Rising UST Yields Creating Problems for Stocks

January 29, 2018

Amazingly, the parabolic move higher in the S&P500 continued last week. The index rose yet another 2.2%, on moderate volume. Contradicting this move higher in prices was the VIX index, which also moved higher—suggesting that at least some investors are beginning to worry about a stock market pullback.

Speaking of parabolic moves, the technical picture for the S&P continues to amaze everyone. While it’s still rare for an individual stock to shoot up in a parabolic fashion, it’s extremely rare to see the entire S&P500 do this—remember this index includes the largest 500 firms in the US. This is a very large index, representing trillions of dollars in market cap. It’s far from easy, or common, to have this index move upward in an almost vertical manner. And as already mentioned last week, such moves always—not usually, but always—correct by moving back down steeply…..eventually. That said, by definition, the greater the rate of ascent, the sooner parabola reaches its peak. So this reversal may not be that far off now.

In US macro news, the news continued to be mixed. The Chicago Fed National Activity Index beat expectations; initial jobless claims were better than predicted. And both durable goods and leading indicators beat their respective estimates. On the other hand, the Richmond Fed manufacturing index, the FHFA House Price Index, PMI composite flash, existing home sales, new home sales, and 4th quarter estimated GDP all missed their respective estimates. So as usual, there’s no economic boom to write about.

In an interesting development, the US Treasury market has made a very dramatic move over the last few months. First, the yield curve has flattened substantially, not because the long end of the curve has fallen in yield, but all because the short end has risen in yield.  To many market and economic observers, a flattening — and more importantly, an inverted — yield curve is a precursor to an economic slowdown, or to be more precise, a recession.  And while the curve has flattened substantially, it has not yet become perfectly flat. much less inverted. So the jury is still out as to whether or not the curve will actually invert…..and therefore signal an imminent recession.

Second, the 10 year yield has now crept up to about 2.7%. This is important because a huge percentage of consumer loans (eg. many home mortgages) are priced off the US 10 year T-note. And since the yield is now higher than it’s been in several years, there is a strong possibility that rising cost of consumer debt will negatively impact these other markets—such as housing and autos. Also, the rising yield in the ultra-safe Treasury market will begin to compete more seriously with the meager yields earned in the US stock markets. The yield on the entire S&P500 is only about 2%. So when the US 10 year yielded less than 2%, many investors refused to buy US Treasuries due to the meager yields; today at 2.7% and rising, this alternative suddenly becomes far more attractive. Will this rise in yields cause investors to sell stocks and buy Treasuries?  Many hugely successful market analysts, from Bill Gross to Jeffrey Gundlach, think so.

Regardless of how bullish you may be about the US stock market, it doesn’t take a genius to figure out that the more risk-free Treasury rates rise, the more difficult it will be for US stock prices to rise. The biggest open question is at what level will rates create a tipping point? In other words, how much further will rates have to rise to cause stock owners to sell, and move their freed up cash into US Treasuries?





Parabolic Markets Never Correct by Going Sideways

January 22, 2018

The parabolic move upward in the S&P500 continued last week. The index gained another 0.86% on moderate to weak volume. Interestingly, because this contradicted the move higher in the S&P, the VIX index also closed higher on the week.

In US macro news, the Empire State manufacturing survey missed consensus expectations. The housing market index also missed. Housing starts disappointed…badly. The Philly Fed business outlook survey also disappointed. And consumer sentiment came in well below expectations. For the week, only industrial production and initial jobless claims showed better than expected results. So on balance, last week’s results were skewed to the downside.

In terms of technical analysis, the S&P continues to trace out a classic parabolic “blow-off top” formation. Prices are not only deviating from long-term moving averages, but the percent of the deviation is increasing. This means that the slope of the increase is becoming more steep. The problem with such a pattern is that historically, it never corrects by going sideways for a while. In other words, prices don’t just pause in a safe range near all-time highs waiting for fundamentals to simply catch up to them. In every case when major equity markets, or even sectors, have gone parabolic, the correction that inevitably followed was roughly and equally steep drop, a drop that completed the second half of the parabola.

So as the fear of missing out grows, and more and more mom-and-pop investors rush in to buy stocks at all-time highs, most everyone joining this party is either unaware of how markets correct or simply refusing to believe that such a correction will happen to them after they get in.

