Category: US & Canada

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Gold bear trap & the AI illusion

Key Points

  • Gold recovered above $4,100 per ounce, signaling another test of $4,400.
  • Silver similarly recovered above $50 per ounce.
  • Bitcoin at 106K indicates improving liquidity.
  • The S&P 500 also completed a bear trap, indicating another rally.
  • A recent Stanford study suggests that the adoption of generative AI has had a minimal impact on employment levels.

Gold recovered above $4,100 per ounce, completing a bear trap with a target of $4,400.

Spot Gold

Silver similarly recovered above $50 per ounce, offering a target of $54.

Spot Silver

Bitcoin, our real-time indicator of financial market liquidity, rallied to 106K. Respect of long-term support at 100K offers a target of 116K, indicating the liquidity squeeze is fading.

Bitcoin (BTC)

The S&P 500 completed a similar bear trap at 6750, suggesting a rally to test 7000. Follow-through above 6900 would confirm.

S&P 500

41 AI-related stocks dominate the market capitalization of the S&P 500. Investors have gone all-in on AI and its ability to generate future earnings.

S&P 500 AI-Related Stocks

Jonathan Levin argues in Bloomberg that, excluding the AI-related Tesla and Amazon, consumer-facing sectors of the S&P 500 are in recession.

S&P 500 Consumer Staples & Discretionary

A recent Stanford study on ChatGPT adoption indicates significant increases in productivity in fields with high adoption rates. However, it notes that the improved productivity has, so far, led to increased wage rates rather than reduced employment levels.

Treasury Markets

10-year Treasury yields are consolidating around 4.10%, with resumed BLS inflation readings likely to provide further direction.

10-Year Treasury Yield

Trump-appointee Fed Governor Stephen Miran on Monday repeated his call for a half-percentage-point cut at the FOMC December 9-10 meeting. (Reuters)

Consumer perceptions of long-term inflation remain elevated, with the University of Michigan survey indicating that perceptions of 5-year inflation have averaged 3.7% over the past three months.

University of Michigan: 5-Year Inflation Expectations

Dollar & Gold

The dollar has weakened following high private sector layoffs in October, with financial market pricing indicating a 63% chance of a 25-basis-point rate cut in December. (Reuters)

Dollar Index

JP Morgan estimates that the labor market added 52K jobs in September but lost 35K in October, increasing the likelihood of another rate cut in December.

JP Morgan Estimated Labor Market Growth

Conclusion

We expect further rate cuts to weaken the dollar and boost prices of gold and silver.

S&P 500 performance depends on projected AI productivity gains, driving a massive increase in earnings for AI-related corporations. However, there is currently limited evidence to support this conclusion.

Acknowledgments

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Record Lows and Highs spell trouble in the USA

Bull/Bear Market Indicator
Stock Market Pricing Indicator

The gauge on the left indicates whether the market is in a bull or bear phase, and the one on the right reflects the current stock market valuation levels. Stock market pricing indicates whether stocks are cheap or expensive relative to earnings, but it is a poor indicator of market timing. We do not recommend selling stocks because the market valuation is high. Still, we advise investors to exercise caution when adding new positions.

Bull/Bear Market

The Bull/Bear indicator remains at 40%, warning of a bear market ahead. Updates to three market indicators (highlighted in orange below) are delayed because of the US government shutdown.

Bull-Bear Market Indicator

Another indicator, the University of Michigan index of current economic conditions, plunged to 52.3, the lowest reading since the series began in 1960. The low reading would typically signal a recession, but has not yet been confirmed by either tighter financial conditions or a fall in the S&P 500.

University of Michigan Current Economic Conditions

The Chicago Fed National Financial Conditions Index turned up to -0.515 but continues to signal loose monetary conditions, which support high stock prices.

Chicago Fed National Financial Conditions Index

The S&P 500 has not experienced a significant correction since April, and the 30-week Smoothed Momentum indicator continues to oscillate above zero.

S&P 500 30-Week Twiggs Momentum Smoothed

Stock Pricing

Stock pricing eased slightly, to 98.32 percent from a new high of 98.66 percent last week, and an April low of 95.04 percent. The extreme reading warns that stocks are at risk of a significant drawdown.

Stock Market Value Indicator

We use z-scores to measure each indicator’s current position relative to its history, with the result expressed in standard deviations from the mean. We then calculate an average of the five readings and convert that to a percentile. The higher that stock market pricing is relative to its historical mean, the greater the risk of a sharp drawdown.

