The catalyst for the decline was an unscheduled early release of a poorer than expected quarterly earnings report from Google on Thursday which sent skittish investors running for the exits en masse. Google lost 19 billion dollars in market capitalization in about 20 minutes between 12:30AM and 1PM EST. Poor earnings results from McDonald's on Friday morning reinforced the mood set by Google and set us up for Friday's sell off.
Here's a daily chart of the Nasdaq 100 Index, comprised of the top 100 stocks in terms of capitalization on the Nasdaq Composite. Technology stocks have been taking this market lower with Apple and now Google leading the charge:
Here's the S&P 500:
As you can see, we're sitting on the 50% Fibonacci level and have penetrated an up trend line (white dashed) established from the June low. In addition, we've penetrated another up trend line (not shown) established from the October 2011 lows. Momentum indicators are horrid and the price relative to the S&P500 (bottom panel) is taking a classic swan dive. I suspect we'll have more downside on the chart to at least the 61.8% Fibonacci level as investors digest the implications of the high tech challenge of monetizing mobile.
We will see more follow through to the downside next week with possibly a breather on Monday (don't count on it, though I'm hoping). Much depends on earnings reports next week. A key report will be UPS which reports on Tuesday,10/23, before the market opens. As the premier global logistics company, any weakness in the report will be another reconfirmation of slowing global growth and will not bode well for stocks.
Treasuries had a lackluster week but finally caught a bid on Friday as money fled "risk on" assets for the "safe haven trade". Here's the iShares Barclays 20+ Year Treasury Bond ETF (TLT):
Treasuries have been in a downtrend since late July with a series of lower highs (3) but only 2 lower lows. With Friday's price action (black arrow) it appears TLT bounced off the 50% Fibonacci retracement level but we'll need to see continued positive price action next week to confirm Friday's move.
In keeping with current inter market relationships, weakness in Treasuries inversely translates to strength in commodities and stocks. The theory behind the relationship is that lower treasury prices (higher interest rates) imply a stronger economy which is positive for stock and commodity price appreciation.
Future price action in the Treasury market (along with the Dollar) will give us the technical signal we need to confirm whether stocks will continue to rise. Excluding Friday's move, the Treasury market is telling us that stocks will soon find a floor beneath them and the sell off on Friday will soon stabilize.
Gold is lost in the present global economic/financial environment we find ourselves. If we're to take its price action as a signal of where equities are going we'd have to say that equities would be flat to down in the coming weeks. Given some of the political and fiscal issues facing the US, Euro zone and China this might be the right prediction:
Gold is presently sitting on a short term Fibonacci support level (red arrow) and momentum on RSI (top panel) is signaling an oversold condition. The longer term momentum indicator, MACD, in the lower panel shows accelerating downside momentum (red dashed arrow). I'll be addressing gold's price behavior in my analysis.
Commodities have been trending lower as I've noted in the past three commentaries:
Here's an updated daily chart of the Dow Jones UBS Industrial Metals Index with Friday's long red candlestick highlighted by the yellow arrow. The index literally poured out of a bearish broadening formation that formed immediately after the FOMC (Federal Open Market Committee) announced QE3.
And here's how the Dollar did this week:
We finished the week on a strong note as investors fled to the Dollar in the face of falling stock prices. However, we're still below a pretty steep down trend line (white dashed) and momentum indicators are bearish to neutral.
Part of the Dollar's problem is Euro strength. The Euro makes up 57% of the Dollar Index and so moves inversely to the Dollar. Euro strength can be attributed with the FOREX (Foreign Exchange) fixation with the supposed inevitability that Spain will ask for a bailout from the ESM (European Stability Mechanism) and ECB (European Central Bank). I'm not suggesting that Spain will not ask for the bailout. I'm just not as convinced as the street is that this may happen in October or even in November for reasons I'll explain below. In any case, Euro strength is keeping a lid on the Dollar and the daily Euro chart is really not suggesting any short term weakness. However, I want to give my readers a longer term perspective on the Euro:
This is a weekly chart of the Euro going back as far as June 2009. Clearly the Euro is experiencing a counter trend rally (purple dashed line) in the context of a larger multi year downtrend (yellow dashed line). Last week's price action (white arrow) is highlighted and the candlestick that was formed, while not a classic bearish candlestick, does denote a failure to rally. In the upper panel the RSI (Relative Strength Indicator) has failed to break through the 60 level. Until it does, this momentum indicator is telling us that Euro strength is living on borrowed time.
It must be remembered that Euro price action cannot be solely determined on technicals. The Euro trade has been the bane of many FOREX traders in the past three years and it always seems to defy its naysayers. If Spain does ask for a bail out, based on present levels, the Euro could rally to the 134.50 - 135.00 level. At that point, it could be a set up for a shorting opportunity. But check European economic fundamentals first. Some of the economic data coming out of the region has been a bit more positive than expected lately.
With all that said, continued Euro strength is a positive for equity prices.
As my opening statement alluded, the sell off this week was all earnings related. IBM's poor earnings report set the stage earlier in the week. The Google fiasco on Thursday brought the negative mood to fever pitch with the classic "everyone running for the exit at the same time" type of stock panic. And McDonald's report before the bell on Friday morning was the coup de grace! Risk assets just couldn't take this triple combination. Stories on CNBC reminding everyone that Friday was the twenty fifth anniversary of Black Monday, the 1987 market crash, certainly didn't help the market's state of mind.
