Entering the “chop zone.” Every time broader markets slip below the 50 week moving average decisively we see more momentum selling. Techs are weighing the hardest on major US indices.
Entering the “chop zone.” Every time broader markets slip below the 50 week moving average decisively we see more momentum selling. Techs are weighing the hardest on major US indices.
First let’s dive in to the mechanics of what’s changed. We were accustomed to a market where there was practically no volatility. Complacency was high and on a technical basis the Dow and S&P were more overbought than at any period since perhaps 1929. In essence euphoria and perhaps even blind optimism were becoming extreme. That condition quickly and violently reversed as more than five trillion dollars of market capitalization have been wiped out by selling since January 26th, 2018.
Volatility has returned
We’re now seeing volatility pick up and equities give back much of their gains over the past several months rapidly. Downward moves are generally faster paced and more intense than moves upward. Easy come, easier go.
That relatively uneventful journey up in most of 2017 is part of the problem with markets right now. During the rise in prices equities didn’t consolidate or correct which led to almost no technical support for buyers.
This is important because when there is volatility, market participants often utilize charts and technical patterns to determine areas of support. But in moves that are parabolic there generally aren’t such areas of technical support on the chart to rely on. So buyers (both human and bots) are more shy to put a bid out.
Fear is a powerful emotion
When volatility picks up and losses accumulate, speculators that used leverage (debt) to buy equities are often hit the hardest, forced to liquidate their positions. When this sort of activity crescendos with other investors panicking we typically see a capitulation selling event. I’m not certain we’ve seen that event as of yet, though. The market will have to demonstrate whether or not it has buyers here.
An example of how powerful fear can be is how inverse volatility index (VIX) ETFs have imploded in the wake of volatility returning to markets, meaning buyers who bet against intense trading price ranges were essentially wiped out. This trade worked well for years — until one day it didn’t.
These dislocations are not enough to create a full on selling panic on their own. Instead they are representative of instruments that were too heavily bought in to on the long side unraveling as the markets normalize to higher levels of volatility.
Bots are not buyers during sell-offs
High frequency trading bots have overtaken humans as the largest component of buying and selling volume for US equities. That seems efficient in theory, but the problem we see is when the selling intensifies the bots stop bidding. That allows declines to intensify as those wishing to exit will be fighting against a larger spread and less buy-side liquidity.
Indeed, during the last week we’ve seen situations where smaller lots were moving markets up and down by handles, rather than ticks. That’s the sort of activity one expects in an illiquid and immature market. Yet we are seeing it on a continuing basis here in the US with its extremely deep and previously liquid stock markets.
Zooming out to a 30,000ft perspective, we haven’t seen any truly significant selling. Even though many points have been lost on major indices, this selling event is relatively normal. The pace of it is a bit intense, but for a maturing bull market one should expect increasing volatility along with leadership consolidation.
The S&P 500 appears to be hitting a lower area of support. Watching to see whether cautious buyers come in for a move more substantive than a “dead cat bounce” is crucial in determining whether or not the downward move is ending or if there is more to go. If we move meaningfully down from here across the US equity indices I believe we are going to see much more significant selling pressure and volatility.
It’s almost entirely about rates
The selling intensity and loss of confidence in bidding up equities seems to be tied to increasing rates on the longer end of the yield curve. Related to that development is that inflation expectations are beginning to change and concerns are rising. That is to say, bond buyers may be questioning whether a 10 year bond at 2.851% is a fair interest rate or if perhaps a higher rate is justified based on what the rate of inflation may be over the next 10 year period. If buyers commit to an interest rate that is lower than inflation they walk away with a loss when the coupon matures.
While the yield curve has had a flattening spread for several years — it is beginning to steepen again. Higher interest rates are also inducing higher borrowing costs for mortgages, margin debt as well as other variable rate debts and could compress consumer spending as well as market buy-side participation. Borrowing costs are one of the most important factors in market psychology as well as interest earned on presumably safe government bonds.
