US & Canada Archives - Page 22 of 169

September 14, 2019September 14, 2019

S&P 500: Upside limited, while downside risks grow

Corporate profits (before tax) ticked up slightly in the second quarter of 2019 but remain below 2006 levels in real terms. The chart below shows corporate profits adjusted for inflation using the GDP implicit price deflator.

Real GDP and Hours Worked

Growth in production of durable consumer goods remains week, reflecting poor consumer confidence.

Durable Goods Production

The chart below shows growth in bank credit and the broad money supply (MZM plus time deposits). Credit growth (blue) remains steady at around 5%, slightly ahead of nominal GDP growth (4.04% for 12 months ending June); a healthy sign. Broad money (green) surged upwards in the first three quarters of this year. Not an encouraging sign when there were similar surges in broad money before the last two recessions.

Broad Money & Credit Growth

The S&P 500 is testing resistance at 3000. Bearish divergence on Twiggs Money Flow warns of secondary selling pressure. Expect a test of support at 2800. Breach would flag a reversal, with a target of 2400.

S&P 500

The cyclical Retailing Index displays a similar pattern, with resistance between 2450 and 2500.

Retail

Our view is that upside is limited, while downside risks are growing.

On the global front, the outlook is still dominated by the prospect of a prolonged US-China trade war. More great insights from Trivium China:

Tariff delays may be aimed at creating warm, fuzzy feelings before the next round of talks in early October, but……These small gestures do nothing to resolve the underlying trade conflict. We’re still pessimistic on prospects for a deal.

Zhou Xiaoming – China’s former top diplomat in Geneva – expressed the same view in a recent interview (Guancha):
“The two sides disagree too much on the objectives of the negotiations……It is almost impossible to reach an agreement in the short term.”

Zhou urged Chinese officials to be clear on the US’s objective:
“Economic and technological decoupling is the objective of the entire US government.”

Zhou said that officials must prepare for that potentiality, even if it is not their desired outcome.

So should we.

Dow Jones – UBS Commodity Index found support at 76 before rallying to 79. Rising troughs on the Trend Index reflect increased support. Consolidation between 76 and 81 is likely but we maintain our bearish long-term outlook for commodities.

DJ-UBS Commodities Index

On the global front, weak crude oil prices flag an anticipated slow-down in the global economy. Trend Index peaks below zero indicate selling pressure. Breach of support at $50/$51 per barrel would be a strong bear signal, warning of a decline to $40 per barrel.

Nymex Light Crude

We maintain our investment in quality growth stocks but have reduced equity exposure to 40% of (International Growth) portfolio value.

September 10, 2019September 10, 2019

Time to be defensive

Bob Doll at Nuveen says he does not expect a recession (for the next few quarters) but remains neutral towards stocks:

“Although stock prices have advanced over the last couple of weeks, investors remain focused on downside economic and policy risks and are increasingly concerned about a possible recession. The latest manufacturing readings hurt economic sentiment, while trade issues, turmoil in Hong Kong, the increasing likelihood of a messy, no-deal Brexit and a downturn in European growth are increasing worries.”

The Institute for Supply Management August Report points to an economic slow-down, with the Purchasing Managers’ Index (PMI) falling to 49.1 percent, from 51.2 percent in July. The New Orders Index also declined, to 47.2 percent from 50.8 percent in July. Readings below 50 indicate contraction.

“…The 2020 U.S. elections linger in the backdrop, offering potential to produce either a dramatic shift in economic policy should the Democrats retake the White House, or continued policy uncertainty should President Trump win reelection.

Against this backdrop, investors are struggling to position their portfolios. Consensus appears to say that it is time to turn more defensive, but U.S. Treasuries and other government bond yields appear to offer little if any value. Indeed, government bond markets are pricing in a high likelihood of a recession and a prolonged period of sluggish growth. At the same time, equity markets have been range bound over the last several months (and, by some measures, since the start of 2018) and are providing unclear signals.

In our view, the preponderance of the evidence suggests that growth will remain sluggish but a recession will be avoided, at least for the next few quarters. In other words, we think the signals coming from the equity markets are more accurate than those coming from government bond markets. Nevertheless, we continue to have a broadly neutral view toward stocks, and think investors should remain selective, focusing on such themes as companies that offer compelling value and those that have the ability to put relatively high levels of free cash flow to work.”

