beat expectations and finally, existing home sales came in higher than predicted. But the overall mix of results was certainly more negative than positive.

In terms of technical analysis, last week’s gain in the S&P500 means that the downward momentum on the short-term charts (daily resolution) is waning and that another upward move can be expected. On the longer-term charts (weekly resolution) the upward momentum is still intact and while not as strong as it was in the winter months, it’s still allowing for more increases…despite the fact that prices are also stretched to the upside by a large degree.

Finally, let’s look at commodities again. Why? Because their prices reflect the overall health of the global economy. If it’s growing at a reasonable rate, then commodity prices would climb. If it’s stagnating, then commodity prices would generally be expected to fall or at least not climb.

So what are key commodity prices doing today?  As measured by DBA (a respected ETF that tracks most major industrial commodities), prices today are at—not near—but actually at lifetime lows. This is not a good sign for global economic growth today. And it also strongly contradicts the generally elevated equity prices in the US and in Europe today, which are at or near lifetime highs.

Sooner or later these two measures will converge—either commodity prices will soar back up to meet stock prices, or stock prices will climb down substantially to meet the depressed commodity prices.

US Housing Market—Fully Recovered

April 17, 2017

The S&P500 lost about 1.1% last week, as geo-political tensions rose in several spots around the world, especially North Korea where the US government has essentially pre-announced that it is likely to take military action. And keep in mind that North Korea has nuclear weapons. So not only did US equities give back some recent gains, but two classic safe-haven assets rose in price:  US Treasuries and gold. S&P volatility, as would be expected, not only increased, but it increased to the highest levels since the November presidential election. US equity trading volume was on the light side, but that’s in part due to the holiday-shortened week.

In US macro news, the results were disappointing. Small business optimism fell off a bit. Producer prices—both core and headline came in well below expectations (not something one would expect in a healthy and growing economy). Retail sales missed badly. Both the headline and ex-autos figure came in well below expectations. And consumer prices (also headline and core) registered far lower readings than economists had predicted. Only consumer sentiment, a fuzzy measure at best, beat expectations.

On the charts, the recent pullback in the S&P500 has now resulted in some technical damage. For example, the 50 day moving average has failed to hold. Last week, prices not only dipped below this average,  but closed the week well below it. That said, prices are still well above the 200 day moving average and the 200 day is clearly sloping upwards….both of these are still bullish, over the medium to longer term.

Finally, it’s interesting to note that US single family housing prices have not only recouped all the losses that were incurred near the lows of 2012, but in many of the major (20 cities measured by Case-Shiller) metro areas in the US, prices have now set new record highs. The question obviously is this—will these price gains be durable, unlike the gains in the prior market peak, circa 2005-2006? While nobody knows for sure, given the fact that the Fed’s ultra-easy monetary policy was primarily responsible for the recent run up in prices, and given that the Fed has now implemented a new policy to reverse much of the old ultra-easy measures, there’s a very good chance that US housing prices will give back at least some of their recent gains.

The crash in US housing between 2006-2012 proves that prices can—and do—move downward as well as upward.

More Stalling in the S&P 500

April 10, 2017

The S&P500 slipped 0.3% last week. Volume was light and volatility inched higher, but nowhere near any levels associated with fear, or much less panic. Diverging bearishly from the S&P, the HYG etf closed higher on the week, suggesting that many investors were more comfortable taking on risk.

In US macro news, there were only a couple of major positive surprises. The ISM manufacturing index beat expectations (but only slightly) and the initial jobless claims figure dropped back to multi-decade lows. Aside from these two beats, most everything else was a miss. PMI manufacturing disappointed. ISM services fell and missed expectations badly. Construction spending missed. PMI services missed. The payrolls result was a huge miss—only 98,000 new jobs were created instead of the 175,000 expected. To add insult to injury, average hourly earnings missed…..and so did the average workweek figure. The bottom line is that last week, US economic data took a turn for the worse.

Technical analysis is now suggesting that the S&P’s surge after the Trump election is once again stalling. Momentum indicators have turn down. MACD for example has diverged negatively for several weeks now on the daily charts; on the weekly charts, MACD is on the verge of diverging bearishly. Also, prices have now dropped back down to the 50 day moving average….and for the last few weeks, this moving average has held, despite being tested 4-5 times. So now any relatively minor movement downward will cause this moving average support level to fail; this would almost certainly lead to more selling…..perhaps at least down to the 200 day moving average.

So the US equity market is once again at a critical cross-road. While valuations remain at nosebleed levels, relative to 100+ years of history, the near-term catalysts for further upward price movement seem to be running out.

Gold and Silver Poised to Rise?

April 3, 2017

Last week the S&P500 bounced back 0.8% but on very light volume. Volatility in the S&P barely changed; it remains on the extremely complacent end of its long-term range. Confirming the move higher in US stocks, the HYG (or high yield) ETF also moved higher by the end of the week. On the other hand, US Treasuries resisted the positive tone in risk asset markets and their yields barely budged, instead of rising to confirm the movement of money into risk assets.

