Saturday, April 20, 2013

Macro Analysis 4/19/2013

Stocks suffered yet another negative week with all the major indices down more than 2% and small caps leading the charge to the downside, down over 3% on the week.  And the "d" word (deflation) was used on the street this week, to the disdain of the stock jockeys.  I'll have more on this most important subject below.

Let's get right to the charts.  Here's a daily chart of the Wilshire 5000 Index which tracks all US equities:

(click on chart for larger image)
I've circled the week's price action and pointed to the 50 day moving average (blue arrow, blue line) which the index managed to close above on Friday.  Here's the S&P 500:

(click on chart for larger image)
Here too, the S&P has closed above its 50 day moving average.  And on both charts the last two days price action denotes a bullish engulfing pattern which suggests a short term upward bias going into next week. 
Breadth indicators, which I'm not going to post, are signalling a "garden variety" correction.  The Treasury market is signalling the same.  Here's the iShares Barclays 20+ Year US Treasury Bond ETF:
(click on chart for larger image)
The week's price action has been circled.  For all the weakness equities manifested this week the long end of the yield curve seems to have met stiff resistance.  Interestingly though, while stocks finished the week with a strong Friday, yields and bond prices barely budged.  Obviously, the Fed's bond purchases are suppressing rates across the entire yield curve but when the S&P rallies 13+ points in a day (which it did on Friday) the ETF above sells off much more than 26 cents.
Until we see much more selling pressure in stocks we really can't even say that this week's price action can be defined as the start of a correction.  The 50 day moving average is holding and as stated above, breadth has not made a serious turn lower. 
However, the issues I identified last week still persist and are not getting any better.  The next five charts highlight the troubled commodity complex and I'm starting with that illustrious professor of global economics, "Dr. Copper".  We'll start with the weekly chart:
(click on chart for larger image)
What can I say?  This chart is absolutely ugly!  But notice the long tail on the candlestick I pointed to and consider this monthly chart of Copper:
(click on chart for larger image)
Notice the blue arrow and a support trend line drawn from early 2007.  Multi year support lines are significant and typically provide strong support.  I believe it's significant that there's a "tail" on the last candlestick and that it obviously bounced off of that support line.  I take this as a positive for the "orange metal".
Here's a weekly chart of Dow Jones US Steel Index.  The index has confirmed breaking a multi year support line (purple dashed):
(click on chart for larger image)
Here's a weekly chart of the Dow Jones World Basic Materials Index:
(click on chart for larger image)
It too has pierced a long term trend line to the downside.  And here's a daily chart of Gold:
(click on chart for larger image)
Gold is experiencing a typical "dead cat" bounce this week and already there are murmurs on the street that it's turning around (not).  Just the nature of the candlesticks formed this week suggests indecision and the price action seems to be forming a "bear flag" pattern which usually signals a continuation to the downside.
Commodity weakness is reflected in global exporting countries; those identified as the emerging markets.  Here's a weekly chart of the iShares MSCI Emerging Markets ETF: 
(click on chart for larger image)
Interestingly, like the monthly chart of copper above, EEM has bounced off a multi year support line and the candlestick is a bullish one.
I'll try to be as brief as I can.  There were more than a few comments regarding deflation in this week's financial press and most respondents were either ambivalent to the concept or attempted to dismiss the scenario. 
Gold's fierce sell off was the center of the conversation.  Many stated that the gold sell off was not deflationary.  Never mind that the initial impetus for the sell off were rumours that the ECB (European Central Bank) was pressuring Cypress into selling 440 million euros in gold in order to honor their commitment to the "troika".  The concern of gold traders was not the measly 440 million in gold that might be dumped on the market but the prospect that other EU nations that are much bigger and have larger gold reserves than Cypress might be forced to do the same.
Many are dismissing gold's sell off as a "one off" event that has nothing to do with deflation.  Let's think about this.  Cypress has to sell gold in order to maintain their solvency.  The perception in the gold market sparks a domino effect that causes an historic sell off in the yellow metal and forces margin calls in equities as traders/investors scramble to cover their losses.  So, how is this not deflationary?
More importantly and going beyond gold's demise, the BoJ's (Bank of Japan) plan to double the size of its balance sheet in the attempt to lift Japan's inflation to 2% appears to be having the opposite effect on the rest of the world. 
By driving Yen valuation lower thru money printing the BoJ has effectively lifted the exchange rate of its competitors in the global export market.  This is stunting economic growth of these countries as they become less competitive and is the reason for the continuing weakness in commodities.
Some on the street are comparing the Yen's devaluation to the events leading up to the Asian Currency Crisis of 1997.  At that time, the Yen's slide strangled the Asian exporting economies and as their external trade imbalances deteriorated, currency speculators started targeting the pegged currencies of one country after the other until a domino collapse enveloped the planet.
Granted, the situation is now different in that there are fewer pegged currencies and many countries are awash in foreign reserves to defend their currencies.  But this time around, the potential crisis could very well play out in the world's bond markets.  Yields worldwide are inching down since the BoJ implemented their program.  Another potential bubble is forming.
To sum up, the street has decided to ignore the clear deflationary implications commodities and gold are forecasting.  The implicit message of gold and commodities is that the central bank formula of papering over trillions of dollars of bad debt is not working.  Consider this comparative chart of the US Dollar and all the other major foreign currencies on a three day moving average basis:
(click on chart for larger image)
The US Dollar is strengthening against all other major currencies.  Without getting into detail which would lengthen this commentary, this, in itself, is extremely deflationary.
 The monthly chart of copper and the weekly chart of the iShares MSCI Emerging Markets ETF posted above may be suggesting that the slide in commodities we have been seeing may be on the verge of turning around.  And with the Fed, in concert with the BoJ, blowing the equity bubble ever larger, there's no apparent reason (for now) to get off the equity bandwagon as it meanders ever higher.  But the bubble is there nonetheless and all bubbles eventually burst, just as the (2000) and real estate (2006) bubbles did.  Now, if I could only forecast the timing ...   :-)
 I welcome any questions or clarifications on anything in this commentary.
Have a great week!