posted on 05 September 2016
by Lance Roberts, Clarity Financial
This past week featured a rather dismal set of economic data confirming continuing weakness from wholesale trade, to ISM manufacturing to the employment report on Friday. The good news is "the market loved it."
Despite the "hawkish" intentions by the Fed to suggest they would raise interest rates in September, the weak data likely keeps them "sidelined" once again waiting for more confirmation of a strengthening economy that never actually comes. However, keeping the Fed on the sidelines when translated means "continued accommodation for the markets."
John Murphy over at Stockcharts.com summed it up well:
So stocks rose on Friday.
Unfortunately, as shown in the chart below. We just aren't really going anywhere.
The good news is the market is holding its bullish trend line which runs along the 50-day moving average. A violation of that moving average will likely lead to a retest of the previous breakout highs which intersects with the more important bullish trend from the February lows. That bull trend line was successfully tested in June allowing for an increase in equity exposure in portfolios at that time. However, since then, not much has happened.
David Larew (you should follow him @ThinkTankCharts) had a couple of very interesting pieces on Friday confirming my own analysis.
The chart below shows the negative divergences in relative strength and the moving average convergence divergence indicators.
David shows the market wrestling with a supportive "neckline" currently which is indicative of a more important developing topping pattern. With the Volatility Index breaking above its moving average, and the range of the VIX very compressed (chart below) a rather violent break to the downside would not be surprising.
This potential topping pattern also brings into focus the more important broadening topping process I addressed last week.
Importantly, for now, the bulls clearly remain in charge of the market. Regardless of the news, it seems as if the market simply will not go down.
I get it.
I understand it.
But, don't get trapped by it.
Take a look at the chart below.
The chase for yield has pushed relative performance of dividend yielding investments will above that of the overall market. Does this at all seem like a normal thing that should be happening? The "chase low volatility/safe haven assets" is very likely the bubble that will be identified in hindsight.
As pointed out by Paul Winter of UBS just recently:
When investors have little, or no, fear of losing money in the market they begin to seek the things with the greatest returns. Over the last few years the chase for yield, due to the Fed's consistent push to suppress interest rates, has driven investors into taking on additional credit risk to increase incomes. That same yield chase has manifested itself also in a massive outperformance of "dividend yielding stocks" over the broad market index as shown above.
The chart shows investors are rapidly taking on excessive credit risk which is driving down yields in bonds and pushing up valuations in traditionally mature companies into stratospheric valuations. As noted recently by Jesse Felder during historic market corrections, money has traditionally hidden in "safe assets."
Lack Of Fear
The downfall of all investors is ultimately "greed." Greed can be measured a couple of ways. The first, as noted by Dana Lyons recently, is the allocation to equities. Historically, this has been a good measure of the "risk appetite"of investors.
But beyond just the "need for greed," investors have been lulled into a deep sense of complacency. Not surprisingly, the volume of bearish ETF's is almost non-existent. To wit:
Importantly, the amount of leverage investors are taking on is further confirmation of the presence of "greed" and "lack of fear." The chart below is the amount of investor's relative positive or negative net credit balances as compared to the index itself.
While margin debt and negative net credit balances have been reduced mildly since the beginning of the year, we are still at levels not seen since the peak of the last cyclical bull market cycle. This should raise some concerns about sustainability currently. It is the unwinding of this leverage that is critically dangerous in the market as the acceleration of "margin calls" lead to a vicious downward spiral. While this does not mean that a massive market correction is imminent - it does suggest that leverage, and speculative risk taking, are likely much further along than currently recognized. Importantly, it is when "greed" turns back into "fear" that margin debt really matters.
Prices are ultimately affected by physics. Moving averages, trend lines, etc. all exert a gravitational pull on prices in both the short and long-term. Like a rubber-band, when prices are stretched too far in one direction, they tend to snap back quickly. It is these reversions, both short and long-term, that generally take investors by surprise because they happen so quickly.
The current deviation of over 7.5% from the long-term trend line is one of the larger in recent history. This deviation also comes at a time when long-term MACD and Momentum measures are on important "sell signals." Such a combination has not turned out well for investors in the past.
But this time could be different? Right?
The only missing ingredient for such a correction currently is simply a catalyst to put "fear" into an overly complacent marketplace. There is currently no shortage of catalysts to pick from an economic disruption, another Eurozone related crisis, or an unexpected shock from an area yet to be on our radar such as the recent bankruptcy of Hanjin Shipping last week.
And there's your next reason for faltering retail sales and weak corporate profits.
One more chart from David:
In the long term, it will ultimately be the fundamentals that drive the markets. Currently, the deterioration in the growth rate of earnings, and economic strength, are not supportive of the speculative rise in asset prices or leverage.
The chart below is simply a quarterly chart of the S&P overlaid against valuations and technical extremes. See the problem here?
The idea of whether, or not, the Federal Reserve, along with virtually every other central bank in the world, are inflating the next asset bubble is of significant importance to investors who can ill afford to once again lose a large chunk of their net worth.
It is all reminiscent of the market peak of 1929 when Dr. Irving Fisher uttered his now famous words:
They weren't and it wasn't.
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