Short-Term US Treasuries Pushing Higher in Yield

July 3, 2017

After stalling the prior week, the S&P500 dropped about 0.6% last week. Volume was light—in part because there was very little conviction behind the selling and in part because the slower summer trading season has kicked in. While volatility did jump one day during the week, it was promptly sold off and finished not much higher than it began….still near 2017 lows. One of the most profitable trades for all of 2017 and much of last year is to sell volatility short. The only problem with this trade is that by selling downside protection insurance, traders are assuming just that—the risk that US stock prices do take a tumble and if so, then this “profitable” trading theme will be destroyed in an instant. Until this happens though, its becoming a crowded trade and ironically helps push up US equity index prices by making the price of volatility fall artificially lower than it would be were it not for the crowding that’s going on in the short vol trade.

In terms of technical analysis, the S&P500 has now formed a bearish pattern on the daily charts. Last week’s pullback in prices cemented this signal. Of course, this doesn’t mean that further price drops are imminent or 100% likely to happen, but it does mean that the risk of further drops, in the near future, has gone up….and that investors should be more cautious. On the other hand, the pattern on the longer-term weekly charts is still strongly bullish. Last week’s pullback on the S&P is barely noticeable on the weekly charts, which are showing that the upward momentum is still in effect.

Last week’s US economic reports were mixed to weak. Durable goods orders, both headline and ex-transportation, came in well below expectations. The Chicago Fed national activity index was a disaster. The Dallas Fed manufacturing survey disappointed. The Case Shiller 20 city home price index year on year) missed. The Richmond Fed manufacturing survey also missed. Pending home sales disappointed. Initial jobless claims were weaker than predicted. And Core PCE, one of the Fed’s favorite measures of inflation, came in lower than expected.  On the positive side, consumer confidence beat expectations. First quarter GDP came in a bit better than predicted (still super low, but not as bad as originally feared). Personal income beat expectations, and so did Chicago PMI.

Finally, the Fed’s rate hiking cycle is beginning to make a notable impact on the short end of the US Treasury curve. While the longer end (eg. the 10 year) is yielding less today than it did on January 1st of this year, the 2 year Treasury is yielding far more. At 1.4%, it’s 20 basis points above the 1.2% it yield at the beginning of the year. And more importantly, it’s yielding almost 2.5 times more than it did only a year ago.

The implications are important, because while loans such as mortgages are priced off the longer-term instruments such as the US 10 year, many other forms of consumer and corporate debt are priced off shorter term reference points. So as the US 2 year yield continues to climb, and climb substantially, this will negatively impact US corporate profits and US consumer disposable incomes (ie. their ability to spend will go down and this will also reduce corporate profits).

The bottom line is that the old saying of “Don’t fight the Fed” works both ways:  when the Fed eases, it pays to be long risk assets, but when the Fed tightens, it makes sense to be cautious about being long risk assets. And today, the Fed is in a full-bore tightening mode, so adopting a more cautious investment outlook seems to make a lot of sense.



The S&P500 is Stalling Again

June 26, 2017

The S&P500 inched up a tiny 0.2% last week. Volume was light and volatility eased back even further toward 2017 lows, as measured by the VIX index.

It was a slow week in terms of US economic reports. While existing home sales, new home sales, and the FHFA house price index beat expectations, the PMI composite flash report and initial jobless claims both came in weaker than expected. Leading indicators only met expectations.

An interesting divergence is developing on the technical charts. On the weekly resolution, the S&P500 continues to push the upper limits of price ranges. For example, the closing price is still hugging the upper Bollinger band. And almost all other indicators on the weekly charts are screaming “full steam ahead”. But on the daily resolution, the MACD momentum indicator has turned bearish. Often, the daily MACD acts as an early warning indicator of an impending short-term pullback in prices. While prices are still above both the 50 and 200 day moving averages (both of which are in turn still sloping comfortably upwards), the upward momentum in prices—at least in the short term—has stalled.

At the same time, the extreme overvaluation of the S&P500 has not abated. For example, the aggregate price to sales ratio for the S&P is still about 100% above its 100 year historical average. The same goes for price to GDP.  This clearly suggests that the S&P could fall by 50% and if it did, it would only come back down to levels consistent with long-term valuations. And since most markets, when they do correct meaningfully, undershoot the average, this means that the S&P500 today is ripe for a “correction” that far exceeds 50% from peak.

It’s critically important, therefore, that investors stay alert for any serious changes in the market psychology. Specifically, it will be critical to distinguish minor market dips (that can and should be bought) from something that is far more serious and severe…..which cannot be bought until the dust settles.