That means if the 10 year bond continues higher, say at 3% or more, then many equity participants may re-balance their portfolio away from equities and more towards US Treasury bonds. Assuming other shorter dated bonds were not as well bought, that change would steepen the yield curve which would also potentially assist lenders in capturing a larger interest rate delta between the short term borrowing they engage in vs. the long term lending at higher rates.
On the other side of that, if yields peak and meaningfully decline then there is a fair chance that a bid returns to the equity markets and they move meaningfully higher. Whether or not stocks are able to make a higher high in prices is the most important technical consideration for maintaining a healthy bull market uptrend.
Economic development trajectory
If economic data begins to slow meaningfully, which it may with higher rates, that is another area where weakness may be demonstrated as a result of reduced economic participant confidence. Such slowdowns often happen as rates increase and borrowing costs rise at the end of a business cycle. The most leveraged companies, states, cities and private debt holders are hit the hardest.
As I told a friend, the “crisis” now is that there is a lack of a crisis to keep crisis-level accommodations flowing. In essence the central bank liquidity spigots are slowing and commercial lending is taking a breather. The Fed has also recently made it clear that the “Powell Put” is at much lower price levels.
These developments impact both equity markets and real-world economic activity. I’ll be watching the economic data releases, interest rate complex, especially 10 year yields and junk bonds, to see where equities may go from here.
The Brazilian Real was walloped and the dollar was clearly a standout winner. Gold’s relative underperformance shows against US dollars that the US dollar is still seen as a safe haven currency.
Until that changes gold will underperform as measured by US dollars. I think we’re closer a that point in time when we see positive price action then we were a year ago, but I can’t say for certain if the markets will agree until stocks move in to a bear market.
As seen in the start of 2016, when stocks were out of favor, gold caught a bid and moved higher each day stocks were sold off. Now that stocks are catching a bid, gold is selling off.
Whether or not 2016 is the year that stocks enter a bear market remains in question. I am inclined to think that we have only seen a prelude for the downside in stocks that could occur this year.
Coincidence or causality?
This could be a bear market rally or the makings of an interim bottom in WTIC. Either way it is a huge reversal. Last night the WTIC futures were down almost 2% and today prices are up 7.16% That’s nearly a 10% swing reversal in a single trading day!
My thoughts are as follows:
1: The Sauds will run out of capital if they keep pumping excess supply in to the market. I believe they are working to curb the oversupply situation by limiting their contribution. I also feel that OPEC will mirror this move. The Saudi idea that they could curb the activities of their competition was met with the reality of 0% interest rate policy here at home keeping it cheaper to sustain than to stop all operations. With all that in mind, prices below $40.00 are unlikely to remain so for long unless China goes in to a full blown recession.
2: We’ve now neutralized the oversold condition on spot WTIC prices and are back above the relatively key level of $45.00. This is an area where there has been significant support in the past. I expect it may act as support again if we see selling pressure. It would also make sense to see some backtesting/consolidating here, perhaps back to the 20 day moving average around $43.10 (which is also where several key price support areas have been).
3: As we’re above $45.00, the next major level of resistance is quickly approaching at $49.01 (50 day moving average). If we are able to make a rally above $49.00 with large volume, then I’d be tempted to say we’ve put an interim bottom in place. That said, “V” shaped bottoms are rare, so a re-test of lower levels first is very likely unless this is merely a bear market rally.
4: The latest sell-off started when there was a ‘death cross’ of the 50 over the 20 day moving average — and ended with a waterfall decline to about $38.00. At that point the relative strength index was under 20 and extremely oversold. Now we are looking to challenge the 50 day moving average from below with relative strength showing the buyers are not exhausted yet.
Truly exciting times in commodities markets. I can smell the panicked short covering today.
Stocks are selling off — and fast. But what exactly is a price trend and what do they look like? Trends are defined as a series of higher highs and higher lows for an uptrend and a series of lower lows and lower highs for a downtrend. Uptrends are the result of more buying than selling for a given period of time while the inverse is true of downtrends. An uptrend is essentially a chart where the price starts on the lower left and ends on the upper right.
