Weather Reports

10112016 October 11, 2016

Current Positions  (No Changes)

I(Intl) – exit; S(Small Cap) – exit; C(S&P) –exit

F(bonds) – up to 75%; G (money market) – remainder

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Weekly Momentum Indicator (WMI) last 4 weeks, thru 10/11/16

(S&P100 compared to exactly 3 weeks before***)

-5.35, +19.83, +8.88, -5.06

Some markets are designed to test the patience and limits of investors, with no gains, no losses, and more guessing and wondering.

For 14 weeks, since the date of the last report, dozens of markets worldwide have moved only slightly from their previous levels.

Tom Fitzpatrick is a top strategist at Citi and studies charts of trading patterns to forecast changes in the stock market.

When he and his team overlaid the current chart of the benchmark S&P 500 with the index in 1987 — right before the crash — they got “the chills.”

• There’s heightened concern about Europe and its banks. The UK has set a March 2017 date for when it will begin legal proceedings to exit the European Union, and Deutsche Bank failed to reach a swift deal that would lower its $14 billion fine with US authorities.
• We’re in “the most polarizing US presidential election in modern times.”
• More reports are circulating about central banks in Japan and Europe removing some of the economic stimulus they’ve provided by tapering their bond purchases. This is raising concerns about the efficacy of central bank policy around the world, Fitzpatrick said.
• And finally, some peculiar market moves: a 16% move in oil prices within a week; a 20-basis-point shift in US 10-year yields in five days; and a $90 move in gold prices in nine days. The Chinese yuan and British pound have made massive moves in a short period of time, too.

The MSCI World Index is a broad global equity benchmark that represents large and mid-cap equity performance across 23 developed markets countries. It covers approximately 85% of the free float-adjusted market capitalization in each country.  This single index covers issues in the following countries: United States, Canada, Austria, Belgium, Denmark, Finland, France, Germany, Ireland, Israel, Italy, Netherlands, Norway, Portugal, Spain, Sweden, Switzerland, United Kingdom, Australia, Hong Kong, Japan, New Zealand, and Singapore.

On July 18, the last Weather Report date, the MSCI World Index was at 1703.93.  It closed on 10/10 at 1715.22, for a net change in nearly 3 months of  0.066%.

The dependence on Fed announcements, meetings, expectations, press events has become extreme.  This ‘screams’ to the absence of a market actually moving on fundamentals of either good or bad data.  Good data encourages.  Bad data implicates more Fed action and dependence.  This is the ‘no-win/no-loss’ short-term cycle, waiting on some major, unexpected event to finally ‘pop’ the complacency; the bubble.

Over the past several months the markets have consistently drifted from one Fed or Central Bank meeting to the next. Yet, with each meeting, the questions of stronger economic growth, rate hikes, and financial stability are passed off until the next meeting. So, we wait….until the next meeting…..and the next meeting…..and the next meeting.

Business channels are already starting their ‘countdown clocks’, now at 22 days, for the next meeting.  BIG YAWN!

Equity Markets – Long Term

The chart below shows the historic ‘topping’ patterns now in place.  What has in the past been a 1-2 year process of ‘topping’, followed by a severe correction, is now a 2-3(?) year process.  The lack of a downdraft, if you ignore the 8-10% pullbacks on October of ‘14, August ‘15, and January ‘16, have created a sense of calm by many who perceive little risk. Nothing could be further from the truth.  In each case, upside has still been limited to a level that is far smaller than the travel downward.  These are tests.  Those who fall asleep fully invested will find themselves rushing for the door a few days too late.

S&P500 July 18th: 2166.89; October 10th: 2163.66; Net Change:-3.23

(We’ve been in this circle on the right for TWO YEARS!!)

In normal times, the S&P 500 Index should compound at 5.7% real return; so, the past five years have delivered roughly double what is normal. Getting double what you deserve (in isolation) should always make you nervous. Deceptively, these returns have only happened because of the combination of FED intervention, increasing margin debt, and stock buybacks, or, in summary, historic levels of financial engineering and borrowed money, from individuals, companies, and central banks.  This money must be repaid.

Market Fundamentals/Economy

(***click chart for better view, press back button to return***)

Something smells funny.

