Posts Tagged 'rally'

And the Dam Bursts…

Like an Orc being washed away by the waters behind the dam after its destruction, markets shorts are finding it equally hard to find their footing.

While many market pundits keep talking down the economy and scream that the market is “overvalued” leading to crash comparisons to (you choose) 2000-2002 Tech Wreck or the 2008-2009 Financial crisis, the market continues its upward trend.

Should investors be fearful? We think not. This has the makings to the start of a truly historic bull run. It may end ugly when it ends, but that could be a long way off.

Let’s look first at the economy. Readers should be familiar with the work done at www.econpi.com as I referenced it many times in the past. Quick refresher, http://www.econpi.com does a nice graphic for where the economy is, and by looking at past graphs you can clearly see where the economy came from.

“It’s the Economy, Stupid”James Carville

First, here is where the economy was prior to the Covid 19 outbreak:

The Red MOC – Mean of all the data coordinates and the Green LD – Leading Indicator plots are in the economic expansion quad.

The average for June:

Clearly in recession for both May and June.

And here is the first week of July:

We have moved into the recovery quad. This is a big incremental change in a week. While there is concern about the closing of the economy, most seem to agree that with masks and social distancing most businesses other than bars and fitness clubs will be opening, even if on a limited basis. Many pundits claim that business will take years to return to normal. I strongly disagree. The flood of consumers to beaches, restaurants and bars indicates to me a consumer that is desperate to return to their normal lives. The biggest exception I see is the airline and cruise industries.

“Don’t Fight the Fed”

Probably the one universal piece of advice to follow as an investor. This is from Fed Chair Powell,

“The Federal Reserve is strongly committed to using our tools to do whatever we can for as long as it takes to provide some relief and stability to ensure that the recovery will be as strong as possible and to limit lasting damage to the economy… The Fed will continue to use these powers forcefully, proactively, and aggressively until we’re confident that the nation is solidly on the road to recovery.” (Congressional Testimony on 6/30/20)

How forceful? The Fed has already announced the creation of facilities to buy corporate bonds, asset backed securities, ETFs and now they have directed Blackrock to buy individual securities for the Federal Reserve account. None of which is allowed by Fed charter. And thus the above reference to the dam breaking. The Fed has literally unlimited resources to print money with the apparent adoption by this administrations of Modern Monetary Theory. There is no theoretical limit to money printing until the economy reaches full employment again. The dam has literally broken.

But let’s hear it from someone else, hedge fund billionaire and owner of the Milwaukee Bucks Marc Lasry in a Market Watch interview,

‘I know you’re not supposed to say this, but it’s a once-in-a-lifetime opportunity. You’re not going to see this again: Where you’ve actually got an economy that’s fine, and you’ve got a Fed pumping trillions of dollars in.’

Negatives? As always there are concerns, and the prudent investor needs to remain wary. Expect volatility especially over the next couple of weeks as earnings are announced for the second quarter.

The market is building up fuel like a California Forest waiting on a lightning strike to set it off. The lightning for the market? Hopefully a treatment or vaccine for Covid 19 that is actually available to the public.

Warning

How volatile the market is over the next six months is anyone’s guess. Between constant Covid 19 news, the election, riots, and protests daily gyrations could be severe. I personally think the biggest test will be if schools open and remain open in the fall. No schools and no football will be a huge psychological blow. If you have cash on hand now we strongly suggest picking and choosing several entry points over the next few months. No one can predict the short term, but the longer term outlook is looking very bullish.

Mr. DeShurko is the Managing Member of 401 Advisor, LLC an independent registered investment advisor. Jim Kilgore CFP ® is an Investment Advisor Representative of 401 Advisor, LLC. They are also registered representatives of Ceros Financial Services, Inc. (Member FINRA/SIPC).  Ceros is not affiliated with 401 Advisor.  The views expressed are those of Mr. DeShurko and do not necessarily reflect those of Ceros Financial Services, Inc., its employees, or affiliates.

Past performance is no guarantee of future results. All investing involves risk. Investments mentioned are not meant to be specific buy or sell recommendations without being taken in the context of an investors’ entire portfolio or investment objectives. Consult an investment professional before investing. 

