Hope is not a strategy

Bob Doll’s outlook this week at Nuveen Investments is less bearish than my own:

Trade-related risks seem to be growing. President Trump looks to be holding out hope that the U.S. economy will stay resilient in the face of escalating tariffs and rising tensions. So far, the U.S. economy has not faltered, thanks largely to continued strength in the consumer sector and labor market. But if business confidence crumbles (as it has in parts of Europe), it could lead to serious economic damage…..

The president’s recent actions to delay the implementation of some new tariffs show that he is sensitive to the market impact of his trade policies. But the erratic nature of his on-again, off-again approach adds too policy uncertainty. At this point, we can’t predict the ultimate economic impact from these issues. Our best guess is that the U.S. remains more than a year away from the next recession, but risks are rising. In addition to the solid consumer sector, we don’t see financial stress in the system. Liquidity is still broadly available, and fixed income credit spreads are generally stable outside of the energy sector.

With additional Federal Reserve rate cuts already priced into the markets and bond yields falling sharply, the only catalyst for better equity market performance could be improving global economic data. We hold out hope that the global economy will improve, and still think there is a better-than-even chance of manufacturing activity and export levels to grow. But those improvements will take some time, suggesting equities will remain volatile and vulnerable for now.

Where we seem to differ is on the inevitability of the US-China trade war escalating into full-blown disengagement. This week’s events have not helped.

China’s national English language newspaper, Global Times, under the People’s Daily, announced new tariffs.

Global Times

Followed by an admission that the timing of the announcement was intended to cause maximum disruption to US stock markets.

Global Times

The inevitable Twitter tantrum ensued.

Donald Trump

The President also tweeted “Now the Fed can show their stuff!”

He is deluded if he thinks that the Fed can help him here. The best response would be announcement of a major infrastructure program (not a wall on the Mexican border). Otherwise business confidence will decline due to the increased uncertainty. Business investment will contract as a result and slow employment growth.

Retail sales have shown signs of recovery in recent months but will decline if consumer confidence erodes.

Retail Sales

Especially consumer durables such as light motor vehicles and housing.

Consumer Durables Production

The global economy is already contracting, as indicated by falling crude oil

Nymex Light Crude

…and commodity prices.

DJ-UBS Commodity Index

Volatility (21-Day) is rising as the S&P 500 tests support at 2840. Breach is likely and would test primary support at 2750.

S&P 500 Volatility

Bearish divergence (13-Week Money Flow) on both the S&P 500 and Nasdaq 100 (below) warn of selling pressure. The Nasdaq 100 is likely to test primary support at 7000.

Nasdaq 100

The Russell 2000 Small Caps ETF (IWM) is testing primary support at 146. Follow through below 145 is likely and would signal a primary down-trend.

Russell 2000 Small Caps ETF

Fedex breach of support at 150 would also warn of a primary down-trend and slowing activity in the US economy.

Fedex (FDX)

We maintain our bearish outlook and have reduced equity exposure for international stocks to 40% of portfolio value because of elevated risk in the global economy.

ASX: Rate cuts not helping

From David Scutt at SMH:

A growing body of evidence suggests interest rate cuts from the Reserve Bank of Australia may be draining confidence in the economy rather than boosting it.

Key Purchasing Managers Index (PMI) figures released on Thursday showed a deterioration in Australian business conditions, impacted by what firms are describing as a general lack of confidence across the economy.

The Commonwealth Bank’s Australia “flash” Composite PMI produced in conjunction with IHS Markit, fell 2.6 points to 49.5 in August.

Commonwealth Bank Markit Flash PMI

The Composite PMI surveys firms from manufacturing and services sectors, accounting for around 75 per cent of the Australian economy. Activity levels have only declined three times since the survey started in May 2016, the last time in March this year.

“Households are taking the lower cash rate as a negative sign, raising concerns about what is happening with the economy that we need interest rates to go even lower,” said Kristina Clifton, senior economist at the Commonwealth Bank.

Ms Clifton cited the ongoing trade dispute between the United States and China, the RBA’s rate cuts, and the drought as factors hurting confidence. “Businesses are feeling this pessimism,” she said.

The decline in the PMI data echoes a similar slump in consumer confidence in the wake of the RBA’s July rate cut, which took the cash rate down to 1 per cent. “That lines up with what we’ve seen in [consumer confidence] where we saw quite a sharp drop following the June and July rate cuts” Ms Clifton said.

The Westpac-Melbourne Institute consumer sentiment survey fell to its the lowest level since August 2017 that month. Confidence subsequently recovered in August following the RBA’s decision to keep the cash rate steady.

Westpac Melbourne Institute Consumer Sentiment

Consumer sentiment is trending lower but there is also a recent series of higher troughs. Breakout from the triangle will indicate future direction.

On the downside, new vehicle sales for July 2019 fell for the 16th straight month.

