US dollar strength knocking commodities down

An unusually strong jobs report, which saw seniors take the lion’s share of the new jobs, caused an enormous continuation of the recent US dollar rally.  The move knocked commodities down, causing the entire complex to shudder.

This strength is predicated on a forthcoming Federal Reserve rate hike in December. The same rate hike that has been put off for almost a year by policy makers that talk a lot, but do very little.

If the past is any indication of how this current trend will play out, most of the strength in US dollar rallies (and conversely, commodity weakness) happen before the first rate hike.

If that’s true, we may be through the worst of the US dollar rally — assuming the Fed actually hikes in December.  If not, or if the dollar continues its ferocious path higher, there will be significant headwinds for US corporate multinational earnings as well as the entire commodity complex.

Inflection point in S&P 500 reached

We’re not out of the woods.  If anything the latest rally’s staying power is about to be tested. Given how heavy the chart looks, I am inclined to think the path of least resistance remains lower.

Only if the S&P 500 can make a new high and close above it on a weekly basis would I be convinced that a meaningful low has been put in.

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Alternatively, if the market breaks below 1,800 on the S&P 500, look out below.  That will confirm a massive head and shoulders topping pattern which could lead the market as low as 1,000 in the intermediate term.

Stay on your toes.  There’s a lot of momentum chasers looking for the next major break.  They will push prices around (up or down) in an exaggerated manner.

The Fed has zero credibility until it raises rates

A lot of hot air, but no substance. That’s what’s been emanating out of the mouths of Federal Reserve officials over the two years about the direction of interest rates — with no follow through of taking rates higher.

As a result the Fed has no more credibility left.  When Fed officials talked about moving rates in the past markets would move with their chatter.

Not so much recently.  Market participants are squelching out the talk and waiting for the Fed to walk the walk.

S&P 500 may hit 1,000 before it makes a new high

Deflation is in the air. It’s gutting the prices of raw materials, emerging markets, junk bonds and starting to catch up to equities.

It’s going to get ugly

The journey up was fast and fortuitous, without the structural economic improvements that should accompany such a prolific bull market.  And more importantly, with enormous leverage and speculation driving prices.

The mini-panic on August 24, 2015 showed us that the market is capable of wild swings, and likely enormous drops.  In 2008 we saw the stock market lose more than a quarter of its value in days.  This sort of action is not only likely, but I expect it.

Why 1,000? 

This level puts the index back to major area of psychological support and also seems to complete what may be a head and shoulders pattern forming on the S&P 500 back to the base of the left shoulder.

1,000 is a level where the market was before the latter incarnations of QE wildly distorted prices higher. I believe that the beneficial effects of QE were overestimated and that the detrimental effects underestimated.

The gross distortion of prices has destroyed many price signal indicators.Adding to that the lack of interest bearing savings account has forced savers to speculate, hoping for a gain.

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Buyback backtrack?

The stock market’s valuation has largely benefited from corporate buybacks.  Now corporations possess an enormous amount of debt.

Additionally, corporations tend to get cold feet as the market is volatile or when prices decline quarter over quarter.  That means less buybacks should occur as fear overtakes greed.

Have some cash set aside

Right now my own inclination is to make a wish list of stocks to own and an idea of what prices make sense to buy them.  Then wait for prices to come to me.

Rather than chasing prices or settling for buying something that may be overvalued I think it makes sense to set cash aside and buy in at lower prices.  In all likelihood they are coming soon.

It may be the worst time in US history to buy real estate

The prevailing belief that helped to spark the last housing crisis was that homes are an investment.  That price will keep going higher.  We’re now 8 years out of the peak of the last housing bubble.  But have we formed a brand new one with reckless monetary policy?

US home prices rose 35% in the last four years

CASE SHILLER

The S&P Case Shiller housing index (above) shows an ominous chart of home values.  The first take away is that even 8 years after the previous housing crisis, prices have not returned to their previous highs, despite a large increase.  And this is with the backdrop of the most accommodative monetary policy in US history — with specific support for mortgage backed securities to help lower interest rates on borrowing.

Adjusted for inflation that gain is muted

Prices, when adjusted for purchasing power, are not responding to stimulus as policy makers may have hoped.  This means that while housing prices have gained in notional value, the purchasing power of the dollar has weakened during that period enough to offset much of that gain. So much for being a promising investment.

Cheap debt is the key to this bubble

The largest support mechanism in place for the current housing market’s uptrend has been very, very low interest rates. Some would say this presents a fantastic opportunity to buy a home with a lower monthly mortgage rate.  But what’s not factored in to that logic is everyone else has the same idea — and thus there is an extremely high amount of artificial demand pushing prices up from borrowers who otherwise could not afford to take out a mortgage on a property that is overpriced.

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The normalization of interest rates would turn this support mechanism on its head and begin to drain excess demand from the housing market.  Whether that happens because the Federal Reserve begins a tightening cycle or because mortgage backed security holders become nervous and begin to sell their assets remains to be seen.

Knowing that the primary support mechanism for the current housing price boom is entirely artificial, and has been for the better part of the last decade, is an important foot note at the very least.  It may even prove to be the signal that tells us when this latest housing bubble may pop.

