Category: Stock Markets

Analysis of major stock markets around the world.

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China: Deja vu all over again

The Shanghai Composite today found support at 3500 today after plunging more than 8% on Monday. The large divergence on 13-week Twiggs Money Flow continues to warn of selling pressure.

Shanghai Composite Index

* Target calculation: 4000 – ( 5000 – 4000 ) = 3000

Japan’s Lost Decade

From Wikipedia:

The Japanese asset price bubble….. was an economic bubble in Japan from 1986 to 1991 in which real estate and stock market prices were greatly inflated. The bubble was characterized by rapid acceleration of asset prices and overheated economic activity, as well as an uncontrolled money supply and credit expansion. More specifically, over-confidence and speculation regarding asset and stock prices had been closely associated with excessive monetary easing policy at the time.

By August 1990, the Nikkei stock index had plummeted to half its peak by the time of the fifth monetary tightening by the Bank of Japan (BOJ)…..the economy’s decline continued for more than a decade. This decline resulted in a huge accumulation of non-performing assets loans (NPL), causing difficulties for many financial institutions. The bursting of the Japanese asset price bubble contributed to what many call the Lost Decade.

“…uncontrolled money supply and credit expansion….overheated stock market and real estate bubble.” Sound familiar? It should. We are witnessing a re-run but this time in China. Wait, there’s more…..

…..At the end of August 1987, the BOJ signaled the possibility of tightening the monetary policy, but decided to delay the decision in view of economic uncertainty related to Black Monday (October 19, 1987) in the US.

…..BOJ reluctance to tighten the monetary policy was in spite of the fact that the economy went into expansion in the second half of 1987. The Japanese economy had just recovered from the “endaka recession” ….. closely linked to the Plaza Accord of September 1985, which led to the strong appreciation of the Japanese yen.

…..in order to overcome the “endaka” recession and stimulate the local economy, an aggressive fiscal policy was adopted, mainly through expansion of public investment. Simultaneously, the BOJ declared that curbing the yen’s appreciation was a “national priority”……

Global stock market crash leads to prolonged monetary easing…… aggressive expansion of public investment to stimulate the domestic economy…..central bank efforts to curb appreciation of the currency. We all know how this ends. We’ve seen the movie before.

It’s like deja-vu, all over again. ~ Yogi Berra

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Transports deflate

Bellwether transport stock Fedex is testing primary support at $164 on the weekly chart. Bearish divergence on 13-week Twiggs Money Flow warns of a reversal. Breach of $164 would signal a primary down-trend — a warning that economic activity is contracting.

Nasdaq 100

The LoDI National Index from University of Louisville and Oklahoma State University also declined for the last two months but remains above 50, indicating a healthy level of economic activity.

LoDI National Index

The LoDI Index uses linear regression analysis to combine cargo volume data from rail, barge, air, and truck transit, along with various economic factors. The resulting indicator is designed to predict upcoming changes in the level of logistics and distribution activity in the US and is represented by a value between 1 and 100. An index at or above 50 represents a healthy level of activity in the industry.

Breach of primary support by Fedex and reversal of the LoDI below 50 would warn of a contraction in economic activity but we are not there yet.

North America

The reporting season got off to a shaky start with Apple disappointing but the ship seems to have steadied. Of the 62 stocks in the S&P 500 that have reported, 43 beat, 5 met and 14 (or 22%) missed their estimates.

The S&P 500 met resistance at 2130 and 21-day Twiggs Money Flow peaks close to zero warn of medium-term selling pressure. Another test of support at 2040/2050 is likely. Recovery above 2130 is unlikely at present, but would offer a target of 2200*.

S&P 500 Index

* Target calculation: 2130 + ( 2130 – 2050 ) = 2210

The CBOE Volatility Index (VIX) remains at low levels typical of a bull market.

S&P 500 VIX

Canada’s TSX 60 respected the upper trend channel, warning of continuation of the correction. Declining 13-week Twiggs Momentum below zero warns of a primary down-trend. Breach of support at 800 would confirm.

TSX 60 Index

* Target calculation: 900 + ( 900 – 850 ) = 950

Australia

The ASX 200 respected resistance at 5650/5700, warning of another test of support at 5400. Breach would test primary support at 5150/5200, while respect would indicate that the correction is over; follow-through above 5700 would confirm. 13-Week Twiggs Money Flow oscillating above zero indicates long-term buying pressure, suggesting that the primary up-trend is intact.