Vehicle Sales

New vehicle sales are a leading indicator for the economy. Automotive Holding Group (AHG) is normally a useful bellwether for the overall ASX 200 index but its latest rally is distorted by a proposed merger with rival AP Eagers (APE).

AHG/ASX 200

The consumer outlook (below) is bearish, with family finances for the next 12 months down 6.5% (YoY) and the next 5 years down 5.3%. But one factor has definitely improved with the latest rate cuts: time to buy a dwelling (YoY) is up 16.7%.

Westpac Melbourne Institute Consumer Survey

Improving sentiment towards housing and rising auction clearance rates, albeit on low volumes, has helped banks, with ASX 200 Financials index finding support at 6000.

ASX 200 Financials

But UBS warn that further interest rate cuts would squeeze bank interest margins and may force them to cut dividends.

Australia: Bank Net Interest Margins

And a major threat is the potential cutback in business investment, because of the uncertain global outlook, and its impact on employment and consumer sentiment.

Australia: Business Investment

Iron ore is edging below support at $94/tonne, suggesting another decline to test support at $80/tonne.

Iron Ore

Materials are undergoing a strong correction. Declining Money Flow peaks warn of strong selling pressure. Breach of support at 12700 is likely and would warn of a test of primary support at 10700/11000.

ASX 200 Materials

On a more positive note, REITs are enjoying strong buying pressure, signaled by Money Flow troughs above zero, as the scramble for yield intensifies. Breakout above 1700 would signal another advance.

ASX 200 REITs

With a bearish outlook in its two largest sectors, the ASX 200 is likely to follow. A harami consolidation above support at 6350/6400 is bearish and breach would warn of a strong decline.

ASX 200

With the uncertain impact of a trade war on the Chinese economy, we reduced our exposure to Australian equities to 20% of portfolio value on 19 August 2019.

Falling Yuan bullish for Gold

China’s Yuan continued its plunge against the US Dollar after the latest Trump tariff tantrum. The trade war is hotting up and we can expect further Yuan weakness, fueling demand for Gold.

CNYUSD

Spot Gold consolidation above $1500/ounce is a bullish sign, while a Trend Index trough above zero indicates strong buying pressure.

Spot Gold in USD

We maintain our bullish outlook for Gold, with a target of the 2012 high at $1800/ounce.

The All Ordinaries Gold Index surprised with a fall despite the weakening Aussie Dollar. Penetration of the rising trendline warns of a correction but the primary trend remains upward. A Trend Index trough that respects the zero line would confirm this.

All Ordinaries Gold Index

Approaching stall speed

With 89.7% of companies having reported, S&P are projecting 4.4% earnings growth for June quarter 2019 compared to the second quarter in 2018. Even more interesting is their projection of 3.4% growth for the September quarter. With EPS growth boosted by a stock buyback yield of 3.5%, this warns that the economy is close to stall speed.

S&P 500 Earnings per share Forecast

The daily chart for the S&P 500 shows support at 2830/2840, while a higher trough on 21-Day Money Flow indicates (secondary) buying pressure. I expect another test of resistance at 3030; breakout above resistance at 2940 would confirm.

S&P 500

But divergence on 13-Week Money Flow, as on the Nasdaq 100 below, warns of longer-term selling pressure.

Nasdaq 100

Small-cap stocks, as depicted by the Russell 2000 ETF below, are not enjoying the same support as large caps. A sign of rising risk aversion.

Russell 2000 ETF

Bellwether transport stock Fedex is testing primary support at 150. Breach would warn of a primary decline, suggesting a slow-down in activity for the broad economy.

Fedex

We maintain a bearish outlook on the global economy and maintain less than 50% exposure to US and International equities. Our view is that probability of a US recession in the next 6 to 12 months is as high as 70% to 80%.

We expect stocks to rally for another attempt at the 3020/3030 high for the S&P 500 and will use opportunity to further reduce our exposure to equities.

Trump: This is going to hurt me more than it hurts you

The chart below depicts container traffic at the Port of Los Angeles, the largest volume US container port. Loaded inbound containers (blue), measured in twenty foot units or TEUs, have far exceeded loaded outbound units (red) for a number of years. What is noteworthy is that the ratio of loaded outbound to inbound containers has deteriorated from 48% to 38% over the last 6 years.

Port of Los Angeles Container Traffic

Imposition of tariffs has not reversed this. In fact the opposite. Stats for July 2019 show an 8.7% increase in inbound traffic and a 4.0% decrease in outbound traffic, while the ratio of inbound to outbound containers fell to a new low of 34%.

Gold pauses after recent surge

China’s Yuan has paused after breaking above 7.0 to the US Dollar. Expect further consolidation, but respect of support at 7.0 would signal a further advance (and Yuan weakness), fueling demand for Gold.

USDCNY

Spot Gold is consolidating above $1500/ounce. Respect of support at $1500 would likewise suggest further gains. The Trend Index trough above zero indicates strong buying pressure.