After the S&P 500 consolidated for about a year it has decidedly turned much lower — and quickly. With the worst three point day rout in the Dow since its inception behind us now, what is going to happen next?
First, I think it’s important to note that while I believe the trend remains down, there is likely some sort of bounce that will come soon. Think of it as a moderating bounce. One where we see some positive price action to push things off the extreme lows and encourage some buying. After all, across just about every measure on the short to intermediate term, stocks are oversold.
That being said, it’s most likely that such a wave of buying will be short lived and followed by additional, deeper selling. The reason I believe that this is the case is that the main catalysts that have driven the market higher, as discussed in my previous article, are largely drying up. While at the same time, the global picture seems to be much more grim.
With all of the fervor over the US dollar index rallying close to 100, a reality check is in order. According to financial media reports the Euro is collapsing, gold is a barbarous relic that’s lust its luster, oil is falling and the commodity complex itself is imploding. Readers of this blog may remember that on November 1st of 2014 I wrote about the possibility that such a situation may play out in 2015.
Sentiment for other major currencies, energy, precious and non-precious metals could not be much worse than it is now. Cautious contrarian investors may find opportunities in the extreme negative sentiment. Certainly many natural resources companies have much more attractive valuations now than they did several years ago. Commodities themselves may also offer more value at these price levels than they did in previous years. Both as a hedge against inflation and a bet that resource consumption will increase in years to come.
Meanwhile US dollar trend followers may pile on to what appears to be a massive multi-year rally in the US dollar index or short other currencies, commodities and similar assets. There already exists an enormous amount of speculative betting on the dollar surging higher and other dollar priced commodities and foreign currencies tumbling. This positioning leads me to believe that we may be closer to a high in the US dollar rally than a base to move higher from.
Thus far the US dollar index on a long term technical basis appears to have made a series of lower highs and lower lows stretching back to the rally in the mid-1980s (see above chart) which began as a result of massive interest rate increases by the US Federal Reserve. In order to break this downtrend the index would have to rally beyond 120 and sustain itself there. Only then would I feel that the US dollar has decisively entered an uptrend. That has not happened yet.
As of the last 10 years we find the US dollar index trading within a range between 72 and 100 (see chart below) which may continue for some time if there isn’t an outside catalyst. Ultimately I believe the US dollar index is headed for a lower low when the current rally stalls further and then reverses lower.
One must remember that the US dollar index is a trade weighted currency basket that measures the dollar vs. the Euro, Yen, Pound Sterling and does not necessarily directly reflect the purchasing power of the US dollar other than when buying these currencies. In addition, the US dollar index has enjoyed its current rally largely on expectations of a widening interest rate differential between the US Federal Reserve and other central banks.
The Federal Reserve has repeatedly delayed its much anticipated interest rate hike, setting expectations that such an event may occur this September — and only if economic data fits their ever moving target. Given the mix of economic data (both good and bad), combined with the backdrop of a significantly weaker Euro and the US dollar beginning to impact multinational companies earnings, I would be surprised if the Federal Reserve set its sights on a heightening cycle. Perhaps a few increases to placate the financial media. But a significant normalization of interest rates would likely have catastrophic effects on multiple asset markets, including mortgages, bonds, stocks and interbank financing.
Up until 2008 the Federal Reserve largely followed the US Treasury 3 month bill rate — rather than vice versa. This meant that interest policy was apparently largely set by the 90-day Treasury Bill market. See the chart above for a visualization of this trend.
Below you will find a chart of the 3 month Treasury bill rate graphed from 2000 to present. In that chart one can see that the same dynamic may no longer exist. That is to say that the 3 month Treasury bill rate is extremely volatile and has been since 2008. Is this an unintended consequence of quantitative easing and zero interest rate policy? Is the Federal Reserve now without guidance from this critical interest rate setting market? Or is the paradigm shift one where the Federal Reserve will now lead where the markets once did?
