The Stock Market
A Brief Look at the Technical Backdrop
We can actually not answer the question posed above with certainty. We don’t know for sure whether the recent market decline was a “warning shot” or merely a short term shake-out. In this we are in good company: the whole world doesn’t know.
However, our guess at this juncture is that the decline was of the “warning shot” variety, as it has violated long-standing uptrend support lines – something that the market has managed to avoid in previous corrections over the past three years. There are also fundamental reasons for thinking so, which we discuss briefly further below. However, based on fundamentals alone, it cannot be determined whether the stock market is already “ripe” for a larger degree decline, or whether its uptrend will resume in the short/medium term.
To be sure, the technical picture certainly conveys no certainties about the future either. However, should the market peak at a “typical” retracement level or at a previous lateral support level (thereby confirming its new status as resistance) and resume its decline from a lower high, yet another change in character will be recorded. In that case, the probability that a larger degree decline is underway would accordingly increase further.
Below are charts of the most important indexes showing Fibonacci retracement levels of the recent correction and lateral resistance levels. Although it is unknowable why the market often finds support or runs into resistance at Fibonacci retracement levels (there is certainly no logical reason for this), it has happened quite often in the past, so it is useful to be aware of them. Possibly it has become a self-fulfilling prophecy, because so many traders use technical analysis nowadays.
More Back-Pedaling – This Time by a “Hawk”
We already pointed out on Tuesday and again on Wednesday that numerous signs of back-pedaling by Fed officials recently emerged – no doubt in reaction to the sudden wobble in “risk” assets (what else could have been the motivation?). On Wednesday we asked rhetorically whether San Francisco Fed president John Williams was actually serious.
Enter St. Louis Fed president James Bullard on Thursday, who only a few weeks ago was talking about wanting to alter the FOMC statement toward indicating a more hawkish tone. Nothing but a less than 10% dip in the spoos to completely change a monetary bureaucrat’s views these days. According to the FT:
“From the transcript of St Louis Fed president James Bullard’s interview with Bloomberg Television:
“I also think that inflation expectations are dropping in the U.S. And that is something that a central bank cannot abide. We have to make sure that inflation and inflation expectations remain near our target. And for that reason I think a reasonable response of the Fed in this situation would be to invoke the clause on the taper that said that the taper was data dependent. And we could go on pause on the taper at this juncture and wait until we see how the data shakes out into December. So… continue with QE at a very low level as we have it right now. And then assess our options going forward. …
My forecast is for rising inflation. That’s why I’m concerned about declining inflation expectations, the five-year TIPS in particular has declined below one and a half percent. The five-year forward is down from its previous levels. And the central bank has to guard against any expectations in the market that would suggest that the central bank is not going to hit its inflation target. So you have to be credible on your inflation target. So a simple – what I’m saying is that a simple step that we may be able to take or maybe the committee might consider at its October meeting would be to just take a pause on the taper, let more data accumulate and see how the U.S. is going to evolve over the rest of the year and into next year. …
I think you should quit numbering the QEs. I’ve been an advocate of having an open-ended program. I do think QE is our most powerful tool when the policy rate is at zero. And I think it’s far more powerful than forward guidance for instance. And I think we saw that during the taper tantrum of 2013. And therefore I think I’ve been for having an open-ended program that reacts to economic data. And so far we’ve been able to taper the program down on the face of really dramatically improving labor markets this year, but maybe this is a juncture where we’d want to invoke that clause about it being data dependent.”
The remarks follow the comments earlier this week by John Williams of the San Francisco Fed, who signaled his willingness to consider a new round of asset purchases if “a sustained, disinflationary forecast” emerges.”
The Dow ended the session down 173 points On Thursday, after falling more than 300 points during the day.
Press reports told us that investors were worried about weak US consumer sales and falling producer prices. Combined with falling crude oil prices, these make it look as though a European-style slump is coming to the whole world. But what did you expect?
It is autumn. The days dwindle down … life closes in on you. It comes as a shock. Like when you turn 60 and you suddenly realize that you are … alas … mortal.
You will not make an infinite amount of money in your lifetime; in fact, you’ve already made most of what you’re likely to make. You will not drink an infinite number of martinis… or have an infinite number of friends… or hear an infinite number of concerts.