And be sure to check out Jim’s new podcast: https://podcasts.apple.com/us/podcast/401-advisor/id1511923745

 Please email either of us with your questions and we will address them on future podcasts.

Can The Market Rally Continue?

The following article first appeared at: www.HorsesMouth.com on 2/14/2013.

Given the recent market highs, are we at the start of a new bull market or wrapping up an old one? We seem to be meeting the five critical conditions for continued gains, but that doesn’t rule out a 10% correction.

 Much has been said about the S&P 500 breaking through its former daily high set in 2007. The question seems to be whether this is the end of a bull market or the start of a new one?

First, let’s put this into perspective. Below is a chart of SPY, the SPDR’s S&P 500 Index tracking ETF, showing monthly returns since 1997. Many pundits like to point out that we have been in a four-year bull market, and therefore, this rally is extended and due to come to an end. This is simply false.

What we have been in for four years is a <i>bear market recovery</i>, as anyone who invested prior to 2008 can tell you. We have simply had a four-year long slog to recovery from the crisis-induced crash.

Figure 1: SPY Monthly Returns (1997 to Present)

Untitled-1

 Source: [freestockcharts.com Free Stock Charts]

 Second, from a longer-term secular reference, we have really been in a 13-year bear market and recovery cycle dating back to the 2000-2002 tech wreck market crash. Since the market peak in March of 2000, we have <i>not gone above, and stayed above</i> that level for 13 years now. This is the definition of a secular bear market.

The good news is that secular bear markets do end.

Know your P/Es

Below is a chart from Crestmont Research showing the history of secular markets in the U. S. since 1900. As you can see, the market’s history consists of long periods of rising markets (green bars) followed by relatively flat periods (red bars). However, “flat” describes the period from the beginning to the end of the period. Flat periods–or secular bear markets–can be filled with large declines and recoveries.

Figure 2: History of Secular Markets

 Untitled-2

Source: [crestmontresearch.com/docs/Stock-Secular-Explained.pdf Crestmont Research]

 My point is not that we are at the beginning or end of a bull market. My point is simply that just because we may have re-attained prior market highs, it does not, in and of itself, mean much of anything as to which way this market goes from here. It is simply not that simple. But it makes for good headlines.

Positive trends

So what would give us an indication as to the market’s next move? Citi equity strategist Robert Buckland recently released a study in which he looked at prior 20% rallies that were then followed by double digit gains. This seems to be narrowing in a bit on our current situation, and may add some relevance to our current market high.

He found that to see continued gains, the markets must meet five conditions:

  1. Lower than average starting valuations
  2. Double digit EPS growth
  3. Rising PMIs
  4. Higher U.S. government bond yields and,
  5. Sustained flows into equities

Let’s take a quick look at where we stand relative to Mr. Buckland’s criteria.

  1. Lower than average starting valuations. According to Zacks, Q4 2012 earnings are coming in slightly better than expectations. More importantly guidance has been positive. Standard and Poors estimates Q4 earnings will be $23.83. If you annualize that number you have a P/E ratio of about 15.7 or pretty close to the long term average. While average is certainly not “low,” we have to give some accounting for “QEfinity” with historic low, albeit manipulated, interest rates. A 15.7 P/E is reasonable, but not where historic bull markets start. On the other hand, again considering interest rates, a bull market should be able to break through a 20 P/E quite easily if the other conditions exist.
  2. Double digit EPS growth. Standard and Poors is currently projecting a 17% year over year growth in S&P 500 earnings for 2013. While estimates have been coming down, they have a long way to go before dropping below a double digit estimate.
  3. Rising PMIs. Below is a chart of current and trend results for PMI and its components as reported by Markit, a London-based CDS specialist. www.markit.com. PMI is growing “faster” based on a two-month trend. While I wouldn’t bet the ranch on a two-month trend, this does meet the criteria for a continued rally.

Figure 3: Manufacturing at a Glance (January 2013)

Untitled-3

Source: [markit.com Markit]

 Higher U.S. government bond yields. This would seem to be both the hardest hurdle and the most counterintuitive. With the Fed buying $85b of paper each month, they would seem to have the ammunition to keep yields low. And most pundits equate rising interest rates as one of the risks to a continued bull market. Below is a chart of the yield curve from Stock Charts.

