Saturday, April 6, 2013

Macro Analysis 4/5/2013

Equities had their second meaningful down week of the year (the first being in late February).  Small caps, commodity related and transport stocks lead the charge lower which does not bode well for the market in the short term.  Friday's decline was attributed to a disappointing monthly employment report.  Non farm payroll job creation came in at a paltry 88,000 versus the 200,000 consensus expectation.  Although the market came back at the end of the day it was not enough to erase the losses on the week.

I've been toying with the idea of sending these commentaries out on a bi weekly basis but based on the feedback from some of you I've decided to continue sending out weeklies.  However, I'll be sending out more condensed commentaries.  One of the challenges of a shorter commentary is that some of my readers may not understand some of the more complex concepts that I identify in the reports which I have attempted to explain up to this time.  I request that if there is something that is not understood in my writings just email me with your questions.  I'll be happy to respond.

Throughout this week I had been concerned with some of the glaring technical divergences that the market has been manifesting.  And although we began to see cracks in the market on Thursday and Friday these divergences are still conspicuous.  More importantly, to my mind anyway, these divergences aren't the "garden variety" type that signal a normal correction.  They look like something much more serious.

Most of you know I'm no fear monger and I'm generally turned off by Armageddon scenarios but some of these divergences are spooking me.  Yet, as Fed liquidity "floats all boats" the popular mantra on the street is "buy the dips".  We saw another example of this on Friday as the major indexes, though finishing at a loss on the day, came back considerably from their intra day lows.

I'm going to outline the divergences I see in order from the most benign to the most serious.

The Dow Transports had been leading this market higher at a frenzied pace but were brutalized this week:

(click on chart for larger image)
I've circled the week's price action and the best we can say about the chart is that Friday's price action formed a "hammer" candlestick which has been known to signal a reversal.  Notice the lower panel which is a price relative comparison of the Transports to the S&P 500. 
Here's a daily chart the Russell 2000.  It must be remembered that small caps as represented by this index have been the stellar performers in this powerful advance:
(click on chart for larger image)

Much the same picture as the Transportation Index above ...

A look "under the hood" of the market reveals a technical divergence in breadth:

(click on chart for larger image)
This is an update on a chart I've posted before, the NYSE Summation Index.  The Summation Index is a breadth indicator derived from the McClellan Oscillator, which is a breadth indicator based on Net Advances (advancing issues less declining issues). The Summation Index is simply a running total of the McClellan Oscillator values.  I've identified the divergence inside the circle and the market is finally getting in sync with the declining breadth.

The following divergences are causing me greater concern regarding the intermediate and long term prospects of this market.  Notice that these are all weekly charts which lends to their greater significance:

Here's Brent Crude:

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Crude oil has penetrated a long term support line going back to a market bottom in 2009.  Weak oil equals a weak global economy.
Here's "Dr. Copper", who has a PhD in Economics:
(click on chart for larger image)
If things are getting so much better why is the most important industrial metal tanking?  The street is dismissing this as mainly a supply/demand issue because of inventory build up in China.  But inventory build up means there's no need for the industrial metal.
Here's the Dow Jones UBS Industrial Metals Index which tracks not only copper but zinc, nickel and aluminum:
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We are presently sitting on major support after this week's price action.
Lastly, here's a weekly chart of lumber:
(click on chart for larger image)
With housing doing so well why has lumber pierced a support line that was established last October?
Admittedly, Brent, industrial metals and lumber are "on the cusp" and could just as easily go up from here.  But Treasuries are verifying their recent weakness.  Here's the iShares Barclays 20+ Year Treasury Bond ETF which is a proxy for the long end of the US Treasury yield curve.  I circled this week's price action:
(click on chart for larger image)
The message of Treasuries must be heeded.  If stocks are going one way and Treasuries the other, listen to Treasuries!  The "risk off" trade is alive and well!  The message of the Bond market is that the economy is weakening. 

Lest I be accused of making a "mountain out of a mole hill" I want to say here that the primary trend in equities remains intact and that trend is up.  But, given the divergences I've identified above, the question has to be asked: why is the trend up?
Simply, the Fed (and all central banks) continue to buoy risk assets with the historically unprecedented liquidity they are pumping into their local economies.  The latest foray into the money printing mania came this week when the BoJ (Bank of Japan) announced new liquidity measures in order to defeat a two decade long virulent deflation that has created a stranglehold on the Japanese economy.  Their target is to reach 2% inflation within two years.  In effect, they are going to print 75% of the money our Fed has already printed and pump it into an economy that is one third the size of ours!  Aside from the immediate effects of such an announcement (a plummeting yen and a soaring Nikkei Stock Index) the long term global reverberations will be significant, especially if they end up buying foreign bonds to effectuate their result.  But look what finally caught a bid on Friday:
(click on chart for larger image)
Societe Generale came out this week reiterating their bleak forecast for gold primarily based on rising interest rates predicated on a strengthening US economy and I have previously gone on record as stating that the gold bull market is dead.  But one thing I've learned is that when everyone moves to one side of the market on an issue, there is usually know one left to sell.  I'll be looking for follow through for the yellow metal in the coming weeks.  The BoJ policy decision may be the catalyst needed to reignite the gold bull market.
With the bad employment report on Friday, many are fearing that the seasonality in economic statistics we have experienced since the post Lehman meltdown in 2008 may be manifesting itself again.  The severity of the economy’s plunge in late 2008 and early 2009 after Lehman Brothers collapsed threw a wrench into models used to smooth the data for seasonal changes.  Closely correlated to this is the "sell in May and go away" phenomenon which has been present in varying degrees over the past three years.  I do believe these distortions are still with us and the divergences identified above are partly the result of these distortions as traders and investors position themselves for the weak data cycle. 
Nevertheless, the weakness in commodities is auguring something much more serious going on in the global economy and unless it turns around soon there is no way the US economy can remain resilient in the face of a deteriorating global economy.

 In the short term I believe we will see more upside next week.  Candlestick patterns and the price action on Friday point to this.  So long as the "buy the dip" mentality prevails any decline will be met by buyers until the Fed starts to signal that they are applying brakes to their unlimited QE.  If the trend in commodities I've identified above continue there is very little chance of that happening.  So wherever central banks "blow their bubble" risk assets will ascend.  Enjoy the ride! 
Have a great week!