Saturday, December 6, 2014

What's ahead for the market in 2015?

Stocks continue their ascent to new all time highs though, from the looks of the charts, the air seems to be getting thin up here:


(click on chart for larger image)

Above is a daily candlestick chart of the S&P 500 covering the last six months and there a few points I want my readers to notice:

  • The small candlesticks in the green shaded areas with black arrows on the main chart highlight the indecision in the market as the S&P moves into new high territory.  When candlesticks are that small with "tails" on the candlesticks it delineates ambivalence and uncertainty among participants regarding future market direction.  Contrast this price action with the larger candlesticks in the earlier advance from the October lows (blue arrows) where the tall candlesticks spoke to conviction in the advance higher. 
  • Also notice momentum indicators are waning with a divergence in the upper panel (black arrow)
Still, the S&P is riding its five day moving average higher (red dashed line on the chart) and there is no indication that a pause in the rally is imminent.  Momentum indicators on daily charts can signal divergences for protracted periods of time before any corrective action can set in.

Sentiment has been extremely bullish in recent weeks which is usually a contrarian indicator.  The idea behind extremely bullish sentiment readings is that if everyone is in the market who is left to buy it?  Below is a chart of the Rydex Total Asset Ratio going back to late 2011.  The ratio measures investors who are in bullish funds versus those in money markets or in bearish funds.  It gives us a snapshot of what investors are doing with real money; not just surveys about how they feel about the market:

(click on chart for larger image)

The three bottom panels on the chart above measure the amount of money in bearish mutual funds, money markets and bullish mutual funds.  Money has moved drastically into bullish mutual funds (bottom panel) since the October 15th low but has backed off a bit in the past week or so which may be giving this market additional breathing room to move higher.  However, the readings are the highest they have been since 2011.

The big question pertaining to the ratio above is how much new money is still sitting on the sidelines waiting to get in.  The prevalent opinion on the street is that there's a lot more.  This factor could provide more levitation to stocks going into the new year.  We shall see ...


With employment numbers coming in better than expected on Friday and various other economic reports signalling a strengthening US economy, any possible corrective action could be worked off with side ways price action before another leg higher.  We also have seasonal factors which are serving as a tail wind to this market.  If we're going to see any weakness in this market it better come in the next week.  Otherwise, the Christmas spirit is going to kick in on the street and we will get our year end rally with the S&P easily piercing the 2100 level.  

If we give any credence to post 2008 crash history, the rally could even persist into February before any marked weakness manifests itself.

With persistent good news about the US economy the market is bracing itself for the seemingly inevitable "normalization" of interest rates and is anticipating that the Federal Reserve will raise short term rates in 2015.  This week, short term rates spiked in the futures market after the non manufacturing ISM came in stronger than expected and the monthly employment report blew away expectations.  Below is a daily ratio chart of the US Two Year Treasury yield and the Ten Year Treasury yield.  The white arrow signifies the yield performance of the Two year compared to the Ten Year while the top panel shows the relative performance of the two yields:  

(click on chart for larger image)

The significance of the chart may be lost on most readers but it is signalling a flattening of the yield curve.  For readers who might not understand the implications, a steeper yield curve signals a healthy economy and when the curve starts to flatten it means that credit conditions are deteriorating as lenders demand higher interest rates for short term money as concerns grow they might not be paid back on time or at all.  

However, in a world where central banks have done all they can to manipulate credit conditions to fight off the gargantuan deflationary forces that are trying to take down the global economy, the traditional interpretation of the yield curve can only be implemented with significant caveats.

With the US economy picking up momentum and the rest of the world in a stagnant economic situation, the market is still anticipating that the Fed will commence raising interest rates next year.  Thus, the futures market is pricing in this supposed inevitability.  However, longer term Treasury rates are barely budging as money in search of yield and more importantly, safety, is still fleeing to the long end of the curve due to continuing weakness in the Euro zone, Japan and China.

And then we have the ongoing argument concerning the precipitous drop in oil prices which is stirring a debate on whether this is good or bad for the global economy.  Some are heralding a deflationary boom next year as lower gasoline prices act as a tax cut, adding more discretionary income to strapped consumers in the hope that they will kick start a still relatively moribund economy.  But it is still an open question as to whether changing demographics and their attendant economic implications will allow this "tax cut" to have much effect on the global economy.

The other side of the argument is that regardless of any particular supply imbalances which may have caused the precipitous drop in oil prices, the price action in "black gold" is speaking to a deteriorating global economy where demand for the backbone commodity which every economic entity needs to fuel growth is seriously waning. 