The black line indicates the current yield curve. The lighter areas show the curve over the last 50 days — darker shaded areas being the most recent. Clearly we have seen a steepening of the yield curve resulting from rising rates.

Figure 4: Dynamic Yield Curve

 Untitled-4

Source: [stockcharts.com StockCharts]

 Sustained flows into equities. Figure 5 is a chart from Citi showing flows in bonds and stocks. There has been a clear flow of money to stocks since about mid December.

Figure 5: Weekly Bond v. Equity Fund Flows

Untitled-5

 Here are some of the numbers from the third week of January:

  • Total equity inflows were $22.2 billion, the second-largest ever.
  • Inflows into long-only equity funds were $8.9 billion, the largest since March 2000 and the fourth-largest ever.
  • Excluding ETF flows, inflows into equity funds were the largest since May 2001, and the first over $5 billion since April 2003, according to Goldman Sachs.
  • Emerging market equity inflows were $7.4 billion, the largest in history.

The rally is on, but…

Current trends definitely support the case for a continued rally, based on Mr. Buckland’s research. The “but’s” would be that the current P/E is not historically low, some “trends” are really too short-lived to comfortably assert that they are in fact trends, and there still are some major macro events lurking on the horizon (will Europe ever be fixed?).

That said, in practice we remain cautiously optimistic. With one short term caveat: the market (SPY) does appear to be at the top of its short term trend line. A 10% correction could take place without violating the current intermediate uptrend as you can see in Figure 6 below.

Figure 6: SPY Trends

Untitled-6

Source: [freestockcharts.com Free Stock Charts]

It’s All About the Bazooka

The markets have been rallying since June 26th when Mario Draghi, the ECB President, announced that the ECB would do “ whatever it takes” (or as Wall Street terms it “will bring out the bazooka”), to save the Euro. Add in the fact that August has been the number one month for the NASDAQ and Russell 2000 indices in election years, and this month’s rally has come as no surprise.

But remember in investing, it is not what you make but what you keep that matters. The following is from Megan Greene, of Roubini Global Economics, and reprinted in John Mauldin’s “Outside the Box” Newsletter.

As usual, this has been a lazy August, but we do not expect the quiet to last. Indeed, for the second September in a row, developments in the eurozone (EZ) have the potential to be highly dramatic.

Greece: The troika is due to return to Athens in September and make a ruling on whether to release additional tranches of funding to Greece. If the troika decides to cut the taps off—and we don’t think it will—then Greece would default and exit the EZ. The Greek government aims to renegotiate the second bailout program when the troika returns to town in September. If the troika plays hardball and does not grant the Greek government any concessions, then the governing coalition would likely collapse. Also in September, the Greek parliament will have to pass a number of measures to generate €11.5 billion in savings for 2013-14. With a high degree of austerity fatigue in Greece, we can expect social unrest.

Portugal: With Portugal starting to slip on its fiscal targets, we expect Portugal to begin negotiations on a second bailout package. Currently, Portugal is meant to return to the markets in 2013 but, with bond yields well above sustainable levels, we regard this as highly unlikely.

Spain: The auditors Deloitte, KPMG, PwC and Ernst & Young are due to present their full reports on the capital needs of Spain’s financial sector in September. The findings of this report will be used to determine the exact amount the Spanish banking sector will need to borrow from the EZ’s bailout fund, the European Financial Stability Facility (EFSF).

Italy: The Italian general election campaign will begin in earnest in September. Although polls point toward a center-left-led coalition, Italian politics is at its most fluid state since the early 1990s and, with so many voters still undecided, it is impossible to call the election.

Germany: The German constitutional court is due to vote on the legality of the ESM (the successor to the EFSF) and the fiscal compact on September 12. We expect the court will deem the ESM legal but, if this does not occur, it would serve a major blow to EZ policy makers, who have committed the ESM to potentially purchasing sovereign debt in the primary markets.

France: The French government is scheduled to unveil its 2013 budget in September. Markets will be disappointed if it does not include large spending cuts, but the announcement of further austerity risks riling trade unions and stoking civil unrest.