Au contraire, the numbers in your life are limited… and probably already undergoing some shrinkage. Your height. Your savings. The years left to you … the number of times you’ll get sick or fall down drunk.
They’re all getting smaller. Then you have to think more carefully about what you’re going to do with the numbers you’ve got left.
(Photo credit: fmh)
Liquidity Dries Up
The Dow Transports managed a bounce on Tuesday. The Dow Industrials just couldn’t get in the mood. They ended the day with a small decline. From financial commentator Wolf Richter:
“80% of the stocks in the Russell 3000 [a good proxy for the entire US stock market] are 10% or more below their highs, according to Bloomberg. Many of them have gotten demolished. Some have gone bankrupt as the appetite for high-risk debt at these low yields is drying up.”
Whether this is the beginning of a major correction or not, we don’t know. We haven’t gotten the email.
But with the Fed ending QE this month, it seems likely that something will give. Zero interest rates and QE bailed out the financial sector, stabilized housing and helped send the S&P 500 up 130% from its March 2009 low. What will the end of QE do? We don’t know, but we’re eager to find out.
Japan and Europe are pumping out trillions of yen and euro in new credit. In the US, Janet Yellen hopes and prays this will be enough to hold off trouble worldwide. Without substantial global liquidity, the US stock market is likely to keep going down.
SPX Slices Through 200-dma
On Monday, the stock market tried to put together a rally all day long – then it fell completely apart in the final hour of trading. In the process, the S&P 500 index sliced through its 200 day moving average for the first time since late 2012 – without even making a pit stop. The intra-day action can be seen below:
New England is stunning this time of year. Just what you’d expect. The leaves turn brown, yellow and red, putting on their best outfits and strutting their stuff in the cool autumn air.
Autumn, especially in New England, is the loveliest time of the year. The sun barely clears the tops of the trees, even at noon. The light, filtered through the colored leaves, gives the earth the rich and heavy air of a funeral parlor.
Perhaps that is why there are market crashes in the fall. Investors feel the approach of death. The stock market fell hard on Thursday … and then kept falling on Friday. Before the week was over, investors were worried.
A Major Move Lower for Stocks
Wow! Dow down 334 on Thursday. Talk about volatility. Things are getting interesting. Meanwhile, what’s wrong with the Bowery?
We search high and low. We can’t find a bum or an alcoholic. The area no longer looks anything like the old down-and-out Bowery of the 1960s and 1970s. Everywhere you look you see the latest fashions… chic New Yorkers… and $600-a-night hotel rooms.
Last night at dinner, our companion nodded toward a nearby table and said, “Look, there’s Michelle Pfeiffer.”
The name sounded familiar, but we couldn’t place her. So we were not as impressed as we should have been. But the Bowery has definitely gone upscale.
Stocks Yanked Back and Forth by Fed “Jawboning”
Back in mid September we presented an update of our chart comparing the stock markets of the euro area’s two largest economies with the S&P 500 (originally our main concern were the glaring divergences between them) and wondered aloud if the DAX and CAC 40 had just “back-kissed” their broken trend lines.
This is what the situation looks like as of Thursday’s close – we left our annotations from September 15 (in blue) on the chart – the added wording is in green.
One thing we would like to point out here is that no divergence exists as of yet with respect to the recent lows – neither the European indexes nor the SPX have as of yet undercut the previous short term low made in August.
The same can not be said of the downside leader Russell 2000, which landed at a new low for the year on Thursday. Along similar lines, the broad-based NYA has undercut its August low clearly by now. It is also worth noting that market internals continue to exhibit significant deterioration – e.g. new lows expanded to 2 – 3 year highs this week, depending on the index one cared to look at.
What If …
When we left off yesterday we were worried. What if we have seen the highs in US stocks and bonds – not just for the next five or 10 years… but for the rest of our lifetimes?
On Tuesday, the Dow fell 272 points. No big deal, of course. But what if it continues?
Just six years ago it fell 51%. It could easily do so again – back down to, say, 8,000. There would be nothing unusual about it. Fifty percent corrections are normal. You know what would happen, don’t you?