The wild card is the impact that high levels of uncertainty may have on business investment and employment.

This is a time to be defensive.

Bonds, traditional dividend-paying blue chips, and growth stocks all appear over-priced at current levels. Small caps are high risk in the current volatile environment and we are focused on large cap stocks with strong cash flows and defensible market position in non-cyclical industries. Some cyclical sectors may present value but investors need to be selective because of vulnerability to a potential down-turn.

September 7, 2019

S&P 500 buying pressure but payrolls disappoint

August labor stats, released today, point to low real GDP growth for Q3. Growth in weekly hours worked came in at a low 1.09% and GDP is likely to follow.

Real GDP and Hours Worked

While inflation is not the primary concern at the Fed right now, rising annual hourly wage rate growth (3.46% for total private) flags an increase in underlying inflationary pressure. This may make the Fed more hesitant about cutting rates despite Donald Trump’s tweet storm.

Average Hourly Wage Rate

Most important is the continued decline in annual payroll growth. At 1.38% for August, further weakness is likely and a fall below 1.0% would warn of an economic slow-down.

Real GDP and Hours Worked

The S&P 500 is headed for another test of resistance at 3000. The Trend Index oscillating above zero for the last 9 months indicates buying pressure but I expect strong resistance at 3000. Upside is limited while downside risks are expanding.

S&P 500

Semiconductors are doing better than expected, despite the trade war, but I suspect will weaken when the surge in orders ahead of tariffs tails off.

Semiconductors

Retail has stalled since late 2018 and bearish divergence on the Trend Index suggests selling pressure.

Retail

Automobiles, in a decline since 2017, have rallied over the last 6 months. But, again, further weakness is expected.

Automobiles

On the global front, weak crude oil prices flag an anticipated slow-down in the global economy. Breach of support at $50/$51 per barrel would be a strong bear signal, warning of a decline to $40 per barrel.

Nymex Light Crude

We maintain our bearish outlook and have reduced equity exposure for international stocks to 40% of portfolio value.

September 6, 2019

Interest spreads hold sway over the global economy

An inverted yield curve is a reliable predictor of recessions but it also warns of falling bank profits. When the spread between long-term Treasury yields and short-term rates is below zero, net interest margins are squeezed.

Yield Differential (10y - 3m)

In a normal market, with a steep yield curve, net interest margins are wide as bank’s funding maturity is a lot shorter than their loan book. In other words, they borrow short and lend long. Few bank deposits have maturities longer than 3 to 6 months, while loans and leases have much longer maturities and command higher interest rates.

When the yield curve inverts, however, the spread between long and short-term rates disappears and interest margins are squeezed. Not only is that bad for banks, it’s bad for the entire economy.

When their interest margins are squeezed, banks become risk averse and lending growth slows. That is understandable. When interest margins are barely covering operating expenses, banks cannot afford credit write-downs and become highly selective in their lending.

Slowing credit growth has a domino-effect on business investment and consumer spending on durables (mainly housing and automobiles). If there is a sharp fall in credit growth, a recession is normally not far behind¹.

Bank Loans & Leases

Right now, the Fed is under pressure to cut interest rates to support the US economy. While this would lower short-term rates and and may flatten the yield curve, cutting interest rates off a low base opens a whole new world of pain.

Quartz this week published a revealing commentary on the damage that negative interest rates in developed economies are doing to bank net interest margins :

The problem for commercial banks is that government bond and mortgage interest rates keep going lower, but it isn’t as easy to cut deposit rates — the rate at which banks themselves borrow from customers — at the same pace. After all, it’s tough to convince people to keep deposits in an account that returns less than they put in (even though this already happens, invisibly, through inflation).

Bank Net Interest Margins in Developed Countries

Ultra-low interest rates are likely to squeeze bank margins in a similar way to the inverted yield curve. And with a similar impact on credit growth and the economy.

If I was Trump I would be pleading with the Fed not to cut interest rates.

Footnote:
1. The NBER declared a recession in 1966 when the S&P 500 fell 22% but later changed their mind and airbrushed it out of history.

August 31, 2019September 7, 2019

S&P 500: Donald Trump and the next recession

Treasury yields continue to fall, with the 10-Year testing long-term lows at 1.50%. A sign that investors are growing increasingly risk averse.