Who wins the argument?  I take the "other side of the argument" because I believe that changing demographics in the consuming economies in the West is the predominant driver for the deflationary forces we are presently dealing with and I would submit to my readers that these changing demographics were the backdrop to the 2008/2009 financial debacle that almost undid the global financial system.  In any case, here's a weekly chart of West Texas Crude after Friday's close:

(click on chart for larger image)

We have some support at $65/barrel.  The Saudis made a statement this week that they see oil (in their case Brent crude) settling at $60/barrel.  In fact, no one knows where oil will settle at.  I believe if we break the $65/barrel level we will move quickly to the $48 to $54/barrel band on the chart (labeled potential drop zone).

Fundamentally it must be remembered that as demand slackens for any commodity the seeds of higher prices are planted as production recedes because producers cannot make money with such low end prices being offered.  And the RSI momentum indicator in the top panel of the chart above is deeply oversold.

Nonetheless, the "knock on" effects of these significantly lower prices which have dropped so suddenly over a very short time period are not a healthy sign in my opinion.

Gold has had some volatility recently and the "bugs" got excited again when the price popped over the past week.  But the prognosis for the "yellow metal" is still negative and is yet another sign of a weak global economy.  Here's a weekly chart of Gold going back six years:

(click on chart for larger image)

Could gold be forming a significant bottom?  Let's hope so!  Because if it drops thru the $1150 - $1100 level and into the potential target area on the chart above it will signify a radical weakening of the global economy.  I've stated many times in past commentaries that, given the preconditions set by global central banks, a sustained bounce in the price of gold will be a verifying signal that the global economy is finding it's way out of this mess.  But, for now, the trend in gold is clearly down.

The rising dollar is having the effect I predicted in past commentaries as money gets sucked out of emerging markets and into the coffers of the safest currency and government bond market in the world.  The following chart is a daily chart of the Wisdom Tree Dreyfus Emerging Markets Currency ETF (CEW) and I've highlighted all the major policy decisions of the Federal Reserve and their effects on Emerging Market currencies:

(click on chart for larger image)

What's readily apparent from the chart and the recent Fed history is that every time the Fed even hinted that US monetary accommodation might be taken off the table emerging market currencies tanked.  The recent weakness in currencies is spilling over into emerging market equities in spite of the worldwide rally in risk assets:

(click on chart for larger image)

This is a daily chart of the iShares MSCI Emerging Market ETF (EEM) and you can see that the ETF never really recovered from the worldwide correction in stocks that took place in September into mid October.

And what about China?  I was challenged this week by a thoughtful investor regarding the recent almost parabolic rally in the Shanghai Composite Index.  I would submit to my readers that the recent spike in the Shanghai Composite is the result of the newly approved link up between Hong Kong and Shanghai that allows easy accessibility for foreign investors to freely trade on the Shanghai; something that has never happened before.  Shanghai-Hong Kong Stock Connect is a securities trading and clearing links program for establishing mutual stock market access between Mainland China and Hong Kong.  This has facilitated an influx of trading volume by investors which is driving prices higher.  Another factor is the ongoing hope that the Chinese government is willing to continue stimulative monetary measures (similar to QE). Their surprise announcement two weeks ago regarding lowering a benchmark interest rate has market participants on the edge of their seats waiting for more monetary accommodation; all the result of a continuing housing bubble deleveraging, continued corrupt market practices and the ongoing challenges inherent in changing their export driven economy into a consumer based economy.  I would submit to my readers that rather than watch the Shanghai composite Index for signs on how China is faring, watch the Baltic Dry index.  This index is one of the purest leading indicators of global economic activity. It measures the demand to move raw materials and precursors to production.  China, being a leading importer and end user of these same raw materials, should be the main catalyst in driving this index higher:

(click on chart for larger image)

The Baltic Dry index is the top chart.  It never really recovered from the Great Financial Crisis of 2008.  It did bounce as did the Shanghai Composite (second panel) as the result of the initial quantitative easing program the Federal Reserve implemented in order to stave off depression.  Since that time both indexes have meandered  flat to lower.  So, where is this sudden strength in Chinese stocks coming from?

I've said it so many times that my regular readers are sick of hearing it but I'll say it again:  China and emerging markets are "the tail the dog wags!"  In our current environment, if you want to know which way the global economy and risk assets are heading in 2015 you need to look to Europe.


Analysis

 :
The Federal Reserve is in a quandary.  With a seemingly strengthening US economy making ZIRP (zero interest rate policy) untenable they are faced with raising interest rates with inflation significantly under their target rate of 2% and with the rest of the globe flirting with deflation!  

Indeed, the Euro zone seems to be losing the battle against the deflationary juggernaut as can be seen in the chart below:

(click on chart for larger image)

With the annual change of the inflation rate only 0.3% the EU could fall into deflation and recession if its economy literally just tripped.  Germany, who carried the EU thru the past five years is also suffering serious disinflationary pressures:

(click on chart for larger image)

German CPI has flat lined at 0.8%

The German manufacturing giant has also fallen into contraction:

(click on chart for larger image)

With all this going on, market participants still continue to "grasp for straws" when any economic report comes in above expectations as a sign that Europe is finally turning around. The market got excited yesterday when German factory orders came in above expectations, as though one reading of this volatile series speaks to a developing trend.

