Why you shouldn’t panic when stocks are getting slammed from CNBC.
Tearing Teslas apart to reveal some of their best and worst decisions
Tesla has a few problems to sort out before it makes our shortlist.
Tearing Apart Teslas to reveal some of Elon Musk's best and worst decisions. https://t.co/egKkIFZLbe via @business
— Colin Twiggs (@Colin_Twiggs) October 19, 2018
Nasdaq warns of broad market correction
Tech stocks fell sharply, with the Nasdaq 100 closing below support at 7400, warning of a correction. Twiggs Money Flow (21-day) cross below zero indicates medium-term selling pressure. Follow-through of the index below 7300 would signal a correction to test 7000.
The S&P 500 has so far respected support at 2870. Breach would confirm a broad market correction and test the rising LT trendline at 2800.
Asia
In China, the Shanghai Composite Index is headed for another test of primary support at 2650. Trend Index peaks at/below zero indicate long-term selling pressure. Breach of 2650 would offer a long-term target of 2000, the 2014 low.
India’s Nifty is undergoing a strong correction. Breach of support at 10,000 would warn of a primary down-trend.
Europe
Dow Jones Euro Stoxx 50 is again testing primary support at 3300. A Trend Index peak at zero warns of mounting selling pressure. Breach of 3300 would warn of a primary decline, with a target of 3000.
The Footsie is also testing primary support, at 7250, but a recovering Trend Index indicates buying pressure.
Rising US interest rates are already hurting developing economies like India and China, and a looming US-China trade war would threaten a global contraction.
Only when the tide goes out do you discover who’s been swimming naked.
~ Warren Buffett
Extraordinary times of low unemployment and low inflation
Unemployment fell to 3.7% for September, well below the long-term natural rate of unemployment. This normally signifies a tightening labor market, a precursor to higher inflation.
But growth in average hourly earnings dipped slightly, to 2.75% for the past 12 months. Underlying inflationary forces remain subdued.
As Fed Chairman Powell suggested, the Fed may be overestimating the natural rate. In his speech on Tuesday Powell summed up the current situation:
…Many of us have been looking back recently on the decade that has passed since the depths of the financial crisis. In light of that experience, I am glad to be able to stand here and say that the economy is strong, unemployment is near 50-year lows, and inflation is roughly at our 2 percent objective. The baseline outlook of forecasters inside and outside the Fed is for more of the same.
This historically rare pairing of steady, low inflation and very low unemployment is testament to the fact that we remain in extraordinary times. Our ongoing policy of gradual interest rate normalization reflects our efforts to balance the inevitable risks that come with extraordinary times, so as to extend the current expansion, while maintaining maximum employment and low and stable inflation.
It’s a bull market
The US economy continues to show signs of a robust expansion. Net capital formation is rising (as a percentage of GDP) as it is wont to do during a boom. In layman’s terms net capital formation is the net growth in physical assets used in the production of goods and services, after allowing for depreciation.
The Wicksell spread has turned positive. When return on investment (we use nominal GDP growth as a surrogate) exceeds the cost of capital (reflected by low investment grade Baa bond yields) that encourages new investment and economic expansion as in the 1960 – 1980 period on the chart below.
Real bond yields, reflected below by Baa yields minus core CPI (blue line) on the chart below, are also near record lows. Low real returns on bonds support high stock earnings multiples.
Fed Chairman Powell summed up the situation in a speech on Tuesday this week:
…Many of us have been looking back recently on the decade that has passed since the depths of the financial crisis. In light of that experience, I am glad to be able to stand here and say that the economy is strong, unemployment is near 50-year lows, and inflation is roughly at our 2 percent objective. The baseline outlook of forecasters inside and outside the Fed is for more of the same.
This historically rare pairing of steady, low inflation and very low unemployment is testament to the fact that we remain in extraordinary times. Our ongoing policy of gradual interest rate normalization reflects our efforts to balance the inevitable risks that come with extraordinary times, so as to extend the current expansion, while maintaining maximum employment and low and stable inflation.
The biggest risk is that investors get carried away and drive earnings multiples sky high, but gradual rate increases from the Fed and the threat of tariff wars appear to be keeping animal spirits in check.
S&P 500 cracks trendline
The S&P 500 penetrated its secondary trendline, indicating a correction to test support at the LT trendline at 2800. Shorter-term 21-day Twiggs Money Flow crossed below zero to warn of a secondary correction. Follow-through below the January high at 2870 would confirm.
Nasdaq 100 breach of 7400 would also confirm, signaling a correction to test support at 7000.
Treasury yields confirm bond bear market
10-Year Treasury yields respected their new support level at 3.00%, confirming a primary advance.
Breakout above 3.00% also completes a double-bottom reversal, signaling the end of a three-decade-long secular bull market in bonds.
The yield differential between 10-year and 3-month Treasuries is declining but a flat yield curve does not warn of a recession. Only if the yield differential crosses below zero, with short-term yields rising faster than long-term, will there be a recession warning.
Real returns on long-term bonds — the gap between the green and blue lines below — remain near record lows.
Only if the gap widens (real returns rise significantly) are we likely to see downward pressure on stock valuations, with falling price-earnings multiples.
East to West: Trade tariffs spark rally
Commodities rallied and Asian stocks found support after a three-month sell-off.
