Tag: S&P 500

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Bearish divergence warns of tech stock retracement

The US recorded more than 75,000 new COVID19 cases on July 16th. The CCP must be smiling behind their masks after successfully containing last month’s outbreak in Beijing.

COVID19 Daily New Cases

Source JHU CSSE

Technology stocks have screamed upwards despite the chaos, but bearish divergence on Twiggs Money Flow now warns of selling pressure. Expect retracement to test support at 2650 on the Dow Jones US Technology Index.

DJ US Technology Index

Dow Jones Banks Index is a more realistic representation of the broader US economy. The weak rally has fizzled out, with a Money Flow peak at zero now warning of strong selling pressure. Breach of short-term support at 320 would signal another test of primary support at 270/280.

DJ US Banks Index

Government support can only cushion the impact of a massive surge in unemployment for a limited time. Then we will witness the full extent of the damage.

Continued unemployment claims jumped to 17.355 million on July 4th, up by 840,000 from a week earlier. Judging by the rising virus count, further increases are likely.

Continuous Claims

But that is only the tip of the iceberg.

The latest Department of Labor update shows 32 million people claimed unemployment insurance benefits in all programs for the week ending June 27.

Department of Labor: PERSONS CLAIMING UI BENEFITS IN ALL PROGRAMS

…..21% of the 152.4 million non-farm workforce in February 2020.

Pandemic Unemployment Assistance (PUA) under the CARES Act, signed into law on March 27, 2020 provides benefits to those individuals “not eligible for regular unemployment compensation or extended benefits under state or Federal law or pandemic emergency unemployment compensation (PEUC), including those who have exhausted all rights to such benefits.”

The S&P 500 is inching upwards, reflecting the tug-of-war between technology stocks and the broader market. We expect retracement of the Technology Index to cause another test of support at 3000 (on the S&P 500).

S&P 500

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A worm in the Apple

Apple Inc (AAPL) enjoyed stellar growth over the past 12 months, jumping more than 50%.

Apple Inc (AAPL)

But is that due to solid operating performance or window-dressing, with almost $140 billion of stock buybacks in the last two years?

Apple Inc (AAPL)

Free cash flow — operating cash flow less stock compensation and investment in plant and equipment — has been falling since 2015.

Apple Inc (AAPL)

And the company has depleted its cash reserves over the last two years, to fund stock buybacks. The graph below depicts the change in Apple’s net cash position (cash plus marketable securities less debt).

Apple Inc (AAPL)

So why the management enthusiasm for stock buybacks?

Is the stock a good investment? No. Free cash flow per share has barely lifted since 2015 despite $237.5 billion used to repurchase 1144 million shares.

Apple Inc (AAPL)

Apple have returned surplus cash to stockholders in the most tax-efficient way possible, by buying back stock rather than paying dividends. The added bonus is the reduced share count which gooses up earnings per share growth and return on equity.

Apple Inc (AAPL)

Investors in turn get excited and run up earnings multiples. The current price/free cash flow ratio of 23.2 exceeds that of the heady growth days up to 2015.

Apple Inc (AAPL)

The stock keeps climbing, supported by buybacks and rosy EPS projections. The problem for Apple is when they run out of cash, or exceed reasonable debt levels, then the band will stop playing and those heady multiples are likely to come crashing down to earth.

It’s not only Apple that’s doing this. The entire S&P 500 is distributing more by way of buybacks and dividends than it makes in earnings, eating into reserves meant to fund new investment.

S&P 500 Buybacks & Dividends

The result is likely to be low growth and even more precarious earnings multiples.

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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.

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S&P 500 in a precarious position

A long-term chart of the S&P 500 highlights the precarious position of the index, having now doubled since its October 2007 high at 1576. Any time that a stock doubles in price, you are likely to get profit-taking, leading to resistance. The same holds true for the index. Probably even more so because individual stocks have the capacity to post higher gains — of even 5 or 10 times — while that isn’t feasible for the index. Even in the Dotcom bubble.

S&P 500

On the one hand we have a massive triple stimulus creating irrational exuberance, while on the other we have concerns over a coronavirus epidemic spreading from China and Donald Trump’s looming impeachment.

CoronaVirus

If you think that Trump is a shoe-in for re-election in November, this analysis of his chances is quite eye-opening.

Trump: Long Shot rather than a Slam Dunk

Expect more erratic behavior in the lead up to November.