The other "straw" investors and traders seem to be hanging on is the supposed inevitability that the ECB (European Central Bank) is inevitably going to break down and buy European sovereign debt, much the way our Federal reserve brought Treasuries over the past five years.  

The weakness in stocks we had during the first hours of trading on Thursday were the result of Mario Draghi, the President of the ECB, comments during his press conference after the ECB governing counsel met.  It was clearly apparent and he even stated that there was significant division among the members of the governing counsel on implementing any other measures that might mitigate the ongoing deflationary pressures building in the Euro zone.  The press conference was decidedly down beat with the further comment that the ECB would monitor the progress of the other stimulus measures already implemented and reassess the situation "next year" and that did not meaning January either.

I've got news for everybody.  The ECB will NEVER buy sovereign debt for the reasons that the Germans, who are the deep pockets in Europe, will never agree to finance their poorer and sometimes profligate southern neighbors.  And if I'm right about this, and I have hardly ever felt so sure of something as this, then Europe is going to have to "pull a rabbit out of a hat" to get their borderline recessionary economy going.

Can they do it?  Anything is possible in the realm of economics and the financial markets but it clearly is not probable.  If US consumption could make the kind of gains that spur emerging market and Chinese economies then our economic steam engine could keep chugging but I cannot say I have a lot of confidence that we could carry the global economy alone.

In the meantime, the Fed seems to be on track to start raising short term rates sometime in the second quarter of 2015 (most think in June).  What would be the implications if they raised rates in an environment where the Eurozone was barely growing?  Well, we're seeing it now as the market is currently pricing in the first raising of short term rates but I suspect that the long end of the yield curve (10 and 30 yr. yields) would also finally jump.  Such a move in the Treasury market would cause the US Dollar rally to continue with the following results:

  1. Deflationary pressures would mount due to the continue strengthening of the Dollar.
  2. Money would continue to be sucked out of emerging market economies but at a quickened pace.  You'll almost be able to hear the sucking sound ...
  3. The strengthening Dollar would negatively impact earnings of US companies doing business overseas by making their goods more expensive in foreign currencies.

So, maybe the Fed will keep ZIRP?  I agree with Jeff Gundlach of DoubleLine that the Fed really has no choice but to start the process.  Jeff even stated that they'll probably do it just to see what happens.

The principle behind raising rates is that the economy is strengthening, allowing creditors to charge more money to lend it.  But we live in a global economy and what we, the Germans, the Chinese and the dozens of emerging market countries do, effects all of us together.  We're no longer silo'd in our own economies. There are "knock on" effects when the largest and most powerful central bank on the planet decides to raise interest rates.  In our present economic environment, even more so ... 

So, the markets in 2015 will be largely and substantively held captive to the economic progress or lack there of in Europe.  

This is my last commentary for 2014.  Have a Merry Christmas and a great holiday season!


The statements, opinions and projections made in this writing are for informational purposes and are my own.  They do not represent the views of my broker/dealer.  Additionally, this writing does not constitute an offer to sell, a solicitation to buy, or a recommendation regarding any securities transaction, or as an offer to provide advisory or other services by me or my broker/dealer in any jurisdiction in which such offer, solicitation, purchase or sale would be unlawful under the securities laws of such jurisdiction

The information contained in this writing should not be construed as financial or investment advice on any subject matter. This writing is not published for the purpose of utilizing the information for short term trading or long term investing in stocks, bonds, ETFs, mutual funds,currencies, indexes, index or stock options, LEAPS, and stock or commodity futures. I expressly disclaim all liability in respect to actions taken based on any or all of the information on this writing.  Seek the personal, face to face guidance of a registered investment advisor before entering any trade or investment.  Anyone who trades or invests based on the information in this commentary does so at his/her own risk.  

Warning!  you can lose some or all of your principal (money) investing in stocks, bonds, ETFs, mutual funds, currencies, indexes, index or stock options, LEAPS and stock or commodity futures!


Saturday, November 22, 2014

Glimmers of reflation?

Equities continue to defy gravity as central bank largess continues and global economic data remains neutral to negative.  An announcement Thursday evening by the PBoC (People's Bank of China) that they were lowering their benchmark interest rats sent the S&P E minis spiking overnight and provided another gap in he cash chart for the S&P 500 and all the major averages on Friday.  Although buying pressure waned throughout the day the S&P came back sufficiently in the last hour of trading and this type of price action can only be classified as bullish.  Here's a one minute chart of the S&P 500 ETF (SPY) that encompasses Thursday and Friday's price action:

(click on chart for larger image)

I had concerns that the market could not hold onto the gains at the outset of the day but in the last hour the "smart money" came in to position themselves for the coming week.

