The real story, however, was the resilience of the equity market in the face of what seemed to be some significant selling pressure. From where the selling pressure came from was not clear but it was evident on Thursday that stocks were very uncomfortable as yields on Treasuries moved higher in the overnight and pre market session. Also a concern seemed to be who might succeed Ben Bernanke as the next Fed chairman. Larry Summers apparently is looked upon as a more hawkish selection that the Obama administration is considering. Nevertheless, stocks came back both on Thursday and Friday from significant deficits.
No index better represents the strength I alluded to above than the S&P 500 Index ($SPX). Below is a six month daily chart of $SPX:
(click on chart for larger image)
Notice on the chart the blue dashed line which is what is called an "inside support line" that was established from November, 2012 lows. The white arrows point to the bounces off of that support save for the period in mid June after Bernanke's "pop the bubble" speech. I circled Thursday & Friday's price action and you can see by the "tails" on the candlesticks that attempts to penetrate that resistance this week were decisively turned away.
For a larger perspective of how far we've come from the dark days of 2009, here's a weekly chart of the Wilshire 5000 which is representative of all publicly traded US equities:
(click on chart for larger image)
Fighting the tape with this kind of price action can be likened to trying to stop a slow moving freight train by standing in front of it. Stocks want to go higher and it doesn't seem as though any negative news can dent the momentum of this market.
Let's take a peek at Treasuries. Here's a daily chart of the iShares Barclays 7-10 Year Treasury Bond Fund:
(click on chart for larger image)
I chose this ETF as it is fairly reflective of the Ten Year Treasury Note from which mortgage rates are derived. As you look at the chart remember that bond prices move inversely to yields. We can see that the Treasury market had been anticipating higher rates on the prospect of Fed "tapering" of asset purchases as early as the first week of May. Bernanke's speech on 6/19 accelerated the sell off. Now, however, Treasury prices have stabilized somewhat but interest rates are still high relative to two months ago and this has hurt home builders. This is the iShares Dow Jones US Home Construction Index (ITB):
(click on chart for larger image)
The chart is a bit busy but I want to highlight how higher interest rates have hurt the home builders. The red box on the chart encompasses the downturn in the ETF with its correlation to the Ten Year Treasury yield in the bottom panel. Up until the end of June the ETF and the Ten Year yield were positively correlated. That correlation quickly turned negative as yields moved higher.
Home building has been the backbone of our recovery thus far and it would be prudent to monitor these stocks going forward as interest rates seem to have nowhere to go but up. I'll have more on interest rates in my analysis.
Gold had a see-saw week but is presently bumping up against Fibonacci resistance that must be penetrated if it is to move higher. This is a daily chart of the SPDR Gold Trust Shares (GLD), which is the popular proxy for the yellow metal:
(click on chart for larger image)
I circled the entire week's price action. The arrow in the upper panel points to a level (60) on the Relative Strength Index that must be exceeded if we are going to say that there's more upside for gold.
The concern I have for gold is that it's stalled at the level on the chart above as the US Dollar continually weakens. The traditional inter market relationship is that the USD and Gold move inversely to one another.
Here's the PowerShares DB US Dollar Index Bullish Fund (UUP) which is the ETF proxy for the currency:
(click on chart for larger image)
The current rally we've seen in stocks has as much to do with the chart above as anything else. The Dollar is weakening as market expectations for a September "tapering" of asset purchases by the Fed wane.
Analysis
In some ways, I found there were subtle messages embedded in the price action of the markets this week. This could just be the result of thin summer trading. Broadly speaking, price action has been impressive and market breadth indicators have recovered from the June swoon. The CBOE Volatility Index (VIX), otherwise known as the "fear gauge", has once more dropped to post Lehman lows (see black arrow):
(click on chart for larger image)
Volume was light this week on all the major indexes as it has been all year. The average up & down volume (minus unchanged volume) for the five trading days on the NYSE was 3,154,720,102 shares. The term "up/down (minus unchanged volume)" simply means the number of shares of stocks that finished the day higher (up) and the number of shares of stocks that finished the day lower (down) without the volume of shares of stocks that finished the day unchanged (minus unchanged). However, on Wednesday, which was the big negative trading day for the week, the volume was 4,196,384,241 shares. This heavy volume in the midst of low volume trading sessions stood out like a "red flag". So I did a little research and went back to the beginning of the year and determined the following:
- the average up/down (minus unchanged) daily trading volume on the NYSE since January 1st is 3,364,070,073 shares.
- there were a total of only twelve trading days when up/down volume on the NYSE exceeded four million shares
- of those days where volume exceeded four million shares, only one of those days saw the S&P 500 higher than the previous day and that was on January 2nd in the aftermath of the Fiscal Cliff deal. All the other days where up/down volume exceeded four million shares the S&P suffered a down day (and most were severe down days).
Is this mere coincidence? Or is it distribution? I know to some of you this type of "data diving" may seem arcane but it is difficult for me personally to dismiss this statistic as coincidental. I am not intimating that this is a signal that the market is setting up to rollover. Certainly, all the other indicators I follow (some of which I've outlined in this commentary) are signaling a steady trajectory higher for equities into the end of the year. However, I do believe it bares watching. It is pretty clear to me that anyone who jumps into the market now is "chasing it higher". And that may not be a bad thing since we don't know when the advance will stop. But the "smart money" always gets out first when the market is ready to correct, leaving "the little guy" holding the bag. However, it's very difficult to see anything on the horizon technically that would put an end to this bull market. Additionally, fundamentals around the planet suggest that we are finally starting to heal from the wounds wrought by the 2008 - 2009 events and their aftermath.
