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.


Oil Price Collapsing

March 13, 2017

The S&P500 dipped about half a percent last week, on very light volume. S&P volatility meanwhile, crept up…..as would be expected during a week when prices fell.

So does the slight pullback in prices change the technical picture? Not at all. On both the daily and the longer-term weekly charts, the S&P is extremely overstretched to the upside. It’s almost parabolic spurt—-starting the day after Trump won the election—-is still in effect.

The big economic news last week was the US payrolls report which showed a higher than anticipated increase in new jobs for the month of February. The downside of this report was the average hourly earnings figure, which disappointingly rose less than predicted. So more jobs, but less pay. In other economic news, wholesale trade, productivity, consumer credit and initial jobless claims all disappointed. On the positive side, only factory orders beat expectations.

So while the march higher in US equity prices continues, something more worrisome is happening in the global oil markets—the price of oil is collapsing, again.  This is important because oil is not only a large industry in the economy but it also functions as a signal of overall economic activity, much like the price of copper. Since oil plunged about 9 percent last week, back down to levels first seen in late 2014, the concern is that the global economy can’t truly be doing very well….as least as well as advertised. Of course, higher supplies can contribute to a glut in oil inventory and hence a lower price, but if the world’s economies were doing well, they would absorb this extra supply with greater demand and at least maintain the price of oil, if not push it higher.

Meanwhile, the price of copper is also turning down lately.

And high yield bond prices are turning down.

At the same time, this week the Federal Reserve is almost 100% certain to raise interest rates, which would be the third increase in this latest hiking cycle, which started in late 2015.

Could the Fed be hitting the brakes just as the US economy is about to slow down anyway?  If so, then the US stock market could get jolted and the Fed could be looking at a very short interest rate hiking cycle….one that stops and even gets reversed after only a handful of increases.


US Stock Market Valuations Nearing Highest Point in History

March 6, 2017

While the S&P500 did not rise every day last week, it did close higher for the entire week. The index rose another 0.67% to set yet another all-time high. Once again, volume was very light, which doesn’t support the rally. But volatility retreated—the VIX index fell back and this movement does mesh with the rise in prices.

The week’s economic reports were mixed as usual—-with roughly half missing expectations and the other half beating expectations. So no change in the anemic pace of US economic growth, growth that’s been anemic ever since the Summer of Recovery began in mid-2009.

The technical picture is beginning to look like the S&P has entered a short-term parabolic blow-off top formation. Ever since Donald Trump won the election, the hopes and expectations of lower taxes and lower corporate regulations have driven stock prices higher at a rate that has been steeper than most other bursts since this market bottomed in early 2009. And all this, despite any concrete plans or details to support the hopes that these Trump initiatives will actually take effect anytime in the near future. So the S&P500 is now even more over-stretched than it’s been in many years.

More importantly, valuations—the driver of long term returns in stock markets—continue to move higher into nosebleed levels. Long time money manager John Hussman describes the situation this way:

“…the consensus of the most reliable equity market valuation measures we identify (those most tightly correlated with actual subsequent S&P 500 total returns in market cycles across history) advanced within 5% of the extreme registered in March 2000. Recall that following that peak, the S&P 500 did indeed lose half of its value, the Nasdaq Composite lost 80% of its value, and the tech-heavy Nasdaq 100 Index lost an oddly precise 83% of its value. With historically reliable valuation measures beyond those of 1929 and lesser peaks, capitalization-weighted measures are essentially tied with the most offensive levels in history. Meanwhile, the valuation of the median component of the S&P 500 is already far beyond the median valuations observed at the peaks of 2000, 2007 and prior market cycles, while our estimate for 10-12 year returns on a conventional 60/30/10 mix of stocks, bonds, and T-bills fell to a record low last week, making this the most broadly overvalued moment in market history”

Think carefully about what he just pointed out. the S&P500 is nearing 2000 bubble highs, the most overvalued point in the history of the S&P! The S&P is already more overvalued than it was in 1929, before the crash that preceded the Great Depression. And you use median valuations, then the S&P is already way more overvalued than it was in the 2000 peak when the overvaluation was driven by relatively few tech firms.

And now interest rates are rising and the Fed has signaled that it will hike rates three times this year.

Super high valuations and rising rates have ALWAYS preceded major (not minor ) stock market corrections. Perhaps this time will be different.


