The Stock Market
Indicator Changes Since Last Week
In part two of last week's missive on stocks we showed a few indicators which we hereby update. The first chart shows the SPX versus the gold-silver ratio adjusted volatility index as well as the JNK/TLT ratio. Briefly, both indicators should ideally confirm new stock market highs. Whenever they fail to confirm them, a warning sign is given, whereby there are frequently lead times of up to several weeks, during which the divergence is either resolved again or gets worse. The current state of affairs is that divergences that have been in evidence for some time are getting worse.
A few words on what the point of adjusting the VIX by the gold-silver ratio is. The idea is that during times of waxing economic confidence, silver tends to rise relative to gold and vice versa during times when economic confidence wanes. The gold-silver ratio thus acts a bit like a credit spread and experience has shown that it tends to give early warning signals. Of course there is no particular fundamental reason to adjust the VIX by it, except for the fact that this creates a unique indicator that has been shown to work well in back-tests.
The JNK to TLT ratio is of course also a measure of credit spreads.
Hedge Funds and the Stock Market
On Tuesday an appearance by hedge fund manager David Tepper on CNBC appeared to trigger a rally in the SPX (at least the market began to rally shortly after he declared himself bullish). He presented a chart on the occasion from a recent NY Fed research paper on the so-called 'equity risk premium'. Reportedly a number of bulls just love this chart (if Business-Insider is to be believed). This rationalization holds however no water – for the simple reason that the basis for calculating the 'risk premium' for equities is simply a variation on the so-called 'Fed model'. In short, the 'risk-free' interest rate is used as the major input in the calculation. Since this interest rate is heavily manipulated by the Fed, this is like saying: “stocks are cheap because the Fed is manipulating interest rates”. This strikes us as a fundamentally wrong way of looking at this.
Earnings Growth versus Market Performance
As long term readers know, we have frequently pointed out that historically, equity prices and the trend of corporate earnings have often diverged for considerable stretches of time. Neither are rising earnings a guarantee for rising stock prices, nor are flat or declining earnings a guarantee that stocks will stall out or fall. There is a long term correlation between nominal earnings and nominal stock prices of course, but they can diverge for such extended periods that it makes no sense to focus on earnings to the exclusion of other market relevant data. That said, the recent rally in global stock markets has been mainly based on valuation expansion, not on earnings growth. A friend sent us the following summary of global earnings and stock market performance since Q 3 of 2011, the time of the last major low. The divergence is of course greatest in Europe, much of which is in recession:
The NYA's Long Term Wave Structure
As discussed yesterday, we want to show why the advance from 2009 has in our opinion the look of a corrective rally in terms of Elliott Wave guidelines. Note here that the fact that a number of indexes have made new all time nominal highs (no new highs have yet been made in real terms) does not mean that the rally cannot be a 'correction' of the underlying primary trend. The 2002-2007 rally was also regarded as corrective in nature, and yet a number of indexes managed to make new nominal highs at its peak as well. The same incidentally happened in 1970 to 1973.
The caveat to this is of course that this 'correction' view is close to running out of real estate, so to speak. A preferred E-wave count can only be used to gauge probabilities, but it can never be entirely ruled out that it will be superseded by a different count. An index that is well suited for the purpose of demonstrating the longer term wave structure is the NYSE composite index, as it is quite a broad market index. The chart below was provided to us by our friend B.A., who has closely followed the evolution of the long term wave count over recent years.
BA's long term chart of the NYA. A case could perhaps be made to count the initial wave A from 2009 as a five wave structure, but it cannot be a wave 1, as then the question arises where wave 3 is supposed to be. For comparison, look at the clearly discernible 5 waves down from 2007-2009. By contrast, after the still relatively spirited initial wave A from the 2009 low, there are lots of wedges and labored looking advances, but no clear impulse – click to enlarge.
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Rise From 2011 Low as a Corrective Wave
Our friend PN has sent us his latest update on the SPX e-wave count. This one is a close look at the advance from the 2011 correction low and is labeled as a corrective C wave with an ending diagonal type structure as its 5th wave.