The bullish tenor of this market cannot be denied and there are even signs that small caps may be stirring with the Russell 2000, which has been flat all year, may be ready for a break out to the upside.  Here's a daily chart of the Russell 2000 since the beginning of 2014.  We had a double top in the early part of the year and it is self evident from the chart that small caps have experienced significant volatility this year:

(click on chart for larger image)

I've identified a possible inverse head and shoulders formation on the chart which could be predictive of a break out to the upside if the right shoulder comes to fruition.  Although I've identified this formation on the chart I personally don't have much confidence in "head and shoulders" formations after the past five years since the pattern has often signaled a false break out.  But I post it nonetheless because if we're going to move meaningfully higher in equities in 2015 then small caps are going to have to participate.  They have led this market higher in the last few years and they're characteristics as high beta (riskier) stocks and indications of a healthy economy necessitate their participation in any market up trends.

As I look at market internals I get the sense that although this market is tired we will continue to move higher into the New Year.  Net new highs on the S&P 500 don't impress me but at the same time there's no cause for concern:

(click on chart for larger image)


Yesterday's price action I outlined above was, for me, a significant indication that there's still enough buying pressure in this market to insure a rally well into 2015, possibly into February when we've experienced some weakness every year for the past few years.

I do think Treasuries are signaling that we're going to seeing some significant moves in the financial markets in the coming months.  Below is a 60 minute chart of the Ten Year Treasury yield for the past two months:

(click on chart for larger image)

The pink shaded area are Bollinger Bands which is a chart overlay that shows the upper and lower limits of 'normal' price movements based on the Standard Deviation of prices.  The fact that they have narrowed this much normally is predictive of a significant move in either direction.  Which way that direction is will have implications for stocks going forward.  However, inter market correlations seem to be changing and it's not readily predictable that a spike lower in interest rates would create a sell off in equities as it normally has in the past.  

In a world where central bank accommodation has the planet awash in liquidity, sovereign interest rates are anchored on the short end of the yield curve by fixed government rates and the long end continues to be suppressed by the same liquidity and buying pressure.  Significantly, the threat of deflation has been the main fundamental of this monetary phenomenon and will continue to be until we see signs of global growth, especially out of the Euro zone.

The US Dollar seems to be continuing its inexorable rise as it broke out to new multi year highs on Friday which is part of the reason why equities reacted in the cash session that day:

(click on chart for larger image)

A stronger dollar aggravates deflationary pressures in commodity prices as the world's reserve currency strengthens.  But the Dollar is also telling the story of a recovering US economy while Europe and Japan remain mired in flat deflationary economic conditions.  And so, the inverse correlation we have often experienced between a stronger US Dollar and US equities has now been significantly mitigated.

Surprisingly, we've been seeing some buying pressure in Gold over the past three weeks  which also has seemed to give the weakened commodity complex some juice:

(click on chart for larger image)

The chart above is a weekly chart and I like the weekly candlesticks with the long wicks on the bottom of each for the past three weeks (red arrow).  This may be signifying a bottom in the yellow metal but it's still too early to tell.  Sentiment has finally started to get ugly for gold which is a good contrarian indicator that the "blood bath" in the precious metal might finally be abating.  But the chart tells me it's still too early to be dogmatic of a turn higher.  

It's important to watch gold in the current global economic situation we find ourselves.  Higher gold prices will be predictive that the global economy is starting to win the battle with deflation.  It will mean Europe is turning around, and as stated in my last commentary, as Europe goes so will the global economy and financial markets in 2015.

As stated above, the jump in Gold has also seemed to drag along the commodities complex.  Below is a daily chart of the Reuters/Jefferies Commodity Research Bureau Index (CRB) and the index has broken out of a multi month downtrend on the daily chart:

(click on chart for larger image)

Are we starting to see glimmers of inflation?  It's still too early to tell but let's hope so!

Finally, I had some concerns on the divergence between the junk bond market and stocks that had developed in recent weeks.  Much of the problem stemmed from the fact that the market was starting to predict that smaller, highly leveraged players in the oil/natgas industry were going to start having problems meeting their financial obligations as oil descended under $80.00/barrel.  However, with some recent buy outs by some of the bigger names in the industry the market seems to have stabilized a bit as seen below on a daily chart of the SPDR Barclays High Yield Bond ETF (JNK):

(click on chart for larger image)

The chart displays a classic reversal pattern.  The high yield market is strongly and positively correlated to equities and the anticipated recovery in this market is bullish for equities.

Regular readers will notice I've stayed away from any fundamental analysis in this commentary.  The reason is that there's simply a lot of "noise" in the financial press on the direction of the global economy.  I outlined the challenges in my previous commentary two weeks ago and nothing has really changed.  Sometimes the best thing to do is let the market speak to you thru the charts and that's what I've done in this commentary.


Have a great week and Happy Thanksgiving!


