Sunday, September 30, 2012

Macro Analysis 9/28/2012

Stocks traded down this week with most of the averages off by between 1 and 2%.  The Street accounted for the weakness as largely the result of a long overdue correction with concerns lurking in the background regarding the 'fiscal cliff" the US economy is facing on 1/1/2013.

Here's a daily chart of the S&P 100 which is comprised of the top 100 stocks in terms of capitalization in the S&P 500.  I've circled this week's price action in blue:

(click on charts for larger image)
  Despite the weakness this week the index is clearly in a strong uptrend.  We'd have to see a violation of the support line (purple dashed) in order to confirm even a short term correction.  The bottom panel shows that large caps have been outperforming their small cap brethren since mid September.
Here's a weekly chart of the Russell 2000 Small Cap Index:
The Russell turned away again from it's attempt at taking out its April 2011 post crash highs but is also clearly in an uptrend.  Note the bottom panel.  It is confirming what the $OEX:$RUT price relative is telling us on the first chart.  As my regular readers know, the health of the present bull market can be measured in the percentage of small cap stocks that are outperforming their large cap big brothers.  In the present case, just the opposite is happening and has been happening since July 2011.
A quick look under the hood of the market speaks to weakening breadth:
This is the New York Stock Exchange Summation Index with the McClellan Oscillator in the lower panel.  The McClellan Oscillator is a breadth indicator derived from net advances, the number of advancing issues less the number of declining issues.  The summation index is simply a running total of the McClellan Oscillator values.
 We can use the Oscillator (bottom panel) to give us short term signals on market direction while the Summation Index assists in measuring the strength or weakness in market price action.  While the Summation Index is turning over it is nowhere near the zero demarcation line which would signal a market correction such as we had in May of this year.
To sum up, all we can say about the current market is that it is back filling before possibly heading higher.  I'll be addressing my concerns surrounding stocks in my analysis below.
For all the talk about inevitable inflation Treasuries refuse to take their cue and we are having a stealth rally in Uncle Sam's "pristine" debt.  Here's a weekly chart of 30 Year T Bond yield:

I've drawn an upward support trend line highlighting the steady rise in yields since mid July but also the rollover of the past two weeks (blue arrow).  I'm expecting a penetration of the support line on the chart and lower yields in October as the FED continues to support the long end of the yield curve with "Operation Twist" and global money flows continue to favor the "safe haven" trade.
Here's a daily chart of the iShares Barclays 20+ Year Bond ETF (TLT), as of Friday's close, which traders and investors use as a proxy for the long end of the yield curve:
We're at the cusp of penetrating a resistance line formed from the July highs.  I expect TLT will take out that line this week.
I haven't written about gold for a few weeks:
 Here's a weekly chart which gives us a pretty good perspective on where we are at in the decade plus bull market in the yellow metal.  I've highlighted the break out with a green arrow and identified a double doji formation that has formed in the past two weeks.  This is spelling indecision in the intermediate term.  The two momentum indicators (top and bottom panel) are giving us different signals but that's because the RSI indicator is a short term momentum indicator while MACD is more of an intermediate to long term indicator.  The "bull" is healthy here but I expect a retreat from these levels for reasons I'll outline below.  In essence, gold is rightly anticipating the onset of inflationary pressures.  However, until the ECB starts up the printing presses and we address the deflationary implications of the fiscal cliff in this country, gold's price appreciation will be stunted.
The same goes for commodities:
Here's a daily chart of the Dow Jones UBS Industrial Metals Index and we're forming a broadening top right below Fibonacci resistance.  Broadening tops are bearish technical indicators.  The Street is widely anticipating a resumption of the bull market in commodities which effectively ended in February 2011 due to the "unlimited QE" announcement from the Fed two weeks ago.  You can see from the chart we did get a pop following the announcement but it's starting to fade.
Let's look at our beloved Dollar which everyone has been trashing since Bernanke announced his latest round of easing three weeks ago.  We're going to compare it to the other major global currencies below:

