Sunday, February 22, 2015

Money moves into Europe!

Since my last commentary the market has been pushed to and fro with concerns over a Greek exit from the Euro Zone and with Friday's "agreement" in Brussels it appears that the Greek saga has been pushed back another four months when another day of reckoning will rear it's ugly head.

Monday will tell us much regarding the Tsipras' government's resolve to stay in the zone when they submit their list of alternative reform measures to the EU.  If there's any fudging on the Greek government's part to dodge the general thrust of the austerity measures originally imposed upon them, it will be back to the drawing board once again and more market volatility will result.  Still, the market has been very resilient throughout the negotiation saga of the past few weeks and I believe any market moves will be muted.

In my opinion, the two biggest concerns market players have at this point is the uncertain ramifications of a Greek exit from the EU and the risk of contagion as other separatist movements on the European continent might be emboldened to instigate a break away from the EU.  While I don't see the latter as a significant risk, the uncertainty of the former is creating market volatility.  However,Greece is the only sovereign "basket case" in the Euro zone and a "Grexit" (Greece leaving the EU) is still a very small probability.  The Tsipras government is playing a game of chicken ...

Cartoon courtesy of SoberLook
@soberlook


 ... which they cannot win and if the ECB withdraws their support from Greek banks it would immediately result in abject destitution for the Greek nation and spawn a humanitarian crisis of huge proportions.

In the meantime, there continues to be glimmers of reflation in the Euro zone.  Here's just one example.  Italy and Spain, two nations which have struggled since 2008, are turning up:

Chart courtesy of SoberLook
@SoberLook

Other economic indicators (credit growth and expanding money supply) are giving significant support to international equity and commodity valuations.

For instance, oil looks like it has found a floor and even after a disappointing report on Friday where the reduction of US rig counts was lower than expected, "black gold" was remarkably resilient.  Many traders (and I) expected a much more severe sell off and it seems like West Texas Crude has some support at $50/barrel:


(click on chart for larger image)

This weekly chart clearly shows the strong bounce in the area I earlier marked as "potential drop zone" and we are now at the top of another resistance area.  My thesis on oil's recent bounce in the face of gross oversupply and static demand is market expectations that Europe is now stirring we are going to start to see some measurable global economic growth which will increase demand for oil.

Whether oil's bounce and recent positive economic reports out of the EU (as unbalanced as they are)  are more than "head fakes" only time will tell but there's no question that cheap oil and a weak Euro are starting to produce some growth in Europe and is gaining the attention of market participants.   We may be starting to see a rotation out of US equities and into European shares as the chart below shows:

(click on chart for larger image)

This is a weekly chart of the Dow Jones Europe 600 Index, a broad based index of European stocks and I want my readers to notice the price relative chart in the bottom panel.  After a long downtrend, European stocks have jumped and are, at least for now, outperforming their US counterparts.  I believe this explains, in part, the relatively sluggish nature of the advance of US equities as money flows are starting to move out of the US into continental stocks.

The beginning of a rotation into European equities may explain why US stocks seem lethargic at these levels and I was thinking there might be a global rotation going on but not so in Emerging Markets:

(click on chart for larger image)

 This is a weekly chart of the iShares MSCI Emerging Markets ETF (EEM) and the price relative chart to the S&P500 in the bottom panel is showing continued under performance.  We do see some glimmers in momentum in the top panel (red arrow) where MACD is undergoing a possible crossover while the ETF itself is snagged on Fibonacci resistance.

I consider the price action in EEM logical given present conditions in the global economy.  I have said more than a few times in past commentaries that, at a macro level, the consuming economies in the West will have to lead us out of this global economic malaise we find ourselves in before we can start to see a significant pick up in economic activity in the developing nations of Asia and the Mid East.  Simply, until Emerging Markets and China transition into true consuming economies, it is dependent on the West (US & Europe) to pull us out of this low growth, disinflationary to deflationary mire we find ourselves in.  There's much more to say on this topic as I believe that, at a foundational level, global economic challenges are structural in nature mainly based on demographics.  However, I neither have the time or the inclination to comprehensively address this issue at this time.

