The Stock Market

     

 

 

Investors are Oblivious to the Market’s Downside Potential

This is a brief update on a number of sentiment/positioning indicators we have frequently discussed in these pages in the past. In this missive our focus is exclusively on indicators that are of medium to long-term relevance to prospective stock market returns. Such indicators are not really useful for the purpose of market timing –  instead they are telling us something about the likely duration and severity of the bust that will follow on the heels of the current market mania. The first chart is an update of the current situation in RYDEX funds. Despite their small size, these funds have always represented a quite accurate microcosm of general market sentiment.

 

A RYDEX overview: RYDEX money market fund assets have recently declined to new all time lows; the pure non-leveraged bull-bear fund ratio is back above 29 (i.e., bull funds assets are more then 29 times larger than bear fund assets). At the top of the tech mania in early March 2000, this ratio peaked at roughly 17. Lastly, the amount of assets in RYDEX bear funds demonstrates that bears remain extremely discouraged. It is fair to say that at this stage almost no-one expects that the market could suffer a serious slump.

 

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Earnings Lottery

Shareholders are are probably asking themselves every quarter how the earnings of companies in their portfolios will turn out. Whether they will beat or miss analyst expectations often seems akin to a lottery.

 

The beatings will continue until morale improves… [PT]

 

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Europe at an Important Juncture

European economic fundamentals have deteriorated rather noticeably over the past year – essentially ever since the German DAX Index topped out in January 2018. Now, European stock markets have reached an important juncture from a technical perspective. Consider the charts of the Euro-Stoxx 50 Index and the DAX shown below:

 

The Euro-Stoxx 50 Index already peaked in early November 2017, the DAX followed suit in January 2018 – such divergent peaks are a hallmark of major turning points. The recent rally has pushed European stocks back up to trendline resistance and they are now severely overbought.

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Introductory Remarks by PT

We have discussed the proprietary Incrementum Inflation Indicator in these pages on previous occasions, but want to quickly summarize its salient features again. It is a purely market-based indicator, this is to say, its calculation is based exclusively on market prices and price ratios derived from market prices.

However, contrary to most measures of inflation expectations, the Incrementum Inflation Signal is not primarily focused on yield differentials, such as is e.g. the case with 5-year breakeven inflation rates.

 

The 5-year breakeven inflation rate is derived from the differential between 5-year treasury note yields and 5-year TIPS yields. Interestingly, it has recently begun to tick up as well after declining sharply for several months.

 

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Has a Bear Market in Stocks Begun?

The stock market correction into late December was of approximately the same size as the mid 2015/early 2016 twin downturns, so this is not an idle question. Moreover, many bears seem quite confident lately from an anecdotal perspective, which may invite a continuation of the recent upward correction. That said, there is not much confirmation of said confidence in data that can be quantified.

 

Our proposed bearish wave count for the S&P 500 Index, which could easily be completely wrong, so take with a big grain of salt. Let us just note here that this chart looks bearish regardless of the wave labels. The latter are mainly meant to serve as an orientation aid (i.e., if something very different from the expected fractal shape develops, we would know that this interpretation is wrong; on the other hand, if the expected shape does develop, we could be reasonably confident of where short term turning points are likely to occur and would have further confirmation that a large scale bear market has begun).

 

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… Something Wicked this Way Comes

Last week the price of gold went up $18, and that of silver 6 cents. Looking at the ongoing stock market drop, someone asked us if this is “it”. So far in Q4, the stock market (S&P 500) has now lost more points than in any quarter during the great financial crisis (though so far less as a percentage). Is this it, will gold hit $10,000?

 

S&P 500 Index, daily – an unseemly slipping on the banana peel. [PT]

 

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Offering Peace and Joy

Heading into the final weekend before Christmas we’ll take a brief hiatus from the economy and markets. We do so, however, with intent and purpose. Our principal objective is to offer peace and joy as you go about your merry way.

 

Unfortunately, Santa isn’t coming this year. Right after losing his behind in cryptos, he went all in with everything he had left on FANG stocks, margined up to his eyebrows. He trusted his well-worn ability to deliver the traditional “Santa Claus rally”, but was waylaid by the dollar-dissolving vampire bat Ptenochirus Iagori Powelli  hiding in a snowdrift. He needs some time off to forget. [PT]

 

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The Seasonal Trend Inversion Continues

By now it has been pretty well telegraphed that the Fed will likely announce that it is going to end its “automatic 25 bps rate hike every quarter” policy and replace it with some sort of “incoming data dependent” version. Normally one would expect this to constitute a “buy the news” event, especially in view of the recent sharp decline in the stock market. However, there are still a few problems with this idea –  the chart below illustrates one of them.

 

The eerie, almost perfect inversion of the usual seasonal mid-term election pattern continues unabated – and even though we have pointed this out for quite some time, we are also a bit surprised by how persistent this phenomenon has been.

 

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The Santa Claus Rally –  A Well-Known Recurring Phenomenon

every year a certain stock market phenomenon is said to recur, anticipated with excitement by investors: the so-called Santa Claus rally. It is held that stock prices typically rise quite frequently and particularly strongly just before the turn of the year.

I want to show you the Santa Claus rally using the Dow Jones Industrial Average (DJIA) as an example. The DJIA has a very long history and is therefore particularly useful for conducting a long-term analysis.

 

Santa Claus, usually known as a reliable purveyor of presents, occasionally steps on something. When he does, it can be fatal. That said, December crashes are historically so rare, one needs only one finger to count them. When the NYSE reopened in December of 1914 after having been closed for several months following the outbreak of WW1, it did so with a~40% gap down – however, the market quickly recovered as war-time inflation began to boost prices. By early 1916 the market was trading at new highs. [PT]

 

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Mud Volcanoes

There are numerous explanations for just what in the heck is going on with the economy.  Some are good.  Many are bad.  Today we’ll do our part to bring clarity to disorder…

 

Two data series it is worth paying attention to at the moment: the unemployment rate (U3) and initial claims. As the chart at the top shows, when the former makes a low it is time to worry about the economy. Low points in the U3 UE rate slightly lead the beginning of recessions. Claims on the other hand are near coincident indicators of the stock market, this is to say, lows in initial claims tend to happen within a time period of four to six weeks surrounding major stock market peaks (in most cases they lead slightly, but small lags have occasionally occurred as well). Note: neither indicator confirms an imminent turning point as of yet – initial claims would e.g. have to rise to around 300k in order to do so. The same is true of other major recession indicators, their most recent readings do not yet confirm that the business cycle is about to turn down. However, there is a lot of circumstantial evidence that indicates such a downturn may soon be confirmed, including recent market moves (i.e., deteriorating stock prices and rising credit spreads). [PT]

 

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A Plethora of Headaches

We hope the recent market turmoil is not giving our readers too much of a headache. As you are no doubt aware, the events of the last few weeks have made maneuvering around global markets rather difficult.

 

A less than happy NYSE floor trader [PT]

Photo crdit: Brendan McDermit

 

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Investment Grade Junk

All is now bustle and hubbub in the late months of the year.  This goes for the stock market too. If you recall, on September 22nd the S&P 500 hit an all-time high of 2,940.  This was nearly 100 points above the prior high of 2,847, which was notched on January 26th.  For a brief moment, it appeared the stock market had resumed its near decade long upward trend.

 

We actually did not believe in the validity of the September breakout attempt: the extremely large divergence between the broad market and the narrow big cap leadership was one of many signs that an internal breakdown in the stock market was well underway. It is probably legitimate to refer to the January 2018 high as the “orthodox” stock market peak – the point at which most stocks topped out. [PT]

 

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