ASX 200

If investing is entertaining, if you’re having fun, you’re probably not making any money. Good investing is boring.

~ George Soros

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Gold crashes through primary support

Gold broke primary support at $1140/ounce, signaling a decline to the target of $1000*. 13-Week Twiggs Momentum peaks below zero have been warning of this for some time.

Spot Gold

* Target calculation: 1200 – ( 1400 – 1200 ) = 1000

Major producer Barrick Gold also broke primary support, at $10, strengthening the bear signal for gold. Similar peaks below zero on 13-week Twiggs Momentum warn of a primary down-trend. Breach of support offers a target of $6.50*.

Barrick Gold

* Target calculation: 10 – ( 13.50 – 10.00 ) = 6.50

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Greece and Iran party but China lurks in the shadows

From the Wall Street Journal:

Greece’s Parliament passed early Thursday a crucial set of austerity measures required for a eurozone bailout package….The measures were supported by 229 lawmakers in the nation’s 300-seat Parliament.

A Grexit has been avoided for the present, but unless the Greeks are successful in implementing structural reform, reversing many years of cronyism and corruption, we are likely to witness further re-runs in the future.

The nuclear deal with Iran has outraged the Right in Israel and the US. There are many pitfalls along the way but I believe this is a bold step forward. The outcome will be uncertain for many years but presents both sides with a chance to build a new relationship where they can peacefully co-exist. The alternative is another war in the Middle East — with no winners.

Iran

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I was surprised to see the Russians playing a constructive role in the dialogue. I am sure that Vladimir Putin would take personal delight in poking a stick through Obama’s bicycle spokes, but the interests of the state come first. “Follow the green” as one US diplomat described it. The New York Times offers a clue:

Sergey V. Lavrov, the Russian foreign minister, lost no time in talking about the accord on Iran’s nuclear program. He was on television minutes after the deal was clinched, and even before the formal news conference had begun, announcing the landmark agreement to the audience back home and emphasizing the many potential benefits, strategic and economic, that it holds for Russia…..Russia possesses some of the world’s foremost expertise in atomic energy, and has helped build and operate atomic reactors in Iran for many years. Rosatom, the Russian state nuclear energy company, helped build and expand the Bushehr nuclear plant and already has contracts to build two more reactors there.

China, on the other hand still lurks in the background. The state managed to stem the flood, suspending trading on more than 50% of stocks and forbidding large stockholders from selling. This is a public acknowledgment that Chinese stock prices are artificial and in no way to be trusted (“What’s new” some cynics would ask). They have destroyed any credibility that their stock markets had. Japan had zombie banks after their 1990 stock market crash, solvent in name only. China seems to be following a similar path with zombie stocks. Banks who have lent money against those stocks are likely to follow.

For a deeper understanding of the situation, read China’s stock market falling off a cliff: Why, and why care? by Alicia Garcia-Herrero at Bruegel.org

Europe

Germany’s DAX recovered above its descending trendline, indicating the end of the correction. Follow-through above 11600 would strengthen the signal, suggesting a fresh advance. Breakout above 12400 would confirm. Recovery of 13-week Twiggs Money Flow above its descending trendline shows that selling pressure has eased.

DAX

* Target calculation: 12500 + ( 12500 – 11000 ) = 14000

The Footsie also recovered above its descending trendline. Follow-through above 6750 would indicate another attempt at 7100. A 13-week Twiggs Money Flow trough at zero flags buying pressure.

FTSE 100

* Target calculation: 7000 + ( 7000 – 6500 ) = 7500

Asia

The Shanghai Composite is testing resistance at 4000. Government efforts to stem the crash are unlikely to restore credibility to stock prices. The large divergence on 13-week Twiggs Money Flow continues to warn of selling pressure.

Shanghai Composite Index

* Target calculation: 4000 – ( 5000 – 4000 ) = 3000

Japan’s Nikkei 225 recovered above 20000, suggesting a fresh advance. Breakout above 21000 would confirm. Recovery of 13-week Twiggs Money Flow above its descending trendline suggests the correction is over.

