Category: Stock Markets

Analysis of major stock markets around the world.

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This time is different

The chart below compares the Wilshire 5000 broad market index (light blue) to the money supply (MZM or “at call” money). The previous two recessions show a surge in the money supply (green circles) as the Fed injects liquidity into financial markets to forestall a deflationary spiral. In both cases, stocks took more than two years to react, with the low-point reached 8 quarters after the Fed started to inject liquidity in Q1 2001 and 9 quarters after liquidity injections commenced in Q3 of 2007.

MZM Money Supply and Wilshire 5000

It took almost 13 years for the index to make a new high after its Q1 2001 Dotcom peak and 5.5 years after its Q3 2007 peak (values are plotted relative to GDP).

The recovery in 2020 was quite different. The index formed a low two quarters after the Fed started to inject liquidity and had recovered to a new high in the next quarter.

While the recovery from the Dotcom crash took an unusually long time — because of the extreme valuations — we can still conclude that the latest recovery was exceptional. Record government stimulus caused a surge in disposable incomes, rather than the fall seen in previous recessions.

Disposable Personal Income

The surge in disposable income combined with a sharp fall in consumption caused a massive spike in personal saving, much of which flowed into the stock market.

Personal Saving

Huge inflows caused a surge in stock prices, which in turn led to similar exuberance to the Dotcom bubble of 1999-2000.

“This is the only time in my 88 years when I saw technology stocks go to 100 times earnings; or, when there were no earnings, 20 times sales. It was insane, and I took advantage of the temporary insanity.” ~ Sir John Templeton, in 2001.

Conclusion

While the government attempt to prevent a fall in personal disposable income during the pandemic is laudable, their overreaction caused a massive spike in personal saving — spreading the contagion to the stock market. Stocks are now trading at precarious levels relative to earnings, with no easy way for authorities to engineer a soft landing.

We are not sure how long the Fed can prop up the stock market but are certain that it will end badly for investors who ignore the risks.

Notes

Sir John Templeton (1912-2008) was an American-born contrarian and value investor, banker, fund manager, and philanthropist. He founded the Templeton Growth Fund in 1954, which averaged more than 15% p.a. over 38 years. In 1999, Money magazine rated him as “arguably the best stock picker of the century.”

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Tech heavyweights pause for breath

Good progress has been made combating the pandemic but daily COVID cases seem to be struggling to break through a floor between 50 and 60 thousand. The vaccine roll-out is ahead of schedule but people need to stop listening to idiots like Rand Paul — who went to the Senate gym while infected — and listen to the Chief Medical Adviser whose advice is to wear a mask.

Daily US COVID Cases

Stocks have paused after the recent run up in Treasury yields. When both stocks and bonds are being sold, there is nowhere to hide.

The Nasdaq 100 is testing support at 12000. At this stage the correction looks mild, with declining Trend Index remaining above zero, but breach of 12000 would signal a test of the Sep 2020 low.

Nasdaq 100

The S&P 500 is performing better but Volatility troughs above 1.0% still warn of elevated risk.

S&P 500 & Twiggs Volatility 21-Day

The big five tech stocks are a mixed bag. Alphabet (GOOGL) and Facebook (FB) show strength. Microsft (MSFT) looks stable, while Mazon (AMZN) and Apple (AAPL) are trending lower.

AAPL, AMZN, GOOGL, FB, MSFT

When leaders no longer lead normally signals the final stage of a bull market. The chart below shows the Russell 2000 small caps ETF (IWM) clearly outperforming the large cap Nasdaq (QQQ) and S&P 500 (IVV) indices with all the tech heavyweights.

IVV, IWM, QQQ

@Schuldensuehner

The steeper yield curve benefits banks, who profit from the wider net interest margin. Major banks have climbed 60% to 80% over the past six months, with Goldman Sachs (GS) leading and Bank of America (BAC) the laggard.

Major Banks

Consumer durables sectors are, again, a mixed bag. Household Goods (HG) is flat, Apparel Retail (RA) is climbing steadily, while Automobiles (AU) is down sharply — mainly because of Tesla (TSLA).

Consumer Durables

Though light vehicle sales were down a million units in February.

Light Vehicle Sales

And heavy truck sales were down 4,000 units compared to January.

Heavy Truck Sales

Prospects for the tire industry are improving. Goodyear (GT) retraced to test its new support level after breaking out above its high from late 2019. Respect would confirm another advance.

Goodyear Tyre Co. (GT)

Conclusion

The recovery is going to be a long hard slog with frequent setbacks. Banks are doing nicely but stocks generally are over-priced and ripe for a major adjustment. There are signs that this is the final stage of the bull market and market risk is elevated.

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S&P 500 fueled by the Fed

The S&P 500 continues, unwavering, in a strong up-trend.

S&P 500

But compare the growth in the S&P 500 index relative to growth in the money supply (M2). In relative terms, the S&P 500 appreciated only 29%, or 2.6% p.a., over the past decade. Most of the stellar performance over the past 10 years can be attributed to the Fed’s expansionary monetary policy.