The S&P 500 reached a new high of 3.28 times sales, compared to a long-term average of 1.80 times.

S&P 500 Price-to-Sales

Conclusion

A record-low current economic conditions index and a record-high price-to-sales ratio for the S&P 500 both warn of instability ahead. Stock prices are supported by loose monetary conditions, but cannot hide the underlying economic fragility.

The bull-bear indicator at 40% warns of a bear market ahead, while extreme pricing increases the long-term risk of a significant drawdown.

Acknowledgments

Notes

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AI might just be a scapegoat for recent layoffs

It’s not easy to use AI to replace jobs.

Many layoffs cite AI as the cause, but the real cause may be that business is declining. It’s known as “AI-washing.”

The artificial intelligence landscape is teeming with players, and they’re not all legitimate. Some are practicing something called “AI washing,” which Securities and Exchange Commission chair Gary Gensler explained in a video includes “false claims to investors by those purporting to use those new technologies.” (CNBC, May 2024)

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US Stock Pricing at New High

Bull/Bear Market Indicator
Stock Market Pricing Indicator

The gauge on the left indicates bull or bear market status, and the one on the right reflects stock market valuation levels. Stock market pricing indicates whether stocks are cheap or expensive relative to earnings, but it is a poor indicator of market timing. We do not recommend selling stocks because the market valuation is high. Still, we would advise investors to be circumspect about adding new positions without carefully investigating the underlying value.

Bull/Bear Market

The Bull/Bear indicator remains at 40%, warning of a bear market ahead. Updates to three market indicators (highlighted in orange below) are delayed because of the US government shutdown.

Bull-Bear Market Indicator

The Philadelphia Fed Coincident Economic Activity Index deserves mention in the absence of updates for some of our regular indicators. A decline below 2.5% typically only occurs several months ahead of a recession.

Coincident Economic Activity Index
The Chicago Fed National Financial Conditions Index continues to signal loose monetary conditions, supporting high stock prices.

Chicago Fed National Financial Conditions Index

However, a decline in bank reserves below $3.0 trillion warns that repo markets are tightening.

Commercial Bank Reserves

And Bitcoin continues to test support at 110K, warning of tighter liquidity.

Bitcoin (BTC)

Stock Pricing

Stock pricing increased to a new high of 98.66 percent, compared to an April low of 95.04 percent. The extreme reading warns that stocks are at risk of a significant drawdown.

Stock Market Value Indicator

We use z-scores to measure each indicator’s current position relative to its history, with the result expressed in standard deviations from the mean. We then calculate an average for the five readings and convert that to a percentile. The higher that stock market pricing is relative to its historical mean, the greater the risk of a sharp drawdown.

Robert Shiller’s CAPE index climbed above 40 for the first time ever outside of the Dotcom bubble. CAPE compares the S&P 500 index to a ten-year average of inflation-adjusted earnings.

S&P 500 CAPE

Conclusion

The bull-bear indicator at 40% warns of a bear market ahead, while extreme pricing increases the long-term risk of a significant drawdown.

Acknowledgments

Notes

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Trump-Xi more of the same

United States President Donald Trump and his Chinese counterpart Xi Jinping have agreed to a trade truce under which the US will ease tariffs and Beijing will restart imports of US soya beans, delay the introduction of export restrictions on some of its rare earth metals, and intensify efforts to curb illegal fentanyl trafficking. (Al Jazeera)

Trump threatened a 100% import tax in retaliation for China’s rare earth restrictions, but he told reporters after the meeting that total tariffs on China would be reduced to 47%.

There is mutual recognition that neither country wants to risk damaging the world economy, as this would harm itself.

When the two were seated at the start of the meeting, Xi read prepared remarks that stressed a willingness to work together despite differences. (APNews)

The meeting was shorter than expected, which indicates that neither side deviated from an agreed-upon script. Trump described the meeting, which lasted an hour and forty minutes, as “amazing” and “12 out of 10,” but analysts remain skeptical.

“The proposed deal on the table fits the pattern we’ve seen all year: short-term stabilization dressed up as strategic progress,” said Craig Singleton, senior director of the China program at the Foundation for Defense of Democracies. “Both sides are managing volatility, calibrating just enough cooperation to avert crisis while the deeper rivalry endures.” (APNews)

The US will likely also reduce restrictions on exports of advanced computer chips to China. According to the president, the issue was discussed, and Nvidia will hold talks with Chinese officials.