The Fed Continues to Tighten…..

June 19, 2017

Last week, the S&P500 ended essentially unchanged. Volume was very light, and volatility dipped back down to super complacent levels….not quite at the lows of the year, but close.

While the price barely moved for the week, the technical picture for the S&P is still pointing to an extremely overbought market. On both the weekly and the daily charts, prices are hugging the upper Bollinger band and show no imminent signs of backing down. Prices are back above both the 50 and the 200 day moving averages, which themselves are both sloping upwards. The current bull market cycle…while extremely long in the tooth….is not breaking down just yet.

In US macro news, last week’s reports were particularly weak. On the inflation front, the news was very disappointing. Core PPI, core CPI and headline CPI all came in well below expectations. This means that the Fed is not achieving one of its primary objectives—-nudging inflation back up to or just over 2.0% per year. Retail sales missed badly—both headline and ex-autos. Business inventories also missed. Export prices came in below expectations. The housing market index missed. Housing starts missed very badly, and consumer sentiment plunged. On the positive side, initial jobless claims were a bit better than expected, and the Philly Fed business outlook survey beat expectations. That said, the US macro data—both hard and soft measures—are now falling more severely than they have in many years.

But despite the overall weak economic data, and in particular the disappointing inflation data, the Federal Reserve continued its rate-hiking process and bumped up the Fed Funds rate by another 25 basis points. In other words, the Fed is tightening despite clearly not achieving one of its two mandates. What was even more surprising was that in the same rate hike announcement, the Fed outlined a fairly detailed plan and schedule for shrinking its bloated balance sheet by several trillion dollars. Essentially the Fed would stop reinvesting in maturing securities (such as US Treasuries) and when these securities mature, the Fed would remove the comparable amount of base money (money it created electronically to buy these securities several years ago)….so that the Fed’s lower level of liabilities and assets match.

What’s critical to understand about this is that most market experts agree that it was precisely the balance sheet expansion pf the Fed (and those of the other major central banks of the world) that has not only propped up asset prices since the Great Recession ended in 2009, but has also driven these prices to all-time record highs.

So if the primary force behind record high financial asset prices is going into reverse, then how realistic is it to believe that these asset prices can remain so high, or much less, go even higher?

FANG Stocks Breaking Down?

June 12, 2017

The S&P500 inched backwards, but barely, last week. It closed down about 0.3%. But volume was very light, so there was no big rush for the exits. Also, volatility—while inching higher—still ended the week near multi-year lows, which also suggests that investors and traders were not panicking.

In US macro news, the results were mostly poor. While productivity finally beat expectations, it did so by coming in at 0.0% rather than the negative 0.2% that was predicted—this is certainly not some big improvement in the poor productivity trends that began several years ago. The PMI services index missed, as did ISM services. Consumer credit logged a dismal result—its lowest reading since August 2011! Initial jobless claims also missed. Factory orders met expectations, but once again, the hurdle was very low—negative 0.2%. As usual, there are zero signs that the US economy is growing at a healthy rate.

From a technical analysis point of view, last week’s tiny retreat was barely noticeable on the weekly charts. While more visible on the daily charts, there’s no real technical damage to note here too. What hasn’t changed is the fact that the S&P is extremely overstretched to the upside and this condition is showing very few signs of changing anytime soon.

That said, there is one sign that things are not so well beneath the surface of the S&P500. Last Friday, the four famous FANG stocks (Facebook, Amazon, Netflix and Google) all suffered big and some might say crash-like drops. This is important because the significant jump in the S&P500 over the last year, and in particular over the last six months, has not occurred with very broad-based participation. Instead, it’s come about because a few “generals” in the army of stocks have made exceptionally disproportionate gains, which pushed up the price of the index while leaving most of the “soldiers” in the army well behind.

So Friday’s mini-crash in the stock market leaders is notable because if even these stocks are starting to hit a wall and retreat by meaningful percentages, then the odds of a general stock market retreat, a retreat that would be considered significant, go up….a lot.

All News is Good News

June 5, 2017

Despite lots of disastrous economic reports and plunging US Treasury yields, the S&P500 managed to jump up another 0.96% last week. Supporting this bullish move in equities, stock market volatility remained near multi-year lows. While the VIX index crept up early in the week, but Friday’s close it fell right back down to the lows of the year.

How bad were the US economic reports? Pretty bad, especially considering the fact that US economic growth over the last 9 years has been very poor already (fun fact—US economic growth from 2007-2016 averaged 1.3% per year; growth from 1930-1939, during the Great Depression, ALSO averaged 1.3% per year!). While personal spending and personal income met expectations (ie. no beat, but also no miss), almost every other report was a miss. Consumer confidence missed. Mortgage applications missed. Chicago PMI missed. Pending home sales missed. Initial jobless claims missed. PMI manufacturing missed. Construction spending missed. International trade missed. And the biggest number of the week, May payrolls, registered a disastrous miss.