Once more, the housing market is entirely dependent on the stability of and confidence in global financial markets.  Any market meltdown will have a profound effect on the housing market.   And every financial market is interconnected to such an extent that a problem in Shanghai can become a problem on Wall Street very quickly.

In conclusion

Prices are artificially high because of monetary stimulus, not a booming economy.  Affordability is near all-time lows for similar reasons.

These gross distortions have created an unsustainable paradox: Houses priced beyond the reach of most Americans — while wages stagnate, labor force participation is at multi-decade lows and the next generation of consumers has an enormous student debt load preventing them from buying a home.

If you are selling a home, this is probably the best time in recent history to exit the real estate market to reduce risk.

If you are buying a home, be extremely careful.  And be prepared to lose a good chunk of that home’s value (or wait until prices normalize and buy in at what will likely be a much lower price).

Don’t buy the dips. Sell the rallies.

It’s not uncommon for bull market opportunities to be exploited by buying dips in prices.  This is not one of them.

The bull market in equities is at least on pause, but in all likelihood over.  The latest series of down days is further confirmation of a lack of conviction.

There simply aren’t buyers.

Prices will go down farther if buyers don’t step up and buy dips.  This has already been evidenced on a day-to-day basis.  Whether it happens in the weekly charts remains to be seen — but price action seems to be confirming that as of late.

Commodity contagion

Weakness in the prices of energy, metals and other products continues to be a persistent theme.  And equities have finally noticed.

Stocks used to shrug off the losses in commodities as some sort of disinflationary tailwind.  No longer is that the case.  Now investors in stocks have become jittery on days when commodities are plunging.

The next leg down

Ultimately, the equity market is at much greater risk of a price decline than a rally.  The run up over the last 6 and a half years has been overextended.  Price to earning ratios, when share buybacks are discounted, are at higher than normal levels.

Corporations have amassed enormous amounts of debt and traders are speculating with more margin than in 2007 (the last stock market peak).  China has seen its managed economy unravel, while Japan’s attempt to start managing its economy is falling apart.

The Euro zone is in serious trouble.  There’s no amount of new debt that can cure the budget problems within many of its countries.

And the United States, which is starting to feel the pain of the rest of the world, is preparing for its own economic slowdown.  The Fed, panicked with uncertainty as its credibility fades away, decided once again to abstain from raising interest rates.

What does it all mean?

We’re closing in on the peak of this business cycle, if it isn’t already behind us.  This means that opportunities will be few and far between to find equities that are worth buying at these values.  Cheaper prices are quite likely in the future.

If I were still long a traditional portfolio of US equities I would take every rally as an opportunity to reduce exposure and raise cash.

Commodities slump as global confidence slips

Commodities, largely a barometer of global economic activity, are slumping in price.  The lack of confidence in the future, driven by China’s economic weakness amidst a weakening global backdrop, seems to be spreading.

Commodities were the first casualty in what appears to be a global rout. During April of 2013 precious metals were slammed lower in a series of bidless days.  In summer of 2014 the crude crash began, followed by copper and other materials.  Now equities appear to be catching down to the lack of performance in the commodity sector.

One thing is certain. The ability to raise interest rates in what has become largely a deflationary (not disinflationary) environment is effectively off the table. Doing so could significantly exacerbate underlying global deflationary contagion.  On the other hand, of course, one begins to wonder if the Fed has run out of credibility and may raise rates in a naive attempt to regain some of it.

Only time shall tell…

Psych! No hike.

With all the prognostication of an interest rate increase happening from Fed watchers and certain economists, I feel a sense of Deja Vu for previously expected rate hikes in this business cycle.  There was no hike, no easing — just more of the same.  What does it all mean?

It’s the economy, stupid.

We’re not recovering. The Fed can see that in its magic crystal ball of financial and economic data. There are even hints of deflation in consumer prices.  Oh no, perish the thought of things getting cheaper when people have less to spend!

What about December?

Hiking near Christmas would make the Fed the Grinch Who Stole Christmas!  It won’t happen.  The next chance is going to be in 2016.

How did markets react?

The Dow briefly turned negative, the S&P shrugged off some of its modest gains and the US dollar dropped.  Some commodities are gaining — as they should — because the dollar’s strength was pushing them down.  And that strength was built on the rumor of a rate hike.

Where do we go from here?

Expect more jawboning about rate hikes, but a hesitant trigger finger.  I don’t think global markets, let alone our own, can withstand higher interest rates.  Ultimately, however, the Fed is losing credibility here — and fast.

Markets mixed ahead of Fed

A little up, a little down. No real certainty to go around.

Things are going to be quiet until the big decision day.  Economists and market mavens can’t decide whether the Fed will engage in more QE, keep rates as is or hike (and if so by how much).

This means the Fed is doing part of their job well.  Forecasting everything ahead of time would leave market participants tempted to front run events like interest rate hikes with their bets.

On the other hand, the lack of certainty also shows that the recent market volatility may have the Federal Reserve Board divided as to how tight financial conditions may be with an interest rate raising cycle coming on to the horizon.

There’s going to be a lot of volatility when the decision comes out. Probably best to expect large price moves with air pockets in the volume of trade — meaning a whipsaw effect up and/or down as the news breaks.

It’s generally a good day to sit on the sidelines and watch the markets rather than participate.