S&P 500/M2 Money Supply

Dollar Index

The Dollar Index continues to test support at 90. A Trend Index peak below zero warns of strong selling pressure. Breach of support is likely and would signal another primary decline.

Dollar Index

The Chinese Yuan, however, has halted in its appreciation against the Dollar. Trend Index peak below the 7-week MA warns of secondary selling pressure. Breach of support at 15.4 US cents would warn of a correction.

CNYUSD

Conclusion

The S&P 500 is likely to continue rising for as long as the Fed expands the money supply. The Dollar, however, is expected to weaken for the same reason.

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Global stock market correction

Strong red candles across major market indices warn of a global correction.

Breach of 3650 on the S&P 500 would warn of a test of the strong band of support between 3250 and 3400. Bearish divergence on Twiggs Money Flow continues to warn of long-term selling pressure.

S&P 500

The European Stoxx 600 threatens a similar secondary correction with a test of support at 375.

DJ Euro Stoxx 600

The Footsie is testing support between 6300 and 6500, while Money Flow reversal below zero warns of strong selling pressure. Breach of 6300 is likely and would indicate a strong correction, with primary support at 5500.

FTSE 100

The reaction on China’s Shanghai Composite is of similar weight to the S&P and STOXX. Breach of medium-term support at 3400 would warn of a test of primary support at 3200.

Shanghai Composite

The reaction on Japan’s Nikkei 225 appears secondary and likely to test the rising trendline at 26000.

Nikkei 225

The Seoul Composite is similar, with a rising trendline at 2700.

Seoul Composite

Selling on India’s Nifty 50 is heavier, flagged by a sharp fall in Money Flow over the past three weeks. Support at the rising trendline is unlikely to hold — which would mean a test of support at 12500.

Nifty 50

Conclusion

The correction across global stock markets appears secondary at this stage and likely to test medium-term support levels. Selling is heaviest on the FTSE 100 and India’s Nifty 50. These are the canary in the coal mine and should be monitored for unusual activity. Further falls on strong volume would indicate that sellers are overwhelming support.

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Can the Fed keep a lid on inflation?

Jeremy Siegel, Wharton finance professor, says the Fed has poured a tremendous amount of money into the economy in response to the pandemic, which will eventually cause higher inflation. David Rosenberg of Rosenberg Research argues that velocity of money is declining and the US economy has a large output gap so inflation is unlikely to materialize.

CNBC VideoClick to play

Both are right, just in different time frames.

Putting the cart before the horse

The velocity of money is simply the ratio of GDP to the money supply. Fluctuations in the velocity of money have more to do with fluctuations in GDP than in the money supply. If GDP recovers, so will the velocity of money. Equating velocity of money with inflation is putting the cart before the horse. Contractions in GDP coincide with low/negative inflation while rapid expansions in GDP are normally accompanied, after a lag, by rising inflation.

CPI & GDP

Money supply and interest rates

Inflation is likely to rise when consumption grows at a faster rate than output. Prices rise when supply is scarce — when we consume more than we produce. Interest rates play a key role in this.

Low interest rates mean cheap credit, making it easy for people to borrow and consume more than they earn. Low rates also boost the stock market, raising corporate earnings because of lower interest costs, but most importantly, raising earnings multiples as the cost of capital falls. Speculators also take advantage of low interest rates to leverage their investments, driving up prices.

S&P 500

In the housing market, prices rise as cheap mortgage finance attracts buyers, pushing up demand and facilitating greater leverage.

Housing: Building Starts & Permits

Wealth effect

Higher stock and house prices create a wealth effect. Consumers are more ready to borrow and spend when they feel wealthier.

High interest rates, on the other hand, have the exact opposite effect. Credit is expensive and consumption falls. Speculation fades as stock earnings multiples fall and housing buyers are scarce.

Money supply is only a factor in inflation to the extent that it affects interest rates. There is also a lag between lower interest rates and rising consumption. It takes time for consumers and investors to rebuild confidence after an economic contraction.

The role of the Fed

Fed Chairman, William McChesney Martin, described the role of the Federal Reserve as:

“…..to take away the punch bowl just as the party gets going.”

In other words, to raise interest rates just as the economic recovery starts to build up steam — to avoid a build up of inflationary pressures.

The Fed’s mandate is to maintain stable prices but there are times, like the present, when their hands are tied.

Federal government debt is currently above 120% of GDP.

Federal Debt/GDP

GDP is likely to rise as the economy recovers but so is federal debt as the government injects more stimulus and embarks on an infrastructure program to lift the economy.

With federal debt at record levels of GDP, raising interest rates could blow the federal deficit wide open as the cost of servicing Treasury debt threatens to overtake tax revenues.

Conclusion

Inflation is likely to remain low until GDP recovers. But the need to maintain low interest rates — to support Treasury markets and keep a lid on the federal deficit — will then hamper the Fed’s ability to contain a buildup of inflationary pressure.

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S&P 500 bubble risk

S&P 500 valuations are higher than the 1929 (Black Friday) Wall Street crash and the October 1987 (Black Monday) crash. The Dotcom bubble is the only time in the last 120 years that the ratio between Price and highest trailing earnings (PEmax) was higher.