When we do look around the world, central banks are as accommodating as they can be. European "tail risks" have disappeared thanks to Mr. Draghi and the ECB. Periphery yields remain low relative to the dark days of 2011 and 2012. Most importantly, German, French and EU manufacturing data surprised to the upside this week, signaling the ever growing probability that the European Recession/Depression has bottomed and is poised for an upturn. German manufacturing data is now in expansionary territory.
I've been waiting for some signs of life in Europe and this weeks "glimmer" is a good sign. As I've stated in previous commentaries, European consumption is a necessary prerequisite for a global recovery. US consumption cannot do it alone. The consuming economies in the West are still the "dog that wags the tail"; that tail being the Emerging Market" economies.
The Emerging Markets chart could be construed positively or there's a possible formation forming that could be interpreted as a rising wedge or bear flag pattern. Here's a weekly chart of the iShares MSCI Emerging Markets ETF (EEM):
(click on chart for larger image)
Objectively speaking, it's more probable that the chart is constructive than negative. Normally, bear flag or rising wedge patterns are not that steep.
On the other hand, the Shanghai Composite cannot build any momentum to the upside and had a terrible week. The Chinese market wants the PBoC (Peoples Bank of China) to feed the economy monetary stimulus but it's becoming more apparent with time that the new Chinese leadership is determined to crack down on the easy credit created by the "shadow banking" system and has tightened liquidity conditions in that country. The SHIBOR (Shanghai Interbank Offering Rate) has risen dramatically in the last week:
(click on chart for larger image)
chart courtesy of Soberlook.com
Tight monetary conditions are slowing down the Chinese economy which is reflected in the Shanghai Composite. Here's a weekly chart of the index in order to give my readers a broader perspective:
(click on chart for larger image)
Believe it or not, 25% of all Eurozone exports go to China. So continued Chinese economic weakness will impede a European economic recovery.
The reflation trade is still "dead in the water" with industrial commodities treading water with a downside bias. Friday's price action in the commodities was especially disappointing with copper and the other industrial commodities taking a significant step back. Here's a daily chart of the Dow Jones UBS Industrial Commodities Index:
(click on chart for larger image)
So there you have it! We have a tepid recovery in this country and a glimmer of hope in Europe that their downturn is panning out. Chinese structural problems and runaway credit conditions are forcing the Chinese government's hand which is slowing down that economy. Emerging markets are being held captive to the consumption based economies of the west but if we are to believe the charts they are probably signaling that the worst has passed. So we're limping along toward a global recovery and thanks to a firmly based free market economy and a central bank that knew when to turn the money spigots on when needed, we in this country are leading the world in economic growth and stronger equity markets.
I've spoken much about the Fed induced liquidity rally in our markets but I would be blind to declare that it is the only reason why our markets are doing so well. The caveat I offer to this thesis is how the market will react to higher interest rates. An argument can be made that the June reaction to the market's perception that the "punch bowl" would be taken away is a precursor to what will happen when interest rates do inevitably rise in earnest. Indeed, the fact that Bernanke has calmed markets with recent dovish talk can be pointed to as the reason for the recovery in stocks from the June swoon. But with an accommodating Fed committed to keeping interest rates low for the foreseeable future, unless they lose control of the yield curve, there's little chance that rates are going to rise to the point of choking off economic growth, which leads me to addressing the price action of gold.
The fact that gold has been snagged on 50% Fibonacci resistance all week while the Dollar has essentially tanked during that time period is an ominous sign. With all the crosscurrents I've identified in this commentary, gold's failure to advance further than it has in face of a weak USD speaks to any or all of the following:
1. the markets are not worried about "tail risk". The Armageddon scenario is "off the table"
2. the markets are not worried about inflation
3. gold is anticipating higher interest rates
Some were looking for a corrective bounce in the "yellow metal" to the $1,500 area but unless we see a decisive move higher from present resistance, gold's next move will be significantly lower. Here's a weekly chart with the next probable target:
(click on chart for larger image)
In the coming week, Europe will be releasing a host of economic data which will be closely watched after the positive numbers we saw last week. China releases manufacturing PMI data on Wednesday evening which always impacts Asian markets but not so much ours lately.
In our country, all eyes will be on the FOMC (Federal Open Market Committee) announcement following their two day meeting on Wednesday afternoon. Attention will be focused on forward guidance and the characterization of the economy; reading the Fed "tea leaves" for signals on the tapering of asset purchases. We also have important manufacturing data released on Thursday along with the ever predominant monthly employment report on Friday which always moves markets.
Of less importance to the market but a number I'll be watching is the Core Personal Consumption spending (PCE) Price Index which measures the changes in the price of goods and services purchased by consumers for the purpose of consumption, excluding food and energy. Disinflationary and deflationary pressures still dominate the globe and any movement away from these pressures will validate other positive economic data. I'm hopeful that we will see our way out of this challenge which everyone seems to be dismissing as transitory. I believe the "verdict is still out" until we see the reflation trade rejuvenated which, in turn, will be a function largely of an EU economic recovery.
Have a great week!
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