The statements, opinions and projections made in this writing are for informational purposes and are my own.  They do not represent the views of my broker/dealer.  Additionally, this writing does not constitute an offer to sell, a solicitation to buy, or a recommendation regarding any securities transaction, or as an offer to provide advisory or other services by me or my broker/dealer in any jurisdiction in which such offer, solicitation, purchase or sale would be unlawful under the securities laws of such jurisdiction

The information contained in this writing should not be construed as financial or investment advice on any subject matter. This writing is not published for the purpose of utilizing the information for short term trading or long term investing in stocks, bonds, ETFs, mutual funds,currencies, indexes, index or stock options, LEAPS, and stock or commodity futures. I expressly disclaim all liability in respect to actions taken based on any or all of the information on this writing.  Seek the personal, face to face guidance of a registered investment advisor before entering any trade or investment.  Anyone who trades or invests based on the information in this commentary does so at his/her own risk.  

Warning!  you can lose some or all of your principal (money) investing in stocks, bonds, ETFs, mutual funds, currencies, indexes, index or stock options, LEAPS and stock or commodity futures!








Saturday, November 8, 2014

Global Economy at a Crossroads

Stocks managed to squeeze out new all time highs on Friday afternoon after the S&P bounced between gains and losses for the entire day.  A one minute chart of the S&P illustrates the nature of the indecisive price action.  The horizontal blue dashed line delineates the day's trading activity:


(click on chart for larger image)

The market seemed to be held captive to a seemingly weaker than expected monthly employment report although the report was not, to me, any weaker or stronger than any other monthly report we have seen in the last year.  Employment continues to grow five years after the Great Recession with the same challenges we face in terms of weakness in hourly earnings and wage growth.

I interpret the surge into the close as a short term bullish indicator as the price action is indicative of the "smart money" taking positions in preparation for next week.  Moreover,that traders were willing to take positions over the weekend is a sign of confidence and probably complacency among market participants.

A long term divergence is manifesting itself on the weekly charts that folks should be cognizant of.  Below is a weekly chart of the S&P 500:

(click on chart for larger image)

While the S&P continues its march higher, momentum has significantly diverged (top panel) from the price action.  While these divergences can persist for long periods of time while the market moves higher it is important to note the divergence because it is usually predictive of some type of corrective action.

There are sector divergences that have me puzzled since other fundamentals would suggest that these sectors should be strengthening.  For instance, the Consumer Discretionary Select Sector SPDR ETF (XLY) has been weakening all year and while the descent relative to the S&P 500 ETF (SPY) has moderated it is still in decline.  The chart below is a daily chart of the Consumer Discretionary Select Sector SPDR ETF (XLY) and the relative price action relative to the S&P 500 ETF (SPY) is in the panel below:

(click on chart for larger image)

With the price of gas as low as it has been for years one would think we would see strengthening in this area.  

Also of note is the price action of Utilities, a defensive sector of the market, which has been outperforming the S&P on a relative basis for weeks:

(click on chart for larger image)

The bottom panel shows the price relative to the S&P and I circled the week's price action on the chart.  Of note technically was the price action on Wednesday and Thursday where the utilities swung wildly and while the two candlesticks on the chart in the green circle I outlined cannot be classified technically as a bearish engulfing pattern, it is close.  Bearish engulfing patterns are predictive of a turn to the downside.  

Still, it's hard to argue against the position that the trend in equities is higher.  With seasonal factors in the market's favor and earnings season being a good one, I'd still have to side with those expecting a surge in equities going into the Christmas season.  However, 2015 may be a different story.

As Treasuries continue to stay levitated while equities rally higher it seems investors are trying to position themselves on both sides of the fence.  And I suspect for good reason.

While the economic recovery from the Great Recession continues to gain momentum in this country it is evident to all but the most uninformed that the rest of the world wallows in flat to no growth conditions.  Indeed, as the European Union continues to teeter on recession and Emerging Markets are held captive to the consuming countries in the west, the US is the only shining economic light on the planet.

The rest of this post will dissect the title of this commentary.  And I'll state my thesis up front:  fundamentally speaking, Europe is the key to the direction of financial markets while the Dollar will serve as the technical catalyst for that direction.

The Europeans have been "hamstrung" by the unique relationships they have in that union.  Those relationships can be summarized as "monetary union without fiscal union" and so as everyone shares the same currency they all go their own way as separate political and fiscal entities.  

The Germans, who have been essentially the glue (aka money) that keeps that union together, are loathe to support their southern neighbor's profligate ways.  This, in turn, has prevented the European Central bank (ECB) from implementing the kind of monetary accommodation that the US and Japan have implemented in the attempt to turn their economies away from the deflationary pressures wrought by the loss of 34 trillion in global wealth in the 2008 - 2009 downturn.