Much as the rate heightening cycle in 2004-2007 set off a powder keg of insolvencies related to highly leveraged speculative bets imploding, I believe any similar rate heightening cycle this time around will have equally disruptivbe, if not worse, consequences. But it’s anyone’s guess at this point. As you can see we are largely in uncharted territory.
A recurring theme in the bull market rally since 2012 has been minimal volatility. The days of enormous whipsaws in price were seemingly behind us until late 2014. The mood of the market has decidedly changed as of late. What used to be a complacent, calm and somewhat orderly march in to parabolic territory has degenerated in to a much more unpredictable series of widening trading ranges.
As volatility increases, there is the potential that fear will overwhelm greed and the bulls will become more concerned about securing profits than taking risk. Margin levels are off the chart and short positioning is still historically low, so downside momentum may hasten quickly if it is perceived that an interim top is forming.
If such a change occurs, it is likely that we will see a long overdue correction occur in the broader equity and lower tier credit markets. It also may prompt an exit from the crowded long dollar trade if the risks are perceived to be domestic. 2015 holds plenty of promise for interesting global and financial market developments. Stay close to the news feed and price ticker.
Six years after the height of the financial crisis, we may be living in one of the most prolific financial bubbles in recent history. Under Dr. Bernanke’s guidance the US Federal Reserve system expanded its balance sheet to about 4.3 trillion dollars, with asset purchases creating a disproportionate wealth effect in equities and debt-based financial instruments.
Despite this massive injection of liquidity, by and large the US economy has not significantly recovered. Yet the US stock market (with the exception of the NASDAQ) is at all time highs. This disconnection in equity prices vs. measurable economic recovery is the primary reason that I believe a bubble exists. In addition, the artificially low interest rate environment (see: ZIRP and QE) has also created an enormous bond market bubble as reflected in US treasury bond yields.
The US workforce is languishing
A quick glance at the US Department of Labor’s recent U3 unemployment data would have us believe that almost as many Americans are employed as had been before the Great Recession. Unfortunately the Department of Labor’s U3 unemployment rate is based on the amount of Americans currently on unemployment benefits — not the number of Americans out of work.
The US Labor Participation Rate is at its lowest levels since 1978, indicating that US job creation is not sufficient to support widespread employment. In addition, the quality of new jobs being created is equally deficient, with lower pay being a prevailing theme. One of the Federal Reserve’s mandates is maximum employment. A mandate they seem to be failing to uphold when utilizing more objective measures of employment.
Raw materials are rolling over
While equity markets re-test all time highs, commodities are sinking fast. Traditionally weakness in industrial commodities and energy prices signal global economic weakness. Since July we have seen that weakness accelerate as the sell-off in commodities prices took the CCI (a broad measure of commodities prices) to multi-year lows. This is a powerful sentiment indicator.
Optimism about global growth would be expressed in higher commodities prices — as more orders for raw materials would increase demand. Another mandate of the Federal Reserve is stable prices. A cursory glance at the above chart shows we certainly don’t have stable prices.
Stronger dollar, weaker world?
Part of the recent decline in commodities prices has been attributed to recent strength in the US dollar index, which is in its most basic form, a measure of the dollar’s spot value vs. the Euro, Yen and GBP. There are other currencies in the basket, but none are quite as influential. In essence, the US dollar currently signals that it is more favored than the Euro, Yen and GBP through its ascent towards 87.
As commodities are priced in dollars, it is expected that some weakness will occur if the US dollar strengthens, especially under the back drop of softening global demand. But one must also question the utility of the current US dollar index structure — and whether or not such an index is relevant in a world that seems to be increasingly moving away from the dollar as the primary trade currency.
Stocks surged on stimulus. Now what?
With the S&P 500 back above 2,000 and optimism among fund managers back to similarly lofty levels, it may be time to examine the US stock market with a degree of skepticism. There exists a very high probability that we are in a bond and equity bubble that was fomented by the US Federal Reserve system. And traditionally these bubbles deflate when policy makers begin to head for the exits.
