Nasdaq Takes a Hit, Rotation Into 'Safe' Sectors Continues
On Friday momentum stocks sold off with some verve again after the release of the payrolls data. Since the latter were actually quite close to the expected number, they cannot really have been the trigger of the sell-off (in other words, it would probably have happened regardless of the data). A few weeks ago, Charles Biederman of TrimTabs warned that the upcoming tax season could lead to some selling, but there is also the presidential cycle to consider. If the market continues to follow this particular cycle model (it has actually done so year-to-date), it should decline from an April high into an October low. What makes the recent market action interesting is that there continue to be multiple divergences in evidence between different indexes:
Russell 2000 Index, NDX, DJIA and SPX – the former two have been in sync, but have diverged from the other indexes. There are many more intra-market divergences between different sub-sectors that have been put in place over recent months.
Two examples illustrating the weakness in momentum names are PNQI (internet power shares) and BBH (a cap-weighted biotechnology ETF). These two were previously among the strongest sectors.
BBH is likewise about to meet with its 200 dma – click to enlarge.
There has been rotation from stocks perceived as risky into stocks perceived as 'safe', such as utilities and tobacco stocks. The ratio of XLU to QQQ has been rising strongly since making a low in mid January. In other words, there have been signs of intra-market deterioration since January already, but since early March they have become a lot more pronounced. This happens to coincide with the beginning of the Fed's 'tapering' of QE3, which may or may not be coincidence.
Utilities rise strongly vs. QQQ (an ETF replicating the performance of the NDX) – click to enlarge.
There is some empirical evidence that supports the idea that there may be a connection between this change in market character and the decrease in monetary pumping (small as it is). Previous pauses in the Fed's extraordinary policy measures have been followed by fairly sizable corrections on both occasions, and the market only regained its poise once new measures were either announced or implemented (QE2 was preceded by an 'announcement effect').
The market even rose after 'Operation Twist' went into effect, although this measure didn't increase the money supply directly. However, it was implemented around the time of the ECB's announcement of its then upcoming 3-year LTRO financing for European banks, and started just as a severe phase of the sovereign debt crisis in the euro area was peaking.
The next chart illustrates the situation – both shortly after the end of 'QE1' and 'QE2', the market started to crumble. This time, the SPX is only just off a record high, as the index has held up relatively well due to the above mentioned rotation. The fact remains though that the market's leading stocks and sectors are in trouble.
The SPX with various monetary pumping measures by the Fed indicated (via stocktwits) – click to enlarge.
One side-effect of the fact that there has so far been rotation rather than a market-wide sell-off is that there has so far not been much deterioration in bullish sentiment. The Investors Intelligence poll's bull-bear ratio has however put in a bearish divergence with the SPX at its recent peak:
The II bullish consensus remains at a historically very high level, but has recently diverged from prices (it seems to be following the momentum sectors rather than the broader market) – click to enlarge.
Along similar lines, the sentiment microcosm represented by Rydex ratios has yet to 'catch up' with the decline in momentum stocks. Here is a long term chart we have shown before, which summarizes the situation. The bear/bull ratio remains at its lowest level since 2000, while money market assets are stuck at levels last seen in the late 1990s.
In short, because the broader indexes mask the weakness in the momentum sectors, Rydex traders have yet to desert the market to any noteworthy degree. They are in fact also rotating between sectors (the hitherto most popular sector fund biotechnology has lost approximately 15% of its assets recently, so the assets of other bullish sector funds must have increased).
Stocks and Rydex assets – click to enlarge.
Update on the Modified Davis Method
A few words on the Modified Davis Method (MDM), which was originally explained and presented by Frank Roellinger here. Below is a weekly line chart of the Russell 2000 since the fall of 2012, compared to the 'trigger line', i.e. the trailing stop level at which the methodology will issue a sell signal.
As of March 28, the trigger level was at 1,137.04 points, not very far from the current level of the index. The probability that a sell signal will be issued is therefore quite high at the moment. Note however that the index came close in January already, but ultimately missed the trigger line by a few points, so one can obviously not rule out another close shave just yet.
The Russell 2000 index with the sell trigger line of the Modified Davis Method – click to enlarge.