Mario Draghi, President of the ECB, keeps on promising more stimulus but unless the Germans acquiesce and allow the ECB to buy sovereign debt (country specific sovereign bonds comparable to US Treasuries) the effects of any other stimulus they have attempted since 2010 has had diminishing effects.  There has been some talk that as recessionary conditions start to spread to the core EU countries (Germany, Netherlands, France, Finland) that Germany may give in and allow such purchases.  Don't hold your breath!  Germans still suffer the scars of the Weimar hyperinflation of 1922-1923 and are not likely to agree to any policy they see as potentially inflationary, like a US style QE.  But this is precisely what is needed to remedy the situation in the EU.

There are some signs that the deflationary pressures may be relaxing.  Money supply there is incrementally improving:

(click on chart for larger image)

And private loan demand is also marginally improving although still negative:

(click on chart for larger image)

Clearly, these glimmers are not enough for me to "hang my hat" on a European recovery.  Others on the street agree with me.  Scott Minerd, Chairman of Investments and Global Chief Investment Officer for Guggenheim Partners believes the Europeans and particularly the ECB must act now to prevent their slowdown and growing deflationary pressures from taking over and dragging the rest of the global economy along with it.

The strength of the US Dollar has been the result of the weakening picture in the EU and is exacerbating the deflationary pressures we are seeing in commodities and particularly gold and oil.  As the Euro, as the result of in some cases negative real interest rates on the European continent, continues to drop, the Dollar index, made up of a basket of currencies of which the Euro is 57%, continues to rally.  As the world's reserve currency, a strengthening Dollar necessarily equates to a depreciation of all other currencies making everything more expensive in those currencies.  This, in turn, only serves to aggravate any economic slowdown in those economies.

For now, the US Dollar seems as though it might have reached a temporary plateau:

(click on chart for larger image)

As seen above, USD is meeting some significant resistance and Friday's price action in the Dollar could be taken as just a rest in response to market perceptions that the monthly employment report was not up to par or it could be interpreted as the beginning of a corrective phase in the Dollar.  I'm going to opt for the latter because I don't believe these markets move that much anymore on these monthly employment reports.  

Fundamentally, the Dollar might be meeting resistance because the US trade deficit, if broken down to petroleum and non petroleum trade deficit, has diverged significantly:

(click on chart for larger image)

Big trade deficits are antithetical to a strong currency.  If this is impacting USD and the Dollar goes into corrective mode it will be supportive of global stock markets.  However, with everyone on a crusade to debase their currencies in order to ignite growth, the US is still the best looking house in the slum and any slowdown in the appreciation of the Dollar will probably be short-lived.

Japan, which announced another mammoth liquidity injection in their economy a week from this past Friday, also adds fuel to Dollar appreciation.  Bank of Japan (BoJ) is going all out to break the hold deflation has had on their economy for over two decades and is flirting with monetary accommodation many see as reckless:

(click on chart for larger image) 

The chart above shows the comparison between the Fed's QE program with projections into 2015 along with BoJ's stimulus.  How can the Dollar not continue to rally in the face of Japanese currency debasement and European inability to stem the deflationary tide seemingly overtaking them?

A stronger Dollar equates into profit margin pressure in US multi national corporations as their products become more expensive overseas in markets with deteriorating global growth.

And what of Emerging Markets?  Many on the street are touting their value in this sluggish global environment.  Not me!  The argument that says that as the Fed attempts to normalize monetary policy by raising short term rates, there will not be a commensurate global shift of assets from the more speculative emerging market complex to the safer haven of the safety of Uncle Sam's debt is misguided.  While it is true that some Asian nations have strong external balances and may be able to fare better than they did in 1997 when the Asian Currency crisis crushed emerging markets, to invest in emerging markets in the face of a strengthening US dollar is a fool's game!  The chart below is a weekly chart of the WisdomTree Dreyfus Emerging Markets Currency ETF (CEW).  This ETF measures the performance of a basket of Emerging Market currencies relative to the Dollar:

(click on chart for larger image)

As can be seen, CEW has been posting a succession of lower highs and is now sitting on major support.  A breakdown under this support is in direct contra distinction to the US Dollar chart I posted above and I would submit to my readers that such a breakdown in CEW and a break out in USD will spell an ugly start to 2015 for global equities.

The iShares Emerging Markets ETF (EEM) is already starting to discount the coming weakness in emerging markets due to a strengthening Dollar.  The chart below is a daily chart of EEM with the S&P500 ETF (SPY) superimposed on it (solid black line) as well as a price relative comparison in the top panel:

(click on chart for larger image) 

In the near term, the massive Japanese stimulus measures announced about a week ago should continue to buoy US equities in the near term and that's why I'm comfortable with predicting a continued rally into year end.  However, there are enough technical divergences and fundamental problems that must be resolved that the new year may auger renewed weakness in global financial markets.  

Make no mistake, Europe is the key to 2015.  Unless, the ECB is given free reign to truly stimulate their currency bloc then we must hope that the few glimmers of economic growth I posted above will evolve into a full blown recovery for the EU.  Absent these two scenarios, a strengthening Dollar will strangle global economic growth to the detriment of everyone, including us in this country.

