Citi’s Ed Morse says that supply is growing faster than expected, while demand is contracting as recession fears grow. His base case is that crude will fall to $85 per barrel.
S&P 500: Stocks lift but jobs and profits a red flag
The S&P 500 has advanced steadily since breaking resistance at 3000.
Lifted by Fed liquidity injections in the repo market.
Optimism over improved global trade has spread, with the DJ Euro Stoxx 600 breaking resistance at 400.
South Korea’s KOSPI completed a double-bottom reversal to signal an up-trend.
And India’s Nifty Index broke resistance at 12,000.
Commodity prices remain low but rising Trend Index troughs on the DJ-UBS Commodity Index suggest that a bottom is forming.
Crude spiked up with rising US-Iran tensions but is expected to re-test support at 50 as supply threats fade.
Fedex recovered above primary support at 150, but the outlook for economic activity remains bearish.
Falling US wages growth warns of slowing job creation.
Declining employment growth highlights similar weakness.
Initial jobless claims, while not alarming, are now starting to rise.
Growth in weekly hours worked has slowed, with real GDP expected to follow.
While GDP growth is slowing, corporate profits (before tax) are also declining as a percentage of 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.
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.
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.
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.
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.
21-Day Volatility remains high and the recent trough above 1.0% warns of elevated risk.
The plunge on 10-Year Treasury Yields, testing support at 1.5%, also warns of a risk-off environment.
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.
The Footsie is similarly testing support at 7000.
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.
The outlook for the global economy is bearish and we have reduced our equity exposure for International Growth to 34% of portfolio value.
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.
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.
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.
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.
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.
DJ-UBS Commodity Index likewise displays Trend Index peaks below zero. Expect another test of support at 76. Breach would signal a (primary) decline.
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.
S&P 500 buying pressure but payrolls disappoint
August labor stats, released today, point to low real GDP growth for Q3. Growth in weekly hours worked came in at a low 1.09% and GDP is likely to follow.
While inflation is not the primary concern at the Fed right now, rising annual hourly wage rate growth (3.46% for total private) flags an increase in underlying inflationary pressure. This may make the Fed more hesitant about cutting rates despite Donald Trump’s tweet storm.
Most important is the continued decline in annual payroll growth. At 1.38% for August, further weakness is likely and a fall below 1.0% would warn of an economic slow-down.
The S&P 500 is headed for another test of resistance at 3000. The Trend Index oscillating above zero for the last 9 months indicates buying pressure but I expect strong resistance at 3000. Upside is limited while downside risks are expanding.
Semiconductors are doing better than expected, despite the trade war, but I suspect will weaken when the surge in orders ahead of tariffs tails off.
Retail has stalled since late 2018 and bearish divergence on the Trend Index suggests selling pressure.
Automobiles, in a decline since 2017, have rallied over the last 6 months. But, again, further weakness is expected.
On the global front, weak crude oil prices flag an anticipated slow-down in the global economy. Breach of support at $50/$51 per barrel would be a strong bear signal, warning of a decline to $40 per barrel.
We maintain our bearish outlook and have reduced equity exposure for international stocks to 40% of portfolio value.
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.
Followed by an admission that the timing of the announcement was intended to cause maximum disruption to US stock markets.
The inevitable Twitter tantrum ensued.
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.
Especially consumer durables such as light motor vehicles and housing.
The global economy is already contracting, as indicated by falling crude oil
…and commodity prices.
Volatility (21-Day) is rising as the S&P 500 tests support at 2840. Breach is likely and would test primary support at 2750.
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.
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.
Fedex breach of support at 150 would also warn of a primary down-trend and slowing activity in the US economy.
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.
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.
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.
The S&P 500 found support at 2850. Rising volatility warns of increased market risk. A test of support at 2750 remains likely.
Declining Money Flow on the Nasdaq 100 reflects rising selling pressure. Expect a test of 7000.
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.
India’s Nifty is testing support at 11,000. Breach would offer a target of 10,000.
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.
The Footsie is similarly testing support at 7150. Breach would offer a target of 6600.
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
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.
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.
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.
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.
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.
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.
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.
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.
Employment stats for July have improved slightly, with Average Hourly Wages growth easing to 3.3% (Total Private).
And annual payroll growth ticked up to 1.5%
But weekly hours worked are declining, warning that real GDP will decline further, after printing 2.3% for the second quarter.
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.
Falling commodity prices warn of declining global demand.
Declining crude prices reinforce the warning.
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.
Capital goods orders, adjusted for inflation, continue to decline.
Housing starts are steady but declining building permits warn of a slow-down ahead.
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.”
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.
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.
The Yield Differential between 10-year (purple) and 3-month (lime) Treasury yields is now negative, a reliable early warning of recession.
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.
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.
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.
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.
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.
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.
On the global stage, commodity prices are falling, indicating an anticipated drop in demand, especially from China.
Nymex crude is following, and expected to test support between $40 and $45 per barrel.
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