Santa rally: Monetary easing offsets China woes

China’s economy is struggling despite injection of moderate stimulus and efforts to support a collapsing real estate sector. Shrinking demand from China threatens a global economic contraction. G7 central banks have responded with monetary easing, causing a broad rally in stocks. This is most likely a bear market rally, with far shorter duration than a bull market.

China’s Shanghai Composite Index is testing primary support at 2900, warning of an economic contraction. The Trend Index peak near zero confirms selling pressure.

Shanghai Composite

Copper, however, has penetrated its descending trendline. Follow-through above 8500 would test resistance at $8750 per metric ton, threatening a wide double-bottom reversal with a target of $9500. Breakout above $8750 would signal global economic recovery, while reversal below $7800 would warn of a global recession.

Copper

US Stocks

The S&P 500 is testing it 2022 high at 4800, buoyed by injections of liquidity into financial markets.

S&P 500

The equal-weighted S&P 500 broke resistance at 6300, suggesting a broader rally than just the top 7 stocks. Retracement that respects the new support level would confirm the target at 6665.

S&P 500 Equal-Weighted Index ($IQX)

The Russell 2000 small caps ETF (IWM) threatens a similar breakout above 200, offering a target of 240. Breakout would confirm that investors are growing more aggressive (risk-on) and downplaying risks.

Russell 2000 Small Caps ETF (IWM)

Interest Rates

Ten-year Treasury yields are retracing to test resistance at 3.9% or 4.0%; respect is likely and would confirm the target of 3.5%.

10-Year Treasury Yield
An increase in supply of Treasury Notes will test bulls’ conviction next week:

A raft of fresh, post-Christmas government bond supply will put that comprehensive bullishness to the test. Next week, Treasury will auction $57 billion, $58 billion and $40 billion in two-, five- and seven-year notes, respectively. That’s up 20%, 15% and 7% from their average sizes over the past four monthly auctions. (Grant’s Current Yield)

The 2-year Treasury yield (purple below) is falling in anticipation of Fed rate cuts next year. A peak in the 2-year tends to lead the first rate cuts by 6 to 9 months. The signal misfired with the SVB banks crisis in March but the October peak warns of Fed rate cuts in Q2 or Q3 of 2024.
Fed Funds Rate Minimum Target & 2-Year Treasury Yield

International Stocks

The FTSE 100 is testing resistance at 7700, with a Trend Index trough at zero signaling buying pressure.

FTSE 100

The DJ Stoxx Euro 600 — reflecting the top 600 stocks in Europe — broke resistance at 470. Follow-through above 480 would test the 2022 high of 494.

DJ Euro Stoxx 600

Japan’s Nikkei 225 is testing long-term resistance at 33750. Breakout would signal a fresh primary advance but declining Trend Index peaks show a lack of commitment from buyers.

Nikkei 225 Index

The ASX 200 is testing resistance at 7600, buoyed by strong iron ore prices and falling long-term bond yields. A sharp rise in the Trend Index indicates buying pressure but reversal below 7400 would warn of a correction to test support at 7000.

ASX 200

Gold & the Dollar

The US Dollar Index respected resistance at 102.50, confirming the target at 100. Trend Index peaks below zero signal strong selling pressure.

Dollar Index

Gold broke through resistance at $2050, closing at $2053 per ounce. Expect retracement to test the new support level; respect would confirm another attempt at $2100. A falling Dollar and increased bullion demand from central banks is expected to maintain upward pressure on Gold prices.

Spot Gold

Conclusion

Stocks are rallying in response to falling long-term Treasury yields and in anticipation of Fed rate cuts next year. But falling LT Treasury yields is a medium-term rally in a long-term bear market, with LT yields expected to rise in 2025. Fed rate cuts are also a bearish sign, normally preceding a recession by several quarters — falling earnings are definitely not bullish for stocks.

Investors will need to be agile, to take advantage of the current bullishness in stocks while guarding against:

  • a trend reversal in long-term yields; and
  • signs that the broad economy is falling into recession.

Vacation

This is our last newsletter of the year as we close our office for two weeks over Christmas and the New Year.

We wish all our readers peace and goodwill over the festive season and hope for a less tumultuous year ahead.

The Magpie by Claude Monet

The Magpie by Claude Monet

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.

S&P 500 and Europe: New deal or a false dawn?

Donald Trump and is making noises about an interim trade deal with the CCP, while Boris Johnson appears to be making progress on a Brexit deal with Ireland premier Leo Varadkar.