Netherlands: A general election is scheduled for September 12. Recent opinion polls suggest the ruling right-of-center VVD will be unable to form a right-of-center majority
government. Consequently, coalition negotiations are likely to be protracted. The left-wing, euro-skeptic SP may win enough votes to be the second-biggest party. This would make it more difficult for the new Dutch coalition to secure parliamentary support for additional support measures for peripheral EZ countries.

Eurozone: There is a progress report on establishing the ECB as a single banking supervisor due out in September. Given that many details have not been hammered out yet, there is a chance that the progress made on this first step toward a banking union will disappoint.

In terms of the broader EZ developments, we expect the Greek government to collapse by the end of the year, and a Greek exit in early 2013, followed by an exit by Portugal by end-2014. Moreover, we expect Spain to receive official support from the EFSF/ESM in late 2012 after the ESM has been fully ratified (the second half of September at the earliest), while Italy will hang on longer but will eventually need support as well.

Add in that seasonally September is one of the worst months for U.S. markets and September could bring back a level of volatility that we have not seen for awhile. While I have been in the camp that just can’t comprehend how Europe holds the Euro together – the amount of money involved is truly staggering, even by U. S. debt and bailout standards, I do think German Chancellor Merkle acquiesces and gets out of the ECB’s way. In other words after a month of haggling, name calling, bluffs, and counter bluffs, the ECB turns on the printing presses before year end. Greece may or may not be invited to the party. But not sure it matters in the medium term.

I have done a 180 and think that even Greece will stay in the Euro. Consider down the road five years if Greece leaves, devalues their currency and now “competes” with the rest of Europe. Shipping costs, one of Greece’s actually industries, plummet due to the devalued Drachma, which revives the glory days of Greek shipping. Tourism is flourishing as it costs have as much to vacation in Greece as anywhere else in the Euro controlled Europe. Wouldn’t Spain, Portugal, Italy, and Ireland all be looking on and reconsider their own Euro status? Just sayin’.

Back to matters at hand. For lots of reasons, including those already mentioned, I think this rally is getting a little long in the tooth. I wouldn’t be jumping in now. Let’s get into September, see if we can find a better entry point, but be ready to invest aggressively in October.

October, November and December are traditionally strong months, especially in election years. If Draghi gets the green light to bring out the bazooka, i.e. print endless amounts of money, the big worry over the market will be lifted. Fiscal cliff will be put off, and China will be priming their pump over the winter. Forget politics, focus on the markets and we could have a strong fourth quarter, but expect things to get worse in order to make them better.

Can the Rally be Trusted?

Article originally appeared on October 20th at www.HorsesMouth.com.

After a solid market rally, sentiment seems to have changed from financial Armageddon to Rally Time. But is the exuberance warranted or irrational?

Looking at Chart 1 below of SPY the SPDR’s S&P 500 ETF, shows reason for caution as we go forward. Even though the markets have regained positive territory on the year (10/14/2011), a look at SPY clearly shows that we are only at the top of the trading range that we entered in August. A peak that we have seen equaled twice before, only to be turned back on negative sentiment. So is this time different?

Chart 1 SPY April 13- October 14 2011

Source: freestockcharts.com 

The one thing to consider as we hit resistance is that in each of the past instances the market has schizophrenically bounced back and forth between resistance and support based on the news from Europe. Last week was very quiet on that front, and news centered on the U. S., specifically earnings. So for a minute, let’s assume that the big Europe bailout comes through and all is good in the (financial) world once again. Is a rally through resistance warranted by U.S. fundamentals?

The most worrisome evidence to the contrary comes from the St. Louis and Chicago Federal Reserves. The KC Fed publishes a monthly Financial Stress Index and the Chicago Fed a National (business) Activity Index.

The two are shown in Chart 2 along with recent recessions in grey.  The indices have longer track records and details can be found here: pdf download  and pdf download.

To sum the Fed literature, the two indices when taken together have predicted the last 7 recessions. The indicator is when the KCFSI is positive (indicating above average financial stress) and when the CFNAI 3 month moving average is below -.7 we have had a recession. While the CFNAI is not quite there yet at     -.43, what is troubling is that a positive KCFSI will drag the economy into a recession if it stays positive, as it did in the late 90’s and early 2000 before the CFNAI dropped to the -.7 level – at the start of the 2001 recession.

