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Bullish Hopes, Bearish Signals

Tyler Durden's picture




 

Submitted by Lance Roberts via STA Wealth Management,

Over the last couple of weeks, I have discussed the entrance of the markets into the seasonally strong period of the year and the potential to increase equity exposure in portfolios on a "short-term" basis. To wit:

"With the markets EXTREMELY overbought short-term, the setup for putting money into the market currently is not ideal.

 

However, as shown in the chart below, the markets have registered a short-term BUY signal that suggests that we remain alert for a pullback that generates a short-term oversold condition without violating any important supports."

The chart below updates that analysis through Monday's close.

SP500-MarketUpdate-111015-1

"As shown, the recent surge in the markets has driven asset prices back resistance near the old highs. Simultaneously, the markets are pushing into very overbought conditions with a rather extreme deviation from the longer-term moving average. Such deviations tend not to last for an extended period.

 

In plain English it essentially means the markets have likely completed its current advance and need a short-term correction to provide a better 'risk/reward' entry for investors to increase equity exposure." 

As shown in the chart above, the expected correction began in earnest this week. Currently, a correction back to previous support levels (2040-2060) will likely find "buyers" betting on the traditional year-end rally. 

Long-Term Concerns Remain

However, it is the longer-term picture that I remain worried about. As noted by my friend Joe Calhoun at Alhambra Partners:

"Stocks also belie this belief that the Fed finally has it right, that growth is finally accelerating and the real recovery is finally underway. Yes, stocks have rallied nicely the last few weeks and have nearly recovered from their August swoon. But all that has done so far is to bring stocks back to where they were in mid-August just before the sell off. While it is certainly possible that we will yet make new highs, I think it is important that momentum is not confirming the move higher except, again, in the very short term. Long term momentum indicators still show a market in the process of topping."

He is correct. As shown in the MONTHLY chart below, a variety of measures still remain very concerning on a long-term basis registering signals only witnessed at peaks of past bull markets.

SP500-MarketUpdate-111015-2

There is little evidence currently that the rally over the last couple of months has done much to reverse the more "bearish" market signals that currently exist. Furthermore, as noted by Jochen Schmidt, the current market action may be more indicative of market topping process.

As shown in the next chart, Jochen's point can be seen more clearly by looking at a longer-term chart of previous bull market topping processes.

SP500-MarketUpdate-111015-4

The combined "sell signals," as measured by moving average crossovers, momentum and MACD, have only coincided near major bull-market peaks and bear-market bottoms.

Importantly, those coinciding signals can occur several months before the actual change to the overall "trend" of the market occurs.

Currently, with two of three longer-term "sell signals" registered, with only the final moving average crossover remaining on a "buy" signal, investors should remain more cognisant about relative risk levels in portfolios currently. 

Not unlike previous market topping action, the markets could indeed even register "new highs," as witnessed in both 2000 and 2007 before the major market correction begins. This is typically how "bull markets" end by providing false signals and sucking in the last of those willing to "buy the top." The devastation comes soon after.

Warning Signs Everywhere

Many have pointed to the recent correction as a repeat of the 2011 “debt ceiling default” crisis. Of course, the real issue in 2011 was the economic impact of the Japanese tsunami/earthquake/meltdown trifecta, combined with the absence of liquidity support following the end of QE-2, which led to a sharp drop in economic activity. While many might suggest that the current environment is similar, there is a marked difference.

The fall/winter of 2011 was fueled by comments, and actions, of accommodative policies by the Federal Reserve as they instituted “operation twist” and a continuation of the “zero interest rate policy” (ZIRP). Furthermore, the economy was boosted in the third and fourth quarters of 2011 as oil prices fell, Japan manufacturing came back on-line to fill the void of pent-up demand for inventory restocking and the warmest winter in 65-years which gave a boost to consumers wallets and allowed for higher rates of production.

2015 is a much different picture. 

First, while the Federal Reserve is still reinvesting proceeds from the bloated $4 Trillion balance sheet, which provides for intermittent pops of liquidity into the financial market, they are now seriously discussing “tightening” monetary policy by the end of the year.

Fed-Balance-Sheet-SP500-102615

Secondly, despite hopes of a stronger rates of economic growth, it appears that the domestic economy is weakening considerably as the effects of a global deflationary slowdown wash back onto the U.S. economy.

ECOI-Events-101215

Third, while “services” seems to be holding up despite a slowdown in “manufacturing,” the service sector is being obfuscated by sharp increases in “healthcare” spending due to sharply rising costs of healthcare premiums. While the diversion of spending is inflating the services related part of the economy, it is not a representation of a stronger “real” economy that creates jobs and increase wages. (via Zerohedge)

Zerohedge-PCE-110315

Fourth, the strong US dollar, as compared to other currencies racing for the bottom, is having a negative effect on companies with international exposure. Exports, which make up more than 40% of corporate profits, are sharply impacting results in more than just “energy-related” areas. As I discussed recently, this is not just a “profits recession,” it is a “revenue recession” which are two different things.

