Sunday, April 22, 2012

Macro Analysis 4/20/2012

Well, I guess I was wrong.  This week's edition of Barron's is heralding "mostly sunny skies" ahead for stocks in the next year.  While it is difficult to predict where the market might be going for the next three months, predicting where it might be in a year, especially in this environment, is akin to fortune telling.  As a contrarian indicator, seeing a headline like this can make one "run for the hills"!  Maybe stocks will end the year higher.  I just don't want to be riding the plunge I think we're setting ourselves up for in the next three to five months.

Stocks had a positive week with all the major indexes up fractionally save the NASDAQ Composite which finished the week down .36%.  Technically we're seeing some mixed signals in our inter market relationships and especially in the "risk on" and "risk off" currencies. 

Let's look at the charts:

(click on chart for larger image)

Here's a daily chart of the S&P500 and you can see that the major uptrend line going back to December has been violated.  In addition we're forming a Bear Flag (green dashed lines) which is normally resolved to the downside.  MACD in the upper panel is negative and the two bottom panels are relative strength charts showing the Technology SPDR (XLK) and the Utility SPDR (XLU).  XLK is manifesting relative weakness compared to the S&P while XLU is showing relative strength.  The message behind the two lower panels is that there is sector rotation going on in the market where money is moving from growth stocks (technology) to defensive sectors (utilities).  These same patterns can be seen when comparing other growth sectors (materials, industrials, consumer discretionary) and defensive sectors (healthcare and consumer staples).  If anyone would like a more detailed explanation of the concept just post a message on the blog or e-mail me and I'll be happy to explain.  The Bear Flag pattern speaks to distribution (smart money selling into strength).

Now here's where it starts getting tricky:

This is a daily chart of the 30 Year Treasury yield.  I posted this same chart on Tuesday and this is the updated version.  I stated in Tuesday's blog post that if we bounced off the lower support line (dashed black line/black arrow) my bearish thesis could be wrong.  Well, we haven't penetrated the support line and the latest bar on Friday spoke to indecision.  The momentum indicators are bearish but as someone who monitors these markets closely I'm not feeling the strong momentum that has been indicative of Treasury strength in the past. 

My concerns are alleviated somewhat when I see this:

I posted this same daily chart of the US Dollar on Thursday and here's an updated version.  We had a big down day on Friday and while the momentum indicators are negative we nevertheless bounced off the green support line on the chart on Friday.  I'm further encouraged by this price action when I step back and take a longer term view of the Euro:

This is a weekly chart of the Euro.  It must be remembered that the Euro is 57% of the Dollar Index so as the Euro goes so goes the Dollar (inversely).  The pink arrow delineates this past week's price action.  As you can see, as measured by the yellow dashed line or the white dashed line, the Euro is in a clear downtrend and last week's price action butted up against initial resistance (white dashed line) but did not penetrate it. 

There has been some technically driven selling of Dollars by central banks which is responsible for Dollar weakness and conversely Euro strength.  Mainly, the Swiss are actively intervening to keep a floor under the Euro because their exports have been suffering due to strength in the "Swissy" versus the Euro.  As well as selling Euros they will sell Dollars to accomplish this.  The other factor driving the FOREX market is the dual pressures of a high net speculative "short" position in the Euro coupled with the low interest rate environment in this country which tends to be a large factor in moving currencies in a normal environment.  This situation provides a "double whammy" on the Dollar whenever a piece of good news about the Euro zone is announced.  The Euro bounces on the news and the "shorts" scramble to cover their positions feeding the rally.  The fact that our interest rates are lower than the Euro Zone provides further impetus to Dollar weakness.

What about commodities?

Here's the Goldman Sachs Industrial Metals Index and you can see from the price action and the momentum indicators that we had a pause in the decline this week and a significant bounce off of Fibonacci support on Friday. 

This situation will need to be monitored closely because if we start to see sustained strength in commodities and especially in industrial commodities my bearish thesis on the market would be suspect.

And Gold?