Chart 2 CFNAI 3 month Moving Average and the KCFSI

Source: St. Louis Federal Reserve FRED

Currently the KCFSI is heading into positive territory with a September reading of .44, up from .37 in August, as seen in Chart 3 below.

Chart 3 Kansas City Federal Reserve Financial Stress index

Source: Kansas City Federal Reserve

Simultaneously the Chicago Activity Index is in negative territory, showing a large slide from July over August as seen in Chart 4 below, from +.02 to -.43. However the 3 month moving average was virtually unchanged. The September data is due out October 29th.

Chart4 Chicago Federal Reserve Activity Index – 3 month moving Average

Clearly, the data from these two indices show that the U.S. economy is on the ropes, all by ourselves, without an implosion over sovereign debt in Europe. Unfortunately the Chicago data is about a month and a half old, and although the Kansas City data is fairly fresh let’s look at some more recent fundamental and technical  data.

The first is the Economic Cycle Research Institute (ECRI), which has already announced that we are in fact in a recession. From the N Y Times, “Relying on  a series of proprietary indexes, the institute…Over the last 15 years ,  has gotten all of its recession calls right, while issuing no false alarms.” In other words things are about to get worse, giving added gravity to the St. Louis Federal Reserve and the Chicago Federal Reserves’ Indexes.

Using the logic behind combining the two Fed indexes- that financial conditions govern economic activity, let’s look at some other financial indicators. Using JNK, the SPDRS Barkley’s High Yield Index ETF as a proxy for the spread between low and high rated corporate securities, clearly JNK has been in rally mode for the past week. However, unlike SPY, while it has re-entered its trading range, it has yet to push up to its resistance level.

Chart 5 JNK

Source: freestockcharts.com

Next, in Chart 6 is XLF, the SPDR Financial Sector ETF. Again, while it has regained its trading range, it has not followed the broader market up, to challenge its resistance level.

Chart 6 XLF

Source: freestockcharts.com

I’ll finish this series with VIX, the CBOE Volatility Index ETF.  While it has –barely, broken through support, it is still well above its range from the beginning of the year through July. Volatility is not consistent with healthy markets.

Chart 7 VIX

Source; freestockcharts.com

Then there are a couple more fundamentals indicators to look at. First is the TED spread which shows the difference between the 10 year Treasury and the LIBOR rate. As the spread widens it shows that banks are charging a higher premium to lend to other banks. Clearly from Chart 9 below, banks faith in other banks credit worthiness is declining, not increasing. The TED spread is an indicator used in the KCFSI, so this does not bode well for the next release.

Chart 8 TED Spread

Source: http://www.bloomberg.com/quote/!TEDSP:IND

The next Chart shows the level of M2, which skyrocketed in July – August during what, so far, has been the peak in pessimism over the European sovereign debt crisis. While the climb has paused over the last month, the overall level has continued to climb higher. The common explanation is that money has fled Europe and has been deposited in “safer” U. S. banks.

Chart 9 M2 Money Supply

Source: Source: St. Louis Federal Reserve FRED

Putting it Together

My investment thesis has been that the U. S. market would live or die with Europe. If Europe can pull itself together and stave off a major crisis, the U S markets would rally based on solid corporate earnings and balance sheets. However, the data outlined above is painting a different picture. With Europe out of the picture for a week the markets did in fact rally – but so far, are still within their trading ranges. In fact key sectors, High Yield Bonds and Financials have yet to pressure their upside resistance levels. The VIX is slightly below support, but well above levels we saw in the first half of the year when the market did rally.

Fundamentals concur. The ECRI and the Federal Reserve generated KCFSI and CFNAI, all have accurately predicted recessions in the past. While the Fed indicators aren’t quite at recession levels yet, more current date like that from the ECRI and the TED Spread do not provide much room for optimism from future releases.

While any rally is welcomed, this is definitely one to be wary of. While I still expect a significant rally if we get good news from Europe. For it to last we need to see a market turnaround in many fundamental indicators.


bill@401advisor.com • 937.434.1790

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Charles H. Dow Award Winner 2008. The papers honored with this award have represented the richness and depth of technical analysis.

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