In US economic news, the results were once again very mixed. The Dallas Fed manufacturing survey missed. So did personal spending. Initial jobless claims came in worse than expected, and consumer sentiment disappointed. On the positive side, international trade beat expectations. So did consumer confidence. Pending home sales and the Chicago PMI also beat consensus estimates.

In terms of technical analysis, the recent retreat in prices (last week’s rise notwithstanding) has slowed the upward momentum that has characterized the Trump reflation trade. For this slowdown to be reversed completely, stock prices would have to continue to rise this week and most likely next week.

The price of gold and silver continue to trace out a long-term bottoming pattern, a pattern that spans more than three years. Specifically, the dip in the fall of 2016 has completed the right (and final) shoulder in an inverted head & shoulders pattern, a bullish pattern that usually precedes a major upward movement in prices. The left shoulder was formed in late 2014 (or possibly mid 2015), and the head was formed in late 2015. The last remaining hurdle in this pattern will be the movement of prices above the neckline, which is approximately at the mid-$1300 level. If prices break above $1375 and stay there, then the long-term nature of this bullish pattern suggests that prices could echo their last bull market run which added over a $1000 to the price of gold. So this means that if another bull market develops, gold could finally reach and exceed $2000. It came close in 2011, but never reached this level.

Almost the exact same analysis applies to the price of silver.

So despite the fact that a huge sword is hanging over the US stock markets, here’s one market that’s poised to do the opposite—enter a major bull market that lasts several years.

Is the Trump Trade Over?

March 27, 2017

While not a massive drop, last week’s 1.44% fall in the S&P500 was the largest….in percentage terms….in many months. Volume was on the lighter side, but volatility did jump—the VIX index rose to the highest levels of the year. That said, there was still not signs of panic, which would require the VIX to jump well over 20. The last time we’ve the VIX over 20 was around election day in November 2016.

Last week was quiet in terms of the number of economic reports that were released. On the positive side of the ledger, the current account wasn’t as bad as forecast. New home sales beat consensus estimates, and headline durable goods orders beat expectations slightly. On the negative side, the FHFA house price index missed badly…coming in well below expectations. Existing home sales also missed. Initial jobless claims were much higher than expected. Durable goods orders excluding the volatile transportation component were far lower than predicted, and finally, PMI composite flash also missed.

Technical analysis, after last week’s loss, is suggesting that the S&P500 is on the verge of a breakdown. At Friday’s close, it came back down to the 50 day moving average, which means that for the Trump rally to continue, it would need to bounce off this support level and continue to move higher from there.

The problem with this test is that after Friday’s close, the Trump administration announced that at least for now, it would give up on repealing and replacing Obamacare. This means that one of Trump’s key election promises failed to become reality due to the inability to get all Republican legislators on board. So naturally, everyone will now ask this simple question—if repealing and replacing Obamacare failed miserably, how can we expect the other major promises to come to fruition, especially the promise about lowering corporate and individual tax rates? And if these two pledges also fail to become reality, then most of the reason for the Trump rally, the rally that began the day after Trump was elected, could disappear.

So US stock investors must suddenly worry about giving up major gains and must decide if they should ride out the probably drop…and perhaps buy more stocks on the “dip”…..or if they should sell now….to lock in gains….and wait for another day to re-enter the market.

Not an easy decision to make!

Something’s Gotta Give

March 20, 2017

The S&P500 ended last week up a fraction—it closed on Friday up 0.24% for the week. Volume was very light. And volatility drifted lower, close to the lows reached in February. Essentially, the S&P500 was treading water and looking for some sort of signal to find a direction for its next meaningful move.

US economic reports were mixed so these provided no clear direction for US financial markets. On the positive side, the housing market index, housing starts, consumer sentiment, and leading indicators all beat expectations. On the negative side, labor market conditions, initial jobless claims and industrial production all missed. At the same time, many reports (including consumer prices, retail sales, and business inventories) came in exactly as expected.

In terms of technical analysis, the S&P remains extremely stretched….obviously to the upside….on both the daily and weekly charts. The short-term parabolic jump that began after Donald Trump won the presidential election is still in effect.

Last week, we discussed how arguably the world’s most important commodity—oil—was diverging from US stock prices. Specifically, as stock prices remain near record highs, the price of oil, which originally crashed in 2014, has resumed its decline by dropping almost 10%. And it continued to creep downward—again—last week.

This week, we’d like highlight how S&P500 aggregate earnings have started to diverge significantly from the overall price of the S&P500. While the correlation over the last 10 years has —- for obvious reasons —- been positive (ie when corporate earnings rose each quarter, the price of the S&P500 rose in tandem with those earnings). But starting in early 2016, the reverse has happened:  GAAP earnings have not recovered; they’ve stayed flat. At the same time, the S&P500 has soared.  This is another very important divergence, arguably even more important than the divergence from the price of oil,that must be resolved on way or another. Either GAAP earnings must rise sharply to match the lofty prices of the S&P500 or the S&P500 must drop precipitously to match the depressed level of corporate earnings.

Once again, we need to wait and see how this convergence plays out exactly.