With QE3 over, and no immediate sign of further stimulus in sight, as well as the Fed signaling that rates are going higher in 2015, perhaps we are closer to seeing this bull market mature. After all, it’s been largely driven by liquidity injections and those have since ended.
A direct connection: Fed assets and stock prices
The correlation here is uncanny. QE’s various incarnations have an incredibly potent effect on boosting US equity prices to all time highs. Just about every dollar the Federal Reserve has injected in to the US bond and mortgage market has found its way in to US equity markets directly or indirectly.
Now that QE3 has ended, what policies will be utilized next? Is the Japanese QE-to-infinity program going to be enough to generate a new carry trade that pops US equities higher? Or are we finally witnessing the tail end of one of the biggest financialized bubbles in US history? One that has brought bond yields to the lowest levels in decades whilst simultaneously inflating mortgage-backed securities (lowering interest rates) and equity prices.
Is this bond bubble ready to bust or is it signaling something worse?
Bond yields are an inverse indicator of the underlying asset price. That is to say, the lower the bond yield, the higher the paper price to buy that bond. This chart illustrates US Treasury bond bubble in no uncertain terms. With US government debt exceeding GDP, whilst simultaneously at all time low yields, there is something wrong with this picture.
Typically the higher the debt level, especially as it exceeds the GDP of a country, the worse its debt outlook becomes. The only exception we’ve seen to this rule has been Japan, which has ‘enjoyed’ a 25 year economic malaise that was culminated by their very own real estate bubble. The deflationary forces at work there have been keeping bond yields and economic activity pinned down for a quarter century.
Reading the tea leaves of macroeconomic data
Signs seem to be pointing to an intermediate term deflationary bias. It’s likely that this situation will be greeted by more quantitative easing from central banks of developed countries around the world. Signals include a rocketing dollar, collapsing commodities, the Bank of Japan already engaging in record QE and the weaker EU countries slipping back in to recession or worse. In addition, China’s miracle growth story seems to be concluding with a not so happy ending.
Velocity of money sinks to lowest level on record
Worse yet, with all of the Fed’s easing and stimulus, the velocity of US money has been collapsing. This is an indication of economic activity insofar as how fast money is changing hands. Generally during periods of strength the velocity of money will increase. What we’ve seen since about 2002 has been just the opposite. A marked decrease in the velocity of money across all measures to the lowest levels ever recorded.
Leverage and levitating stock prices
Margin debt on the NYSE (see above chart) is at record highs, and similar leverage is being employed across many equity and bond markets around the world. That means that the level of debt-based risk taking now exceeds what we saw during previous bull market peaks and as such a reversal in psychology would be even more dangerous to stock prices.
A replay of 2008’s volatile panic selling of various asset classes is quite possible. The level of complacency and leverage in financial markets is similar to where we were in the fall of 2007 before the financial system began to collapse.
Watch these trends carefully. Further deterioration of M2 stock velocity, commodity prices and increased dollar strength will signal the increased potential for a renewed deflationary global recession. If such a situation unwinds, and if equity prices are dragged down in sympathy, then I do believe the Federal Reserve will begin to reinvigorate its stimulus programs and we could see the pendulum swing back towards a more inflationary bias.
What remains a mystery is how the Fed will do so when it already possesses the biggest balance sheet in its history — and has largely failed across many metrics to remedy the economic problems that face the US. Alternatively, if Bernanke’s Bubble is allowed to burst, the consequences will be catastrophic, not the least of which for the Federal Reserve and its balance sheet.
Silver and silver-related assets were smashed across the board on Friday as the World Bank and IMF met in Washington, DC to discuss the worsening global crisis. Other commodities saw sharp declines as well. More silver was traded that day in any given hour than silver is available on the market for an entire year. It was an electronic sell-off. Physical prices now command a 10-20% premium to spot paper prices, the highest in years. Gold to silver ratio is now over 1:50, the highest in a very long time.
Predictably news comes out after the trading day (but we must assume the large insiders knew the whole time) that COMEX was raising margins by 15.6% on silver.