Meanwhile, the list of new records, records that put into perspective the magnitude of this sky-rocketing stock market, continues to grow. In only a short while, the S&P will be setting the new all-time record for the most number of consecutive  trading days without suffering a 5% correction. Remember, this type of record goes back not just a decade or two, but about a hundred years. Apparently, many investors refuse to believe that any such correction could ever happen again, or if it does, somehow—unlike almost everyone else already in the stock markets—they, and only they, will have the wisdom to know it’s coming and will be able to jump out before stock markets actually correct.

Gold Continues to Climb

January 16, 2018

The S&P500 is seemingly unstoppable. Last week it climbed yet another 1.6%. Volume was light, so again there was no rush of new money chasing stocks higher; instead, this move had the typical feel of a slow melt-up. And volatility inched higher; that said, it still closed the week near multi-decade lows. In short, the blow-off top formation in the S&P is continuing to build. At this point, it’s not clear at all, when and how this formation will end.

Other technical indicators continue to display extreme readings. Prices are now deviating (to the upside) from most moving averages by record percentages. And this applies to both the daily and the weekly time resolutions. Other momentum indicators, such as MACD and RSI, are also stretched to extremely high levels.

Of course all these extremes will someday be corrected—they always do correct. But once again, there’s no rule in markets that prevents even higher extremes from being hit.

In US macro news last week, the results took a turn for the worse. Job openings, in the JOLTS survey, plunged. Export prices fell, instead of rising as expected. Initial jobless claims continued to disappoint….this week they missed badly. Retail sales missed on the headline number; for sales ex-autos, the results only met expectations. And while core producer prices were lower than expected, core CPI was hotter than predicted. Only consumer credit and business inventories beat their respective consensus estimates last week.

Finally, gold has continued to rally. Lat week it added another one percent in gains. More importantly, gold has now almost completed a super long-term inverse head-and-shoulders bottoming formation. This formation, as seen on the weekly charts, spans almost five years, and extremely bullish. For this formation to be confirmed, gold now has to rise by only about $35 dollars. And if it does, then many technical traders around the world will take note and likely will trade gold from the long side. What’s also interesting is that the upside for gold is also very encouraging. If or when this inverse head-and-shoulders formation is confirmed, then the immediate next target for gold would be well over $1,500 and closer to $1,550. And if $1,550 were to be reached, then that would represent a rise of almost 50% from the lows reached in late 2015.

Not bad for a barbarous relic!

Treasuries and Gold don’t agree with Stocks

January 8, 2018

The S&P500 started the new year with a bang—it jumped 2.6% for the week. This is a huge gain for only four trading days; the week was shortened by the New Year holiday. Volume, however, was quite low. And volatility plunged; the VIX index fell to some of the lowest levels in its history.

From a technical analysis perspective, the S&P500 is tracing out a blow-off top formation. On both the weekly and the daily charts, the S&P has rocketed way past its respective upper Bollinger band. This is a situation that is rarely witnessed; prices almost always stay within the two Bollinger bands. What makes this even more interesting is that this movement is happening after the S&P has already had a massive run-up in prices over the last 8-9 years. It seems like even the most reluctant and cautious bears are capitulating and buying into the US stock market frenzy…at prices that have never been higher. Apparently the simple concern about buying “high” has tossed out the window; the bigger concern is the “fear of missing out”.

In US macro news, the big story of the week was the disappointing payrolls report for December. New jobs came in far lower than expected. On the other hand, the rest of the report merely met expectations—average hourly earnings, the average workweek, and the unemployment rate. In other news, ISM manufacturing, construction spending, PMI services and factory orders all beat consensus estimates. On the other hand, initial jobless claims, international trade, and ISM services all missed.

Ironically, as the US equity markets continue to march higher, two other important markets are moving in the opposite direction—they’re movements are best explained by an economy that’s not doing so well. First, the US Treasury market yields, especially the 10 year yield, has not soared higher….as would be expected in an economy that’s growing strongly. In fact, the 10 year yield finished the year (2017) yielding slightly LESS than it did at the beginning of the year. Also, the price of gold has been soaring lately. For the entire year 2017, gold was one of the best performing asset classes. The problem is that gold would be expected to sell off when the stock markets rise—generally it’s an asset class that moves inversely to risk assets. But gold’s been rising lately, and that too signals that many investors are concerned in a way that’s not expressed in US stock market prices.