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Inflation quiet before the storm

Key Points

  • Core CPI declined to 3.0% for the twelve months to September.
  • However, consumers expect a strong upturn in inflation in the next twelve months.

According to the delayed BLS report for September, core CPI decreased to 3.0% for the twelve months, matching the headline CPI figure.

CPI & Core CPI - Annual

Both headline and core CPI are affected by a sharp monthly fall in Owners Equivalent Rent (OER), which declined to 0.12% in September, compared to 0.38% in August. OER is a major component of CPI, accounting for 26% of headline and 33% of core CPI. (Wolf Richter)

However, sticky CPI less Shelter, which excludes OER, also slowed to 3.0% for the twelve months.

Core CPI, and Sticky CPI

The ALICE Essentials Index also indicates that annual inflation slowed to 3.1%. ALICE (orange below) is produced by United Way as an alternative to CPI (blue) to highlight the impact of inflation on low-income earners.

ALICE Essentials Index

Another alternative inflation measure is Truflation, which tracks up to 15 million online prices to calculate a daily-updated index. Prices are weighted more towards goods than services, which accounts for the lower readings compared to CPI.

Truflation jumped to 2.48% on October 26, the highest since January. The index has increased by 1.9% since April 2, reflecting the impact of tariffs on goods prices.

Truflation

Consumers are unconvinced that inflation is moderating, with last week’s University of Michigan survey indicating an average expected increase of 4.6% in the next twelve months.

University of Michigan: 1-Year Inflation Expectations

They aren’t buying the Fed’s “transitory” pitch either. Expected price increases over the next five years increased to 3.9% in October, almost double the Fed’s 2.0 percent target.

University of Michigan: 5-Year Inflation Expectations

Conclusion

Consumer inflation is currently close to 3.0%. The University of Michigan survey indicates that consumers expect prices to rise by 4.5% over the next twelve months and that inflation will be persistent rather than “transitory.”

Acknowledgments

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US stock pricing at new high

Bull/Bear Market Indicator
Stock Market Pricing Indicator

The gauge on the left indicates bull or bear market status, and the one on the right reflects stock market valuation levels. Stock market pricing indicates whether stocks are cheap or expensive relative to earnings, but it is a poor indicator of market timing. We do not recommend selling stocks because the market valuation is high. Still, we would advise investors to be circumspect about adding new positions without carefully investigating the underlying value.

Bull/Bear Market

The Bull/Bear indicator remains at 40%, warning of a bear market ahead. Updates to three market indicators (highlighted in orange) are delayed because of the US government shutdown.

Bull-Bear Market Indicator

The University of Michigan consumer survey indicates that perceptions of current economic conditions dropped to 58.6, the lowest level in more than three years. Readings below 100 signal risk-off, but the Chicago Fed National Financial Conditions Index or 30-week Smoothed Momentum for the S&P 500 still needs to confirm this.

University of Michigan: Current Economic Conditions

Stock Pricing

Stock pricing increased to a new high of 98.59 percent, compared to an April low of 95.04 percent. The extreme reading warns that stocks are at long-term risk of a significant drawdown.

Stock Market Value Indicator

We use z-scores to measure each indicator’s current position relative to its history, with the result expressed in standard deviations from the mean. We then calculate an average for the five readings and convert that to a percentile. The higher that stock market pricing is relative to its historical mean, the greater the risk of a sharp drawdown.

The Price-Earnings ratio of highest trailing earnings eased slightly to 29.3, but remains extreme compared to the fifty-year average of 16.3.

S&P 500 PE of Highest Trailing Earnings

Conclusion

The bull-bear indicator at 40% warns of a bear market ahead, while extreme pricing increases the long-term risk of a significant drawdown.

Acknowledgments

Notes

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Better Buckle Up

Key Points

  • Bitcoin broke through the band of support at 110K, warning of a correction.
  • The secured overnight financing rate (SOFR) spiked above the interest rate paid on reserve balances at the Fed, warning of a sharp contraction in liquidity in financial markets.

Better buckle up. Bitcoin serves as the canary in the coal mine for financial markets.

A breach of the band of support between 108K and 110K warns of a correction that is likely to spread to major stock indices such as the Nasdaq and S&P 500.