Ever since the “Black Monday” stock market crash in 1987 it has been standard procedure for the Fed to react quickly.
But what if Yellen & Co. got out the party favors… set up the booze on the counter … laid out some dishes with pretzels and olives … and nobody came? What if the stock market stayed down for 30 years, as it has in Japan?
A Blast from the Past
In his most recent commentary on the stock market, John Hussman makes a few important observations. Very often, bubble-like advances in financial asset prices can become far more extended than rational, sober observers think possible. One result of this is that those who are warning that the situation is inherently unsustainable are often dismissed as “perma-bears” not worth heeding anymore. It is certainly a label Hussman has been stuck with, although it is simply not true (he is known for taking constructive stances on the market when valuations and /or constructive market internals suggest they are appropriate).
The important point is however this: the warnings (which are both fundamentally and technically based in Hussman’s case) do not become less important when a bubble stretches further, but more so. Moreover, a greater overshoot does not create a “cushion” that ensures that one cannot lose. It merely creates conditions that are more likely to eventually produce an all the more pronounced reaction. Here are a few pertinent excerpts from Hussman’s update:
“The lesson we’ve drawn from recent years is not that historically reliable valuation measures are no longer useful. It’s not that overvalued, overbought, overbullish conditions can persist indefinitely without awful consequences. It’s not that “this time is different” in some way that cannot be accounted for with historically-informed methods.
The primary difference between the half-cycle since 2009 and prior market cycles across history is that overvalued, overbought, overbullish conditions have been extended to further extremes, without a material correction, for a much longer period than usual as a result of yield-seeking speculation. The central lesson we’ve drawn is about the criteria that distinguish when the consequences of overvalued, overbought, overbullish extremes may be deferred, and when those consequences are likely to emerge with a vengeance.
We now observe conditions under which the belief that “this time is different” has historically been most likely to implode.
There’s really no point in trying to convert anyone to our viewpoint. Somebody will have to hold stocks over the completion of the present cycle, and encouraging one investor to reduce risk simply means that someone else will have to bear it instead. But for those who understand the narrative of the recent half-cycle, where our challenges have been, and how we’ve addressed them, I do encourage reviewing all risk exposures from the standpoint of the losses that have repeatedly occurred over the completion of market cycles that have reached valuations anywhere near current levels (1929, 1972, 1987, 2000, and 2007). The point is not to discourage stock holdings entirely, but rather to ensure that exposure is not so large that a steep market loss would be intolerable. It’s important to recognize that the market is not only at a point where unusually rich valuations are already in place, but also where market internals and our measures of trend uniformity have clearly deteriorated. This is the most hostile set of market conditions we identify, and it closely overlaps periods in which the stock market has been vulnerable to abrupt air-pockets, free-falls, and crashes.
Yesterday, gold climbed back above $1,200 an ounce. US stocks went nowhere. Meanwhile, a chill went down our spine. A sense of dread filled our frontal cortex.
We read a report that was designed to give investors courage and hope. Instead, it felt to us like a guilty verdict in a murder trial. Even with good behavior, our sentence would probably last longer than we would.
A chart told the story. It showed three bull markets over the last 20 years. In the 1990s, the S&P 500 total return was 227%. Then from 2002 to 2007, another bull market. The total return this time: 108%. And from 2009 to 2014, the S&P 500 returned another 195%.
The lesson is unmistakable. It tells you to get in stocks… and stay in. If the market has a fainting spell, don’t get dizzy. Stick with stocks!
Don’t let the occasional 50-60% crashes disturb your peace of mind! You will always win in the long run! Long term bear markets don’t exist…well, maybe except in Japan. And much of the 18th century. But other than that, nothing can go wrong – click to enlarge.
Incredible Wall Street Stories
Sometimes the market provides us with stories that one wouldn’t believe if one weren’t able to observe them with one’s own eyes. Occasionally they involve outright fraud, such as the artificial short-squeeze organized in CYNK earlier this year – a “social media” company based in Belize with a single employee, that never had a single dime in earnings or revenues for that matter, and does not even have a web site (i.e., a shell company).