We saw the Dollar top in July and then take a nose dive that accelerated before the Fed announcement in early September.  But it has bounced relative to the other major currencies (with the exception of the Japanese Yen) in the past two weeks. 
What is the Dollar telling us?  Like Treasuries, it is telling us that the "safe haven" trade is still alive and well.  The Dollar's performance relative to the Japanese Yen confirms my thesis as the Yen is also a safe haven currency.
And the Euro, which is roughly 57% of the Dollar index signalled a key reversal on Friday:
We had a bearish engulfing pattern develop on Friday which portends more weakness in the Euro Zone fiat currency and conversely, more strength for the world's reserve currency.
In spite of central bank promises to paper over the world's financial problems, risk assets are hesitating at already lofty levels. 
We're starting to see the beginnings of a deliberate pull back in industrial commodities that can be attributed to an ongoing Chinese slowdown that analysts are contending is bottoming out.  And Gold doesn't know quite what to do.
Some are making an analogy to the recent price action with November 2010 when we saw a shallow correction right after the Fed started implementing QE2.  And while I've seriously considered that we may be seeing the same reaction this time around since we're only three weeks into QE3 I don't believe the comparison is valid.  The global macro economic environment is altogether different this time around.
While the ECB has largely taken care of known tail risks in Europe thanks to Draghi's commitment to support periphery debt, other leaks in the dyke keep popping up.  I addressed one of those issues this week in a blog post when I identified the political turmoil in the Spanish region of Catalonia which is threatening to secede from Spain.  The Street has been largely dismissive of such a scenario but it seems pretty apparent to me that the Spanish population (as well as the Greeks) are not very happy campers.  I don't believe we can dismiss the threat of a Catalonian secession at this time.  As stated in my blog post last Tuesday, Catalonia is sitting on 42 billion euros of debt.  Any indication that they would renege on all or part of that debt would send serious reverberations throughout the global financial world.
Now, if Rajoy would ask for a bailout from the ESM and the ECB much pressure would be taken off this whole issue.  But Rajoy has political motivations that I cannot expand upon here to hold off requesting the bailout until the latter part of October. 
There are other issues in Europe still brewing.  The Greek issue has not been addressed yet and probably will not until after our election.  In addition, while it is pretty apparent that Spain will eventually cave and request a bailout, the street is concerned that the market's focus will now turn to Italy.  But I think that the market will not only focus on Italy but also France going into year end.  Hollande's fiscal policies are destroying the French economy and the problems there will come home to roost sooner than many realize.
And then we have our fiscal cliff.  It amazes me when I hear so many pundits who believe that, considering the track record of the past two years, there will be compromise between the polarized political elements inside the beltway.  Color me skeptical that an Obama administration (yes, he will be our president for another four years) can orchestrate a compromise with a Republican led Congress that are committed to no new tax increases. 
In stating that Obama is going to win the election I am in no way making a political statement supporting his election. I'm just foretelling what many others are starting to see based on multiple polls in swing states and Intrade.
I hope I'm wrong about the ability of our politicians to avoid "the cliff" because if I'm right we will have a recession in this country next year.  That along with a continuing contraction in China and the Euro zone cannot and will not bode well for risk assets worldwide.
The mantra on Wall Street is "don't fight the Fed" and so even on days when we get negative news the downside is blunted but we also can't seem to get any traction to the upside because of the multiple issues I've addressed above.  The Fed's liquidity seems to have put a firm floor under risk assets (though we are starting to see cracks in commodities) but unlike the previous two QEs we are not seeing the steady, grinding upward moves that characterized those liquidity injections.
Under these circumstances the best I can envision is a trading range which on the S&P 500 would be between 1425 and 1470.  But my feeling is the longer we stay at these levels with the issues above not being addressed the chances of a market sell off, regardless of the "Bernanke put", grow with every passing day.  The market does not like uncertainty and will only be patient for so long.
Have a great week!