Nikkei 225 Index

* Target calculation: 21000 + ( 21000 – 19000 ) = 23000

India’s Sensex recovered above 28000, suggesting a fresh advance. A 13-week Twiggs Money Flow recovery above zero indicates medium-term buying pressure. Breach of primary support at 26500 is now unlikely.

SENSEX

* Target calculation: 30000 + ( 30000 – 27000 ) = 33000

North America

The S&P 500 respected medium-term support at 2040. Another 13-week Twiggs Money Flow trough above zero would confirm long-term buying pressure. Breakout above 2120 would offer a target of 2200*.

S&P 500 Index

* Target calculation: 2100 + ( 2100 – 2000 ) = 2200

The CBOE Volatility Index (VIX) retreated to low levels typical of a bull market.

S&P 500 VIX

The Nasdaq 100 is approaching its Dotcom-era high of 4800. Breakout above 4550 would signal a test of long-term resistance. 6-Month Twiggs Momentum oscillating above zero reflects a healthy long-term up-trend.

Nasdaq 100

Canada’s TSX 60 recovered above support at 850/855. Breakout above the upper trend channel would indicate the correction is over, suggesting another test of 900. Recovery of 13-week Twiggs Momentum above zero would strengthen the signal. Respect of the upper trend channel is unlikely, but would warn of continuation of the down-trend.

TSX 60 Index

* Target calculation: 900 + ( 900 – 850 ) = 950

Australia

The ASX 200 broke out above its descending trend channel, flagging end of the correction. A 21-day Twiggs Money Flow trough above zero indicates medium-term buying pressure. Follow through above 5700 would signal another test of 6000.

ASX 200


More….

Could a new property tax save the Australian economy?

Will Iran deal nuke crude?

Hint of Greek bailout revives rates (and the Dollar)

Bank share prices tipped to decline

Gold: Is Barrick next?

APRA considers two per cent capital adequacy increase

Greece: the musical (with thanks to Grease)

Markets are constantly in a state of uncertainty and flux and money is made by discounting the obvious and betting on the unexpected.

~ George Soros

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Another week another crisis

The crisis in Greece continues, dragging down stocks across Europe.

Germany’s DAX broke support at 11000, warning of a decline to 10000. Reversal of 13-week Twiggs Money Flow below zero would warn of a primary down-trend. Recovery above 11500 is unlikely, but would signal a fresh advance.

DAX

The Footsie found short-term support at 6500. Decline of 13-week Twiggs Money Flow below zero warns of a primary down-trend. A peak below zero or breach of support at 6100 would confirm.

FTSE 100

* Target calculation: 6700 – ( 7100 – 6700 ) = 6300

Asia

Events have been overtaken by collapse of Chinese stocks. The Shanghai Composite found support at 3500, but government efforts are unlikely to stem the rout. Reversal of 13-week Twiggs Money Flow below zero would warn of further selling pressure. Expect support at the primary trendline, around the 3000 level.

Shanghai Composite Index

* Target calculation: 4000 – ( 5000 – 4000 ) = 3000

Japan’s Nikkei 225 was unsettled by events in Shanghai, breaking support at 20000 to warn of a correction. The decline on 13-week Twiggs Money Flow is gradual, suggesting a secondary correction.

Nikkei 225 Index

* Target calculation: 20000 + ( 20000 – 18000 ) = 22000

India’s Sensex retreated below 28000 warning of another test of primary support at 26500. A 13-week Twiggs Money Flow trough above zero, however, would indicate medium-term buying pressure. Breach of support at 26500 is also unlikely, but would signal a primary down-trend with support at 23000*.

SENSEX

* Target calculation: 26500 – ( 30000 – 26500 ) = 23000

North America

The S&P 500 is testing medium-term support at 2040. Declining 13-week Twiggs Money Flow suggests a test of primary support (1980/2000) but today’s rally in China may alleviate this. The index is likely to range below 2120 until the situations in both China and Greece reach a conclusion.

S&P 500 Index

* Target calculation: 2120 + ( 2120 – 2040 ) = 2200

The CBOE Volatility Index (VIX) is fairly subdued but likely to break 20, indicating moderate risk.