Spot Gold in USD

The trouble with an accelerating up-trend (or blowoff as they are often called) is that they seldom give you adequate warning of a reversal. The All Ordinaries Gold Index retreated this week and is testing its rising trendline at 8000. Breach of 8000 seems unlikely but would warn of a correction.

All Ordinaries Gold Index

We maintain our bullish outlook for Gold, with a target of the 2012 high at $1800/ounce.

ASX 200 breaks support

Iron ore continues to test support at $94/tonne. Breach of support would signal a decline to test $80/tonne.

Iron Ore

The ASX 200 broke support at 6450/6500 after a hesitant rally, warning of a decline to test support at 6000. Descending peaks on Twiggs Money Flow signal rising selling pressure.

ASX 200

The ASX 300 Banks index retreated from resistance at 8200 and is testing the rising trendline. Penetration is likely and would warn of another test of primary support at 6750.

ASX 300 Banks

We maintain a bearish outlook for Australian stocks and reduced our exposure to 30% on 5 August 2019.

Recession ahead

There are clear signs of trouble on the horizon.

10-Year Treasury yields plunged to near record lows this month as investors fled stocks for the safety of bonds.

10-Year Treasury Yield

The Federal deficit is widening — unusual for this late in the cycle as Liz Ann Sonders points out. We are being prepared for the impact of a trade war: pressure the Fed to cut rates and raise the deficit to goose stocks.

Federal Deficit

Gold surges as Chinese flee the falling Yuan.

Spot Gold

Commodity prices fall in anticipation of a global recession.

DJ-UBS Commodity Index

Are we there yet? Not quite. The Philadelphia Fed Leading Index is still above 1% (June 2019). A fall below 1% normally precedes a US recession.

Leading Index

Volatility (Twiggs 21-day) for the S&P 500 is rising, as it usually does ahead of a market down-turn, but has not yet formed a trough above 1% — normally a red flag ahead of a market top.

S&P 500 Volatility

And annual payroll growth is still at 1.5%. This is the canary in the coal mine. A fall below 1% (from its 2015 peak) would warn that the US is close to recession.

Payroll Growth and FFR

What to watch out for:

  • Falling commodity prices below primary support (DJ-UBS at 75) will warn that the trade war is starting to bite;
  • Falling employment growth, below 1%, would signal that the US economy is affected; and
  • September is a particularly volatile time of the year, when fund managers clean up their balance sheets for the quarter-end, with a history of heavy market falls in October as cash holdings rise.

I tell my clients to sell into the rallies. Don’t wait for the market to fall. Rather get out too early than too late.

Of course I cannot guarantee that there will be a recession this year, but there are plenty of warning signs that we are in for a big one soon.

S&P 500: Flight to safety

10-Year Treasury yields are near record lows after Donald Trump’s announcement of further tariffs on China. The fall reflects the flight to safety, with rising demand for Treasuries as a safe haven.

10-Year Treasury Yield

Crude found support at $50/barrel. Breach would warn of a new down-trend, with a target of $40/barrel. Declining crude prices reflect a pessimistic outlook for the global economy.

10-Year 3-Month Treasury Spread

The S&P 500 found support at 2850. Rising volatility warns of increased market risk. A test of support at 2750 remains likely.

S&P 500

Declining Money Flow on the Nasdaq 100 reflects rising selling pressure. Expect a test of 7000.

Nasdaq 100

The Shanghai Composite Index broke support at 2850. A Trend Index peak at zero warns of strong selling pressure. Expect a test of support at 2500.

Shanghai Composite Index

India’s Nifty is testing support at 11,000. Breach would offer a target of 10,000.

Nifty Index

Dow Jones Euro Stoxx 600, reflecting large cap stocks in the European Union, is testing primary support at 368. Strong bearish divergence on the Trend Index warns of a double-top reversal, with a target of 330.

DJ Euro Stoxx 600

The Footsie is similarly testing support at 7150. Breach would offer a target of 6600.

FTSE 100

I have warned clients to cut exposure to the market. It’s a good time to be cautious.

“There is a time for all things, but I didn’t know it. And that is precisely what beats so many men in Wall Street who are very far from being in the main sucker class. There is the plain fool, who does the wrong thing at all times everywhere, but there is the Wall Street fool, who thinks he must trade all the time.”

~ Jesse Livermore

Gold spikes as Yuan falls

China has broken its unwritten guarantee that the PBOC will maintain the Yuan below 7 to the US Dollar. Official fixings for USDCNY crept above 7.0 this week, indicating the PBOC is no longer prepared to support its currency.

USDCNY

This is a two-edged sword. While it makes exports cheaper, counteracting the effect of US tariffs, it makes imports more expensive, spiking inflation. It is also likely to spark capital flight, as evidenced by the sharp spike in Gold.

Spot Gold broke resistance at $1450, surging to $1500/ounce. A narrow consolidation at $1500 is likely, signaling further gains. The Trend Index trough above zero indicates strong buying pressure.

Spot Gold in USD

The next major resistance level is the 2012 high of $1800/ounce.