The S&P 500 and Plan B

The S&P 500 penetrated its rising trendline, warning of a re-test of support at 3000. But selling pressure on the Trend Index appears to be secondary.

S&P 500

Transport bellwether Fedex retreated below long-term support at 150 on the monthly chart — on fears of a slow-down in international trade. Follow-through below 140 would strengthen the bear signal, offering a target of 100. The bear-trend warns that economic activity is contracting.

Fedex

Brent crude dropped below $60/barrel on fears of a global slow-down. Expect a test of primary support at 50.

Brent Crude

Dow Jones – UBS Commodity Index broke primary support at 76 on the monthly chart, also anticipating a global slow-down.

DJ-UBS Commodity Index

South Korea’s KOSPI Index is a good barometer for global trade. Expect a re-test of primary support at 250.

KOSPI

While Dr Copper, another useful barometer, warns that the patient (the global economy) is in need of medical assistance.

Copper (S1)

The Fed can keep pumping Dollars into financial markets but at some point, the patient is going to stop responding. In which case you had better have a Plan B.

Commodities & Global Growth

Commodity prices warn that the global economy is still in a slump.

The Dow Jones – UBS Commodity Index remains at one-third of its 2007 peak, with no sign of recovery.

DJ-UBS Commodity Index

The fall in crude prices hasn’t been as severe, but Brent Crude is again weakening and looks set for another test of $50/barrel.

Brent Crude

Shipping rates for dry bulk goods, such as iron ore and coal, have fallen, with the Baltic Dry Index close to long-term support at 500.

Baltic Dry Index

Supply interruptions to iron ore production in Brazil have cushioned Australian producers from a sharp down-turn in iron ore prices. But coal exporters are feeling the pinch.

RBA Chart Pack: Bulk Commodity Prices

Recovery of Brazilian production over the next two years is expected to add downward pressure to iron ore prices.

The only positive appears to be container shipping rates. The Harpex Index rose steeply in 2019, reflecting increased demand for container shipping of finished goods.

Harpex Index

Somewhat surprising, since this coincided with US-China trade tensions and tariff increases. The answer may lie with importers on both sides of the Pacific attempting to front-run the imposition of tariffs and build inventories in case of supply interruptions and to allow time to adapt their supply chain. Expect the index to retreat in the early part of 2020.

It looks like low global growth will continue.

S&P 500: Stocks lift but jobs and profits a red flag

The S&P 500 has advanced steadily since breaking resistance at 3000.

S&P 500

Lifted by Fed liquidity injections in the repo market.

S&P 500 and Fed Assets

Optimism over improved global trade has spread, with the DJ Euro Stoxx 600 breaking resistance at 400.

DJ Euro Stoxx 600

South Korea’s KOSPI completed a double-bottom reversal to signal an up-trend.

KOSPI

And India’s Nifty Index broke resistance at 12,000.

Nifty

Commodity prices remain low but rising Trend Index troughs on the DJ-UBS Commodity Index suggest that a bottom is forming.

DJ-UBS Commodity Index

Crude spiked up with rising US-Iran tensions but is expected to re-test support at 50 as supply threats fade.

Nymex Light Crude

Fedex recovered above primary support at 150, but the outlook for economic activity remains bearish.

Fedex

Falling US wages growth warns of slowing job creation.

Average Hourly Wages

Declining employment growth highlights similar weakness.

Employment Growth

Initial jobless claims, while not alarming, are now starting to rise.

Initial Claims

Growth in weekly hours worked has slowed, with real GDP expected to follow.

Real GDP and Weekly Hours Worked

While GDP growth is slowing, corporate profits (before tax) are also declining as a percentage of GDP.

Corporate profits Before Tax/GDP

Market Capitalization of equities has spiked to a ratio of 20 times Corporate Profits (before tax), an extreme only previously seen in the Dotcom bubble.

Market Cap/Corporate Profits before Tax

The market can remain irrational for longer than you or I can stay solvent, but this is a clear warning to investors to stay on the defensive.

We maintain our view that stocks are over-valued and will remain under-weight equities (over-weight cash) until normal earnings multiples are restored.

Fedex breaks support

Bellwether transport stock Fedex (FDX) broke long-term support at 150, warning of a decline with a long-term target of 100. A down-trend on Fedex has bearish implications for the broader economy, signaling that activity is declining.

Fedex

We have been here before: November 2007 – Fedex Warns of Worse to Come.

A down-turn in durable goods orders (adjusted for inflation) reinforces our bearish outlook.