It is only a very simple trend-following method, but it has handily outperformed the indexes. The chart below shows the long term performance (since 1960) of the SPX and the Russell 2000 (the Russell index was created in 1979, prior to that the Value Line Geometric index is used) without dividends or dividend reinvestment, compared to the trading result of the system (which is either 100% long, 50% long, 50% short or – very rarely – not invested at all). Interest income that could have been earned on the cash portion during the times when the system was either only 50% invested or 100% in cash is excluded as well. It is assumed that $100,000 were invested at the beginning of the period (buy & hold in the indexes). While past results cannot guarantee that it will work similarly well in the future, the track record to date is quite impressive.
MDM vs. SPX and RUT (VL geometric index prior to 1979) – click to enlarge.
Money Supply Growth and Stocks
There is a variable lead-lag time between the growth rate of money TMS-2 and stock market trends. In 2007, the lag time between the slowdown in money supply growth and the market peak was longer than in 2000, but keep in mind that US house price indexes peaked already in mid 2006. It is possible that a higher threshold level will be relevant this time, given the weakness of the economic recovery (which reflects the capital consumption of the preceding credit boom periods, as well as the decision to arrest the liquidation of malinvested capital by means of monetary pumping at a very early stage of the process).
We have employed a simplified version of TMS-2 that excludes memorandum items, as they only represent a tiny percentage of the total money supply and are not updated as frequently as the main components. As a result, the chart is slightly more up-to-date, while the difference to the complete version is actually barely noticeable.
The same chart with the SPX overlaid. Money supply growth accelerations and slowdowns tend to lead trends in the stock market, but the lead-lag times vary. Note that while the peak in the y/y money supply growth rate was higher after the collapse of the Nasdaq bubble than after the 2008 crisis (due to the lack of inflationary lending by commercial banks after the latter), it has remained at very elevated levels for a longer period after 2008. However, just as has happened prior to previous major market peaks, it is clearly trending down now – click to enlarge.
It is not possible to tell whether a sell-off from a recent high indicates merely a short term correction or the beginning of a bigger downtrend, as both initially look similar. However, we know from the presidential cycle model, the recently recorded extremes in sentiment data and the slowdown in money supply growth that one must pay close attention at the moment.
Charts by: stockcharts, decisionpoint, stocktwits, St. Louis Federal Reserve Research
You may have noticed that our so-called “semiannual” funding drive, which started sometime in the summer if memory serves, has seamlessly segued into the winter. In fact, the year is almost over! We assure you this is not merely evidence of our chutzpa; rather, it is indicative of the fact that ad income still needs to be supplemented in order to support upkeep of the site. Naturally, the traditional benefits that can be spontaneously triggered by donations to this site remain operative regardless of the season - ranging from a boost to general well-being/happiness (inter alia featuring improved sleep & appetite), children including you in their songs, up to the likely allotment of privileges in the afterlife, etc., etc., but the Christmas season is probably an especially propitious time to cross our palms with silver. A special thank you to all readers who have already chipped in, your generosity is greatly appreciated. Regardless of that, we are honored by everybody's readership and hope we have managed to add a little value to your life.
Bitcoin address: 1DRkVzUmkGaz9xAP81us86zzxh5VMEhNke
2 Responses to “Dive in Momentum Stocks Resumes”
Most read in the last 20 days:
- Strange Moves in Gold, Federal Reserve Policy and Fundamentals
Counterintuitive Moves Something odd happened late in the day in Wednesday's trading session, which prompted a number of people to mail in comments or ask a question or two. Since we have discussed this issue previously, we decided this was a good opportunity to briefly elaborate on the topic again in these pages. A strong ADP jobs report for March was released on Wednesday, and the gold price dutifully declined ahead of it already, while the stock market surged concurrently. Later in...
- Gold – An Overview of Macroeconomic Price Drivers
Fundamental Analysis of Gold As we often point out in these pages, even though gold is currently not the generally used medium of exchange, its monetary characteristics continue to be the main basis for its valuation. Thus, analysis of the gold market requires a different approach from that employed in the analysis of industrial commodities (or more generally, goods that are primarily bought and sold for their use value). Gold's extremely high stock-to-flow ratio and the main source of...