Here in the US, stocks continue higher with unimpressive momentum as can be seen in a daily chart of the Wilshire 5000 Index below.  All the major averages saw all time highs again on Friday but we're starting to see that rounding top action which usually presages either a "garden variety" correction or a consolidation:

(click on chart for larger image)

This is a daily chart of the Wilshire 5000 which is the entire US stock market.  US stocks managed to break out of a trading range (green highlight) that started right around the first of the year on what I consider unimpressive momentum.  We'll see if the market can sustain the breakout and Friday's candlestick was a positive but my intuition tells me we may not maintain these levels in the short term. I suspect we'll retrace Friday's price action back below the break out (brown line) on Monday.

When all is told, the markets are generally moving true to their inter market relationships.  Part of oil's bounce and the possible ascent of US stocks can be traced to what is at least a consolidation in the US Dollar.  Below is a chart of the Powershares DB US Dollar Bullish Index Fund (UUP) which is a popular trading vehicle if you don't want to trade the currency directly:

(click on chart for larger image)

The dollar is forming a less than perfect bullish ascending triangle which usually means a break out to new highs.  However, the Relative Strength Indicator (RSI) in the top panel has weakened considerably which makes me think the dollar could fall out of the triangle to the downside.  This would be a catalyst for equities and commodities in the short term and would serve to mitigate disinflationary and deflationary pressures in the global economy.

In my last commentary I made much of the price action of Treasuries in determining general market direction.  Well, if rates are any indication, this market is moving higher:

(click on chart for larger image)

Here's an update of a chart I've posted many times before of the Ten Year Treasury yield.  Since February 2nd, the yield has backed up almost 45 basis points(green highlight)!  Treasuries are telling us that while rates are still incredibly low, economic growth is gaining momentum.  Now, we've seen this movie before so I wouldn't be surprised if this is a "head fake" and a trend line I drew on the chart above shows we haven't broken trend yet but the spike in yield in a few weeks is impressive.

Much of the action in the Treasury market is the result of participants trying to discern when the Fed will commence raising short term interest rates.  While some are targeting June others are targeting September and still others are targeting 2016.  My view is that it will happen later rather than sooner.  Everyone expecting a June lift off points to the seemingly excellent employment reports we have been seeing.  And I know this is anecdotal, but I don't know anyone who lost a job in 2008 who, if they found a job, is making more money than in the job they previously lost and I don't know anyone who's pulling down annual raises that are meeting even the lowest inflation levels we are experiencing.  If the employment reports were threatening an overheating economy we would be seeing inflationary expectations rising.  And we're not:

(click on chart for larger image)

This is the TIP:IEF ratio which is a measure of the market's expectation of where inflation is going.  I have posted a more detailed explanation of how the ratio works in past commentaries but for now, if the ratio is rising inflationary expectations are gaining steam and if the ratio is dropping, disinflationary to deflationary expectations are taking over.  I highlighted where we are now in (green) and we've just bounced in the last few weeks after a sustained descent that started in July 2014.  The bounce can be explained by the recent comeback in the price of oil as anything else.



Summing up, I'm constructive on equities going into mid year with a possible slowdown in the next month.  The Treasury market is telling us that Greece is a non event and that global economic growth is turning positive.  If we get some continued traction in the Euro zone we could be setting up for another banner year in equities.  But as I've harped on in previous commentaries, Europe is the key to the global economy truly turning the corner. Certainly, there appears to be movement into European stocks as evidence that the reflation trade is starting to take hold over there.  I'll be watching for signs of life in Emerging Markets next.

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, February 7, 2015

The Message of Treasuries

This is my first post in three weeks and it will be a shorter commentary than most.  Equities have been dealing with some major issues which have been creating considerable volatility:

1.  Oil prices
2. Events in the Eurozone, particularly Greece
3. Concern a stronger US Dollar will have on earnings 
4. Ongoing disinflationary and deflationary pressures in the global economy.

The stock market tends to be a much more emotional market than the global bond and currency markets.  What I mean is that one may glean much better directional signals for stocks by watching currencies and bonds.  These two markets are the "dog that wags the tail (stocks)".  And it's these two markets, particularly bonds, which I'm going to focus on in this brief commentary.