Trump’s announcement is little more than a sham, intended to goose financial markets, with nothing yet committed to writing:

“Trump said the deal would take three to five weeks to write and could possibly be wrapped up and signed by the middle of November….”

…what could possibly go wrong?

The economy continues to tick along steadily, with unemployment and initial jobless claims near record lows.

Unemployment & Initial Jobless Claims

But high levels of uncertainty are likely to create a drag on consumer spending and stock earnings.

At the outset of Donal Trump’s presidency, value investor Seth Klarman, who runs the $30 billion Baupost Group hedge fund, predicted the impact that Trump would have on financial markets:

“The erratic tendencies and overconfidence in his own wisdom and judgment that Donald Trump has demonstrated to date are inconsistent with strong leadership and sound decision-making…..

The big picture for investors is this: Trump is high volatility, and investors generally abhor volatility and shun uncertainty…. Not only is Trump shockingly unpredictable, he’s apparently deliberately so; he says it’s part of his plan.”

In his letter, Mr Klarman warned: “If things go wrong, we could find ourselves at the beginning of a lengthy decline in dollar hegemony, a rapid rise in interest rates and inflation, and global angst.”

While not entirely prescient — we have low interest rates and low inflation — Klarman was right about the decline in dollar hegemony and the rise in global angst.

Markets are clearly in risk-off mode.

US Equity ETFs recorded a net outflow of $824m this week, compared to a net inflow of $2,104m into US Fixed Income. Year-to-date flows present a similar picture, with a 3.3% inflow into US Equity compared to 13.9% into US Fixed Income (Source: ETF.com).

ETF Flows YTD

Long tails on the S&P 500 candles indicate buying support. Expect another test of our long-term target at 3000. Volatility remains above 1%, however, indicating elevated risk. Breach of 2800 is unlikely at present but would offer a target of 2400.

S&P 500

According to Factset, the S&P 500 is likely to report a third quarter this year with a year-on-year decline in earnings.

S&P 500 Earnings

The Nasdaq 100 paints a similar picture, with another test of 8000 likely.

Nasdaq 100

It is becoming impossible to justify current heady earnings multiples when reported earnings are declining.

Europe

If Johnson’s “free trade zone” for Northern Ireland can break the Brexit impasse, then there may be room for optimism over the future UK – EU relationship.

Europe seems to be stirring. Trailing a distant third, to North America and Asia in terms of investment performance, there are some early encouraging signs. A higher trough indicates buying pressure and breakout above 400 on DJ Stoxx Euro 600 would signal a primary advance.

DJ Euro Stoxx 600

The Footsie shows similar early signs of a potential recovery. A higher trough on the trend Index indicates buying pressure. Breakout above 7600 would signal a primary advance.

FTSE 100

Let us hope that this is not a false dawn and the UK and EU are able to resolve their differences.

For the present, our outlook for the global economy remains bearish and equity exposure for International Growth is a low 34% of portfolio value.

S&P 500 survives but risk is elevated

Our recession indicator, a 3-month TMO of seasonally adjusted non-farm payrolls, ticked up slightly to 0.52%. This reflects a slight improvement in monthly employment data but the indicator remains precariously close to the amber (high risk) warning level of 0.50%. The red warning level of 0.30% would signal extreme risk of recession.

Non-Farm Payrolls Recession Indicator

During the week we discussed the high cost of uncertainty and how this impacts on business investment and consumer spending. Slowing growth in hours worked suggests that real GDP growth is likely to slow towards an annual rate of 1.0%. This would obviously be a drag on stock earnings.

Real GDP and Hours Worked

The S&P 500 retreated from resistance at 3000 but a long tail on this week’s candle indicates buying support. Another test of 3000 is likely. Breach of 2800 is unlikely at present but would signal a reversal with a target of 2400.

S&P 500

21-Day Volatility remains high and the recent trough above 1.0% warns of elevated risk.

S&P 500 21-Day Volatility

The plunge on 10-Year Treasury Yields, testing support at 1.5%, also warns of a risk-off environment.

10-Year Treasury Yields

On the global stage, low manufacturing purchasing managers index (PMI)  warn that Europe is at risk of recession.  DJ Euro Stoxx 600 is retracing to test support at 360/366. Breach would signal a primary down-trend.

DJ Euro Stoxx 600

The Footsie is similarly testing support at 7000.

FTSE 100

Nymex Crude is heading for a test of support at $50/barrel. Trend Index peaks below zero warn of selling pressure. Breach of support would signal a primary down-trend — suggesting a contraction in global demand.

