As always, very useful economic and market commentary from David Rosenberg.
If this European crisis has accomplished anything, it has taken the froth out of commodity prices. Even gold is softening but every time it goes to test the 200-day m.a. — now at $1,100 oz — it becomes a great buying opportunity. Moreover, this has all but eliminated the overvaluation gap in the Canadian dollar for the first time in four months.
Take note that there was not one particular piece of news that drove the markets lower yesterday and this is key because it goes to the root of Bob Farrell’s rule that “the markets make the news, the news does not make the markets.” There are simply now more sellers than there are buyers because portfolio managers went into this latest chapter of the global credit story fully invested, the hedgies had already met their high-water marks, the shorts had been covered long ago and the general investing public seem to be in a multi-year phase of bolstering its underweight position in the fixed-income market.
Moreover, the “pig farmers” at the prop desks at the big banks, the ones who drove the last leg of the bear market rally, seem to be placing their bets the other way right now and with few bids, the prices are adjusting lower (the ‘flash crash’ was an exaggerated version of how a market can move when there is no bid). Since much of the bear market rally off the March 2009 lows was technical rather than fundamental in nature, one cannot rule out a move down towards the 900-950 area for the S&P 500, which is where a classic retracement would take it; not to mention where it would offer fair-value on a normalized P/E ratio basis.
- As it stands, this is the first official correction in equities since the market came off the lows 14 months ago:
- The S&P 500 is now down 12% from the nearby highs.
- The Russell 2000 is down 14%.
- TSX is down 7%.
- Oil is down 21%.
- Copper down 19%.
- The CRB is off 15%.
- The yield on the 10-year note is down 80bps.
- Investment grade corporate spreads have widened 61bps while high-yield spreads have moved out 161bps.
- The VIX has surged 193%.
- The euro is down 15% and while the CAD has outperformed its commodity counterparts, it has sagged 7% from the recent highs.
Since the market highs in the S&P 500, the best performing equity sectors have been Telecom, Consumer Staples, and Industrials; the worst three have been Financials, Energy and Health Care — in a sign of how the complexion has shifted towards a less cyclical stance.
Look, there’s no sense getting overly bearish and while those of us with cash on hand that had been waiting for this opportunity in Godot-like fashion, the correction comes as good news. But for the economy, it cannot be a bad thing to have oil prices come down, which helps add cash to consumer pocketbooks and protect profit margins, and of course this wonderful bond rally has acted as a source of social policy seeing as it has helped pull mortgage rates down to six-month lows, to 4.8% for the U.S. 30-year fixed rate product.
While we did have a few quarters of respite in consumer spending, make no mistake that the trend is down, not up (real per capital household spending has not even made a new high yet) and the frugality theme we introduced more than two years ago is fully intact. For some evidence on this front, the just-released USA Today/Gallup poll show that 27% of Americans plan to travel less this summer; only 18% intend to travel more. This will likely put a dent in the hotel and airline sectors, which, according to the latest CPI statistics, had been showing some nice pricing power improvement in the past 2-3 months.
The must read of the day, if there is one, is the Paul Krugman’s column on page A23 of the NYT — Lost Decade Looming? He starts off with “despite a chorus of voices claiming otherwise, we aren’t Greece. We are, however, looking more and more like Japan.”
We have been saying this since late 2008 when the Fed dropped the funds rate to zero and that still couldn’t put a floor under either the economy or the equity and debt markets. What did put in a bottom was an experimental toolkit that involved an unprecedented expansion of the central bank’s balance sheet, which is now concentrated more in residential mortgages than in government securities. One other thing — it is not one lost decade in Japan, it is two.
The equity market is technically oversold right now and is due for a near-term bounce, but that would be a rally that I would fade if we see it. There has been too much of a rupture to ignore with the S&P 500, Dow and Nasdaq all closing below their 200-day moving averages (fist time in almost a year for the Nasdaq). There were only 11 new highs yesterday and 212 new lows, so this ratio is still quite bleak. Decliners/advancers were also 11-to-1 on the major exchanges. This is what I mean by rupture.
On average, corrections that take place after such a massive move up from a depressed low is 20%, which would mean that we could expect to see the S&P 500 still test the 970 level; with a prospect of a second-order Fibonacci retracement implying a move below 950. Remember that before the last big leg up in the market last summer, the S&P 500 was hovering around the 920 level, which is my target to begin getting interested again.
A 10% correction, even in a bull market, is pretty normal, and historically has occurred about every 12 months — and tends to occur more in the second year of a rebound, or bull market, than in year-one. So the European debt crisis is certainly the catalyst for this renewed round of risk aversion, but is not out of line with market patterns over the past century.
Two critical data points to watch for — the May 6 flash-crash intraday low of 1,065 on the S&P 500, followed by the 1,044.5 low on February 5. If these don’t hold, and the bulls need these levels to hold, then another leg down to or through the 950-970 levels is likely.
To turn bullish, we would need to see Libor-OIS spreads begin to narrow again, corporate spreads tighten, and stability in the euro. That would be important signals from the other asset classes. Technically, it would be encouraging to see two big up-days in the stock market with large volume — we need a follow-through with huge participation. It would also help if market sentiments swung towards the bearish camp — believe it or not, the most recent Investors Intelligence survey has the bulls at 43.8% and the bears at 24.7%. At the lows, we would expect these numbers to be reversed.
The fly-in-the-ointment is that unlike 1987 or 1998, this is not just a financial crisis but one that is occurring with the global economy in a post-bubble fragile state — if it is a recovery, it is a nascent recovery. And, already we see that the U.S. leading economic indicator fell in April, which is unusual at this early stage of the cycle, and jobless claims heading back above 470k, if sustained, is worrisome because in the past this has coincided with job losses fully 75% of the time. By the time the jobless recoveries were over and done with in 2003 and 1993, claims had already moved down to 400k in the former and 350k in the latter. And, practically every house price measure in the U.S.A. is rolling over right now. The lesson of 2002 is that market priced for perfection does not even need a classic double-dip to falter — a simple growth relapse will do the trick.