But first, here's where US stocks are as measured by the S&P 500:


(click on chart for larger image)

I've highlighted the widely identified triple bottom everyone is talking about as well as what is looking like a triple top (thick purple dashed line) that repelled the S&P on Friday, February 6th (blue arrow).  We're clearly in a trading range but what's notable is that the S&P 400 Mid cap Index made a new all time high on Thursday, February 5th and Small Caps as measured by the Russell 2000 and the S&P 600 Small Cap Index are outperforming their large cap brethren in the S&P 500.  This is a sign of internal market strength and a reflection of the market's perception that large caps, most of which have international exposure, will be negatively impacted to some extent by a stronger US Dollar.

There has been much concern and market volatility over Greece and the new leftist government under Alexis Tsipras and their avowed pledge to gain debt relief from the EU and ECB.  The situation is rather complex and I won't get into the fundamentals other than to say that if Greece thinks it's having a tough time now in the EU, they should consider that they will be far worse off if they ever left the union.  But this is all a moot point because they're not leaving.  At least that's what the US Treasury market is telling us with this week's price action.  Yields spiked this week with some good US economic numbers and if there was truly a serious probability of Greece upsetting the global economy "apple cart", the "flight to safety trade" would have prevented the spike;


(click on chart for larger image)

The daily chart above details the yield on the Ten Year US Treasury Note and it gives a history of the Ten Year yield going back to 2008.  As can be seen, yields are still at historic lows for reasons I've articulated many times in past commentaries but my point is that the spike in yield highlighted above with the black arrow tells me there's no fear over any issues related to Greece.  If things get dangerous over there you will see this yield and all yields along the Treasury yield curve drop like a rock.  Then you can start worrying!

I've detailed in previous commentaries how the US Treasury yield curve has been flattening which is usually predictive of weaker economic growth and in looking at the chart below that trend is still intact.  But this week's yield action (black arrows) might be an early indicator that this might be changing.  This is a chart of the Ten Year Yield (green line) and the Two Year Yield (red line):


(click on chart for larger image)

Analysis

The Treasury market is telling us there is no fear in the global financial system.  The bounce we got in oil prices over the past week has helped to stabilize equities as disinflationary trends have been mitigated (at least for now).  

Inter market relationships are by no means definitive at this point as certain markets are moving according to their respective supply/demand fundamentals (oil), while Gold is more in inverse "lockstep" with the US Dollar.  Stocks and the US Dollar have been generally positively correlated for some months now which is signalling a continuation of normalcy: the value of a nation's currency is in direct proportion to it's economic and financial health.

If someone had asked me a week ago where stocks were headed I would have told them that there was a good chance we were lining up for a serious correction.  But the Treasury market and the charts above tell me that is not in the cards.  Still, there will need to be a catalyst to shake stocks out of their obvious trading range in the first chart above.  Perhaps, Greece and the EU settling their differences could provide such a catalyst for stocks.

So, watch Treasuries!  They will tell us where equities are going.  

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, January 17, 2015

Big week! Outcomes & Consequences

We've seen quite a bit of volatility in all markets in the past two weeks and much of it has been primarily the result of the radical slide in oil prices which consumers are loving but oil producers and their creditors aren't.  Here's an update of the chart I posted two weeks ago of the Wilshire 5000 which is the entire US stock market:


(click on chart for larger image)

As noted in the previous commentary, the "ascending triangle" (red dashed lines) was violated this week and I've targeted the the 20225 area for support.  However, with Friday's price action a bullish candlestick pattern (a bullish engulfing pattern) has formed and I believe we are going to get a bounce from here.  My confidence in this call is supported by the price action which reversed right on a Fibonacci support line (love those Fibonacci lines!).  And, as we see the previous corrective patterns on the chart (blue arrows), leaving the October correction aside, the recent weakness can be seen as a "garden variety" pullback.  It's always good to step back and "see the forest for the trees", especially with all the gut wrenching volatility we've experienced in the past few weeks.

Another reason why I believe the short term trend is now positive is because it appears that with Wednesday's surge in crude prices, oil may be consolidating at these levels.  Here's a daily chart of West Texas Crude with the S&P500 below.  I highlighted the point when the sell off in crude accelerated (red vertical line) and have lined the two charts up with a correlation coefficient in the bottom panel:

(click on chart for larger image)

The chart serves to show the strong correlation between the price of oil and equities over the past month.  The correlation is really no surprise as any market watcher could glean this but it also tends to validate my thesis that to the extent oil consolidates, equities will stabilize and move higher.