Here's an updated version of a chart I've posted a number of times in the past.  If you recall, I'm monitoring an inverse head and shoulders formation which could have bullish implications to the $2,075.00/$2,100.00 area.  The right shoulder of the formation seems to be breaking down.  Nevertheless, we must remember that these formations don't have to be "picture perfect" or perfectly symmetrical.  I highlighted this week's price action with the purple circle.

Gold is a psychologically driven asset.  In 2010 and 2011 it was driven higher by the perception that central bank money printing would inevitably produce inflationary pressures (an accurate thesis) and the fears of a global financial implosion.  However, when the ultimate deflationary scare came upon the world's doorstep last fall Gold and all risk assets sold off as everyone fled to the safety of US Treasuries and the Dollar.  Since then Gold seems to be lost; slowly losing value as the predominant sentiment is that we are seeing our way out of the mess we've been in since 2008.

I think in many ways Gold's price behavior going forward will tell us much about the future of the global financial system.  I wish I had the time to comprehensively address the multi faceted investor attitudes toward Gold and their implications.  I'll sum up my position on Gold with this statement:  if Gold is weakening because of perceptions that we are coming out of the problems we've been having since 2008 then it's price action is contradicting the long standing Keynesian premise that incremental inflationary pressures are needed in the credit based global economy that currently exists.  Therefore, if Gold continues to weaken it's not a sign of a healthy global economy but of a sick one where deflationary pressures reign supreme.

It's impossible to address all the factors that may impact the financial markets but let me sum up my position on where I see them going in the coming months with a few bullets:

1. Seasonality is upon us.  The market historically has underperformed from May thru October.  This "Sell in May and go away" psychology has been especially pronounced in the past two years.  Some say that in an election year it could be different.  But the present administration is under constraints to intervene in the economy or financial markets.  The distribution I identified in this commentary further supports the thesis that this phenomenon will continue this year.
2.  Commodities have been showing relative weakness since late January and even this week's stabilization is a mere "blip" on the radar of steady declines.  Weak commodity prices are not indicative of a strengthening global economy.
3. Technically, the charts (both daily and weekly) are not predicting higher prices but lower prices.  Now, this could change but it's not the majority scenario.
4.  All the Bulls have to hang their hat on is the short term strength of the Euro and the tepid momentum Treasuries are exhibiting. 
5.  Fundamentally, Europe is heating up.  Everyone is focusing on French elections but I will submit that it's the Greek elections we have to worry about.  I feel very comfortable in saying that the Greeks will renege on their austerity pledges and leave the European Union.  While this, in itself, won't portend a global financial meltdown it will certainly create unwanted volatility in world financial markets.  Increased pressure on Spain however will threaten global financial stability and contagion will quickly spread to Italy.  The only remedy to the economic and financial straight jacket Europe finds itself in is for the ECB (European Central Bank) to backstop the entire system like our FED did in 2008 and allow pro-growth policies to jump start periphery nation economies.  The present policy of austerity will just continue to fuel the already massive deflationary forces that exist and will inevitably threaten the existence of the European Union.   

News that may move markets this week:

- The Group of 20 is meeting this weekend and they have pledged 430 billion in new funding to the IMF in order to backstop Euro Zone problems.  This may be seen as an initial positive by the markets but understand that even this pledge along with all the other liquidity facilities already in place cannot address the problems Spain and Italy could face if contagion spreads.
- Chinese HSBC Manufacturing Flash PMI will be announced this evening.  A number over 50 will spark an international risk asset rally.
- Any news surrounding French and Greek parliamentary elections or even the Irish referendum coming up on May 31st could move markets. The focus would be mainly on negative news out of Greece.
- The FOMC (Federal Open Market Committee meets on Tuesday and Wednesday with an announcement at 12:30PM EST on Wednesday followed by a Bernanke press conference at 2:30PM EST.  Many in the market are looking for any comments which may be suggestive of QE3.  I personally believe they will be disappointed.
- The week is busy with a host of US economic reports.  Depending on market mood any of them could be a big mover.  Watch especially new home sales on Tuesday, durable goods orders on Wednesday, jobless claims on Thursday and Quarterly GDP on Friday.

Have a great week!