S&P 500 VIX

Dow Jones Industrial Average broke support at 17600. Follow-through below 17500 would warn of a test of primary support at 17000. Decline of 13-week Twiggs Money Flow below zero indicates strong selling pressure but this was aggravated by yesterday’s technical trading halt on the NYSE and recovery above zero is likely.

Dow Jones Industrial Average

Canada’s TSX 60 broke support at 850, warning of a test of primary support at 800. Decline of 13-week Twiggs Momentum below zero suggests a primary down-trend. Recovery above the descending trendline is unlikely, but would indicate the correction is over.

TSX 60 Index

* Target calculation: 850 – ( 900 – 850 ) = 800

Australia

The ASX 200 found support at 5400, highlighted by the long tail on today’s candle. Breakout above the trend channel is still unlikely, but would indicate the correction is over. It would be prudent, in the current climate, to wait for a higher trough or some other confirmation. Rising 21-day Twiggs Money Flow indicates moderate buying pressure.

ASX 200


More….

Gold Bugs warn of a bear market

Dollar calm while prospect of rate rises fades

Silver tests primary support at $15

Australia: Rising foreign debt

RBA strategy: Fight fire with gasoline

Crude breaks $54

Australian stocks: Buy in July?

Never let a serious crisis go to waste.

~ Rahm Emanuel

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Australian stocks: Buy in July?

Australian stocks typically encounter tax loss selling in June (before end of the financial year), followed by a rally in July/August that often carries through into the next calendar year. Sale of poor performing stocks before EOFY withdraws money from the market and effectively lowers all stock prices. After the year end, investors start to accumulate stocks again, lifting the market.

ASX 200 Accumulation Index

A monthly chart of the ASX 200 Accumulation Index since 2006 shows 2 years where the rally started in August (dark green), 5 years where the rally started in July (light green), and 2 years (red) where the EOFY rally disappointed, continuing a down-trend.

This year is complicated by turmoil in Greece and China. July 2011 also had its Greek drama. Prime Minister George Papandreou survived a confidence vote but was eventually replaced by Lucas Papademos, former governor of the Bank of Greece and vice-president of the European Central Bank. S&P also downgraded US government debt at the start of August 2011.

What does July 2015 have in store for us?

I don’t have a crystal ball, but breakout above the trend channel on the ASX 200 daily chart would indicate the correction is over, suggesting another advance. Rising 21-day twiggs Money Flow indicates mild buying pressure.

ASX 200 Index

But it would be prudent to wait for confirmation, in case it turns into a bull trap like 2011.

ASX 200 Index

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Australian stocks: Buy in July?

Australian stocks typically encounter tax loss selling in June (before end of the financial year), followed by a rally in July/August that often carries through into the next calendar year. Sale of poor performing stocks before EOFY withdraws money from the market and effectively lowers all stock prices. After the year end, investors start to accumulate stocks again, lifting the market.

ASX 200 Accumulation Index

A monthly chart of the ASX 200 Accumulation Index since 2006 shows 2 years where the rally started in August (dark green), 5 years where the rally started in July (light green), and 2 years (red) where the EOFY rally disappointed, continuing a down-trend.

This year is complicated by turmoil in Greece and China. July 2011 also had its Greek drama. Prime Minister George Papandreou survived a confidence vote but was eventually replaced by Lucas Papademos, former governor of the Bank of Greece and vice-president of the European Central Bank. S&P also downgraded US government debt at the start of August 2011.

What does July 2015 have in store for us?

I don’t have a crystal ball, but breakout above the trend channel on the ASX 200 daily chart would indicate the correction is over, suggesting another advance. Rising 21-day twiggs Money Flow indicates mild buying pressure.

ASX 200 Index

But it would be prudent to wait for confirmation, in case it turns into a bull trap like 2011.

ASX 200 Index

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Sources of stock-market fluctuations: New evidence | VOX

Interesting work by Dan Greenwald, Martin Lettau and Sydney Ludvigson on what moves the market.

There is little mystery that the real value of the stock market drifts upward over long periods in a largely predictable way as productivity (driven by technological progress) improves. This same deterministic trend has also propelled output per capita and the average standard of living upward over the last several centuries. It is instead the random shocks, the boom and busts around this trend, about which we have little knowledge, yet on which a continuous stream of media speculation centres. Such random shocks can persistently displace the market from its long-term trend for periods as long as several decades. What drives these movements in the market?