10-Year Treasury Yields

Crude oil prices remain weak; a bearish signal for the global economy. Breach of support at $50/$51 per barrel would warn of a decline to $40.

Nymex Light Crude

Volatility (21-Day) above 1.0% on the S&P 500 is flashing an amber warning. Breakout above 2940 is likely and would signal another test of 3000. But expect stubborn resistance at our 3000 target level.

S&P 500 Volatility

Bearish divergence (13-Trend Index) on the Nasdaq 100 warns of secondary selling pressure. Breach of 7400 would warn of a test of primary support at 7000.

Nasdaq 100

Robert Shiller maintains that Donald Trump is unlikely to survive a recession:

“So far, with his flashy lifestyle, the US president has been a resounding inspiration to many consumers and investors. But his personal narrative is unlikely to survive an economic downturn….the end of confidence in Trump’s narrative is likely to be associated with a recession.

During a recession, people pull back and reassess their views. Consumers spend less, avoiding purchases that can be postponed: a new car, home renovations, and expensive vacations. Businesses spend less on new factories and equipment, and put off hiring. They don’t have to explain their ultimate reasons for doing this. Their gut feelings and emotions can be enough.”

I would go further and argue that Trump’s management style is likely to cause a recession.

Some of the aims the President is attempting, like addressing China’s unfair trade practices, are vitally important to long-term US interests and he should be given credit for tackling them. But his constant hyperbole, erratic behavior, with a constant mix of bouquets and brickbats, and on-again-off-again tactics, has elevated global uncertainty. Consumers are likely to increase savings and cut back on expenditure, while corporations may cut back on hiring and new investment, which could tip the economy into recession.

GDP growth contracted to 2.3% in the second quarter, while growth in hours worked contracted to 0.92% for the year ended July 2019, pointing to further falls in GDP growth for the third quarter.

Real GDP and Hours Worked

August employment figures are due for release next week and will either confirm or allay our fears.

We maintain our bearish outlook and have reduced equity exposure for international stocks to 40% of portfolio value.

August 28, 2019August 28, 2019

S&P 500 target

My target for the current S&P 500 long-term advance has been 3000 for a number of years. The chart below explains the target calculation.

Click here to view a full screen image.

The Dotcom bubble retraced from a peak of 1500 to a low of 800. Readers who are familiar with my method will know that on a short- or medium-term chart I would simply extend the retracement above the previous peak of 1500 (giving a target of 2300) but long-term charts work better on a log scale.

If we extend the distance between peak and trough above the peak on a log scale chart, we get a target of 2800.

If we do the same for the global financial crisis (GFC), we get a target of 3200.

Mid-way between the two is another important target, of 3000, which is double the previous two peaks at 1500.

Of the three targets, I feel that 3000 is the strongest. Not only because it is the middle target and double the previous peaks, but round numbers are important psychological barriers. The Dow, for example, took more than 10 years to break resistance at 1000.

Now some may feel that technical analysis like this has as much significance as reading tea leaves or consulting your astrological charts. But observation shows that market activity tends to cluster around significant levels (e.g. 1500) or numbers and can present formidable barriers to trend progress.

Primary Support

The next question is: if the market reverses at 3000, how far is it likely to retrace? There is no straight answer, but primary reversals normally retrace between 50% and 100% of the previous gain, or between 25% and 50% of the current level.

There are two major support levels evident on the chart:

The 2100 peak from 2015, a 50% retracement (on a log scale) of the preceding advance; and
The 1500 peak from 2000 and from 2007, marking 100% retracement of the previous advance and also a 50% retracement from the current level.

A lot would depend on the severity of the reaction.

“You watch the market — that is, the course of prices as recorded by the tape with one object: to determine the direction. Prices, we know, will move either up or down according to the resistance they encounter. For purposes of easy explanation we will say that prices, like everything else, move along the line of least resistance. They will do whatever comes easiest, therefore they will go up if there is less resistance to an advance than to a decline; and vice versa.”

~ Jesse Livermore

August 24, 2019August 24, 2019

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.

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

The inevitable Twitter tantrum ensued.

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.

August 17, 2019

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.

August 17, 2019

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%.

August 13, 2019August 13, 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.