The problem is the COMEX does not have the silver to deliver, so forced liquidation is the strongest tool they have to bring prices down and take parties who would seek delivery out of the equation.
Silver is still up 46.31% on the year and has strong support in the $30.00 area. I think we need to see what the price action is when buyers step in and shorts cover. It could very well move up as fast as it did down (and higher) if we see ECB rate cuts, a Greek bail out, good earnings in the US, emergency Fed easing or other central bank policy movements as well as any geopolitical or event risk scenarios playing out.
Given that even though silver fell to $30.00, but physical silver commands a price of $33-35.00, there is evidence of a growing paper vs. physical price discovery bifurcation.
As far as my strategy goes, I don’t see any change in the situation for the dollar long term. The recent strength has been more of a liquidation panic in Europe and foreigners buying dollars because it’s the least bad currency for the moment. There’s even some rumor of weaker central banks liquidating gold and silver holdings to raise liquidity.
I saw the same pattern of behavior in 2008 and 2009, yet gold and silver are much, much higher now despite the occasional (and sometimes violent) correction.
Over the last 11 years silver and gold have outperformed all sectors of the S&P 500 by many multiples. There is no paper asset class quite as trusted during times of crisis, either.
http://finance.yahoo.com/q/ta?t=my&s=SLV&l=on&z=l&q=l&c=SPY (three year chart)
Now, given the potential for further easing by the Fed, ECB, BOJ, BOE, SNB and others, the need to monetize debt in the US to keep the government open (i.e. the necessity for QE3) — without debt monetization the government will go in to a crisis mode where their ability to spend will be limited as interest rates rise because treasuries are sold more than bought. But we’re not the only country that has to monetize debt. Keep in mind the US government has over $75 trillion in unfunded liabilities and there’s no ‘economic growth’ scenario that allows these debts to be funded from revenues.
QE3 from the Fed at this point seems like a foregone conclusion once we see a sovereign debt or large bank collapse. The ECB is also monetizing debt in the Euro zone for a few of the larger PIIGS, the BOE has QE’d in England and there’s a good chance the BOJ and SNB will continue to print money to artificially devalue their currency.
These actions will create a short to intermediate term burst in global money supply — and hot money seeking a high return. These types of inflationary pressures lead to booms for precious metals.
Greece’s default is all but inevitable, and that is going to rock the world and create the need for much, much more liquidity. This situation will spread throughout Europe and spread here and to Asia. Lower rates and more stimulus will follow.
Many shops sold out of their silver bars and coins on Friday because the appetite for physical silver was so strong at $30.00 (even though customers gladly paid the $5.00+ premium making purchases $35.00+ per ounce). In fact I still saw online stores selling silver for $45.00 to $50.00 per ounce.
I believe that the bifurcation in physical and paper prices is important to note because it indicates that there are two markets. A real market and a phony market. The phony market is being manipulated downward to an artificially depressed price.
This happened in 2008, too. But from that low price of $8.00 silver quickly rose to $48.00 in the course of three years, a 600% increase or averaged to 200% per year.
Gerald Celente, one of the best trend forecasters of our era is now buying physical silver. He made the announcement on Friday, so I believe that will mean something to the many that follow his advice and watch his investments closely.
Tonight silver is testing the 350 day moving average. Some continuation selling was to be expected after Friday’s drop, but we’re looking for some consolidation or even a short term reversal due to the very, very oversold condition, combined with the support of the 350 day moving average at 29.57 as well as the appetite that should be present in Asia during this season.
We’re also dealing with price move that is over a four standard deviation event — i.e. something that is extraordinarily rare and it’s punctured the bottom bollinger band, leaving a reversion to the moving average around $37.00-40.00 quite possible if technical buyers come in.
Volume is light as to be expected, but once Sydney and Hong Kong open we’ll get a better idea of what the Asian appetites for metals are after last week’s discount.
Personally, I am tempted to buy silver and silver-related assets given these discounts. Even if prices are weak short term, I know they will be much, much higher in the intermediate and longer term.