They identify 3 types of shocks that account for market fluctuations around the long-term trend:

  1. Productivity shocks which increase total output relative to inputs
  2. Factor shocks which increase/decrease the share of output paid to workers
  3. Changes in investor risk tolerance which affect their willingness to hold stocks.

For example a company may experience a surge in output through improved technology. The share of increased earnings paid to workers will determine the level of profits remaining for distribution to shareholders. I illustrated this recently in a graph of the inverse relationship between employee compensation and corporate profits as a percentage of value added.

Profits and Labor Costs as a percentage of Net Value Added

The current “Grexit” turmoil is an example of the third factor, investor risk tolerance, where output and factor shares are unaffected but investor willingness to hold stocks decreases. The increased risk premium demanded causes market valuations to fall while earnings are unaffected.

….We find that these shocks explain the vast majority (87%) of fluctuations in quarterly stock wealth growth, implying that we can decompose almost all of the variation in the US stock market into components corresponding to these three sources of economic variation. We find that:

When we measure variation in the stock market over short to intermediate horizons (i.e. over months, quarters and business cycle frequencies), fluctuations in stock market growth are dominated by shocks to risk tolerance that have no discernible effect on the real economy.

Over longer horizons (i.e., over years and decades), 40-50% of the variation in stock wealth growth can be attributed to factors share shocks–those that move the stock market in one direction and labour income in the other.

Shocks to productive technology have a very small effect on fluctuations in stock prices at all horizons.

Factor Shocks

This does not mean that we should ignore market valuation. High earnings multiples are more prone to shocks than low ones. But we can ignore secondary influences on risk premiums — I call them “media corrections” — caused by market noise. The study also confirms that fluctuations in factor shares (or profits as a percentage of value added) can last for more than a decade; so reversion of US profit margins to the mean may take some time.

Read more at Sources of stock-market fluctuations: New evidence | VOX, CEPR’s Policy Portal.

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Are US stocks really over-valued?

Let us start with Warren Buffet’s favorite market valuation ratio: stock market capitalization to GDP. I have modified this slightly, replacing GDP with GNP, because the former excludes offshore earnings — a significant factor for multinationals.

US stock market capitalization to GNP

The ratio of stock market capitalization to GNP now exceeds the highs of 2005/2006, suggesting that stocks are over-valued — approaching the heady days of the Dotcom era.

Corporate Profits

If we dig a bit deeper, however, while the ratio of market cap to sales is also high, market cap to corporate profits remains low.

US stock market capitalization to Business Sales and Corporate Profits

Clearly profit margins have widened, with corporate profits increasing at a faster rate than sales. The critical question: is this sustainable?

Sustainability of Profits

At some point profit margins must narrow in response to rising costs. Increases in aggregate demand may lift employment and sales, but also drive up labor costs.

Profits and Labor Costs as a percentage of Net Value Added

The brown line above depicts labor costs as a percentage of net value added, compared to corporate profits (blue) as a percentage of net value added. There is a clear inverse relationship: when labor costs rise, profit margins fall (and vice versa). At first the effect of narrower margins is masked by rising sales, but eventually aggregate profits contract when sales growth slows (gray stripes indicate past recessions).

Interest Rates and Taxes

Other contributing factors to high corporate profits are interest rates and taxes. Corporate profits (% of GNP) have soared over the last 30 years as bond yields have fallen. The benefit is two-fold, with lower interest rates reducing the cost of corporate debt and lower finance costs boosting sales of consumer durables.

Corporate Profits as % of GNP and AAA Bond Yields

Lower effective corporate tax rates (gray) have also contributed to the surge in profits as a percentage of GNP.

US stock market capitalization to GNP

The most enduring of these three factors (labor costs, interest rates, and tax rates) is likely to be taxes. Corporate tax rates have fallen in most jurisdictions and US rates are high by comparison. Even if a long-overdue overhaul of corporate taxation is achieved in the next decade (don’t hold your breath), the overall tax rate is likely to remain low.

If Not Now, When?

The other two factors (labor costs and interest rates) may not be sustainable in the long-term but it will take time for them to normalize.

Treasury yields are rising, with the 10-year at 2.37 percent. Breakout above 3.0 percent still appears some way off, but would confirm the end of the 35-year secular down-trend.