As we have previously discussed a few times, from an EW standpoint the longer term advance from the March 2009 low has the problem that its shape is far more easily counted as a large corrective wave than an impulse wave, as the typical and usually easily spotted third wave advance cannot be discerned. What it can no longer be is a second wave of a primary wave C as originally proposed by Bob Prechter (to quickly summarize that idea: given that the 2000-2002 bear market was an A wave and the 2002-2007 bull market a B wave, Prechter assumed that the decline from 2007 to 2009 was wave 1 of what would ultimately become a wave C composed of 5 waves. However, this idea did not survive the rise to a new nominal all time high, as the presumed wave 2 rally was not allowed to exceed the beginning of wave 1).
This Time It's Different!
That is what the world's yield chasers must be thinking – egged on by quantitative easing programs enacted by the Federal Reserve and the BoJ, and the lowest administered interest rates the world has ever seen, the hunt for yield has become downright bizarre.
In action that surely leaves all old market hands slack-jawed, the Barclay's US High Yield index yesterday fell below 5% for the first time ever. BAML's High Yield Master Index II meanwhile remains only a smidgen above 5%. There was a time when a 10 year US treasury note yield at 5% was considered low. The action in junk bonds tells us that according to the collective wisdom of market participants, nothing can possibly go wrong (and we thought that was what they had already concluded in 2006/7).
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Leon Black is Selling, but Speculators Aren't Seeing Things his Way
That the memories of investors are rather short was already clear in 2007. Evidently, nothing has changed. Dispensing a bit of biblical wisdom last week, Apollo's Leon Black remarked:
“It's almost biblical. There is a time to reap and there's a time to sow," Leon Black, chairman and chief executive of Apollo Global Management declared to the Milken Institute's global conference in Los Angeles, alluding to that same Scriptural passage. "We are harvesting," he added pointedly.
That is, the private-equity giant is a net seller because things simply can't get much better. "We think it's a fabulous environment to be selling," he says, noting Apollo has sold about $13 billion in assets in the past 15 months. "We're selling everything that's not nailed down. And if we're not selling, we're refinancing."
That's because there has never been such a good time to borrow — which is raising warning flags for Black. "The financing market is as good as we have ever seen it. It's back to 2007 levels. There is no institutional memory," he observed, referring to the peak of the last credit bubble. That was when then-Citigroup CEO Chuck Prince famously said that as long as the music was playing, bankers had to keep dancing — which they did, with disastrous consequences when the band stopped.”
A Bubble in 'Safe Assets'?
Bloomberg recently published an article on a report by Seth Masters, the chief investment officer of Bernstein Global Wealth Management, entitled “Desperately Seeking Safety”. Masters argues that bonds, gold and 'safe' stocks are all 'dangerously overpriced'. To be sure, we at least partly disagree with this thesis on the grounds that first of all, one cannot simply regard all these assets as belonging to the same class. The temptation to do so stems mainly from the fact that they have risen in parallel for a long time due to specific historical circumstances. However, if we e.g. look back to the 1970s, we can see that these assets can often take completely different paths. It all depends on the precise type of economic and market upheaval the world is experiencing.
Moreover, the pricing of these assets reflects the ongoing uncertainty in a world that is in the grip of the lunacy of policymakers who have seemingly lost all sense of perspective and are engaged in a huge gamble. This essential fundamental backdrop has not changed for the better lately, but for the worse. Masters has to assume that these crazy policies will somehow 'work' all of sudden in order for his argument to fully stand up.
Economic Data Are Deteriorating Across the Board
Last week and this week we received the new 'Flash' manufacturing PMI data from Markit, as well as the newest retail PMIs. In short: economic fundamentals continue to weaken across the board all over the world. Euro area PMI data remained solidly in contraction territory, China's HSBC flash PMI of the private sector barely eked out a gain (note that the 'official' PMI includes the state-owned sector, which distorts the data somewhat), and even US manufacturing seems to be weakening now, with the overall gain in PMI well below expectations, a datum that was then further confirmed by a strong contraction in the durable goods orders data a few days later.
