Aunt Minnie: The World as We See it on Macro Monday

“Over
the years, I’ve noted that certain subsets of market conditions –
occurring together – are associated with very specific outcomes, such as
oncoming
recessions, abrupt
market weakness, strength in precious
metals, and so forth. Such indicator subsets, or Aunt Minnies, are
essentially “signatures” that often have very specific implications. In
medicine, an Aunt Minnie is a particular set of symptoms that is
“pathognomonic” (distinctly characteristic) of a specific disease, even
if each of the individual symptoms might be fairly common. Last week, we
observed an Aunt Minnie featuring a collapse in market internals that
has historically been associated with sharply negative market
implications.

“Of
the 3257 issues traded on the NYSE last week, 2955 declined and just
275 advanced. The S&P 500 has now abruptly erased nearly 8 months of
progress. Moreover, we observed a “leadership reversal” with new
52-week lows flipping above the number of new 52-week highs. Our broader
measures of market action deteriorated to a negative position as well.
Historically, we can identify 19 instances in the past 50 years where
the weekly data featured broadly negative internals, coupled with at
least 3-to-1 negative breadth, and a leadership reversal. On average,
the S&P 500 lost another 7% within the next 12 weeks (based on
weekly closing data), widening to an average loss of nearly 20% within
the next 12 months – often substantially more when the Aunt Minnie
occurred with rich valuations and elevated bullish sentiment.

“The most recent instance was November 9, 2007, which was
followed by a market loss of more than 50%, but the instances also
include September 22, 2000, prior to a nearly two-year bear market
decline; July 14, 1998 prior to the “Asian-crisis” mini-crash; July 27,
1990, at the beginning of the pre-Gulf War plunge; October 9, 1987, just
prior to that market crash; July 2, 1981 at the beginning of the
1981-82 bear market and again in May 21, 1982, following a strong rally
during that bear market, leading into a steep decline to the final lows;
November 9, 1973 (just after a swift rally during the 1973-74 bear
market, and leading into the main portion of that loss); and November
21, 1969, at the beginning of the 1969-70 bear market.The combination of unfavorable
valuations and collapsing market internals is a sharp warning to examine
risk exposures carefully here.”       

–
John P. Hussman, Weekly Market Comment      

This week’s comments from Dr. Hussman
are worth a close read.  In addition to the excerpt above, we would also
recommend reading the section from his November 12, 2007 comment,
reprinted in this week’s comments.      

Last time we shared our Macro
Monday notes with readers was February 1^st when we
noted “There’s
Nothing Good Here, except for the potential for a short-term bounce
from oversold levels.”  The market predictably marched higher from the
“hammer lows” produced later on February 5^th (admittedly,
much higher and much longer than we would have expected), but two steep
weekly declines in May, have wiped out all of that progress and them
some!       

Ironically, we find ourselves in an
eerily similar position today with markets extremely oversold on a short
term basis.  To review, back in February we noted: the percent of
stocks above their 200 DMA rolling over; credit spreads widening; dollar
strength an indication of deflationary pressures; Euro weakness
signaling sovereign debt concerns; money supply growth declining;
growing red flags in the commodity space; and rampant pessimism in
treasury markets.  Despite the potential for an oversold bounce, we
suggested that “given the massive underlying risks from a macro
perspective, it is prudent to leave the last ten percent for the next
guy.”      

Today, we recommend investors re-read
that last sentence as Mr. Market is telling us that these risks are
real.  The potential for policy mistakes has increased, while the
consequences of any missteps are not pretty, according to Aunt Minnie.
 Market action last week was typical of wholesale liquidation – think
Lehman.  Despite the potential for another oversold bounce, the
deterioration in trend, coupled with emerging cracks in credit markets
are more than enough to keep us on the sidelines especially when viewed
in the broader context of an extended debt deleveraging process. With
that said, here is the world as we see it this Macro Monday
Morning:      

• Credit is a Concern.  LIBOR spreads are
  widening . . . again.  The bulls argue that spreads are nowhere near
  Lehman levels.  We say, you gotta start somewhere.  We expect more
  deterioration ahead, driven by an emerging crisis across European banks.

Source:
Thechartstore.com

•  Treasury Yields are Freaking Out!  Later
  in the Year . . . Is Now!  Note the near record foreign purchases
  of US Treasuries as investors flock to safety.

• CPI is rolling over despite all the
  yelling and screaming from the Inflationistas.  Expect yields to follow
  lower.

Source:
The Business Insider

• LEIs are rolling over . . . globally.