Durable Goods Orders

The S&P 500 is retreating from resistance at 3000. Expect a test of support at 2800. Breach remains unlikely but would signal a reversal with a target of 2400.

S&P 500

With year-on-year earnings growth projected at a low 2.1% for the third quarter, the forward price-earnings ratio remains high at 18.97 times forecast earnings. A rough rule-of-thumb:

  • below 15 is a buy signal; and
  • above 20 is a sell signal.

But when long-term growth prospects are low, then both levels should be adjusted downward.

S&P 500 Forward PE

On the global front, crude has recovered from the attack on Saudi Arabia. Follow-trough below $55/barrel would signal another test of long-term support at $50. Trend Index peaks below zero warn of selling pressure.

Nymex Light Crude

DJ-UBS Commodity Index likewise displays Trend Index peaks below zero. Expect another test of support at 76. Breach would signal a (primary) decline.

DJ-UBS Commodities Index

The outlook for commodities — and the global economy — remains bearish.

We have reduced our equity exposure for International Growth to 36% of portfolio value because of our bearish outlook on the global economy.

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.

Global Times

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

Global Times

The inevitable Twitter tantrum ensued.

Donald Trump

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.

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.

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

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

S&P 500: Short-term versus long run

The market is excited at the prospect of Fed rate cuts (in response to the US-CCP trade war), with the S&P 500 headed for another test of its earlier high at 2950. A Trend Index trough above zero indicates short-term buying pressure.

S&P 500

Falling bond yields, however, warn of a flight to safety. 10-Year Treasury yields have fallen close to 120 basis points (bps) since late 2018, as investors shift from equities to bonds. Prices are being supported by stock buybacks rather than investor inflows.

10-year Treasury Yields

The Yield Differential between 10-year (purple) and 3-month (lime) Treasury yields is now negative, a reliable early warning of recession.

Yield Differential: 10-Year and 3-Month Treasuries

Corporate bond spreads, the difference between lowest investment grade (Baa) and Treasury yields, are rising. An indicator of credit risk, a spread above 2.5% (amber) is an early warning of trouble ahead, while 3.0% (red) signals that risk is elevated.

10-Year Baa minus Treasury Yield

Falling employment growth is another important warning. Annual employment growth below 1.0% (amber) would normally cause the Fed to cut interest rates. In the current scenario, that is almost certain.

Employment Growth & FFR

What is holding the Fed back is average hourly wages. Annual growth above 3.0% is indicative of a tight labor market and warns against cutting rates too hastily.

Average Hourly wage Rate

Stats for Q1 2019 warn that compensation is rising as a percentage of net value added, while profits are falling. As can be seen from the previous two recessions (gray bars), rising compensation (as % of NVA) normally leads to falling profits and a recession. Cutting interest rates would accelerate this.

Profits & Compensation % of Value Added

Annual GDP growth came in at 3.2% (after inflation) for the first quarter, but growth in hours worked is slowing. GDP growth is likely to follow.

Real GDP & Hours Worked

Personal consumption expenditure for Q1 was largely positive, with an uptick in services and non-durable goods. But consumption of durable goods fell sharply, warning that consumer confidence in the medium-to-long-term is declining.

Consumption

On the global stage, commodity prices are falling, indicating an anticipated drop in demand, especially from China.

DJ-UBS Commodity Index

Nymex crude is following, and expected to test support between $40 and $45 per barrel.

Crude Oil

Short-term prospects may appear reasonable, but the long-term outlook is decidedly negative.

In the short run, the market is a voting machine but in the long run, it is a weighing machine.

~ Benjamin Graham

Gold and Silver break support

The Dollar index retracement respected support at 97.50, confirming the advance. Follow-through above 98.00 would further strengthen the signal. Target for the advance is 100.

Dollar Index

10-Year Treasury yields penetrated the descending trendline, signaling that a base is forming around 2.50%. Rising troughs on the Trend Index also indicate support. Higher yields strengthen demand for Dollars.

10-Year Treasury Yield

The stronger Dollar is weakening demand for Gold. Declining Trend Index peaks warn of selling pressure. Spot Gold broke support at $1280/ounce, warning of a correction with a target of primary support at $1180.

Spot Gold in USD

Silver likewise broke support, at $15/ounce. Expect a test of primary support at $14.

Spot Silver in USD

The broad DJ-UBS Commodity Index continues to trend lower, in support of precious metals. Breach of primary support at 77 would warn of another decline.

DJ-UBS Commodity Index