Is the sell off in oil over?  A lot of people are hoping but I'm not so sure.  The geopolitical and economic fundamentals driven primarily by the Saudis tell me it is not.  The Saudis can drive the price down to $20/barrel before it is unprofitable for them to pull it out of the ground.  However, fiscally they need $77/barrel to maintain their economic and social programs in the country.  They have already warned their population to tighten their belts.  The Saudis are on a mission and are accomplishing two objectives simultaneously.  They are hurting their enemies in that area of the world (Iran & Russia) and they are protecting their "swing producer" status be breaking the back of highly leveraged "frackers" in the US.  And I don't believe their objective has been met yet.  Another technical reason why I believe we will still see lower prices is the following chart:

(click on chart for larger image)

This is a weekly chart showing the spread between the price of Brent Crude and West Texas Crude.  Historically, Brent has sold at a premium to West Texas over the past five years at $10/barrel.  That spread is now less than $4.00.  Without getting into details that some of my readers might not understand, the spread is a reflection of the supply in the market and with Brent so low as compared to West Texas, buyers are just as willing to buy Brent that's sitting offshore in oil tankers in the Gulf of Mexico as to buy it from domestic suppliers.  This over hang of supply is not a good harbinger for the future price stability of "black gold".

With the short term trend higher there are still major challenges brewing this year which will have a profound effect on stocks.

Certainly, the message of Treasuries is that we are in the midst of a weakening global economy.  Yields in this country are dropping like a rock since the new year began and although we've had some tepid economic numbers in this country over the past few weeks, with international economic challenges growing money is continuing to flow into the safe haven of Uncle Sam's debt, pushing Treasuries higher (with lower yields) and strengthening the US Dollar.  Here's a seven year daily chart of the Ten Year US Treasury Yield.  I've highlighted a few historical points to give my readers some perspective on where we're at:

(click on chart for larger image)

Here's an updated version of the US Dollar chart I posted two weeks ago:

(click on chart for larger image)

What's significant about the Dollar chart above is that it is a monthly chart.  Moreover, the Dollar is cutting through multi year resistance like a hot knife through butter.  Now, the month is not over and I suspect we may see some Dollar weakness going into a very eventful upcoming week (more on this below).  Admittedly, in a technical sense I don't have much to hang my hat on in this regard but I sense there's going to be a lot of positioning in the currency market prior to the European Central Bank's upcoming meeting this Thursday, January 22nd.  Here's the daily chart of the US Dollar and I circled the price action over the last week and a half:

(click on chart for larger image)

 The price action reflected in the individual candlesticks speak to a slow down in the currency's steep rise.  Ideally, I'd like to have other technical indicators corroborating my thesis but there is none to be found.  So I may very well be wrong.  We'll see ...

Speaking of currencies, the FOREX (foreign exchange) market was thrown into turmoil on Thursday when the Swiss National Bank decided to ditch a cornerstone of their monetary policy: "pegging the Euro" (1.20 Swiss Francs to one Euro).  As the Swiss Franc soared and the chaos subsided, the surprise move shuttered a firm in New Zealand and FXCM, the largest retail currency trading firm had to scramble to seek emergency funding when $225 million in it's clients margin calls could not be met.  Leucadia National finally threw them a $300 million lifeline so they could stay open.  But the big winner in all this was:

(click on chart for larger image)

Gold had been consolidating and most traders thought it might be just a rest before another leg lower.  And they still might very well be right.  However, with the Swiss Franc now free floating against the Euro the safe haven status of the Swiss Franc is reaffirmed and the world's truly hard currency, gold, has broken out of a multi month downtrend as seen on the chart above of the SPDR Gold Trust Shares ETF (GLD), the popular trading vehicle for those traders/investors who do not want to trade the metal directly in the commodity market.

It will be important to monitor the price of gold here.  This could be a false breakout.  I'm not saying this because I have any antipathy towards gold.  Some dear friends of mine (both here and departed) are "gold bugs".  But soaring gold and a surging Dollar are not correlative in a deflationary environment which we find ourselves.  True, gold fared well with a strong Dollar in the 1930's however, at that time the US government had pegged it's price at $35/ounce and it manifested it's strength through gold mining companies that traded at that time.  We'll see where we go from here.