From Reuters (September 19):
Copper jumped to its highest in three weeks on Wednesday, boosted by a weaker dollar after a new round of U.S.-China trade tariffs were not as high as previously expected.
China will levy tariffs on about $60 billion worth of U.S. goods in retaliation for U.S. tariffs on $200 billion worth of Chinese goods. Washington’s new duties, however, were set at 10 percent for now, rising to 25 percent by the end of the year, rather than starting immediately at 25 percent…….
“In some ways the bad news had been priced into the markets and, if anything, the news on trade had been slightly less severe than we had thought it would be,” said Capital Economic analyst Caroline Bain.
“It’s still too early to talk about this as sustainable … it just seems to be a bit of a relief rally after all of the bad news.”
The Shanghai Composite Index rallied off primary support at 2650, a slight bullish divergence on the Trend Index signaling short-term buying pressure. Penetration of the descending trendline would suggest that a bottom is forming.
Japan’s Nikkei 225 is testing its January high at 24,000.
India’s Nifty is testing support at 11,000. Long tails indicate buying pressure. Respect of support would signal another advance.
Europe
Dow Jones Euro Stoxx 50 rallied off primary support at 3300 but is yet to break the down-trend.
The Footsie also rallied, finding support at 7250, but a declining Trend Index warns of continued selling pressure.
North America
The S&P 500 rallied off the new support level at 2875 and is likely to test its long-term target of 3000.
The Nasdaq 100, however, continues to test support at 7700. Breach would warn of a correction to test 7000.
Canada’s TSX 60 found support at 950 but declining peaks on the Trend Index continue to warn of selling pressure.
Markets are dominated by one concern, a US-China trade war, and volatility is likely to remain high until a resolution is found.
How will a bond bear market affect stocks?
10-Year Treasury yields broke out of their triangular consolidation at 3.00%, while the Trend Index recovered above zero signaling a fresh advance.
Importance of resistance at 3.00% is best illustrated on a long-term monthly chart. Yields declined for more than three decades (since 1981) in a bond bull market but the rise above 3.00% completes a double-bottom reversal, warning of rising yields and a bond bear market. Target for the advance is 4.50%.
The yield differential between 10-year and 3-month Treasuries has declined since 2010, prompting discussion as to whether a flat yield curve will cause a recession. Interesting that the yield differential recovered almost 20 basis points in September, with long-term yields rising faster than short-term. Penetration of the descending trendline would suggest that an imminent negative yield curve is unlikely.
How would a bond bear market affect stocks?
Capital losses from rising yields on long-maturity bonds would increase demand for shorter maturities, driving down short-term yields and causing a steeper yield curve. A bullish sign for stocks.
Inflation is low and the rise in long-term yields is likely to be gradual. Another bullish sign.
The last bond bear market lasted from the early 1950s to a peak in September 1981. Higher interest rates were driven by rising inflation ( indicated below by percentage change in the GDP implicit price deflator). The 1975 spike in inflation was caused by the OPEC oil embargo in retaliation for US support of Israel during the 1973 Yom Kippur war.
Stock prices continued to climb during the bond bear market, apart from a 1973 – 1974 setback, but the Price-Earnings ratio fell sharply in ’73-’74 and only recovered 10 years later, in the mid-1980s.
Alarmists may jump to the conclusion that a bond bear market would lead to a similar massive fall in earnings multiples but there were other factors in play in 1975 to 1985.
First, crude prices spiked after the OPEC oil embargo and only retreated in the mid-1980s.
The rise of Japan also threatened US dominance in global markets.
We should rather examine the period prior to 1973 as indicative of a typical bond bear market. The S&P 500 Price-Earnings ratio was largely unaffected by rising yields. Real interest rates actually decreased during the period, with the gap between 10-year yields and the inflation rate only widening near the 1981 peak.
At present, real interest rates are near record lows.
We can expect real interest rates to rise over time but that is unlikely to have a significant impact on earnings multiples — unless there is a strong surge in long-term yields ahead of inflation.
East to West: Asian stocks find support
Asian stocks are finding support after a sell-off over the last three months.
The Shanghai Composite Index is showing a slight bullish divergence on the Trend Index. This is secondary in size and suggests a bear market rally.
South Korea’s Seoul Composite Index displays a stronger bullish divergence. Breakout above 2350 and the descending trendline is still unlikely but would indicate that a bottom is forming.
Japan’s Nikkei 225 broke through resistance at 23,000, signaling an advance to the January high at 24,000.
India shows strong buying pressure, with long tails on the Nifty suggesting another strong advance.
Europe
Dow Jones Euro Stoxx 600 is trending lower. Support at 374 is secondary but the Trend Index near zero indicates hesitancy.
The Footsie found medium-term support at 7250 but a declining Trend Index warns of another test of primary support at 6900/7000.
North America
The S&P 500 retracement respected support at 2875, suggesting an advance to the long-term target of 3000.
Canada’s TSX 60 on the other hand is undergoing a correction, perhaps exacerbated by concerns over NAFTA. Expect support at 935/940.
Nothing much has changed. While Japan and India are bullish, China and South Korea remain in a bear market. Europe looks hesitant, while the S&:P 500 continues in a strong bull market.
The generally accepted view is that markets are always right — that is, market prices tend to discount future developments accurately even when it is unclear what those developments are. I start with the opposite view. I believe the market prices are always wrong in the sense that they present a biased view of the future.
~ George Soros
You must be logged in to post a comment.