Yes, the strong uptrend in US stock markets must be respected; until it turns, it’s futile to fight it. But the contradictory movement in the US Treasury and gold markets must also be respected. They’re both telling a story that’s very different from the one being told by the stock market.

Is Bitcoin a Sign of Bubble Mania?

January 2, 2018

Surprisingly, the Santa Claus rally in US stocks failed to materialize last week. Instead of gently melting up in price, the S&P500 dipped almost 0.4%. Unexpectedly, volume in the holiday-shortened week was extremely light. And volatility, while creeping higher, still closed the week…and the year….at extremely low levels.

Technically, the minor dip in the S&P500 was barely visible on the weekly charts, where the bull market is still clearly in effect. On the daily charts, however, a clear downshift in momentum has been established. So at least in the short term, a pullback over the next several weeks would not be out of the question.

In US macro news, the results were mixed as usual. On the bright side, the Case Shiller home price index continued to show strength in home price appreciation; the results beat expectations by a small percentage. The Dallas Fed manufacturing survey came in stronger than expected. And the Chicago PMI beat consensus estimates. On the down side, the Richmond Fed manufacturing survey missed. Consumer confidence missed. Pending home sales missed. International trade in goods was worse than expected, and initial jobless claims were also worse than predicted.

Unless you’ve been ignoring mainstream news lately, there’s no way anyone could have missed the news about the soaring price of Bitcoin, a crypto currency that has recently attained about $200 billion in total market value, a valuation that’s grown from zero in less than 10 years.

But it’s important to remember that this “technology” has essentially no intrinsic value. By comparison, even thought the US dollar arguably also has no intrinsic value (such as gold), it does have the full backing of the US government and importantly, all US obligations must be settled in US dollars. In addition, the US government dollar does not have competing “currencies” that can pop out of nowhere, at any time, as an alternative to the dollar. New crypto currencies are seemingly appearing almost every month lately.

So it’s no surprise that Jamie Dimon, the CEO of  JP Morgan, has referred to Bitcoin as a fraud.

But more importantly, it appears that Bitcoin is signalling to the world that global markets awash with trillions of dollars of traditional money created by major central banks are chasing even the craziest ideas for earning returns in a low-return environment. Back in the late 1990’s during the late stages of the dot.com bubble, many new businesses with almost no revenues (much less profits) were enjoying massive valuations because the were getting a lot of “eyeballs” visiting their websites. Many others were valued, perversely, on the rate at which they burned cash—the more they burned and the faster they burned it, the more highly the firms were valued.

We all know now how that bubble ended. Or do we? Is it possible that, as several older and astute economists have pointed out over the last 100 years, investors are once again displaying a remarkably short financial memory?  And if so, have they already forgotten what happened 17 years ago, when the NASDAQ crashed by over 80% from peak to trough?

To anyone who read the Wall Street Journal 20 years ago, and especially to anyone who’s been participating in the financial markets for over 20 years, this Bitcoin phenomenon feels awfully familiar. We’ve seen this movie before….and we already know how it will end.

Santa Claus Rally in the S&P500?

December 28, 2017

Last week, to absolutely nobody’s surprise, the S&P500 closed with another gain, a small gain but a gain nonetheless. This time, the increase was +0.28%. Volume was very light, and volatility hovered near all-time lows. The low volume and low volatility was also not surprising because this was the week before the Christmas and New Year holiday weeks.

The technical picture hasn’t changed much in the last several weeks. On the weekly charts, the S&P500 looks like it’s enjoying a parabolic blow-off topping run. When it ends, nobody knows. But until it does, the clear trend is not only to the upside, but also at a very steep trajectory. On the daily charts, while the trend is undoubtedly bullish, there is a bit of a slowdown in momentum given the relatively small percentage increases over the last few weeks. That said, it’s too early to read any sort of reversal into this momentum slowdown on the daily charts.