Here are links to the individual reports (all in pdf format):
Manufacturing 'Flash PMI' data for April, with brief comments:
Euro Zone : “Eurozone suffers ongoing downturn in April”
Germany: “German private sector output declines for first time since November 2012”
France: “The downturn in French private sector output eased in April from March’s four-year record, but nonetheless remained sharp”
US : “PMI points to weakest manufacturing expansion since last October”
China: “The HSBC Flash China Manufacturing PMI came in at a two-month low, but still managed to expand modestly in April, albeit at a much slower pace.”
Links to the retail PMI's (also in pdf format) with comments:
Euro-Zone: “Eurozone retail sales continue to fall sharply in April”
Germany: “April’s survey highlights a disappointing start to the second quarter for the German retail sector; Sharpest decline in stocks of goods for resale since October 2010; Weakest pace of job creation since March 2011”
Italy: “Sharpest decrease in retail sales in 2013 so far; Margins and employment fall again.”
France: “French retail sales down for thirteenth successive month; Downturn in sales remains steep despite easing from survey-record pace; Margins continue to be heavily squeezed.”
Central Banks Wade Into Stocks
Readers may recall that we have frequently remarked that the fact that central banks have reportedly become fairly large net buyers of gold over the past two years was at best irrelevant and at worst a contrary indicator. What it never was and never will be, is bullish. There is some hope that it may not be a big negative signal, due to the fact that the central banks doing the buying are not the same ones that sold between $250 and $600 and because they only buy fairly small amounts. However, it sure hasn't been a positive signal so far. Central banks as a rule are the worst traders in the world.
It is therefore interesting that the latest central bank fad is apparently to buy stocks. They didn't buy stocks in early 2009, mind. They probably had to wait for the markets to 'look safe' or something like that.
“Central banks, guardians of the world’s $11 trillion in foreign-exchange reserves, are buying stocks in record amounts as falling bond yields push even risk- averse investors toward equities.
In a survey of 60 central bankers this month by Central Banking Publications and Royal Bank of Scotland Group Plc, 23 percent said they own shares or plan to buy them. The Bank of Japan, holder of the second-biggest reserves, said April 4 it will more than double investments in equity exchange-traded funds to 3.5 trillion yen ($35.2 billion) by 2014. The Bank of Israel bought stocks for the first time last year while the Swiss National Bank and the Czech National Bank have boosted their holdings to at least 10 percent of reserves.
The survey of 60 central bankers, overseeing a combined $6.7 trillion, found that low bond returns had prompted almost half to take on more risk. Fourteen said they had already invested in equities or would do so within five years. Those conducting the annual poll had never before asked that question.
“I definitely see other central banks doing or considering equities,” said Jan Schmidt, the executive director of risk management at the Czech National Bank in Prague, which has built up stocks to 10 percent of its $44.4 billion in reserves since 2008.
Central banks’ purchases of shares show how the “hunger for yield” is changing the behavior of even the most conservative investors, according to Matthew Beesley, head of equities at Henderson Global Investors Holding Ltd. In London, which oversees about $100 billion.
“Equities are the last asset class standing,” Beesley said in a phone interview on April 18. “When you have dividend yields in excess of bond yields, it’s a very logical move.”
Good grief. Yes, it's only 'logical' to invest in the 'last asset class standing' – which means in translation: the one asset class that's recently been in an uptrend. We weren't actually aware that central banks had a 'hunger for yield'. Aren't they supposed to be out there 'fighting inflation'? Just kidding.
However, they are supposed to be the stewards of the currencies they issue, and it is not entirely clear why that suddenly requires them to pile into equities. One thing is certain though: it is an example of very interesting timing.