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Playing the long game

Chart for the Week

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

Corporate profits Before Tax/GDP

Yet the S&P 500 and other major indices are rising, lifted by Fed liquidity injections in the repo market. The red line shows total assets on the Fed’s balance sheet.

S&P 500 and Fed Assets

The Long Game

We play the long game — reducing exposure to equities when market risks are high and staying on the defensive until normality is restored — even if this means sitting on cash while equities rise. The only alternative, unless you trust your ability to accurately identify exact market tops and bottoms, is to hang on to your positions no matter what happens. But there are few individuals who can withstand the stress and make rational decisions during a major market draw-down.

Updates for Market Analysis Subscribers

Best wishes for the New Year. It promises to be an eventful one.

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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.

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What is causing the current S&P 500 rise and how is it likely to end?

In November 2007, six months after the inverted yield curve (3M-10Y) recovered to a positive slope, bellwether transport stock Fedex broke primary support at 100 to warn of an economic slow-down.

Today, two months after rate cuts restored an inverted yield curve to positive, Fedex again broke primary support, this time at 150. Their CEO observed that the stock market might be booming but the “industrial economy does not reflect any growth at all.”

Fedex

Real GDP growth is slowing, with our latest estimate, based on weekly hours worked, projecting GDP growth of 1.5% for the calendar year.

Real GDP and Weekly Hours Worked

While real corporate profits are declining.

Corporate Profits Before Tax adjusted for Inflation

What is keeping stocks afloat?

First, a flood of new money from the Fed. They expanded their balance sheet by $375 billion since September 2019 and are expected to double that to $750 billion — bringing total Fed holdings to $4.5 trillion by mid-January — to head off an expected liquidity crisis in repo and FX swap markets. The red line below shows expansion of the Fed’s balance sheet, the blue is the S&P 500 index.

S&P 500 and Fed Assets

Second, ultra-low bond yields have starved investment markets of yield, boosting earnings multiples. P/E of historic earnings rose to 22.01 at the end of the September quarter and is projected to reach 22.82 in the December quarter (based on current S&P earnings estimates).

S&P 500 P/E (maximum of previous earnings)

That is significantly higher than the peak earnings multiples achieved before previous crashes — 18.86 of October 1929 and 18.69 in October 1987 — and is only surpassed by the massive spike of the Dotcom bubble.

How could this end?

First, if the Fed withdraws (or makes any move to withdraw) the $750 billion temporary liquidity injection, intended to tide financial markets over the calendar year-end, I expect that the market would crash within minutes. They are unlikely to be that stupid but we should recognize that the funding is permanent, not temporary.

Second, if bond yields rise, P/E multiples are likely to fall. 10-Year breakout above 2.0% would signal an extended rise in yields.

10-Year Treasury Yields

China has slowed its accumulation of US Dollar reserves, allowing the Yuan to strengthen against the Dollar (or at least weaken at a slower rate). Reduced Treasury purchases are causing yields to rise. The chart below shows in recent months how Treasury yields have tracked the Yuan/US Dollar (CNYUSD) exchange rate.

CNYUSD

Accumulation of USD foreign exchange reserves (by China) is likely to be a central tenet of US trade deal negotiations — as they were with Japan in the 1985 Plaza Accord. Expect upward pressure on Treasury yields as growth in Chinese holdings slows and possibly even declines.

Third, and most importantly, are actual earnings. With 98.6% of S&P 500 companies having reported, earnings for the September quarter are 6.5% below the same quarter last year. Poor Fedex results and low economic growth warn of further poor earnings ahead.

We maintain our view that stocks are over-priced and that investors need to exercise caution. We are over-weight cash and under-weight equities and will hold this position until normal P/E multiples are restored.

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S&P 500 recovers but employment gains sluggish

Short retracement on the S&P 500 that respected support at 3000 strengthens the bull signal. Further gains are expected in the short- to medium-term.

S&P 500

Corporate profits before tax continue to decline after adjusting for inflation, exposing the vulnerability of high earnings multiples.

S&P 500

Hours worked (non-farm payroll x average weekly hours) for November also point to low annual GDP growth of around 1.5% after inflation.

Real GDP and Hours Worked

Employment growth for the 12 months to November came in at a similar 1.48%.

Employment Growth & Fed Funds Rate

Not enough to justify a P/E multiple of 23.25.

