Tag: S&P 500

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S&P 500: Plan B

The S&P 500 is testing its all-time high at 2950. Bearish divergence on Twiggs Money Flow warns of secondary selling pressure. Respect of resistance is likely and would signal retracement to test support at 2750.

S&P 500

The 10-Year Treasury yield has fallen to 2.0%, indicating that the Fed is expected to cut interest rates in the second half of 2019.

10-Year Treasury yield

Stocks are still running on hope of a deal in the US-China trade dispute. Xi Jinping and Donald Trump will meet this weekend to discuss the way forward. Chinese preconditions for a trade agreement are likely to include the US lifting its ban on the sale of technology to telecommunications giant Huawei and removal of US tariffs on Chinese imports, according to The Wall St Journal. The US is unlikely to accede and chances of a deal are slim to nonexistent.

Trump doesn’t seem concerned: “My Plan B with China is to take in billions and billions of dollars a month and we’ll do less and less business with them……My plan B’s maybe my plan A.” (Bloomberg)

Plan B is the likely outcome, with a moderate impact on US corporate earnings and Fed rate cuts to keep the market on track. Risks rise while the potential upside declines. It’s a good time to be cautious.

We must recognize that as the dominant power in the world we have a special responsibility. In addition to protecting our national interests, we must take the leadership in protecting the common interests of humanity……There is no other country that can take the place of the United States in the foreseeable future. If the United States fails to provide the right kind of leadership our civilization may destroy itself. That is the unpleasant reality that confronts us.

~ George Soros: The Age of Fallibility

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A good time to be cautious

Markets are buoyant with the S&P 500 headed for another test of its all-time high at 2950. Bearish divergence on Twiggs Money Flow warns of secondary selling pressure but the overall technical outlook looks promising.

S&P 500

So why should it not be a good time to invest in stocks?

First, the yield curve warns of a recession in the next 6 to 18 months. The 10-year Treasury yield is below the yield on 3-month T-bills, indicating a negative yield curve. This is our most reliable recession signal, with 100% accuracy since the early 1960s.

Yield Differential

Annual jobs growth has declined since January. Further declines in the next few months would further strengthen the recession warning.

Annual Growth in Total Payrolls

Small cap stocks in the Russell 2000 lag well behind the S&P 500, indicating that investors are de-risking.

Russell 2000 ETF

Cyclical sectors like Automobiles & Components also offer an early warning, anticipating slower consumer spending on durables such as housing, clothing and automobiles.

S&P 500 Automobiles & Parts

Lastly, the historic Price-Earnings ratio is above 20 (PE and PEmax are equal at present), indicating stocks are over-priced.

S&P 500 historic PE ratio based on highest prior earnings

It’s a good time to be cautious.

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S&P 500 hesitancy

This week’s doji on the S&P 500 signals hesitancy. Reversal below the mid-point of the previous week’s candle would complete a bearish doji star reversal. Breach of support at 2750 would further strengthen the bear signal, warning of a test of 2400.

S&P 500

Small caps are a lot weaker, with the Russell 2000 (iShares ETF) testing support at 145. Breach would warn of a test of primary support.

Russell 2000 Small Caps

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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

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Trade war reality sinks in

Realization that we are slipping into a trade war is starting to sink in.

The S&P 500 broke medium-term support at 2800, warning of a correction. The target is primary support at 2400. Volatility is flashing an amber warning, above 1.0%.

S&P 500

Nymex crude is plunging as anticipated global demand falls.

Crude Oil

Long-term Treasury yields are falling, with the 10-Year headed for a test of support at 2.0%. The Yield Differential (purple line) is back below zero, warning of a recession.

Yield Differential: 10-Year and 3-Month Treasuries

As I have mentioned earlier, a negative yield curve is a reliable early indicator of recession but trouble is imminent when it recovers above zero. Normally caused by the Fed cutting interest rates in response to falling employment growth. The critical indicator to watch is non-farm payroll growth. When that falls below 1.0% (right-hand scale), watch out!

Employment Growth and Fed Funds Rate

War is an evil thing; but to submit to the dictation of other states is worse…. Freedom, if we hold fast to it, will ultimately restore our losses, but submission will mean permanent loss of all that we value…. To you who call yourselves men of peace, I say: You are not safe unless you have men of action on your side.

~ Thucydides (circa 400 BC)

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S&P 500 and the trade war

We are now headed for a full-blown trade war. Donald Trump may have highlighted the issue but this is not a conflict between him and Xi — it should have been addressed years ago — nor even between China and the West. Accusations of racism are misguided. This is a conflict between totalitarianism and the rule of law. Between the CCP (with Putin, Erdogan, and the Ayatollahs in their corner) and Western democracy.

Australia will be forced to take sides. China may be Australia’s largest trading partner but the US & UK are it’s ideological partners. I cannot see the remotest possibility of Australia selling out its principles for profits, no matter how tempting the short-term rewards (or threatened hardships). We have a proud history of standing up against oppression and exploitation.

Disruptions to supply chains and supply contracts in the US (and China) are going to be significant and are likely to impact on earnings. The S&P 500 reaction is so far muted, with retracement testing medium-term support at 2800. There is also no indication of selling pressure on the Trend Index. Nevertheless, a breach of 2800 is likely and would warn of a test of primary support at 2400.

S&P 500

Falling Treasury yields highlight the outflow from equities and into bonds. Stock buybacks are becoming the primary inflow into stocks.

10-Year Treasury Yields

However, corporate bond spreads — lowest investment grade (Baa) yields minus the equivalent Treasury yield — are still well below the 3.0% level associated with elevated risk.