Finally, let's take a look at Emerging Markets.  Here's a daily chart of the iShares MSCI Emerging Market ETF (EEM):

(click on chart for larger image)

EEM has been flirting with gap resistance for a number of weeks and because of this, I'm of the opinion that we will see a breakthrough here.  Now, this thesis is incompatible with other inter market relationships that seem prevalent in the market but as I stated in my last commentary, traditional inter market relationships have been inconsistent recently.  For a student of inter market relationships, it's sort of like flying blind.  EEM's price action does not make sense to me in a deflationary world where the exporting economies of Asia and South America depend on the consumption of the developed countries of the West.  So, a break out here would be very constructive for the global economic picture and if EEM is decisively turned away here it would reaffirm the deflationary stranglehold that appears to be taking over the planet.


ANALYSIS

The major event that will have an impact on stocks for at least the first half of this year is the upcoming ECB meeting on January 22nd.  It is widely expected that the outcome of the meeting will be a significant policy change so that policymakers can stave off the deflationary spiral that is threatening the Euro zone.  But deflation is already there:


(click on chart for larger image)

The ECB's goal is to expand their balance sheet to a trillion euros.  So far, they have calculated that by buying covered bonds and ABS (asset backed securities) they can expand the balance sheet to maybe 450 billion euros.  The market is expecting an announcement where they will commit to purchasing $500 billion in sovereign bonds in the secondary market.

This is hardly the "shock and awe" that accompanied both the US and Japanese QE efforts.  And there in lies the concerns market participants are starting to have and has been, in my opinion, an attendant reason for the market volatility the past few weeks.

First of all, there's a possible chance that there will be no announcement on Thursday, the 22nd.  ECB President Mario Draghi made that clear in his last press conference.  The announcement could come in June.  But the chart above speaks for itself and, like inflation, waiting will only exacerbate the deflationary spiral.  Many are arguing that it may already be too late to stem the tide.

Secondly, there is the important argument surrounding how effective sovereign bond purchases would be.  Yields are already so low that the benefits in attempting to push them lower may not be worth it and may create other significant distortions that make the effort dangerous.  After all, if the ECB buys the debt, who holds it?  This is an ongoing debate in the ECB governing council and rumors persist that while the ECB will implement the policy the national banks will hold the debt.  But in a deflationary environment national banks take on a dangerous exposure if the bond buying does not accomplish the goal of reflation.  And then there's always the moral risk associated with these purchases which is behind the Germans main objection to this proposal.

Behind the German concerns and a huge part of the problem is the quiet recognition in the Euro area that monetary policy can only go so far in "kick starting" a recessionary economy and that fiscal policy must take over.  But there is no will in the Euro zone, either among the Italians, French or the Germans to confront this issue.  I cite in defense of this position the recent submission of France's national budget to the EU which was over the mandatory 3% deficit threshold.  The result is that they went into "negotiations" with the EU on this budget and the whole issue was essentially glossed over. 

I understand that issues are much more complex than stated above but these events underline the deeply flawed concept behind the EMU (European Monetary Union).  Monetary union without fiscal/political union is untenable.

And so the Germans, which are the deep pockets over there, don't want to get caught holding the bag.  And they have significant political sway in the ECB although they can be overruled.

So, whatever is announced on Thursday (if it is announced) is more likely to disappoint the market than to encourage it.  Certainly a "shock and awe" surprise would be met with frenzied buying in the equity markets but no rational person can expect this outcome.  

It's difficult to speculate the market reaction, especially with the focus on the price of oil (another deflationary beacon notwithstanding arguments that it's about oversupply).  But I now believe the best outcome will be for the market to take the announcement in stride unless they postpone their decision. 

If they postpone the decision things will probably get ugly.  If they come in with $500 billion in sovereign purchases we're liable to see a rally but not of the magnitude I previously had predicted.  After all, as stated above, they're at the point where they are confronting diminishing returns unless they go "all out"; buying anything and everything they can in the bond and debt markets.  And for reasons stated above, they will not do that.