Bitcoin (BTC)

The S&P 1500 Regional Banks Index fell sharply this week as markets were spooked by three large defaults, which appear to involve fraudulent disclosure. A peak below the 50-day weighted moving average and a Trend Index peak below zero both warn of selling pressure.

S&P 1500 Regional Banks Index

This week everyone is beared up on regional banks (again). Zions lost $50mn on a loan. A loan equal to 0.08% of their loan book. Yes, less than 0.1%. There have been a series of fraudulent loans uncovered and investors are worried these are signs of a bigger problem. The cockroach metaphor.

Yes, it’s scary for 3 fraudulent loans to come up all at once (Tricolor, First Brands and the Zions loan), but rather than it being a systemic problem is it possible that after the Tricolor loan went bad, every bank immediately began scrubbing every loan for irregularities and that is why these disclosures are coming up so quickly? On a practical basis it’s hard to have a systemically high level of loans be fraudulent. Possible, but hard. Bank loan underwriting has been around for a long time, and it’s pretty stringent, which is why private credit is doing so well. If you have an irregular profile and want a risky loan, go to a private credit fund, not a super regulated regional bank. (YWR)

Financial Markets

The secured overnight financing rate (SOFR) spiked to 15 basis points above the rate paid to commercial banks on their reserve balances at the Fed (IORB), indicating that large banks are reluctant to lend in the repo market despite the collateralized security.

Secured Overnight Financing Rate (SOFR) & Interest on Reserve Balance (IORB)

SOFR is the rate charged by banks on overnight borrowing secured by Treasury securities as collateral (repo).

Banks usually are comfortable lending in the repo market, and the SOFR typically trades at a discount to IORB because of the preference for high-quality UST collateral. The SOFR spike above the IORB warns that the financial markets are under stress, with a sharp contraction in liquidity as lending dries up.

The Fed will likely intervene, injecting liquidity to calm the markets, and a rate cut at the next FOMC meeting on October 28-29 is now almost inevitable.

Gold

Gold hesitated at $4,300 per ounce and will likely retrace to test support. A correction that respects support at $4,000 would signal a fresh advance with a target of $4,600.

Spot Gold

Conclusion

Be prepared for a volatile week ahead.

The Bitcoin breach of support at 110K and a spike in the secured overnight financing rate (SOFR) warn of a sharp contraction in liquidity. We expect a sharp fall in stocks unless the Fed intervenes to inject liquidity before markets open on Monday.

Acknowledgments

Posted on

US Stock Pricing at Extreme

Bull/Bear Market Indicator
Stock Market Pricing Indicator

The gauge on the left indicates bull or bear market status, and the one on the right reflects stock market valuation levels. Stock market pricing indicates whether stocks are cheap or expensive relative to earnings, but it is a poor indicator of market timing. We do not recommend selling stocks because the market valuation is high. Still, we would advise investors to be circumspect about adding new positions without carefully investigating the underlying value.

Bull/Bear Market

The Bull/Bear indicator remains at 40%, warning of a bear market ahead.

Bull-Bear Market Indicator

Updates to three market indicators (highlighted in orange) are delayed because of the US government shutdown.

The Chicago Fed National Index of Financial Conditions dropped to -0.559 on October 10, indicating a return to pandemic-era loose monetary conditions. NFCI values above zero indicate monetary tightening, while values below signal loose financial conditions.

Chicago Fed National Financial Conditions Index

Stock Pricing

Stock pricing increased to 98.45 percent, compared to a high of 98.56 percent two weeks ago, and an April low of 95.04 percent. The extreme reading warns that stocks are at long-term risk of a significant drawdown.

Stock Market Value Indicator

We use z-scores to measure each indicator’s current position relative to its history, with the result expressed in standard deviations from the mean. We then calculate an average for the five readings and convert that to a percentile. The higher that stock market pricing is relative to its historical mean, the greater the risk of a sharp drawdown.

Robert Shiller’s CAPE measure reached 39.20 this week, the highest ever recorded outside of the Dotcom bubble in 1999-2000.

S&P 500 CAPE

CAPE compares the S&P 500 index to a 10-year average of inflation-adjusted earnings.

Conclusion

The bull-bear indicator at 40% warns of a bear market ahead, while extreme pricing increases the long-term risk of a significant drawdown.

Acknowledgments

Notes

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