The chart below shows the S&P 500 as compared to the US Dollar. Since the turn of the century, declines in this ratio below the 18-month moving average, have been coincident with more severe market reversions and economic recessions.

SP500-MarketUpdate-110315-2

Lastly, it is important to remember that US markets are not an “island.” What happens in global financial markets will ultimately impact the U.S. The chart below shows the S&P 500 as compared on a performance basis to the MSCI Emerging Markets and Developed International indices. I have highlighted previous peaks and subsequent bear markets. Currently, the weakness in the international markets is being dismissed by investors, but it most likely should not be.

SP500-MarketUpdate-110315-3

 

Looking For "Santa Claus"

As I suggested above the "seasonally strong" period of the year may present an opportunity for more seasoned and tactical traders willing to take on additioinal risk.  However, for longer-term investors the risk/reward ratio is not favorably tilted currently.

As we progress though the last two months of the year, historical tendencies suggest a bias to the upside. This is particuarly the case given the weakness this past summer which has left many mutual and hedge funds trailing their benchmarks. The need to play "catch-up" will likely create a push into larger capitalization stocks as portfolios are "window dressed" for year end reporting.

This traditional "Santa Claus" rally, however, does not guarantee the resumption of the ongoing "bull market" into 2016. 

For that corporate earnings will need to recover, and soon. However, as Joe notes in his missive, this is unlikely to occur:

"That shouldn't really be that surprising considering what is going on with earnings. With so much hoopla surrounding the Fed it has almost been lost in the shuffle but earnings this quarter have not been very good overall. If you look at "operating earnings" – earnings before all the bad stuff that is allegedly one time but rarely is – over 70% of companies are beating estimates although the beat rate for revenue is quite a bit lower. However, reported earnings paint a different picture with less than half the companies beating estimates. This kind of divergence happens every cycle as we get near the end of the expansion. It speaks to the quality of the earnings and the creativity of CFOs at the end of an expansion.

 

Companies this cycle have loaded up on debt to buy back stock and keep earnings per share rising. That and other means of cost cutting were necessary because revenue growth has been hard to come by. Particularly hard hit recently have been the US multinational companies, hit by the double whammy of a rapidly rising dollar."

There is a vast difference between having a strong dollar in a strongly growing economy, and a strong dollar in a weak one. The later weighs on further growth as the deterioration of exports is not offset by the rising consumption of imports. As I discussed last week, a combination of plunging imports and exports is something that should not be ignored.

Trade-Deficit-110415-2

"The sharp rise in the dollar, which has been cited by many companies as the reason for weak earnings results due to the negative impact to exports, should be a boon for consumers as the stronger dollar makes imports cheaper. However, that has clearly not been the case and suggests the domestic consumer is substantially weaker than other headline data suggests."

 

The import/export data is suggesting that the global weakness arising from China and the Eurozone have now impacted the domestic economy. While the Fed continues to suggest that economic strength is improving, the underlying data continues to suggest it isn't."

As I have continued to suggest, there is a probability that the markets could rally through the end of the year. However, without a strengthening of the earnings and economic backdrop, such a rally will likely be a continuation of the current market topping process over the intermediate term.

While none of this means that a major market reversion is imminent, it does suggest taking on an accelerated risk profile in the current environment will likely not be greatly rewarding.

 

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Tue, 11/10/2015 - 17:39 | 6774306 lasvegaspersona
lasvegaspersona's picture

Watch for the 'Z' top...as in Zimbabwe....just when all appears to be sinking fast the central bank comes to the rescue and turns a 20,000 market into a 20,000,000,000 market...and everyone is HAPPY (nominally)

Tue, 11/10/2015 - 17:46 | 6774332 highandwired
highandwired's picture

When will this shitshow finally end? 

Tue, 11/10/2015 - 18:36 | 6774498 negative rates
negative rates's picture

Soon, very soon, since we already proved hope ends in failure. And why continue feeding failure?

Tue, 11/10/2015 - 20:18 | 6774913 HowdyDoody
HowdyDoody's picture

US worried about bearish signal seen over Syria.

http://cs543101.vk.me/v543101175/5a41/Rjp1RLKx6Wc.jpg

 

 

Tue, 11/10/2015 - 19:40 | 6774735 SILVERGEDDON
SILVERGEDDON's picture

Jesus H christ - so much chart porn, I was looking for Reggie Middleton in a cheesecake photo of hisself in his traditional loin cloth with a spear in the headliner.

Those were the heady early days of Zero Hedge.

Attaboy, Reggie. Chart porn lives on.

Tue, 11/10/2015 - 18:16 | 6774444 Carpenter1
Carpenter1's picture

Bull trap gonna slaughter many bulls. Judgment is finally here.

Tue, 11/10/2015 - 18:18 | 6774449 BullyBearish
BullyBearish's picture

Topping Pattern = The time it takes for the A$$holes to sell their stinking bags of $hit to the bagholders

Tue, 11/10/2015 - 17:48 | 6774323 John Law Lives
John Law Lives's picture

API just announced a 6.3 million barrel inventory build in crude oil.

http://www.investing.com/economic-calendar/api-weekly-crude-stock-656

Tue, 11/10/2015 - 20:19 | 6774921 HowdyDoody
HowdyDoody's picture

Is this real crude, fiat crude or ETF crude?