However, the market is wiser than any individual or entity engaged in it and anything can happen.  The fact that inter market relationships are getting tricky and that emerging markets have been resilient in the face of significant volatility is encouraging to me.

There are also issues going on in Greece that I'm not too concerned with at this time but which must be watched.  And it is becoming more apparent that the Fed's anticipated interest rate increases will be postponed until later in the year?  Remember "Liquidity Traps Revisited"?  I'll be addressing these issues in my next commentary in two weeks.

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, January 3, 2015

All eyes on Europe!

As we commence a new year, stocks still hover at all time new highs and while cracks seem to be forming in the market there is still no indication that any type of significant correction (over 20%) is on the horizon.

The following is a daily chart encompassing the last year and eight months of the Wilshire 5000 which is the entire US stock market:


(click on chart for larger image)

The chart is instructive in that it identifies a series of short term corrections (tan arrows) that punctuated the inexorable rise higher.  In spite of successive new highs momentum indicators have deteriorated (top two panels above the chart) and with the October down draft we broke a long term uptrend line (blue dashed) that started in July 2013.  The subsequent rally to new highs and then the December weakness has created an "ascending triangle" (tan dashed lines) which is a bearish formation.  

Nevertheless, the size of the triangle and the time it's taking to form suggest that, even here, any pullback will be relatively shallow.

Discussions and decisions are being made in the policy rooms of central banks which will have profound consequences for all financial markets in 2015 and in the meantime is wreaking havoc with traditional inter market relationships that have prevailed in some cases for up to almost eighteen years!

Let me lay a foundation for the rest of the commentary by making a statement everyone already knows: the entire bull market in equities over the past six years has been predicated on central bank largess; the deliberate inflation of risk assets in order to buy time for the global economy to heal after the loss of tens of trillions of dollars in wealth as a result of the 2008-2009 crash.

That regime has now ended in this country and the Federal Reserve is actually preparing to start a tightening cycle by reversing their zero interest rate policy (ZIRP) by raising short term interest rates.  In a global economy where the US Dollar is the reserve currency this can be problematic if other economies are not in a recovery phase of their business cycle.  And frankly, at this point, no one is but us.

The impact of Fed policy is already having a huge impact on emerging markets which is only exacerbated by the mammoth global deflationary forces that still exist.  With the anticipation of higher interest rates in this country, our currency is strengthening with the commensurate effect that money is being sucked out of emerging markets.  The following is a weekly chart of the Wisdom Tree Dreyfus Emerging Markets Currency Fund (CEW) with the US Dollar super imposed on it.  The almost lockstep inverse relationship is quite obvious:

(click on chart for larger image)

As the US Dollar strengthens, all debt denominated by dollars in the emerging market complex becomes more expensive in their currencies and it is only a matter of time before defaults take place and economic growth slows even further:

(click on chart for larger image)

Above is a daily chart of the iShares MSCI Emerging Market ETF (EEM) and you can see that while US stocks fully recovered from the nasty October down draft, emerging markets stocks did not and they were turned away from gap resistance last week in the midst of our "Santa Claus" rally.  This is all the result of a stronger Dollar.  

There is no end in sight to the Dollar's incredible rally.  This is a monthly chart of the US Dollar going back to the late 1990's and we are in the midst of piercing key multi-year resistance.  Fundamentals suggest we will be surpassing this level shortly:

(click on chart for larger image)

The reason for the Dollar rally is simple enough. While we have completed our monetary easing cycle in this country it is apparent that the other two countries whose currencies make up the majority of the Dollar Index are just starting their easing cycles.  

The Japanese Yen, which makes up 13.6% of the Dollar Index is literally being trashed by a quantitative easing program which proportionally speaking, dwarfs the Fed's easing efforts of the past six years.  And now, with the possibility that the European Central Bank (ECB) is  finally going to do what they have to in order to expand their balance sheet to facilitate easy credit conditions, the Euro, which is 57.6% of the Dollar Index, is precipitously dropping, possible to parity (one to one) with the US Dollar.

Because global central bank policies cannot synchronize policy, technical distortions are starting to manifest themselves in the market, turning traditional inter market relationships on their head.