The most recent data on the US economy continues to show that the economy is limping along slowly, certainly not about to slow down anytime soon, but also not about to take off with strong and robust growth. Last week, durable goods orders, both headline and ex-transportation, missed badly. Initial jobless claims surprisingly came in weaker than expected. Third quarter GDP registered a weaker reading than economists had predicted. The Chicago Fed National Activity Index missed. Personal income missed. Consumer sentiment as well as the Kansas City Fed manufacturing index also both missed. On the positive side of the story, the housing market index beat expectations, and so did housing starts and existing home sales. The FHFA house price index registered a beat, and so did the Philly Fed business outlook survey. Leading indicators beat consensus estimates. Personal spending recorded a beat, and so did new home sales.

All in all, the US housing market continues to show resilience, even as prices have returned to….or in some cases exceeded….former all-time high levels reached in 2006. At the same time, many other aspects of the economy, such as real wages, continue to struggle to improve.

Finally, in the last week of the calendar year, it’s not going to surprise anyone if the S&P500 records yet another week of weekly gains. This is the week between Christmas and New Year’s when many investors and traders go on vacation….and historically during this week, the risk asset markets have tended to creep higher, not by much, but upwards nonetheless.

Let’s see what the new year brings us, starting with the first week of 2018, which begins next week.

Does the S&P500 Need a Catalyst to Spark a Correction?

December 18, 2017

Here we go again. Like clockwork, the S&P500 advanced another week. This time it added about 0.9%, on top of record high levels reached the week before. Volume was modest. And volatility was almost non-existent; the VIX index ended the week once again below the 10 level, a level rarely reached over the last 20 years.

In terms of US macro news, the results were mixed last week. In the JOLTS survey, job openings missed. Producer prices, both headline and core, came in hotter than expected. So there’s more upstream inflation than economists had anticipated. Consumer prices, on the other hand, met expectations; core CPI, however, came in lower than expected. So there’s little evidence of downstream inflation heating up. PMI composite flash came in weaker than expected, and industrial expectations also missed. On the positive side, initial jobless claims were better than predicted; they’re now lower than they’ve been in decades. And retail sales also beat consensus estimates.

In terms of technical analysis, the over-stretched condition in the S&P500 just keeps on getting more distorted, ie. over-stretched. On a monthly basis, prices have now deviated from the two-year moving average by a large percentage than they did near the peak of the 2000 tech bubble. Prices on this measure are so stretched that it would take a roughly 15% correction to just bring them back to this super long-term moving average. Keep in mind, this type of correction would not even break the uptrend. In other words, even if a 15% correction materialized, many technicians would argue that the bull market cycle would still be in effect! It would take a far larger drop to break this bull cycle.

So many market analysts are asking—exactly what type of catalyst would be needed to spark such a larger correction, a correction that has ended every bull market cycle in the history of US equity markets?

And surprisingly, given today’s market action, more and more analysts—analysts who should know better—are starting to argue that with the Federal Reserve supporting US risk asset markets with current and with potential monetary easing, that for the first time in US financial market history, US stock market investors should not worry about any major correction. Instead, they should continue to confidently buy every minor dip….and continue “making money” year in and year out with US equity markets.

These analysts argue that even if some sort of huge catalyst were to appear—think war with North Korea—that the Fed would simply open up the monetary firehose and push prices right back up to where they were…and then even higher to new all-time record highs.

In short, according to the new conventional wisdom, stocks cannot go down. And if they even so much as suffer a hiccup then the wise investor should be thankful for the short-term “sale” and just buy more.

The problem with this thinking is that many analysts assume that some sort of big catalyst would be needed to start—even if temporarily—a US stock market decline. What if the fundamental reason for the future decline is simply a matter of obscene valuation?  If the Shiller P/E of the S&P500 reaches say 30, then will it be the fault of some war (against North Korea, or anyone else) that really causes the S&P500 to fall by more than 15%?  Or will it be the fact that investors collectively pushed the S&P500 to obscenely high valuations …..and that a trigger, ANY trigger, was all that was needed to create fear among investors who would collectively….yet unsuccessfully….all rush for the exits?

Given the fact that a huge percentage of today’s traders are too young to have ever experienced a bear market, and given the fact that in risk asset markets in general, all investors tend to forget the lessons—and losses—of the past because they’re too absorbed with the paper gains of the present, it’s very likely that when the next bear market finally arrives….and it will….that the cited “catalyst” for the correction will only be a diversion, an excuse, for what only a few long-term investors will rightfully point out to have been the cause—excessive valuation that was reversed by a collective change in market psychology, a psychology emphasizing greed that suddenly shifted to a psychology of fear.