S&P 500 PE of Highest Trailing Earnings (PEmax)

PEmax eliminates distortions in the price/earnings multiple caused by sharp falls in earnings during recessions. The current multiple of 26.93 compares the index at December 31, 2020 to highest trailing earnings of 139.47 (for the 12 months ended December 2019) rather than expected earnings of 95.22 for the 12 months ended December 2020. Highest trailing earnings in such a case are a far better reflection of future earnings potential than more recent results.

Payback model

Using our payback valuation model, we arrive at a fair value estimate of 2331 for the S&P 500 based on:

  • highest trailing earnings of 139.47;
  • a long-term growth rate of 5% (the highest nominal GDP growth achieved in recent years was 6.0% in Q2 2018); and
  • a payback period of 12 years — normally only used for stable companies with a strong defensive market position.

The LT growth rate required to match the current index value (3851) is 12.0%. The only time such a growth rate was achieved, post WWII, is in the 1980s, when inflation was in double-digits.

Nominal GDP & Inflation (CPI)

Conclusion

Stock prices are in a bubble of epic proportions. Risk of a major collapse remains elevated.

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S&P 500: Leaders no longer leading

Daily new cases of COVID-19 continue to spike upwards, warning of further shutdowns as medical facilities are overrun.

USA: Daily COVID-19 cases

Payrolls

The latest labor report disappointed, especially as the November survey came before the latest round of layoffs after states imposed tighter restrictions.

Payroll growth flattened, leaving total payroll down 5.99% compared to November last year.

Payrolls Annual Change

Hours worked are slightly more encouraging, down 4.68% on an annual basis, compared to -2.9% change in real GDP.

Real GDP & Hours Worked

Vaccines

Encouraging news on the vaccine front but “when you hear the cavalry is coming to your rescue, you don’t stop shooting. You redouble your efforts.” (Dr Anthony Fauci)

Now This News

Stocks

Progress in manufacturing vaccines that will soon be widely available has buoyed stocks despite the dismal economic outlook. The S&P 500 made new highs, assisted by hopes of further stimulus and ultra-low interest rates. The large megaphone pattern is a poor indicator of future direction but does flag unusual volatility.

S&P 500 SPDR (SPY)

Growth in the big five technology stocks has slowed in recent months, with only Alphabet (GOOGL) breaking above its September high. Too early to tell, but failure of market leaders to make new highs is typical of the late stages of a bull market.

AAPL, AMZN, GOOGL, MSFT, FB

Conclusion

Vaccines should succeed in flattening the third wave and suppressing future outbreaks but are unlikely to succeed in restoring the economy to normalcy.

Federal debt is at a record 123% of GDP and growing. Further stimulus is required to support the still-fragile recovery.

The Fed will continue to expand its balance sheet to support Treasury issuance.

Ultra-low interest rates are likely to stay for a number of years.

If massive federal debt, QE and ultra-low interest rates does not cause a spike in inflation, that will encourage authorities to push the envelope even further (we fear this would have disastrous consequences).

Unemployment is expected to remain high and GDP growth likely to remain low.

Zombie corporations and commercial real estate with unsustainable debt levels will continue to be a drag on economic growth.

Growth stocks are expected to remain overpriced relative to current and future earnings.

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Bearish divergence warns of tech stock retracement

The US recorded more than 75,000 new COVID19 cases on July 16th. The CCP must be smiling behind their masks after successfully containing last month’s outbreak in Beijing.

COVID19 Daily New Cases

Source JHU CSSE

Technology stocks have screamed upwards despite the chaos, but bearish divergence on Twiggs Money Flow now warns of selling pressure. Expect retracement to test support at 2650 on the Dow Jones US Technology Index.

DJ US Technology Index

Dow Jones Banks Index is a more realistic representation of the broader US economy. The weak rally has fizzled out, with a Money Flow peak at zero now warning of strong selling pressure. Breach of short-term support at 320 would signal another test of primary support at 270/280.

DJ US Banks Index

Government support can only cushion the impact of a massive surge in unemployment for a limited time. Then we will witness the full extent of the damage.

Continued unemployment claims jumped to 17.355 million on July 4th, up by 840,000 from a week earlier. Judging by the rising virus count, further increases are likely.

Continuous Claims

But that is only the tip of the iceberg.

The latest Department of Labor update shows 32 million people claimed unemployment insurance benefits in all programs for the week ending June 27.

Department of Labor: PERSONS CLAIMING UI BENEFITS IN ALL PROGRAMS

…..21% of the 152.4 million non-farm workforce in February 2020.

Pandemic Unemployment Assistance (PUA) under the CARES Act, signed into law on March 27, 2020 provides benefits to those individuals “not eligible for regular unemployment compensation or extended benefits under state or Federal law or pandemic emergency unemployment compensation (PEUC), including those who have exhausted all rights to such benefits.”

The S&P 500 is inching upwards, reflecting the tug-of-war between technology stocks and the broader market. We expect retracement of the Technology Index to cause another test of support at 3000 (on the S&P 500).

S&P 500

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