Here's a chart of the German Ten Year Bund yield (green line) with the Commodity Research Bureau (CRB) Index (a basket of 19 commodities-yellow area))  super imposed upon it which highlights the direct effect of deflationary forces on global interest rates:

(click on chart for larger image)

And yet, with global commodity prices still dropping which is the classic sign of weak economic conditions, the Fed is preparing to raise short term interest rates!  

In a normal economic and business cycle, the so called "yield curve" (a line that plots interest rates at a set point of time) should steepen in a healthy economy and gradually flatten until it becomes inverted as an economy deteriorates and slips into recession.  However, the US yield curve has been gradually flattening for the past few months as the futures market prices in the supposed inevitability that the Fed will raise short term rates while the "long end" of the curve stays anchored and moves lower:

(click on chart for larger image)

And why is this happening?  With so much slack in the global economy and the prospect of rising interest rates in the US, global money flows are still reaching for "safe yield" and Uncle Sam's debt is the safest place to park your money in a world where most economies are flirting with economic contraction.

At the heart of the situation is a virulent deflation which is manifesting itself to the public in incredibly lower gasoline and producer prices.  While seemingly a boon to our wallets, dropping commodity prices in the environment we find ourselves in is a "double edged sword" that can have very negative implications

And so, divergent policies emanating out of Japan and the US and a stubborn Europe which seems unable to make a commitment which would create the necessary conditions to facilitate global growth are creating a tension which must be unwound.  We may start to see the unwinding later this month when the European Central Bank meets on January 22nd.  The expectation is growing in the market that the ECB will be compelled to start sovereign bond purchases in the market in order to ease credit conditions in the Euro zone.  While I still have my doubts on whether this will occur, others who I greatly respect think that some sort of sovereign bond purchase program will be announced after the meeting.

I had the opportunity to interact with Marc Chandler, Senior Vice President and Global Head of Currency Strategy at Brown Brothers Harriman in New York on line a few days ago, and he believes the ECB may elect a 500 billion euro program in which the national banks carry the debt on their balance sheets rather than the ECB; a policy that would appease the Germans (somewhat).

I believe that the results of the January 22nd meeting in Europe will have a determining effect on the direction of equities in 2015.  With a Federal Reserve ready to raise interest rates in this country, a sovereign bond purchasing program in the Euro zone would fit "like a glove" to soothe the tensions both in the global economy and in the financial markets.  The fundamental ramification of such a policy decision would be the expectation that global economic conditions would start to normalize, allowing the rest of the planet to commence growing as Europe starts consuming again, thereby providing the catalyst for growth in the emerging economies of Asia and the Pacific Rim, regardless of a strengthening dollar.  Whether this expectation is ultimately viable without structural economic reforms in the Euro zone is irrelevant to the markets over the next year.

Remember the simple formula: the emerging markets and China, being primarily export driven economies, are held captive to the consuming economies of the developed world (US & Europe).  With a firm commitment in the Euro zone to truly implement a significant monetary easing program, I believe emerging market economies and their stocks would take off to the moon!  Moreover, I predict another year for US equities similar to 2013, where the S&P500 returned north of 29% for the year.

And speaking of China, I've had a few inquiries regarding the Shanghai Composite's incredible rally.  This is the daily chart and it is certainly impressive!:


(click on chart for larger image)

  Here's the weekly chart:

(click on chart for larger image)

So, given my grand thesis articulated in this commentary, how can China be rallying when the rest of the world, save the US, is floundering?  A simple answer: Chinese government stimulus.  In a deflationary environment and with an economy that is still export based (regardless of the  desires of Chinese officials for a consumer based economy which is still years away), the economic numbers coming out of that nation are either flat or in contraction  territory which is just what we would expect in a world still dominated by the consuming economies of the west.

What would change my mind about China?  A breakout on the weekly chart above would compel me to rethink my thesis not only on China but my grand thesis on what will be moving our markets in 2015.

So the outcome of the ECB meeting on the 22nd and the details of any sovereign bond purchase (if there is one) will be pivotal to the market's reaction, either good or bad.  With the Fed ready to raise interest rates in the world's reserve currency, any indication that the ECB is waffling or holding back will precipitate a world wide sell off in equities with emerging markets and China taking the brunt of the beating.  And this is why volatility is starting to enter equity markets (along with over-bought conditions and unbalanced sentiment readings).

We'll see what happens on the 22nd!  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, 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!