- Doomsday Device
Disappearing Credit All across the banking world – from commercial loans to leases and real estate – credit is collapsing. Ambrose Evans-Pritchard writing for British newspaper The Telegraph: Credit strategists are increasingly disturbed by a sudden and rare contraction of U.S. bank lending, fearing a synchronized slowdown in the U.S. and China this year that could catch euphoric markets badly off guard. Data from the U.S. Federal Reserve shows that the $2 trillion market...
- The Balance of Gold and Silver – Precious Metals Supply and Demand
Orders of Preference Last week, we discussed the growing stress in the credit markets. We noted this is a reason to buy gold, and likely the reason why gold buying has ticked up since just before Christmas. Many people live in countries where another paper scrip is declared to be money — to picture the absurdity, just imagine a king declaring that the tide must roll back and not get his feet wet when his throne is placed on the beach — not real money like the US...
- The American Empire and Economic Collapse
Dashed Hopes Despite widespread optimism among libertarians, classical liberals, non-interventionists, progressive peaceniks and everybody else opposed to the US Empire that some of its murderous reins may finally be pulled in with the election of Donald Trump, it appears that these hopes have now been dashed. Liberty... some of it is still above water, but definitely not as much as there could or should be.* While the hope for a less meddlesome US foreign policy...
- Pulling Levers to Steer the Machine
Ticks on a Dog A brief comment on Fed chief Janet Yellen’s revealing speech at the University of Michigan. Bloomberg: “Before, we had to press down on the gas pedal trying to give the economy all of the oomph that we possibly could,” Yellen said Monday in Ann Arbor, Michigan. The Fed is now trying to “give it some gas, but not so much that we’re pushing down hard on the accelerator.” […] “The appropriate stance of policy now is closer to, let me call it...
- Credit Contraction Episodes
Approaching a Tipping Point Taking the path of least resistance doesn’t always lead to places worth going. In fact, it often leads to places that are better to avoid. Repeatedly skipping work to sleep in and living off credit cards will eventually lead to the poorhouse. Sometimes the path of least resistance turns out to be problematic The same holds true for monetary policy. In particular, cheap credit policies that favor short-term expediency have the...
- The Empire Needs an Emperor
Unknown (sort of) Head of State BUENOS AIRES – Type Swiss President “Doris Leuthard” into Google. You will get about 450,000 results. Do the same with Donald Trump, and the number is closer to 396 million. That’s 87,900% more references. The world’s press is as fascinated by President Trump as it is indifferent to President Leuthard. Doris Leuthard, President and energy minister of Switzerland. She has won her second presidential term this year. It basically...
- Mea Culpa – Precious Metals Supply and Demand
Input Data Errors Dear Readers, I owe you an apology. I made a mistake. I am writing this letter in the first person, because I made the mistake. Let me explain what happened. The wrong stuff went into the funnel in the upper left-hand corner... I wrote software to calculate the gold basis and co-basis (and of course silver too). The app does not just calculate the near contract. It calculates the basis for many contracts out in the distance, so I can see the...
- The Cost of a Trump Presidency
Opportunity Cost Rears its Head Last Thursday’s wanton attack on a Syrian air field by the US and its bellicose actions toward North Korea have brought the real cost of candidate Trump’s landslide victory last November to the forefront. It didn't take long for Donald Trump to drop his non-interventionist mask. The decision was likely driven by Machiavellian considerations with respect to domestic conditions, but that doesn't make it any better. Unlike...
- India – Is Kashmir Gone?
Everything Gets Worse (Part XII) - Pakistan vs. India After 70 years of so-called independence, one has to be a professional victim not to look within oneself for the reasons for starvation, unnatural deaths, utter backwardness, drudgery, disease, and misery in India. Intellectual capital accumulated in the West over the last 2,500 years — available for free in real-time via the internet — can be downloaded by a passionate learner. In the age of modern technology, another mostly...
- French Election – Bad Dream Intrusion
The “Nightmare Option” The French presidential election was temporarily relegated to the back-pages following the US strike on Syria, but a few days ago, the Economist Magazine returned to the topic, noting that a potential “nightmare option” has suddenly come into view. In recent months certainty had increased that once the election moved into its second round, it would be plain sailing for whichever establishment candidate Ms. Le Pen was going to face. That certainty has been...