The street was supposedly ready for a weaker earnings season based on the forward guidance of multiple large cap companies but the prevailing opinion still is that the potentially unlimited liquidity the Fed is pumping into our economy has put a floor under stocks. My concern here is not that there's a floor under stocks but where that floor is. Certainly gold should be reacting better to the 40 billion + the Fed is priming our economy with. Why isn't it?
Earnings disappointments have changed the tenor of the market, even diverting attention from the fiscal cliff where it's becoming more apparent that a decision by Congress will be delayed until we're into the new year.
The situation in Europe remains essentially the same. The European Summit on Thursday and Friday came and went with no firm policy pronouncements. Why am I not surprised ... As stated previously in this commentary, everyone is of the opinion that Spain will eventually ask for a bailout and I don't necessarily disagree with that thesis. However, I am not of the opinion it will necessarily come in the next two months. Spain has the liquidity to see itself through to the end of the year and Draghi's jawboning thru OMT (outright monetary transactions - aka buying periphery debt) has kept Spain's borrowing costs relatively low and sustainable. Even Italy's bond auctions are receiving adequate demand with relatively low rates due to Draghi's plan.
Spain is concerned about further austerity requirements being imposed should they decide to partake from the ESM/ECB trough. Northern periphery nations (Germany, Finland, the Netherlands) are becoming increasingly impatient with the lack of progress in the PIIGS (Portugal, Italy, Ireland, Greece, Spain) and getting parliamentary approval to pour more money into the perceived "black hole" of periphery debt will be a hard pill to swallow unless politicians bait the requests with more severe austerity measures. But Spain's Rajoy has already put in place very unpopular and radical austerity measures to avoid any further strictures from the EU. This dovetails into my next concern ...
No one seems to believe that the present separatist movements in Spain (Catalonia and the Basque region) or the incredible social unrest in Greece and to a lesser extent Portugal have the potential to upset EU and global financial stability. And no one seems to think there's the possibility that this social unrest could be the impetus for revolution.
I personally believe that this theoretical scenario becomes more possible as time passes. Please understand, I'm not saying it will happen; I'm just saying not being ready for such an event is imprudent.
In Barbara Tuchman's seminal work, The Guns of August, she highlights the fact that virtually no one in global politics at that time actually believed that the political events in August, 1914 would actually escalate into a full blown global war. I remind my readers of this historic fact not only to highlight the myopia humans often struggle with in their efforts to be prescient but also to speak to the fact that the European mindset is radically different than the American mindset. And while those intricacies are too varied and complex for me to articulate here, those of you who have read me religiously since I started composing these commentaries know I've touched on them in the past.
What would happen if there was a coup d' etat in Greece? Do we think there would be an orderly default of their debt? I'll leave my readers to their imaginations as to the ramifications of such a scenario.
On the other side of the globe, I identified last week that there were some better economic numbers coming out of China in September. The growing opinion on the street is that the Chinese economy has turned the corner. The updated daily chart of the Shanghai Composite Index is showing incremental improvement but nothing to write home about:
I'll be more positive on China's turn when we penetrate the multi year down trend line (green dashed). However, it's worth mentioning that China tends to lead the world economy by about five or six months. We saw this in 2008 when the Chinese stock market hit its bottom in late October, nearly five months before our market bottom in early March 2009. Markets never exactly repeat but they will often rhyme!
With all that's been said, where are these markets going from here?
Technically, we need to take our cues from the Treasury market. In our "risk on"/ "risk off" environment, the flows into or out of Treasuries will tell us where stock prices are going. And other than Friday price action, Treasuries are telling us that the path of least resistance for equities is up.
The Dollar can assist us in determining market reaction but as articulated above, the Euro's influence on the Dollar is skewing its message. So in the short term, I'm using the Dollar as a secondary indicator for market direction.
Gold, as stated above, is lacking short term direction after a considerable run up in price. The inevitability of central bank money printing should insure us that it's decade plus bull market is intact. Yet it concerns me that with 40 billion in Fed liquidity entering our economy on a monthly basis, gold is in correction mode at this time. This is the kind of signal we should not ignore. And the signal it is speaking to is deflation! While it's true that dependable inter market relationships can become skewed on a short term basis we cannot and should not ignore what the yellow metal is telling us. If the message of Treasuries and the Dollar is correct, we should see gold resume its upside price action soon. If it doesn't it must call into question what the Dollar and Treasuries are telling us.
Commodities, especially industrial commodities, are telling us that the global economy is very "mushy", with varying areas of strength. They say the US economy can be likened to the nicest house in a slum. Europe is in contraction, although recent data suggests that there too, the slum is mixed. China might be turning a corner on its growth but one can never definitively know because the statistics may not be accurate. Certainly, commodities are definitely telling us that the global economy is in the doldrums.
In the short term we could see additional selling pressure on equities this week. However, if the message of Treasuries and the Dollar is correct, we should find a floor soon to the market decline. Over the longer term, issues surrounding the fiscal cliff and Europe still have the potential to roil our market. As always, anything can happen in the market, especially with so many issues hanging in the balance.
Watch the UPS earnings report before the market opens on Tuesday morning. If earnings disappoint, look for another sell off. I expect earnings to disappoint ...
Have a great week!
NOTHING IN THIS COMMENTARY SHOULD BE CONSTRUED AS AN OFFER OR ADVICE TO BUY OR SELL ANY SECURITIES, OPTIONS, FUTURES OR COMMODITIES. THE OPINIONS ARTICULATED ARE ONLY THIS AUTHOR'S WHO IS NOT A REGISTERED INVESTMENT ADVISOR OR BROKER ... yet!