Nymex Light Crude

The outlook for the global economy is bearish and we have reduced our equity exposure for International Growth to 34% of portfolio value.

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

The eye of the storm

“On Wednesday, the US Department of Commerce added Huawei – and 70 other companies – to its “Entity List.” …. Huawei cannot buy parts or components from US companies without the explicit approval of the US government.” (Trivium China)

We are sliding towards a fully-fledged trade war. Following straight after the imposition of tariffs by both the US and China, US action against Huawei will be taken as a direct attack on Chinese industry.

The CCP is already stoking nationalist sentiment to bolster public support.

“Last night and today, CCTV replaced regularly scheduled programming with two films about the Chinese army fighting the US in the Korean War.” (Trivium China)

Market response is so far muted. On the daily chart, the S&P 500 correction is modest. Expect another test of 2800. Breach would offer a target of 2600.

S&P 500

The Nasdaq 100 retreated below its new support level at 7700 but Money Flow remains strong.

Nasdaq 100

China’s Shanghai Composite found support at 2900.

Shanghai Composite Index

Japan’s Nikkei 225 is ranging between 20000 and 24000. Expect another test of primary support at 20000.

Nikkei 225

India’s Nifty is testing support at 11000. Respect would confirm the primary up-trend.

Nifty Index

In Europe, The DJ Euro Stoxx 600 is undergoing a correction that is likely to test support at 365. But Trend Index above zero continues to signal buying support.

DJ Euro Stoxx 600

The Footsie found support at 7200, with Trend Index again signaling buying support.

FTSE 100

10-Year Treasury yields are testing support at 2.40%. One of the few clear signs that markets are growing increasingly risk averse, as demand for bonds drives down yields.

10-Year Treasury Yields

Robust US employment but global bear market warning

The US economy remains robust, with hours worked (non-farm) ticking up 2.2% in January, despite the government shutdown. Real GDP growth is expected to follow a similar path.

Real GDP and Hours Worked

Average hourly earnings growth increased to 3.4% p.a. for production and non-supervisory employees (3.2% for all employees). The Fed has limited wiggle room to hold back on further rate hikes if underlying inflationary pressures continue to rise.

Average Wage Rate Growth

History shows that the Fed lifts short-term interest rates more in response to hourly wage rates than core CPI.

Average Wage Rate Growth, Core CPI and 3-Month T-Bills

The Leading Index from the Philadelphia Fed ticked down below 1% (0.98%) for November 2018. While not yet cause for concern, it does warn that the economy is slowing. Further falls, to below 0.5%, would warn of a recession.

Leading Index

Markets are anticipating a slow-down, triggered by falling demand in China more than in the US.

S&P 500 volatility remains high and a large (Twiggs Volatility 21-day) trough above 1.0% (not zero as stated in last week’s newsletter) on the current  rally would signal a bear market. Retreat below 2600 would strengthen the signal.

S&P 500

Crude prices have plummeted, anticipatiing falling global (mainly Chinese) demand. Another test of primary support at $42/barrel is likely.

Light Crude

Dow Jones-UBS Commodity Index breached primary support at 79, signaling a primary decline with a target of 70.

DJ-UBS Commodity Index

China’s Shanghai Composite Index is in a bear market. Respect of resistance at 2700 would confirm.

Shanghai Composite Index

Bearish divergence on India’s Nifty also warns of selling pressure. Retreat below 10,000 would complete a classic head-and-shoulders top but don’t anticipate the signal.

Nifty Index

DJ Stoxx Euro 600 rallied but is likely to respect resistance at 365/370, confirming a bear market.

DJ Stoxx Euro 600 Index

The UK’s Footsie also rallied but is likely to respect resistance at 7000. Declining Trend Index peaks indicate selling pressure, warning of a bear market.

FTSE 100 Index

My conclusion is the same as last week. This is a bear market. Recovery hinges on an unlikely resolution of the US-China ‘trade dispute’.

Concessions to adversaries only end in self reproach, and the more strictly they are avoided the greater will be the chance of security.

~ Thucydides (460 – 400 B.C.)

Risk averse rather than fearful

The S&P 500 is again testing the band of primary support between 2600 and 2550. Follow-through below this level would warn of a bear market. Volatility (21-day) is in the amber zone between 1% and 2%. A real test of market resilience will be the next sizable rally or advance. If declining volatility remains above 1%, that would warn of an imminent market sell-off.

