Saturday, April 27, 2013

Macro Analysis 4/26/2013

As I surveyed this week's results stocks basically made back what they lost last week and the short to intermediate term direction is still up. 

Commodities had an upward bias early in the week but were slapped down on Friday when US first quarter GDP came in below expectations.  Representative of the entire industrial commodity complex is the updated weekly chart of the Dow Jones UBS Industrial Metals Index.  We've broken long term support:

(click on chart for larger image)

While I've been emphasizing the negative relationship between deflating commodity prices and a weakening global economy there is a brighter side to this as the Wall Street stock jockeys continually remind us.  Lower commodity prices generally lead to lower input costs and expanding profit margins on corporate balance sheets.  The wider thesis is that so long as the US economy can keep its head above water lower commodity prices are not only good for corporations but also the consumer.  To this I would not argue so long as our economy can keep it's head above water.  I think growth in an inter connected global economy could be a very formidable challenge unless the Euro zone starts to come out of recession.  And there is no sign of that yet.

Last week I posted a weekly chart of the iShares MSCI Emerging Markets ETF (EEM) and explained that the ETF had firmly bounced off a long term support line and that therefore commodity weakness may not be foretelling a global recession.  Here's an update of the same chart:

(click on chart for larger image)
 
I circled the last two weeks price action and we had follow thru off of last week's bounce.  And here's a weekly chart of the China Shanghai Composite Index:

(click on chart for larger image)

China had a down week and after an encouraging bounce at the end of last year the index appears to be floundering. As representatives of global exporting strength, these two charts will speak clearly on where the global economy is going in the coming weeks.

Of biggest note this week has been the upward move in Treasuries.  Here's a daily chart of the Dow Jones CBOT Treasury Index which measures the performance of three Treasury futures contracts traded on CBOT (Chicago Board of Trade).  It includes the price of the front-month future contracts for 5-year and 10-year notes as well as the T-bond (30 year):

(click on chart for larger image)

The index is currently at the top end of a multi month trading range.  No doubt central bank purchases (mainly the Fed) has buoyed these contracts but I believe there's a lot more to the story than just Fed purchases. 

As per our inter market correlations, rising Treasury prices and rising stock prices cannot continue in unison.  Either Treasuries have to sell off or stocks have to.  However, there's a good chance that central bank distortions are finally impacting this traditional inter market relationship as well. 

Here's a weekly chart of the 10 Year Treasury yield:

(click on chart for larger image)
 
We've decisively closed below a support trend line drawn from the July 2012 all time lows.  The chart otherwise speaks for itself. 

In last week's commentary I pointed to the pressure the Bank of Japan (BoJ) monetary policy is putting on global financial markets; not only in the FOREX (foreign exchange) but international bond markets as well.  Supposedly, data being released is showing that Japanese institutions have been net sellers of international bonds this year.  Well then, who's buying European bonds?  Here's a weekly chart of the Powershares DB Italian Treasury Bond Futures ETN (Exchange Traded Note) which has been representative of the entire European Bond market for some months:

(click on chart for larger image)

Pretty good for a country and a region in the throes of recession/depression!  Italy and Spain are basically comatose economies!  And the ECB is not in the market propping up these bonds.

Global bond strength is partly a reflection of behavior in a yield starved world.  As of Friday's close you could buy a 5 year BTP (Buoni del Tesoro Poliennal) that yields 2.8%.  It's US counterpart closed on Friday yielding 0.686%! 

The appreciation in European bonds has been facilitated in the last week by the rising expectation that the ECB (European Central Bank) is finally going to relent and cut it's key lending rate.  And, of course, actions in the past by Draghi have taken the extreme "Armageddon scenario" tail risk out of the market with the result that investors feel safe investing in what would otherwise be considered "junk".

Money is flooding into global bonds. Another bubble ...

I want to point out two more quick things.  Last week, I noted that Gold was in the process of making a "dead cat" bounce after the drubbing it took earlier in the month.  Well, it's a bit more than a "dead cat" bounce.  Below is a daily chart of the SPDR Gold Trust Shares ETF.  I'm using this ETF instead of the spot price for a specific reason.  The spot price chart is a continuous contract that trades 24 hours a day except between 5PM EST on Friday and 6PM EST on Sunday.  As such, you'll never see a gap on a continuous contract:

(click on chart for larger image)
 
In technical analysis, in all time frames, when a stock or commodity gaps up or down, the gap will almost always serve as formidable resistance or support, depending on which way the asset is moving.  Traders will constantly trade off of these gaps as they act as anchors, protecting traders against sudden moves against their positions.   Well, GLD filled the gap this week to the penny!  Look for more upside in the yellow metal up to the 148.50 area where another gap needs to be filled.
 
Secondly, I've mentioned in recent commentaries that there were signs that the decade plus relationship between the US Dollar and equities was breaking down.  Since 1997-1998, a strong dollar has equated to weaker stock prices and a weaker dollar had the opposite effect.  The next chart serves to support the thesis that the relationship that has held sway for the past 15 years is eroding.  Here's a weekly chart of the New York Stock Exchange Composite Index ($NYA) which comprises the 1900+ stocks traded on the NYSE:
 
(click on chart for larger image)
 
Notice the top panel which correlates the dollar to the index.  That correlation has been below the "0" line (negatively correlated) except for very short periods over the time frame of this chart (almost three years).  That started to change in 2013 (blue box).  What is this telling me?
 
Prior to the Asian Currency Crisis in 1997 stocks and the dollar were positively correlated.  A strong Dollar was good for stocks as the currency accurately reflected the economic strength of the nation.  The panic that ensued in 1997 followed by the imploding of the Long Term Capital Management Hedge Fund in 1998 created the "risk off" trade (a term that was not yet coined at that time) which is essentially a flight into dollar denominated assets (the dollar and Treasuries); a phenomenon we have been living with ever since. 
 
If the chart above is any indication we may be getting back to the normal relationship that a currency and it's equity market is positively correlated which, by extension, would mean that global financial markets are starting to return to stability.  Now, I'm not dogmatic that this is indeed changing yet. However, all I know is that I can no longer depend on the "risk off" relationship of the dollar and stocks in my positioning in the market.  We shall see if this continues ...
 
 Well, that's it for now.  I realize that there are a number of seemingly contradictory points in this commentary as to where stocks and the broader economy are going.  This is especially true when we see what's going on in global bond markets and the dollar's relation to stocks.  I attribute these mixed messages to massive central bank intervention which has intensified recently.  I've already stated that the Fed is blowing an equity bubble but now with the BoJ printing trillions of Yen we're extending that bubble to the global bond market. 
 
It's easy to prognosticate what the Fed should or should not be doing and I do believe that QE3 (aka unlimited QE) was too much.  But now, with Japan jumping on the money printing bandwagon and other countries responding by protecting their currencies, it really doesn't matter what the Fed is doing.  Paper money is finding it's way into paper assets the world over.  The charts in this commentary are a testimonial to that fact.  Maybe that's why GLD filled that huge gap so quickly ...

 
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.