 

Tue, 11/10/2015 - 18:00 | 6774390 two hoots
two hoots's picture

With the Fed so interwined in the markets who knows what's what?   The long list of negatives will, at some point, carry the day/week/month/year(s).  Then, life as we now know it will change with it.

Tue, 11/10/2015 - 18:09 | 6774419 Consuelo
Consuelo's picture

"...they are now seriously discussing “tightening” monetary policy by the end of the year."

 

'They' were seriously discussing tightening monetary policy in January of this year.   And March.   And April.   And May.  And June, July, August, September and October as well, were 'They' not...?

 

Give it up Lance...

 

 

Tue, 11/10/2015 - 18:17 | 6774446 Carpenter1
Carpenter1's picture

Fools think a market will go up forever, and there's plenty here. This isn't Zimbabwe BTW. QE/ZIRP junkies gonna end the way all junkies do, going through withdrawal and suffering.

Tue, 11/10/2015 - 18:55 | 6774568 Clowns on Acid
Clowns on Acid's picture

It is like Zimbabwe except President Robert Mugabe doesn't like homos.  Mugabe began the white privelege meme by forcefully taking farms from the white owners.  Obama does the same thing in the US via the Quota system in US.

Tue, 11/10/2015 - 18:48 | 6774542 Not Goldman Sachs
Not Goldman Sachs's picture

Really? ThThems alot of graphs n stuff analyzin nuttin useful.

Tue, 11/10/2015 - 19:07 | 6774620 Pareto
Pareto's picture

16,750 next point for the DJIA.  then north again.

Tue, 11/10/2015 - 19:35 | 6774703 Arthur Schopenhauer
Arthur Schopenhauer's picture

If the Fed doesn't raise rates in December its Shutup and Print 500 more points. 

Tue, 11/10/2015 - 22:04 | 6775421 vinny vici
vinny vici's picture

At last!  A time to buy the top, not just the dip.  Go for it!

Wed, 11/11/2015 - 02:21 | 6776088 polo007
polo007's picture

According to VTB Capital:

Low-flation liquidity trap

It is nearly seven years since the Fed cut official short-term interest rates to zero. Professor Paul Krugman observes that, in length, the era of lowflation plus liquidity trap now rivals the 1970s era of stagflation. Now we are used to central banks in the major economies persisting with unconventional monetary policies that have been positive for financial asset prices but with less clear effects on the real economy. Fiscal policy has less scope to stimulate economic growth in those countries where high budget deficits and high debt/GDP ratios constrain policy-makers even though borrowing costs are at historical lows. Twelve countries in Europe now have negative two year yields.

Proponents of the debt-supercycle thesis argue that the increase in debt levels that has taken place since the 2007 crisis requires further debt deleveraging before economic growth can return to its pre-cycle path. Secular stagnationists point to insufficient investment demand to absorb all the financial savings done by households and corporates. Adverse demographics worsen the outlook. A chronic shortfall in global aggregate demand and a supply glut equals disinflation. Negative real equilibrium real interest rates are the end of result and monetary policy becomes ineffective. Professor Krugman argues that if nobody believes that inflation rises then it won’t. The only way to be sure at all of raising inflation is to accompany a changed monetary regime with a burst of fiscal stimulus. However, policymakers are reluctant to go down this path.

Clearly the problem at hand is not a lack of liquidity, though the paradox is that in a world of ample central bank liquidity, market liquidity has shrunk. This might to some extent be the impact of regulatory policy as well as a shrinkage in the supply of ‘safe assets’ for use as high quality collateral in repo markets. This ends up pushing up the price of liquidity. Other commentators argue that central banks have lost their way by being fixated on inflation targeting in a world where inflation in goods and labour prices does not exist. In this view, monetary policy has been transformed from an agent of price stability into an engine of financial instability. Over the last 15 years, the real fed funds rate i.e. adjusted for inflation, has been in negative territory for 60% of the time, according to Stephen Roach. This generates persistent bubbles in financial asset prices not just in US markets but globally too. Most central banks take the view that the decline in CPI inflation rates is temporary and mostly due to ‘transitory’ factors such as the slump in energy prices. In their view, this will unwind and CPI inflation will return to the 2% official target. The BoE’s Inflation Report on Thursday, for example, is expected to take this view. However, there are new global forces pressing down on inflation, not least of which are the deflationary pressures emanating from China’s excess capacity. The IMF predicts that the price deflator for all advanced economies is to increase just 1.5% per year until 2020, which is little different from the crisis-depressed rate of just over 1% of the last six years.

Our thesis is that the Fed has become increasingly boxed in and at the mercy of adverse domestic and external events. The door is closing in terms of its ability to ‘normalise’ monetary policy, especially in the run-up to the US Presidential Election in November 2016, which means that QE4 cannot be ruled out.

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