Have a great week!


The statements, opinions and projections made in this writing are for informational purposes and are my own.  They do not represent the views of my broker/dealer.  Additionally, this writing does not constitute an offer to sell, a solicitation to buy, or a recommendation regarding any securities transaction, or as an offer to provide advisory or other services by me or my broker/dealer in any jurisdiction in which such offer, solicitation, purchase or sale would be unlawful under the securities laws of such jurisdiction

The information contained in this writing should not be construed as financial or investment advice on any subject matter. This writing is not published for the purpose of utilizing the information for short term trading or long term investing in stocks, bonds, ETFs, mutual funds,currencies, indexes, index or stock options, LEAPS, and stock or commodity futures. I expressly disclaim all liability in respect to actions taken based on any or all of the information on this writing.  Seek the personal, face to face guidance of a registered investment advisor before entering any trade or investment.  Anyone who trades or invests based on the information in this commentary does so at his/her own risk.  

Warning!  you can lose some or all of your principal (money) investing in stocks, bonds, ETFs, mutual funds, currencies, indexes, index or stock options, LEAPS and stock or commodity futures!


Saturday, October 25, 2014

The Tension of Dichotomy

Amidst Ebola scares and concerns about global deflationary pressures stocks, which had looked like they were about to fall off a cliff in the traditionally volatile month of October, did an abrupt "about face" and had a huge reversal day on Wednesday, October 15th, and it now appears the rally is on. 

The fundamental impetus for the move was a statement from St. Louis Fed President Jim Bullard who publicly stated that if disinflationary pressures persisted in this country we could have more "QE" (quantitative easing). The PBoC (People's Bank of China) helped by injecting additional liquidity in their banking system.  Like a junkie who just had his fix, the market sprung forward in euphoria!

Seasonality is taking over and with economic news out of the Euro zone this past week that suggests that, for now, things aren't getting any worse over there, it looks like we're going to come out of October on a strong footing going into the seasonally strong months of November and December. A chart of the NYSE Composite which represents 1900 stocks traded on the NY Stock Exchange is representative of the turn in equities:

(click on chart for larger image)

The NYSE managed to close above neckline support turned resistance (red dashed line) on Friday which I consider to be a significant positive development for stocks generally.  If we look at the Wilshire 5000 Index which is a composite of all US equities the positive development is more apparent:

(click on chart for larger image)

We can see here that the Wilshire has decisively cleared a similar resistance area that coincides with a Fibonacci retracement level.

Technically, we can say that all indicators point to an assault on all time new highs for US stocks.  Of course, anything can happen, and in a world with geo political tensions, Ebola and whatever else pops up, volatility is liable to be with us into the strong seasonal months of November and December.  However, it is hard to ignore what the technicals are telling me. 

Treasuries remain elevated in this environment and this inter market anomaly remains cause for concern.  In a world flirting with deflation, interest rates are anchored and remain near historic lows; not a positive indication for global economic growth.  Here's a daily line chart of the Ten Year Treasury Note yield:

(click on chart for larger image)

The chart is instructive as it points out the post World War II lows in the Ten Year yield back in July, 2012 and the recent plunge in yield which started in late September (green circle).  We're coming back a bit from that plunge and October 15th was a huge reversal day for Treasuries as well as stocks so that could be the "flush out" that was needed for a sustained trend higher in interest rates.  But that is mere conjecture on my part as interest rate sensitive utilities which correlate well with bonds have been resilient throughout.  Here's a daily chart of the Dow Jones Utility Average that tracks the performance of 15 well known utility companies.  Utilities rise when traders/investors anticipate falling interest rates. That's because utilities are big borrowers and their profits are enhanced by lower interest costs. Conversely, utility prices tend to decline when investors expect rising interest rates. Because of this interest-rate sensitivity, the utility average is regarded by some as a leading indicator for the stock market as a whole.:

(click on chart for larger image)

Utilities have surged to all time new highs and on a price relative basis they have drastically outperformed the S&P 500 since late September.  Money continues to flow into the defensive sectors of this market as investors remain caught between a rock and a hard place.  Everyone wants to take the ride higher but in relatively safe sectors (utilities, healthcare and consumer staples). 

As I had outlined in my previous commentary, the distinction of a growing economic recovery in this country along with a European deflationary slowdown has created a tension in global financial markets which makes the idea of a healthy stock market problematic to many.  Even in the US with the positive earnings season we are having which is one of the main drivers of this recent rally, earnings continue to increase on declining revenues:

(click on chart for larger image)
Chart courtesy of Bespoke Investment Group

If stronger earnings are being driven largely by operating efficiencies,how healthy can the US and global economy be?  It's been my thesis for awhile that declining revenues are an indirect result of changing demographics in the developed world (US & Eurozone).  Welcome to the "new normal"!