S&P 500

Profits may fall due to supply disruption (similar to 2015 on the chart below) but the Fed is unlikely to cut interest rates unless employment follows (as in 2007). Inflation is likely to rise as supply chains are disrupted but chances of a rate rise are negligible. Fed Chairman Jay Powell’s eyes are going to be firmly fixed on Total Non-farm Payrolls. If annual growth falls below 1.0% (RHS), expect a rate cut.

S&P 500

This excerpt from a newsletter I wrote in April 2018 (Playing hardball with China) is illuminating: “In 2010, Paul Krugman wrote:

Some still argue that we must reason gently with China, not confront it. But we’ve been reasoning with China for years, as its surplus ballooned, and gotten nowhere: on Sunday Wen Jiabao, the Chinese prime minister, declared — absurdly — that his nation’s currency is not undervalued. (The Peterson Institute for International Economics estimates that the renminbi is undervalued by between 20 and 40 percent.) And Mr. Wen accused other nations of doing what China actually does, seeking to weaken their currencies “just for the purposes of increasing their own exports.”

But if sweet reason won’t work, what’s the alternative? In 1971 the United States dealt with a similar but much less severe problem of foreign undervaluation by imposing a temporary 10 percent surcharge on imports, which was removed a few months later after Germany, Japan and other nations raised the dollar value of their currencies. At this point, it’s hard to see China changing its policies unless faced with the threat of similar action — except that this time the surcharge would have to be much larger, say 25 percent.

I don’t propose this turn to policy hardball lightly. But Chinese currency policy is adding materially to the world’s economic problems at a time when those problems are already very severe. It’s time to take a stand.

Krugman (no surprise) now seems more opposed to trade tariffs but observes:

….I think it’s worth noting that even if we are headed for a full-scale trade war, conventional estimates of the costs of such a war don’t come anywhere near to 10 percent of GDP, or even 6 percent. In fact, it’s one of the dirty little secrets of international economics that standard estimates of the cost of protectionism, while not trivial, aren’t usually earthshaking either.”

Trump has to show that he is prepared to endure the hardships of a trade war and not kowtow to Beijing. But the chances of a reasonable response are unlikely.

Men naturally despise those who court them, but respect those who do not give way to them.

~ Thucydides (circa 400 BC)

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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

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S&P 500: No deal

It looks like there will be no trade deal any time soon.

“Trade talks between China and the United States ended on Friday without a deal as President Trump raised tariffs on $200 billion worth of Chinese imports and signaled he was prepared for a prolonged economic fight….. Trump is now moving ahead with plans to impose 25 percent tariffs on all remaining Chinese imports. Those new tariffs could go into effect in a matter of weeks.” (New York Times)

Signature of a document was always going to be more theater than substance. Earlier in Bloomberg:

“U.S. President Donald Trump has good reason to be skeptical about China’s willingness to live up to its commitments in any trade deal. Seasoned foreign business executives on the mainland know that any agreement there represents the start of a bargaining process, not the end….”

Response of stock markets, to signs that negotiations had reached an impasse, were muted. The pull-back on the S&P 500 is modest.

S&P 500

The Nasdaq 100 retreated below its new support level at 7700 but the Trend Index remains strong.

Nasdaq 100

China’s Shanghai Composite is undergoing a correction but this week’s long tail suggests selling pressure is moderate.

Shanghai Composite Index

The yuan fell sharply, acting as a shock-absorber.

Chinese Yuan/US Dollar

Stocks like Boeing and Apple may be re-rated but the broad view of the market seems largely unchanged.

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Employment lifts but S&P 500 tentative

Growth in total non-farm payrolls ticked up to 1.76% for the 12 months to April 2019, supporting Fed reluctance to cut interest rates.

Payroll Growth

The Philadelphia Fed Leading Index has been revised upwards, above a comfortable 1.0%.

Leading Index

Real GDP growth came in at a healthy 3.2% for the 12 months ended 31 March 2019 but growth in total hours worked sagged to 1.47%, suggesting that GDP growth is likely to slow.

Real GDP and Total Hours Worked

Growth in average hourly earnings came in at 3.23% (total private), suggesting that inflationary pressures remain under control. Little chance of a Fed rate hike either.

Average Hourly Earnings

The S&P 500 retracement respected support at 2900. Rising Money Flow indicates buying pressure but gains seem tentative.

S&P 500

US growth looks to continue but commodity prices warn that global growth is slowing.

Nymex crude penetrated its lower trend channel, warning of a correction. Despite the supply impact of increasing sanctions on Iran and Venezuela, and the threat of supply disruption in Libya.

Nymex Light Crude

A similar correction on DJ-UBS Commodities index reinforces that global demand is slowing.

DJ-UBS Commodities Index

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Nasdaq breaks resistance

Real GDP growth came in at a healthy 3.2% for the 12 months ended 31 March 2019. Growth in total hours worked is lagging below 2.0%, suggesting that further acceleration is unlikely.

Real GDP and Total Hours Worked

Growth in total non-farm payrolls continues at close to 2.0%, minimizing the chance of an interest rate cut by the Fed.

Payroll Growth

The S&P 500 is testing its previous high at 2940, while a rising Trend Index (13-week) indicates buying pressure.

S&P 500

The Nasdaq 100 broke resistance at 7700, signaling another advance. Expect retracement to test the new support level. The long-term target is 9000.

Nasdaq 100

A rapid advance would outstrip earnings growth, with high earnings multiples warning of elevated risk. The market is quite capable of continuing this behavior for an extended time but I urge readers to be cautious and look for rising sales and earnings to support the stock price.

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