Average hourly earnings growth is increasing, especially for production & non-supervisory employees (3.65% for 12 months to November), but in the present environment the Fed seems unconcerned about inflationary pressures.

Average Hourly Earnings

Patience

Patience is required. We have had a weak S&P 500 retracement confirm the breakout but there is minimal up-turn in November employment indicators to support the bull signal. Market risk is elevated and investors should exercise caution.

“The world has a way of undermining complex plans. This is particularly true in fast moving environments. A fast moving environment can evolve more quickly than a complex plan can be adapted to it….”
~ Carl Von Clausewitz, Vom Kriege (On War) (1780-1831)

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S&P 500: Betting on QE

The S&P 500 continued its cautious advance in a shortened week due to Thanksgiving. Expect retracement to test the new support level at 3000.

S&P 500

I believe that the latest surge has little do with an improved earnings outlook and is simply a straight bet that Fed balance sheet expansion (QE) will goose stock prices in the short- to medium-term. The chart below highlights the timing of the increase in Fed assets and its effect on the S&P 500 index.

S&P 500 and Fed Total Assets

There is plenty of research on the web pointing to a strong correlation between QE and equity prices. Here are two of the better ones:

Economic Activity

If we look at fundamentals, many of them are headed in the opposite direction.

Bellwether transport stock Fedex (FDX) is testing primary support at 150. Breach would warn of a slow-down in economic activity.

Fedex

Monthly container traffic at the Port of Los Angeles shows a marked year-on-year fall in imports and, to a lesser extent, exports.

Port of Los Angeles: Container Imports & Exports

Rather than boosting local manufacturers, industrial production is falling.

Industrial Production

Production of durable consumer goods is falling even faster, though the October figure may be distorted by the GM strike.

Industrial Production: Durable Consumer Goods

What is clear is that slowing growth in the global economy is unlikely to reverse any time soon.

Market Cap v. Corporate Profits

Yet market capitalization for non-financial stocks is at a precarious 24.7 times profits before tax, second only to the Dotcom bubble. The surge since 2010 coincides with Fed injection of a net $2.0 trillion into financial markets ($4.5T – $2.5T in excess reserves).

Nonfinancial corporations: Market Capitalisation/Profits before tax

The problem, as the Fed unwind showed, is that once central banks embark on this path, it is difficult for them to stop. The Bank of Japan started in the late 1980s — and is still at it.

Bank of Japan: Total Assets

Margin Debt

This chart from Advisor Perspectives compares the S&P 500 to margin debt. The decline since late 2018 appears ominous but November margin debt levels may reflect an up-turn. We will have to keep a weather eye on this.

FINRA Margin Debt & S&P 500 Index

Patience

Patience is required. First, wait for S&P 500 retracement to confirm the breakout. Second, look for an up-turn in November economic indicators, especially employment, to support the bull signal. Failure of economic indicators to confirm the breakout will flag that market risk is elevated and investors should exercise caution.

“If the mind is to emerge unscathed from this relentless struggle with the unforeseen, two qualities are indispensable: first, an intellect that, even in the darkest hour, retains some glimmerings of the inner light which leads to truth; and second, the courage to follow this faint light wherever it may lead.”
~ Carl Von Clausewitz, Vom Kriege (On War) (1780-1831)

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S&P 500: A cautious advance

A monthly chart shows the S&P 500 cautiously advancing after breaking resistance at 3000. Short candle bodies reflect hesitancy but Trend Index troughs above zero remain bullish.

S&P 500

ETF flows reveal risk-averse investors, with outflows from US Equities in the last week and a relatively much larger outflow from Leveraged ETFs. Inflows are mainly into Fixed Income and Inverse.

ETF Flows

Year-to-date flows tell a similar story, with outflows from Equities and into Fixed Income. So where is the money flow into equities coming from?

Twitter: Buybacks

Meanwhile, the Fed has eased up on their balance sheet expansion now that the PBOC is back in the market. But broad money (MZM plus time deposits) continues to spike upwards, warning that the Fed is trying to head off a potential liquidity squeeze. They are not always successful. A similar spike occurred before the last two recessions.

Fed Assets and Broad Money Growth

The personal savings rate is climbing. Far from a positive sign, this warns that personal consumption, the largest contributor to GDP, is likely to fall.

Saving Rate

This is a dangerous market and we urge investors to be cautious.

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