The company’s market cap rose from an already far too high $17 million to an incredible $6.4 billion in the space of three weeks until trading was suspended by the SEC. By this time, most of the short sellers had already been bankrupted – not only by the huge price rise in the stock, but by the enormous cost involved in borrowing the shares (these borrowing costs seem to actually have been a major feature of the scam). In fact, the most recent information suggests that CYNK was also tied to a complex money laundering scheme. Amazingly, the stock still trades at 11 cents, presumably because its price has been supported by frantic short covering on the way down. “Pump and dump” schemes are a dime a dozen, but this one was noteworthy because it involved a different and quite innovative method of defrauding investors. Instead of mainly aiming to defraud the buyers of the stock, it was designed from the outset as a way of bilking short sellers. What the perpetrators probably didn’t consider was that the squeeze would drive the price to a level that would alert the authorities.
Pump and dump in CYNK – a sophisticated scheme to bilk short sellers by lending them shares in an essentially worthless company at outrageous borrowing costs and then organizing a squeeze. In the meantime it has been reported that the activity may have been tied to a money laundering scheme – click to enlarge.
Still, while the CYNK case is unique among pump-and-dump schemes in some respects, it is still clearly identifiable some kind of fraud.
Market Reaction to Payrolls Data
Payrolls and unemployment reports should normally be regarded to be among the least useful economic data, as they are lagging indicators of the economy. Insofar the recent improvement in employment data only confirms what has already happened: economic activity has increased (note that this tells us nothing about the quality of said activity). It tells us absolutely nothing about the future.
The reason why the markets tend to react strongly to these data is mainly the Federal Reserve’s nonsensical “dual mandate”. Enacted in the heyday of Keynesianism, the mandate is based on the belief that both prices and employment can be successfully centrally planned by manipulating interest rates.
Cumulative non-farm payrolls, initial unemployment claims and the U3 unemployment rate (which excludes about half of the people who are actually unemployed). If we had asserted a few years ago that the Federal Funds rate would be at zero with the unemployment rate at 5.9%, we’d have been declared insane – click to enlarge.
Downturn in High Yield Bonds Continues
On Thursday the stock market had a down day that was actually not very remarkable in terms of its extent – it was only remarkable because even such relatively middling down days have become rare these days. Another thing that made it remarkable is that there was no “obvious” trigger for the selling, which started right out of the gate.
However, as we have previously discussed, market internals have weakened all year long (see “Market Internals Are Weakening” for a recent update) and most recently we have pointed out a number of divergences that have occurred, including the long term downshift in the ratio of HYG to the SPX (see this chart). High yield debt has recently continued to weaken, after a rebound rally that appears to have failed at a lower high. Along with this event, an attempt by treasury yields to break higher seems to have failed as well:
HYG (a high yield bond ETF) suffers its biggest correction in a long time, and treasury note yields turn lower again (admittedly this may turn out to be just a brief pullback in t-note yields) – click to enlarge.
IPOs and Secondaries Surge
Alibaba’s IPO last week – which amounted to $21 billion in value – was the biggest in history. It was also wildly successful, as the stock surged by 38% on its first trading day. However, the US IPO market was already heating up before Alibaba’s debut: Q2 2014 saw the heaviest issuance since Q4 2007.
Recall that in spite of the fact that NBER later dated the beginning of the recession to Q4 2007, there was zero awareness that a recession might even be in store at the time. In October of 2007, shares in companies that would be bankrupt and in need of bailouts a few months later were still trading in the stratosphere (Fannie Mae’s common stock changed hands for $70, shares in mortgage insurer Ambac did likewise – the latter eventually fell to less that 2 cents). The opinion of the bien pensants at the time was that the “sub-prime mortgage credit crisis was well contained”, and the DJ Transportation Average even climbed to a new all time high in May of 2008. So Q4 2007 was definitely still a fairly good time to flog IPOs.
The time is even better now – in the wake of Alibaba’s IPO, 2014 is already all but certain to break previous issuance records. Here is a chart showing the pre-Alibaba situation as of Q2:
By Q2 2014, 160 IPOs had been issued – almost as many as in the 7 quarters Q1 2009-Q3 2010. 2011 and 2012 were relatively quiet years, but that has changed in 2013 as the market continued to surge. 2014 is well on its way to becoming a record year – click to enlarge.
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