S&P 500

The Nasdaq 100 is in a similar position, with declining Money Flow warning of medium-term selling pressure.

Nasdaq 100

Of the big five tech stocks, only Microsoft looks strong. Facebook is in a primary down-trend but Apple and Google are testing primary support. Apple’s exposure to China is obviously a concern. China accounts for roughly 25% of Apple’s global market but Apple estimates that it is responsible for 4.8 million jobs in China which gives them some negotiating clout.

Big Five tech stocks

If two more of the big five broke primary support, that would in my opinion signal a bear market.

Asia

The Shanghai Composite Index is consolidating in a narrow band below 2700. Downward breakout is likely and would signal another decline, with a target of 2300.

Shanghai Composite Index

India’s Nifty is testing resistance at 11,000. Respect would be bearish, warning of another test of primary support at 10,000. Declining peaks on the Trend Index warn of long-term selling pressure.

NSX Nifty

Europe

Dow Jones Euro Stoxx is in a primary down-trend. Follow-through below 350 confirms a bear market, warn of a decline to test 305/310.

DJ Euro Stoxx 600

The Footsie also broke primary support at 6900. Retracement is testing the new resistance level but respect of 7000 is likely and would confirm a bear market, with a target between 5600 and 6000.

FTSE 100

There is a high level of uncertainty in global markets at present. Europe has Brexit and Italy. The US has investigations into Donald Trump’s election campaign. China has the threat of a trade war with the US. But my sense is that the market has become risk averse rather than fearful. There is no sign of panic selling as yet. But investors are clearly on the defensive and prepared to sell off vulnerable stocks.

Adopt the pace of nature: her secret is patience.

~ Ralph Waldo Emerson

Europe cracks but US steady

Dow Jones Euro Stoxx 600 followed through below 350, confirming a bear market in Europe. A Trend Index peak below zero warns of strong selling pressure. Expect a decline to test 305/310.

DJ Euro Stoxx 600

The Footsie broke support at 6900, signaling a primary down-trend, while a Trend Index peak at zero warns of selling pressure. Expect a decline, with a target of 6000.

FTSE 100

US markets are high on volatility but low on direction.

The S&P 500 continues to range between 2600 and 2800. Breach of 2600 would warn of a primary decline but rising volatility does not flag immediate danger. A large trough above 1% extending over at least six to eight weeks, however, would warn of elevated risk.

S&P 500

The Nasdaq 100 shows a W-shaped bottom above primary support at 6500. Declining Money Flow is still above the zero line suggesting that the sell-off is secondary in nature.

Nasdaq 100

Last week I mentioned that bellwether transport stock Fedex had breached primary support but quarterly Fedex Express package shipments were rising in August 2018. Statistics for Q2, to November 30, are due for release on December 18 and I expect will reflect a robust economy.

Fedex

East to West

The S&P 500 put in a strong blue candle this week but one swallow doesn’t make a summer. Follow-through above 2800 would signal a test of 2950. Small bullish divergence on Twiggs Money Flow looks promising but is secondary in nature and may not alter the larger trend.

S&P 500

The Nasdaq 100 shows a similar W-shaped bottom but weaker divergence.

Nasdaq 100

Bellwether transport stock Fedex recovered above the former primary support level at 225 but still looks weak. Reversal below 220 would warn of another decline.

Fedex

Asia

The Shanghai Composite Index rally ran out of steam. Respect of 2700 warns of another decline, with a target of 2300.

Shanghai Composite Index

India’s Nifty is headed for a test of 11,000. Respect would be bearish, warning of another test of primary support at 10,000. Declining peaks on the Trend Index warn of long-term selling pressure.

NSX Nifty

Australia

The ASX 200 is testing primary support at 5650 following a down-turn on the mining index. Bullish divergence on Twiggs Money Flow has now rolled over, with penetration of the rising trendline. Breach of primary support would warn of a decline, with a target of 5000.

ASX 200

Europe

Dow Jones Euro Stoxx warns of a bear market. Breach of primary support at 365, and respect of the new resistance level on the subsequent retracement, warn of a decline to test 305/310.

DJ Euro Stoxx 600

The Footsie is testing support at 6900, while bearish divergence on the Trend Index warns of selling pressure. Breach would signal a decline, with a target between 5600 and 6000.

FTSE 100

Never cut a tree down in the wintertime. Never make a negative decision in the low time. Never make your most important decisions when you are in your worst moods. Wait. Be patient. The storm will pass. The spring will come.

~ Robert Schuller