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Witching hour on Friday

“Witching hour” refers to the last hour of trading on days, normally the third Friday of the month, when there is a simultaneous expiry of options and futures in derivatives markets. Traders who don’t roll-over into a new contract are forced to cover their positions, which can lead to massive intra-day volatility in underlying markets.

“Quadruple witching” happens four times each year — on the third Friday of March, June, September, and December — when index futures, index options, stock futures, and stock options expire simultaneously. With that level of futures and options expiring, trading volume in equities usually spikes in the last hour.

Spot the June and September witching hours on the chart below.

Witching Hour June & September 2018

Note that June had witching hours on Friday 15th and 22nd. Also note that there was not a lot of price movement despite the heavy trading volumes. That’s not to say that witching hour is incapable of disrupting an already unstable market but it’s unlikely to have a long-term impact if conditions are settled.

After the liquidity squeeze earlier this week, it’s important to keep an eye on this.

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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.

S&P 500 Target CalculationClick 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:

  1. The 2100 peak from 2015, a 50% retracement (on a log scale) of the preceding advance; and
  2. 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

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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

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S&P 500: Treasuries reflect flight to safety

10-Year Treasury yields plunged below 2.0% on Donald Trump’s announcement of further tariffs (10% on $300bn) on China. The fall reflects rising demand for Treasuries as a safe haven in these turbulent times.

10-Year Treasury Yield

The spread between 10-Year and 3-Month Treasuries recovered above zero. This is a bearish sign: recession normally follows the recovery and not the initial inversion.

10-Year 3-Month Treasury Spread

The S&P 500 retreated below 3000 on Trump’s announcement, strengthening the bearish divergence signal on Twiggs Money Flow which warns of a correction. A test of support at 2750 is likely.

S&P 500

The Russell 2000 ETF (IWM) is expected to test primary support at 145. Small cap stocks have lagged the S&P 500 this year, highlighting risk aversion.

Russell 2000 Small Caps Index

Dow Jones Euro Stoxx 600, reflecting large cap stocks in the European Union, is similarly headed for a test of primary support at 365. Strong bearish divergence on the Trend Index warns of a reversal.

DJ Euro Stoxx 600

Falling commodity prices reflect market concerns for the global economy. A Nymex Light Crude breach of $51/barrel would signal a primary down-trend. Declining peaks on the Trend Index warn of selling pressure.

Nymex Light Crude

The DJ-UBS Commodity Index is similarly headed for a test of support at 75. Breach would signal a primary down-trend. A peak near zero on the Trend Index warns of strong selling pressure.

DJ-UBS Commodity Index

Dr Copper, often used as a barometer of the global economy, has breached primary support at 5800, signaling a decline. Again, a Trend Index peak below zero warns of strong selling pressure.

Copper

Employment stats for July have improved slightly, with Average Hourly Wages growth easing to 3.3% (Total Private).

Average Hourly Wage

And annual payroll growth ticked up to 1.5%

Employment Growth & FFR

But weekly hours worked are declining, warning that real GDP will decline further, after printing 2.3% for the second quarter.

Real GDP & Weekly Hours Worked

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

“Price is what you pay; value is what you get.”

~ Benjamin Graham

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ASX: Iron ore plunges

Iron ore spot prices plunged from $120 to $106.50/tonne in two days. Penetration of the rising trendline is highly likely and would warn of a strong correction. A spike up is often followed by a spike down.

Iron Ore

The ASX 200 retreated from its 2007 high at 6830. Penetration of the rising trendline is now likely and would warn of a correction. The first line of support is 6350, with stronger support at 6000.

ASX 200

We have increased the level of cash in our Australian Growth portfolio.

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Be wary of investing in a rigged market

The S&P 500 recovered above 3000, suggesting another advance, but bearish divergence on Twiggs Money Flow warns of (secondary) selling pressure.  Further tests of new support at 2950 are likely.

S&P 500

Falling commodity prices warn of declining global demand.

DJ-UBS Commodity Index

Declining crude prices reinforce the warning.

Nymex Light Crude

While in the US, the Cass Freight Index formed a lower peak. Follow-through below the previous trough would warn of a down-trend and declining activity.

Cass Freight Index

Capital goods orders, adjusted for inflation, continue to decline.

Capital Goods Orders

Housing starts are steady but declining building permits warn of a slow-down ahead.

Housing Starts and Building Permits

Craig Johnson of Piper Jaffray says odds of a recession are growing:

“The bond market has already priced in two rate cuts at this point in time, and potentially part of a third,” Johnson said. “History has always said that bonds lead equities and we need to listen to that message. I think that’s what the smart money is doing…I guess we can’t seem to quite get off of the monetary train that we’ve gotten ourselves onto, and I don’t think it’s quite so simple.”

S&P 500 PEmax

Trailing price-earnings (PEmax) are above 20, historically a warning that the market is over-heated. The biggest buyers of stocks are the companies themselves, through buybacks. The Fed is expected to cut rates while employment growth is still strong. Price signals are being distorted.

Be wary of investing in a rigged market. It’s a good time to be cautious.