That smell is what we call price/earnings (P/E) ratio multiple expansion. Rather than waiting for actual growth in earnings, the marketplace, over the past five years, has simply decided to pay more for earnings. Paying more for the same dollar of earnings is rarely wise and often foolish.

The chart below covers stock price to earnings ratios over the past 75 years.  One thing is clear; bull markets neither sustain themselves nor continue from these levels.

When you hear that ‘stocks are cheaper than they’ve been in 10 years’, keep this picture below in mind.  It most certainly is not true.

We’ve returned, once again, to the most expensive market levels in several generations. Markets are within a fraction of the valuations last seen before the last peak in late 2007. Even if some are willing, for no good reason, to chase prices higher, it doesn’t mean that they won’t be left holding the bag by those who choose not to do so.

The latest data from FactSet shows that S&P 500 companies spent $125.1 billion on share buybacks during the second quarter of 2016, the lowest figure in nearly three years:

Share buybacks have been one of the biggest drivers of US equity markets since the end of the financial crisis.

Between 2012 and 2015, US companies bought $1.7 trillion of their own stock, according to Goldman Sachs. Without these big purchases, US equity flows would have actually been negative by over $1 trillion during that period. Low interest rates have encouraged companies to take on debt, and much of it was used to buy back shares rather than investing in their underlying businesses.

Whether the latest cooling in share buybacks will continue or the larger trend will resume is unclear. If it’s the latter, I’d expect equity market volatility to increase in coming quarters.

Shorter term, the stock market appears to be stuck in neutral since July-August and the trading range is narrowing.  Some indexes show a coiling in a sideways triangle pattern, which says we’re going to get a strong move soon.

The month-to-month indecision shows a conflict between obvious central bank purchases for temporary support, and the reality of declining earnings, decreases in major asset purchases by the Fed (ended Oct. ’14),  European Central Bank (ending in Mar. ’17), and the Bank of Japan. (decreases not yet announced, but, expected)

Overall, more than $20 TRILLION dollars worldwide have created artificial buoyancy to world markets in the past 7 years.  It can’t go on forever, because the pace, methods and impact of ‘unwinding’ are not predictable.

These charts show different levels of resistance for different reasons.  Primarily, trend lines for each chart extend back into last year, and possibly before.

EuroStoxx 50 July 18th: 2949.17; October 10th: 3035.76; Net Change: +86.59

Nikkei 225  July 19th: 16723.31; October 10th: 16860; Net Change:+136.78

DJIA July 18th: 18533; October 10th: 18329; Net Change:-204

– Dow Industrials –  resistance at 18531, reflecting the May 2015 high.

S&P500 July 18th: 2166.89; October 10th: 2163.66; Net Change:-3.23

– S&P500 – support at the May 2015 high of 2134, but, resistance at this year’s high of 2188

Nasdaq 100 July 18th: 4619.78; October 10th: 4893.77; Net Change:+273.99

– Nasdaq 100 – resistance at 4887, stretching back to a line drawn from July & November 2015 highs

Russell 2000 July 18th: 1208; October 10th: 1251; Net Change:+43

– Russell 2000 – resistance between 1264 and 1294, against a rising trend line due to a rising channel

– AGG (F Fund) – support near today’s low, longer support from the previous February 2016 high; more support just below at the September 9th low; reversal up possible

EFA (I Fund) – range-bound, and with negative momentum

Prior to the most recent dip of about 2.5% on September 9th, the markets had traded in the 4th tightest range since 1928 for over 40 days, with no move on any day more than +/- 1% over the previous day.  That rather dramatic, all-day, September 9th sell-off was generated by Fed governor’s strong suggestions of a September rate hike, which ultimately did not happen.  With only one rate hike in the past 9 years(!), done last December, it is most irrational, thinking that a quarter point increase is nothing more than a mosquito bite in the long term scenario. This comes from decades of fearing a recession brought on by Fed rate hikes. The Fed has a gun with only 1 bullet, from last December’s rate hike. We are going to see a recession at some point in the next 18-24 months and the Fed is desperate to reload by adding some rate hikes to their arsenal. The higher the interest rate when we reach the next recession, the more times they will be able to cut to slow those recessionary forces. They only have one bullet today and it is scaring them because they see the long-term outlook.