US Treasuries Diverging from US Stocks

February 27, 2017

The S&P500 continued to march higher last week. The index moved up almost 0.7% by Friday’s closed. Of course, there was no real enthusiasm on the part of investors because volume fell to one of the lowest levels of the year, so far. Also not confirming the rise in stock prices was the stock market volatility which barely budged; normally the VIX would fall when stock prices rise.

In US macroeconomic news, the results were mixed. On the positive side, existing home sales and consumer sentiment both beat expectations. On the negative side, PMI manufacturing, the Chicago Fed National Activity Index, and new home sales all missed expectations. Initial jobless claims and the FHFA House Price Index both met expectations. So once again, the US economy is not showing any signs of entering any period of robust growth.

If technical analysis suggested that the S&P500 was stretched to the upside the prior week, last week’s additional increase in prices means that the index is even more stretched now. Anyone who puts more or new money to work in this type of market is simply betting that overstretched prices will become even more overstretched in the near future. Clearly, the S&P’s performance over the last several years suggests that this is entirely possible, even in the face of stagnant corporate sales and declining corporate earnings.

Finally, the US Treasury market has begun diverging from the US stock market over the last several weeks. Normally, when stock prices rise, the prices of US Treasuries fall (ie. yields go up).  And this is exactly what’s been going on for most of the period since the S&P took off after the election of Donald Trump. But lately, especially over the last few weeks, the reverse has happened—as stock prices continued to climb, UST yields have started to drop, and by meaningful amounts. In other words, UST prices (and yields) are diverging—negatively—from US stock prices. While this doesn’t mean that stock prices are bound to drop because of this reason alone, it is something that’s important to watch….especially because the size of the US Treasury market is so huge and because it has a good track record of reflecting the views of smarter, more sophisticated institutional investment money.


The Corporate Buyback Story

February 20, 2017

Pushing their luck, stock investors enjoyed another notable jump in the S&P500 last week. The index jumped 1.5% pushing what was already a commonly accepted overvalued market to an even more severe overvalued condition. Confirming that this increase is not some sort of exuberant movement by investors to jump in with both feet is the fact that volume fell. This means that while stocks keep rising, it’s not because there’s a lot of enthusiasm behind the move. S&P volatility crept up; this contradicts the recent price jump. And the price of the US dollar (which tends to rise when equity or risk markets fall), also crept higher to close near multi-year highs. So the strength of the US dollar over the last 24 months also contradicts the jump in US stock prices over the last several months.

US economic reports were mixed last week. Retail sales, the Empire State manufacturing survey, and leading indicators all beat expectations. Industrial production and the housing market index missed expectations. At the same time, consumer prices came in higher (or worse) than expected.

In terms of technical analysis, the S&P500 is almost as stretched as it was in the period leading up to the peak during the dot-com bubble. In no way does this mean that another burst is imminent. but it does suggest that prior major retreats began from technical conditions similar to the one we see today.

In Seeking Alpha, writer Eric Parnell recently analyzed the run-up in US stock prices over the last five years and found a striking correlation between corporate buybacks of their shares and the prices of those stocks. He notes that aggregate corporate earnings have barely budged between 2011 and 2016, but the price PER SHARE has gone up substantially because corporations—through buybacks—have been consistently reducing the number of shares over which this static aggregate corporate earnings figure is spread. And while the earnings per share has gone up, so has the price multiple associated with this EPS. Clearly, this has made the stock market advance look more normal (ie. not so out of whack) because it has artificially increased the earnings per share levels.

How have corporations done this?  Simple—they’ve not only used the bulk of their free cash flows (operating cash flows less net capex) but they’ve borrowed massively. The result is that book equity has been driven down; at the same time, total debt has been driven higher, to replace the reduced equity capital. In fact, the ratio of corporate debt to total capital reached multi-decade highs in the period between 2014 and 2016.

And corporations have gotten away with this massive increase in leverage because the Fed had driven down interest rates to record lows. This kept the total dollar interest expenses manageable. the problem is that while leverage is reaching an “upper bound” of reasonableness, interest rates have jumped substantially since bottoming in June 2016. They rate on the US 10yr Treasury is now about 100 basis points higher than it was back then.

The result is that corporate buybacks have started to slow down massively. Something similar happened in early 2008, well before the stock market collapsed later that year.

The bottom line is that one of the greatest sources of fuel behind the run-up in stock prices over the last five years is now clearly going away, leaving the US stock market at super-stretched prices and more vulnerable than ever to a severe pullback.