But no matter, US stock markets rallied on the week.

So now (once again) US equities are extremely overstretched from a technical analysis point of view…. using daily, weekly and monthly charts. Also US equities are extremely overvalued from a fundamental point of view…..both aggregate price to sales and aggregate price to GDP are near 100 year highs.

At the same time, oil prices (and other commodity prices) have resumed their retreats. And US Treasury yields have fallen back down to levels last seen when the S&P500 was more than 10% lower than it is today.

But again, nothing seems to matter.

It’s getting to the point where not only the average person on the street is convinced, utterly convinced that there is no alternative to buying stocks ….. but lately top Wall Street strategists are doing the same.  A few days ago, for example, Bank of America Merrill Lynch published report with a headline: “All News is Good News”.

In it, they stated: “clearly, equities continue to respond well to both positive and negative economic data….”

Some day, this insanity will end, but in the meantime, the easiest and surest path for US stocks is to the upside.

May is Almost Over, and Nobody is Selling

May 29, 2017

Amazingly, the S&P500 continued to climb higher. Last week, it added another 1.4% and in the process, it set another new all-time high. As usual, volume was light—so this jump in prices did not happen because investors poured new money into the equity markets. Very likely, some of the last remaining short sellers covered their losing bets, leaving most investors and traders—once again—almost all invested on the long side. And supporting this theory is the VIX Index which obediently retreated back down to its multi-year lows.

If you’re a US equity investor, everything looks just fine.

In macro news, the story of course is not so rosy. Last week, the Chicago Fed national activity index registered a stronger than expected result. Also, the FHFA house price index beat expectations. Durable goods orders looked better on the surface, but core orders (excluding transportation) they plunged, missing badly. Other bad news came from new home sales, which also plunged and missed consensus estimates. The Richmond Fed manufacturing index missed badly. Existing home sales also missed. International trade missed as well. So continuing the pattern of the last couple of years—while Main Street USA struggles to progress, Wall Street is enjoying a raging party.

In terms of technical analysis, the S&P500 is now is as overbought as it’s ever been. Prices on the daily, weekly and monthly resolutions are hugging the upper Bollinger Band, something that we don’t usually see simultaneously on all three time frames. Also, the S&P has jumped back well above the 50 day moving average, and the 200 day is sloping comfortably in an upward direction.

Finally, what makes this most recent all-time high more interesting is that it’s happening just as the month of May is ending. Seasonal data shows a historical pattern where equity index prices typically tend to give back some gains by the end of May; that’s where the old saying “sell in May and go away” comes from.

But this May, with June starting just a couple of days from now, the S&P500 is still setting records. Once again, this is confounding market experts who continue to be amazed that nothing, truly nothing, seems to be able to faze this US equity bull market.


Mini-Panic in US Equities

May 22, 2017

The S&P500 lost 0.38% last week on slightly higher volume. Volatility, as measured by the VIX index, closed higher on the week.

US macro news flow was light. The Empire State manufacturing index missed expectations—badly, by falling when it was projected to rise. Housing starts also missed. On the other hand, the housing market index, industrial production and the Philly Fed survey all beat consensus expectations. And initial jobless claims continued to hover near multi-decade lows.

The technical picture got uglier last week, not so much because of the modest weekly drop, but more because of the one-day panic sell off that approached two percent. While two percent, on the surface, shouldn’t be such a big deal, it did become a big deal last week because the S&P500 hadn’t had such a large drop in many months. In other words, investors had grown accustomed to unusually minor day-to-day variations in the S&P, so when a slightly larger sell-off occurred, a lot of investors got caught off guard.

More importantly, many investors got re-acquainted with risk, specifically risk to the downside in US equity prices.

With the big one-day sell-off (and despite the fact that a great deal of the one-day loss had been recouped by week’s end), many technical indicators suddenly grew more bearish. Most momentum indicators got pushed downward, and if they were already pointing down, they became even more bearish. Also, the 50 day moving average was not only broken, but the average itself stopped sloping upwards.

That said, this is still a relatively short-term moving average. Longer, and arguably more important moving averages such as the 200 day, are still solidly sloping upward…..and prices never even came close to falling below it.

So all in all, last week’s price action suggests that beneath the calm surface, the US equity markets are fragile and susceptible to sudden and meaningful drops….at least on a short term basis.