10-Year Treasury Yields Secular Trend

Interest rates are likely to remain low until rising labor costs force the Fed to adopt a restrictive stance.

Labor Costs as a percentage of Net Value Added

Labor markets have tightened to some extent, as indicated by the higher trough on the right of the above graph. But this is likely to be slowed by the low participation rate, with potential employees returning to the workforce, and a strong dollar enhancing the attraction of cheap labor in emerging markets.

Hourly earnings growth in the manufacturing sector remains comfortably below the Fed’s 2.0 percent inflation target. Any breakout above this level, however, would be cause for concern. Not only would the Fed be likely to raise interest rates, but profit margins are likely to shrink.

Manufacturing: Hourly Earnings Growth

For the present

None of the macroeconomic and volatility filters that we monitor indicate elevated market risk. I expect them to rise over the next two to three years as the labor market tightens and interest rates increase, but for the present we maintain full exposure to equities.

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Are US stocks really over-valued?

Stock Market Capitalization

Let us start with Warren Buffet’s favorite market valuation ratio: stock market capitalization to GDP. I have modified this slightly, replacing GDP with GNP, because the former excludes offshore earnings — a significant factor for multinationals.

US stock market capitalization to GNP

The ratio of stock market capitalization to GNP now exceeds the highs of 2005/2006, suggesting that stocks are over-valued — approaching the heady days of the Dotcom era.

Corporate Profits

If we dig a bit deeper, however, while the ratio of market cap to sales is also high, market cap to corporate profits remains low.

US stock market capitalization to Business Sales and Corporate Profits

Clearly profit margins have widened, with corporate profits increasing at a faster rate than sales. The critical question: is this sustainable?

Sustainability of Profits

At some point profit margins must narrow in response to rising costs. Increases in aggregate demand may lift employment and sales, but also drive up labor costs.

Profits and Labor Costs as a percentage of Net Value Added

The brown line above depicts labor costs as a percentage of net value added, compared to corporate profits (blue) as a percentage of net value added. There is a clear inverse relationship: when labor costs rise, profit margins fall (and vice versa). At first the effect of narrower margins is masked by rising sales, but eventually aggregate profits contract when sales growth slows (gray stripes indicate past recessions).

Interest Rates and Taxes

Other contributing factors to high corporate profits are interest rates and taxes. Corporate profits (% of GNP) have soared over the last 30 years as bond yields have fallen. The benefit is two-fold, with lower interest rates reducing the cost of corporate debt and lower finance costs boosting sales of consumer durables.

Corporate Profits as % of GNP and AAA Bond Yields

Lower effective corporate tax rates (gray) have also contributed to the surge in profits as a percentage of GNP.

US stock market capitalization to GNP

The most enduring of these three factors (labor costs, interest rates, and tax rates) is likely to be taxes. Corporate tax rates have fallen in most jurisdictions and US rates are high by comparison. Even if a long-overdue overhaul of corporate taxation is achieved in the next decade (don’t hold your breath), the overall tax rate is likely to remain low.

If Not Now, When?

The other two factors (labor costs and interest rates) may not be sustainable in the long-term but it will take time for them to normalize.

Treasury yields are rising, with the 10-year at 2.37 percent. Breakout above 3.0 percent still appears some way off, but would confirm the end of the 35-year secular down-trend.

10-Year Treasury Yields Secular Trend

Interest rates are likely to remain low until rising labor costs force the Fed to adopt a restrictive stance.

Labor Costs as a percentage of Net Value Added

Labor markets have tightened to some extent, as indicated by the higher trough on the right of the above graph. But this is likely to be slowed by the low participation rate, with potential employees returning to the workforce, and a strong dollar enhancing the attraction of cheap labor in emerging markets.

Hourly earnings growth in the manufacturing sector remains comfortably below the Fed’s 2.0 percent inflation target. Any breakout above this level, however, would be cause for concern. Not only would the Fed be likely to raise interest rates, but profit margins are likely to shrink.

Manufacturing: Hourly Earnings Growth

For the present

None of the macroeconomic and volatility filters that we monitor indicate elevated market risk. I expect them to rise over the next two to three years as the labor market tightens and interest rates increase, but for the present we maintain full exposure to equities.

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