Barron's Big Money Poll Bullish Consensus Reaches a Record High
This week's Barron's magazine contains the latest Barron's 'big money' poll. Evidently they interviewed a herd – there was once again near unanimity on a number of markets. The bullish consensus on US stocks clocked in at a new all time high for the Barron's poll with 74% of those surveyed declaring themselves 'bullish or very bullish on US stocks'. Only 7% are pessimistic. By contrast, only 45% were bullish in the spring of 1999 and 54% in the fall of 1999. One third of those taking part in the survey expect the DJIA to reach 16,000 points within about one year, 25% think it will go higher than that.
That is just for the US stock market, mind. Apparently there is a separate category asking about 'stocks in general', as well as about real estate. This has to be seen to be believed:
“Even so, the managers aren't just bullish on U.S. stocks, but on equities generally. Some call it the TINA trade, for "there is no alternative" to stocks in a slow-growth, ultra-low interest rate world. Eighty-six percent of poll respondents are bullish on stocks for the next 12 months, and a whopping 94% like what they see for the next five years. Real estate has similar approval ratings.
Nothing can go wrong! Maybe we should type that in all caps, so that it goes better with the “94% that like what they see for the next five years”. An appropriate cartoon accompanied this unabashed show of giddiness.
The 'big money' is up to its eyebrows in stocks and giddy like never before …
RUT and SPX Diverge
As an addendum to our article on the decline in the NFIB small business survey, it is worth noting that a number of negative divergences have lately begun to plague the Russell 2000 small cap index.
Not only is there now a glaring divergence between prices, RSI and MACD, but a small divergence with big caps has also made an appearance (admittedly, this latter divergence is still small, it is only noteworthy because of the other divergences mentioned).
Here is a chart illustrating the situation:
The Russell 200 index gives us warning signals: Price, RSI and MACD are diverging, as is the Russel with the SPX, with the latter making new highs and the former rising to a lower high. The green line is the SPX – click for better resolution.
Another Warning Sign Emerges
Fully cognizant of the fact that monetary pumping has continued to allow the market to defy all sorts of warning signs that have popped up in recent weeks and keep its slowly grinding levitation to higher levels intact, we still want to point out when new worrisome signals are coming to light. One (or rather, yet another one) has just done so: short sellers have apparently capitulated to a noticeable extent.
“Investors reduced bearish stock bets to the lowest level since at least 2007 as the bull market in American equities begins its fifth year.
Short sales in the Standard & Poor’s Composite 1,500 Index fell to 5.6 percent of shares available for trading in February, down from a record 12 percent during the credit crisis and the lowest ever in data compiled by Bespoke Investment Group and Bloomberg starting six years ago. The last time the number of shares borrowed and sold short approached this level, the equity gauge lost 3.3 percent in the next three months.
Bulls say the capitulation by market bears shows the rally remains intact and that more money will flow into stocks after individuals sent $37.9 billion to mutual funds in January, the most since 2004. It also means a source of demand is diminishing, a traditional signal for caution in an aging bull market. Less than one percent of the shares of Ford Motor Co. and Cabot Oil & Gas Corp. (COG) have been borrowed and sold short by speculators hoping to return them to owners once prices fall.
“When you look at short interest, and it’s low like right now, it means people are very, very bullish about the market,” Uri Landesman, president of New York-based hedge fund Platinum Partners, which manages $1.15 billion, said in a Feb. 28 phone interview. “When that happens, it’s a bearish sign, because if all minds change, there’s downside, not upside.”
Insiders Are Selling and Another Sentiment Marker Goes Nuts
It probably had to eventually happen in the current climate, but this is still something we'd like to point out. Before we get to the new extreme that was recorded in market sentiment, we would note that now that the market has more or less returned to previous highs, people are all of a sudden convinced that the secular bear market is over. We suppose they thought the same when the market made a new all time high in January of 1973, or when it made new highs (at least some parts of it) in 2006/2007. However, new nominal highs are not the criterion by which the end of a secular bear market can be recognized. In fact, we doubt that the actual end of the secular bear market will be discussed on TV when it happens.