And then we have oil!  The recent sell off has spurred both positive and negative arguments for economic growth.  On the one hand, consumers benefit significantly from a drop in gas prices as more discretionary income becomes available to them.  On the other hand, the oil and gas boom in this country will abruptly stop if oil drops below $80.00/barrel, as anyone who lives in Texas knows.  It's not profitable to take it out of the ground for prices below that mark.  Here's a monthly chart of West Texas intermediate Crude oil going back to mid 1996:

(click on chart for larger image)

We've penetrated a support line going back to mid 2010 while a larger trend line going back to 1999 (blue dashed) is intact.  Fracking technology and the boom have created an over supply and politically, it is said the Saudis are cutting production in order to punish those they see as their geo political opponents, particularly Russia.  This situation is having an unsettling effect in global markets not only for it's deflationary implications but because it is destabilizing nations like Russia and Venezuela who derive most of their wealth from oil production.  We here in Texas need to be especially concerned because we have weathered the global economic downturn since 2008 very well, largely due to the oil and NATGAS boom.  

Inevitably, the overriding concern I've outlined in many commentaries persists and it's origin lies in the Eurozone. With persistent deflationary pressures emanating out of Europe can there be a dichotomous global growth picture?  Can the US go it alone and grow while the rest of the globe continues in a disinflationary to deflationary low to no growth economic state?

Michael Gayed, in a recent piece here, has consistently argued that inter market relationships continue to warn us that this party cannot go on much longer without some sort of "flush out".  Michael is fond of using the TIP:TENZ ratio to measure investor expectations of future inflation/deflation which is posted below:

(click on chart for larger image)

This ratio measures the iShares Barclays TIP Bond Fund in relation to the PIMCO 7 to 15 Year US Treasury Index.  Investors buy TIPs (Treasury Inflation Protected Securities) when they are concerned about mounting inflationary pressures.  Conversely, regular Treasuries tend to rally in a lower inflationary environment when investors are concerned that economic growth is slowing.  Thus, the numerator (TIP) in the ratio drops when inflationary pressures are waning.

The ratio above plunged in the recent market slide in early to mid October only to recover above a support line established in August, 2011 when markets suffered a serious correction due to concerns over the US credit rating and especially the fear that the Eurozone was set to implode.  

I prefer to use the TIP:IEF (iShares Barclays TIP Bond Fund: iShares Barclays 7 to 10 Yr Treasury Bond Fund)  ratio because it has a longer track record but the theory behind using the chart is the same as Michael's:

(click on chart for larger image)

This ratio continues to drop.

In a brief email interaction I had with Mike in response to his article I cited above I wrote on October 19th:

I believe it can get worse.  I believe in inter market correlations (both inverse and positive).  I don't believe TIP/TENZ can break support without ultimately causing a sell off in equities.  But as I tried to articulate in our interaction on Twitter, as soon as the junkie (the market) gets a whiff of positive central bank news, risk assets turn around on a dime and go higher.  

There's an obvious breaking point in all this.

The other end of the equation is the balance between an obvious yet tepid recovery in US and an EU looking more and more like its going into a deflationary spiral.  Japan is already there.  I ignore China because it is simply the "tail the dog wags".

Can the US go it alone and prosper (relatively) while EU and Japan wallow?  I say no but stranger things have happened and even the brightest among us do not have a definitive answer until after the fact.

As long as the market continues to get it's "fix" and think central banks "have it's back" then investors will focus on earnings and the earnings so far this quarter are beating street estimates (never mind that this is a big game in and of itself).  And that's why I think we could see a year end rally.

As long as central banks prolong the global economy taking its medicine they forestall the inevitable.  The Central Bank experiment to buy time has about run it's course.  Some day soon even "Fed speak" will not move these markets.  And then watch out ...



Have a great week!


The statements, opinions and projections made in this writing are for informational purposes and are my own.  They do not represent the views of my broker/dealer.  Additionally, this writing does not constitute an offer to sell, a solicitation to buy, or a recommendation regarding any securities transaction, or as an offer to provide advisory or other services by me in any jurisdiction in which such offer, solicitation, purchase or sale would be unlawful under the securities laws of such jurisdiction

The information contained in this writing should not be construed as financial or investment advice on any subject matter. This writing is not published for the purpose of utilizing the information for short term trading or long term investing in stocks, bonds, ETFs, mutual funds,currencies, indexes, index or stock options, LEAPS, and stock or commodity futures. I expressly disclaim all liability in respect to actions taken based on any or all of the information on this writing.  Seek the personal, face to face guidance of a registered investment advisor before entering any trade or investment.  Anyone who trades or invests based on the information in this commentary does so at his/her own risk.  

Warning!  you can lose some or all of your principal (money) investing in stocks, bonds, ETFs, mutual funds, currencies, indexes, index or stock options, LEAPS and stock or commodity futures!