The challenge is figuring out which way it is likely to break and then get in front of the move. The deception of a balance between an eventual breakout (up), and a breakdown (down) might find clues with this table.  It shows over 60% of these U.S. and European indices having more than a month since their last high, and/or, currently riding BELOW their 50 day averages.

The next table shows how a majority of market levels in the U. S. and Europe are, once again, looking backward from today at their highest levels.

The 50DMA represents the average of the last 50 days on a moving average basis.

They are in order from the oldest date of hitting their recent highest level.

The longer the passage of time, the lower the likelihood of a continuation to higher levels, and the greater likelihood of stagnation, higher risk, and/or weakness/losses.

BREXIT Plus 90 Days

The initial market snap back in late June that accompanied the referendum was just a bit of ‘kicking the can’, given the reaction to the initial shock, leading to the long process involved from the vote to the execution.  Now, after the resignation of David Cameron, and the installation of Theresa May, it’s now time to get to work.

Now, the question is whether there will be a ‘soft’ (best case), or a ‘hard’ (worst case) BREXIT scenario!  There are too many variables involved for anyone to accurately project.

“It is in everyone’s interests for there to be a positive outcome to the negotiations that is mutually beneficial for the U.K. and the EU, causes minimum disruption to the industry and benefits customers,” said Miles Celic, chief executive officer of lobby group TheCityUK.

Adam Marshall, acting director general at the British Chambers of Commerce, said “in a period of historic change, business communities all across the U.K. need to feel supported, not alienated.”

May’s strategy amounts to a bet that voters’ opposition to immigration outweighs all else and that the economy will find support from easier fiscal policy, new trade deals emerge and banks don’t flee London, said Simon Tilford, deputy director at the Center for European Reform. The political payoff could be more support for her Conservatives at a time when the opposition Labour Party is in disarray.

“May wants to give the people what they want and thinks that the people voted for a hard Brexit and that the economic costs are exaggerated,” said Tilford. “A lot of this has to do with Conservative Party unity and she has a better chance of unifying the party going for a hard Brexit.”

Meanwhile, despite “Brexit,” weakening economic growth, declining profitability, terror attacks, Presidential election antics, and Deutsche Bank, the markets continue to cling to its bullish trend. Investors, like “Pavlov’s dogs,” have now been trained the Fed will always be there to bail out the markets. But then again, why shouldn’t they? The chart below shows this most clearly.  (***click chart for better view, then, press back button to return***)

Recession Indications

Several measures of the probability of a recession have recently appeared.

Existing home sales in August totaled 5.33mm, 120k less than expected and down from 5.38mm in July. This is the slowest pace of closings since February.

Unemployment – September’s jobs report contained a sign that investors should be on alert for a U.S. recession, judging by bond guru Jeff Gundlach’s favorite warning signs. (***click chart for better view, press back button to return***)

During a panel discussion at the New York Historical Society back in May, the Doubleline Capital LP chief executive officer revealed that one of his top three recession indicators was when the unemployment rate breaches its 12-month moving average.

Over the past year, the trend in the unemployment rate has flipped from improving to deteriorating.

“This indicator is a necessary, but not sufficient, sign of a coming recession,” wrote Gundlach in an email to Bloomberg. “It is worth factoring into economic analysis but not a reason for sudden alarm.”
Auto Sales – The first is that while the ‘annualized’ reported sales number was near the highest in 10-years, the historical average of cars sold is still at levels below both previous peaks.  Secondly, and more importantly, is both previous peaks in total auto sales were preceded by a decline in the annual percentage change of cars sold.

In September, US commercial bankruptcy filings soared 38% from a year ago to 3,072, the 11th month in a row of year-over-year increases, according to the American Bankruptcy Institute.

Commercial bankruptcy filings skyrocketed during the Financial Crisis and peaked in March 2010 at 9,004. Then they fell on a year-over-year basis. In March 2013, the year-over-year decline in filings reached 1,577. Filings continued to fall, but at a slower and slower pace, until November 2015, when for the first time since March 2010, bankruptcy filings rose year-over-year. That was the turning point. Note that there is no ‘plateauing’:”