Source: The Business Insider

• Commodities are following in lockstep
  (with precious metals a notable exception).  As we suggested in
  February, “When CPI rolls, run for the exits!!”  Ladies and gentlemen,
  CPI is rolling.  Take another look at the Consumer Price Index above.
  Again, we’d encourage China bulls to review our Cautionary
  Fable and Edward Chancellor’s Red
  Flags.

Source:
Thechartstore.com

• Commodity Currencies are telling the
  same story as our short term, intermediate term and long term trend
  models are all in synch and pointing lower for the Aussie and Canadian
  Dollars.  It should not come as a surprise that the setup for Euro and
  Sterling is identical.  In fact, the only currencies bullish across all
  three durations today are the USD and the Yen.  Does that concern anyone
  else?   

Source: Thechartstore.com

We fully recognize that the simple fact
that we are sharing our concerns with readers again, all but assures a
powerful short covering rally that may have already begun.  We’d welcome
said rally as an opportunity to sell strength.  The data points above,
along with many others point to an important regime shift.  In a bull
market, corrections producing oversold conditions should be bought. 
Conversely, in a bear market, oversold conditions can quickly become really
oversold.  Short term bounces within a downtrend, should be sold.  We
think that advice is applicable today. While those looking to play a
bounce, point to the percentage of stocks above their ten-week moving
average, as proof of an oversold extreme, we are skeptical.  With less
than 10% of stocks trading above this mark, Mr. Market is certainly
stretched to the downside.  Importantly though, when combined with the
percentage of stocks above their forty-week moving average, we reach a
much different conclusion.  In an uptrend (with most stocks above their
long term trend, defined here as the forty-week moving average),
short-term oversold levels (like the ten-week moving average) provide
attractive entry points.  But with the majority of stocks below both
their ten-week and forty-week moving averages, a condition Ned Davis has
observed 17.4% of the time, and one we observe today, the market has
historically declined at 15.8% annual rate. 

It’s interesting to note that the
1997-1998 Asian Crisis sparked a 20%-30% correction in domestic equity
markets, before both indices exploded higher in 1999.  We continue to
think that the Asian Crisis is a good playbook for investing around
today’s Global Sovereign Debt Crisis.  An ugly global market sell-off in
risk assets, which erodes investor optimism and rids us of complacency,
may very well set the stage for Jeremy
Grantham’s Third Year Presidential Cycle Rally, as the Fed keeps
the pedal to the metal in an attempt to overcome the threat of Fisher’s
Debt Deflation.  More on this later.  Right now, I’ve got to get some
work done before heading to Greece later this week, where I’ll hopefully
have some free time to chat with our friends in the Hellenic CFA
Society.  I’d imagine they’d have some interesting tidbits to share as
well.  

Disclosure: At the time of
publication, the author was long US Government Bonds, Precious Metals
and the US Dollar, and short the Euro and  Australian Dollar, although
positions may change at any time 

Comments

[Rantor]

Your charts show it is all going down against the dollar, exactly what a deflationary depression would predict...  Commodities are going down too, that should include Gold...  so why be long Gold? 

Look at the M2 and M3 - regardless of CPI we are in a deflationary period.

[RockyRacoon]

Follow that link in the first sentence and you get this concerning gold:

http://www.hussmanfunds.com/html/gold.htm

$/ounce of gold = $/FC x FC/ounce of gold.

Stare at that equation for a minute. Any time you see the price of gold rise, one of two things must be true. Either the foreign price of gold (FC/ounce of gold) has increased, or the value of the dollar must have declined (i.e. foreign currencies have become more expensive, and $/FC has increased).

As a result, huge and sustained moves in the price of gold require either 1) worldwide inflation, or 2) a plunging U.S. dollar. Unquestionably, rising inflation - particularly worldwide inflation, is a plus for gold prices, but the real action comes when inflation rates are rising worldwide and the dollar is under pressure.

So if we're looking for a rally in gold, we're really looking for 1) World inflation, particularly in the U.S., and 2) falling long term Treasury bond yields. This combination is most frequently seen early in a recession. Remember, unless demand is actually falling, slower economic growth is correlated with faster inflation. That means that inflation is generally rising at the time the economy enters a recession. At the same time, it turns out that long term interest rates stagnate or fall as the economy enters a recession. The net result is that as the economy softens, long-term real interest rates tend to decline, and the value of the dollar typically plunges. That's the time you want to own gold.

[Matto]

Such a clever squirrel.

[Joe Shmoe]

Super clear argument.  I've been making a similar case to clients for the past month.  You make a much clearer case than I (luckily, I've been getting my point across well enough to make appropriate moves).  Thanks.