“It is optimism that is the enemy of the rational buyer.”

~ Warren Buffett

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Iron ore tailwinds lift the ASX

Further increases in iron ore prices are predicted. Enrico de la Cruz at Mining.com reports:

Singapore-based steel and iron ore data analytics firm Tivlon Technologies is keeping its price forecast of $150 a tonne by October.

“We expect the launch of infrastructure projects in China to peak in the third quarter and further uplift demand for steel,” it said in a note.

Narrow consolidation is a bullish sign, suggesting another advance.

Iron Ore

The Materials index continues its up-trend. A Trend Index above zero would signal increased buying pressure.

ASX 200 Materials

Financials continue to test resistance at 6450 but face headwinds from the housing market and construction.

ASX 200 Financials

The ASX 200 is testing its 2007 high at 6800. A rising Trend index indicates buying pressure. Penetration of the rising trendline on the index chart is unlikely but would warn of a correction.

ASX 200

We maintain a high level of cash in our Australian Growth portfolio because of expected headwinds from housing and construction.

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S&P 500 selling pressure

The S&P 500 is retracing to test its new support level at 2950. Bearish divergence on Twiggs Money Flow warns of (secondary) selling pressure. Breach of support would warn of a correction to test primary support at 2750.

S&P 500

Sector indexes are approaching a watershed moment, with Autos rallying to test their descending trendline.

S&P 500 Automobiles

Retail is also headed for a test of its rising trendline after making a new high.

S&P 500 Retail

Even Semiconductors have recovered to test their 2018 high at 1450.

S&P 500 Semiconductors

I still believe it’s a good time to be cautious.

“Be fearful when others are greedy and greedy only when others are fearful.”

~ Warren Buffett

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Buybacks are hurting growth

Preliminary Q1 results from S&P Dow Jones Indices show S&P 500 dividends and buybacks continue to exceed reported earnings in the first quarter of the current year.

S&P 500 Buybacks, Dividends & Earnings

While this could be a spill-over of offshore funds repatriated as a result of the 2017 Tax Cuts and Jobs Act, companies have distributed more than they earned since 2014 (Q4). That leaves nothing in reserve for new investment or increases in working capital, both of which are necessary to support growth.

In my last post I highlighted that before-tax corporate profits, adjusted for inflation, are below 2006 levels and declining. Reported earnings for Q1 2019 on the above chart (preliminary results) are only 3.5% higher than the same quarter in 2018. If we strip out inflation, estimated at 2.0%, that leaves only 1.5% real growth.

S&P 500 earnings per share growth for Q1 2019 is marginally better,  at 6.1%, because of stock buybacks.

S&P 500 Earnings per share Growth

But the S&P 500 buyback yield is 3.49% (Source: S&P Dow Jones Indices). On its own, that should boost eps growth by 3.6% (1/[1 – 0.0349] – 1 for the quants). There seems to be 1.0% missing.

S&P 500 Earnings per share Growth

Warren Buffett has pointed this issue out repeatedly for the past 20 years:

“…We will repurchase stock when it falls below a conservative estimate of its intrinsic value. We want to be sure that when we repurchase shares that the remaining shareholders are worth more the moment after we repurchased the shares than they were before.”

If stock is repurchased at above intrinsic value then shareholders will be worse-off. The company receives a poor return on its investment in much the same way as if it had over-paid for an acquisition.

Here is a simple example:

If a company is trading at 100 times earnings and achieving 20% organic earnings growth per year, it is most likely over-priced. Now that company buys back 10% of its own stock (numbers are exaggerated for illustration purposes). Earnings will stay the same but earnings per share (eps) increases by 11.1% (the inverse of 90%).

If the same funds used for the buyback had been invested in a new project with a modest 5% initial return on investment, earnings would have increased 50% (and eps likewise).

The larger the buyback yield, the more that growth is likely to deteriorate — especially when earnings multiples are dangerously high.

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ASX 200: Iron ore tailwinds continue

The ASX continues to enjoy a massive tailwind, with iron ore spot prices holding above $120/tonne. Prices are expected to moderate, with Brazilian exports recovering. Clyde Russell at Mining.com comments:

“Even if Brazil’s exports do remain slightly below normal, it may be the case that the iron ore forward curve is currently too optimistic. The Singapore Exchange front-month contract closed at $121.24 a tonne on Wednesday, while the six-month contract was at $100.52 and the 12-month at $89.52. This shows traders do expect prices to moderate…”

Iron Ore

The Materials index continues to climb, with rising troughs on the Trend Index signaling buying pressure.

ASX 200 Materials

REITs continue their strong up-trend, in expectation of lower interest rates. The equity (dividend) yield on VAP/ASX 300 REITs has fallen to 4.3%.

ASX 200 REITs

Financials are testing resistance at 6450 but face headwinds from declining house prices and construction work.

ASX 200 Financials

The ASX 200 is headed for a test of its 2007 high at 6830, with a rising Trend index indicating buying pressure. Penetration of the rising trendline on the index chart is not likely but would warn of a correction to test support at 6000.

ASX 200

We continue to maintain a high level of cash in our Australian Growth portfolio.