posted on 31 October 2016
by Lance Roberts, Clarity Financial
This week I want to discuss several risks I am currently watching starting to manifest “behind the scenes" so to speak. But first, let’s take a quick review of the markets which currently are flashing some very troubling signs.
Last week, I discussed the ongoing consolidation and struggle as the markets remain “trapped" between downtrend resistance and the crucial support levels of the previous breakout to new highs. The charts below have been updated through Friday afternoon.
The two dashed red lines show the tightening consolidation pattern more clearly.
Importantly, while the market has remained in suspended animation over the past three months, the deterioration of the market is quite evident. However, despite the ongoing political circus, weak corporate earnings (considering the massive reductions in expectations since the beginning of the year), Apple (AAPL) and Amazon (AMZN) both missing expectations (which really goes to the heart of the consumer,) and consumer sentiment waning, it is surprising the markets are still holding up as well as they are. As long as the markets can maintain support about 2125, the bull market is still in play, but at this point, not by much.
More importantly though, despite the ongoing defense of support at current levels, the deterioration in momentum and price action has now triggered intermediate and longer-term “sell signals" as shown below.
Importantly, notice that both of the previous bullish trend lines (depending on how you measure them) have now been violated. Previously, when both “sell signals" have been triggered, particularly with the market overbought as it is now, the subsequent decline has been rather sharp.
Lastly, as stated above, the 50-dma moving average has begun to trend lower, the downtrend resistance from the previous market highs remains present and the “sell signal" occurring at high levels suggests the risk of a further correction has not currently been eliminated.
As stated last week, and remains this week:
Just be cautious for the moment.
Economy About To Hit The Dollar “Wall"
Since early May, I have continued to maintain an outlook for a stronger dollar as higher U.S. interest rates continue to attract foreign inflows.
As I wrote several weeks ago:
Of course, the real problem of a stronger dollar at this juncture is that it weighs on exports which comprise about 40% of corporate earnings. As I stated last week:
The chart below shows the relationship between exports and the dollar.
Of course, despite the “whooping and hollering" over the advance print of GDP at 2.9% on Friday, such exuberance may be a tad premature as the next chart shows the relationship between the dollar and the economy itself.
This is particularly interesting given the recent number of companies trying to lay off weak earnings reports on the election. As Paul La Monica wrote this past week:
Whether it was the CEO of Dunkin’ Brands (DNKN), which owns both Dunkin’ Donuts and ice cream chain Baskin-Robbins, McDonald’s (MCD), YUM! Brands (YUM) or Popeye’s Louisiana Chicken (PLKI), they all pulled the excuse the election was hurting their results.
As Paul goes on to state:
Paul is absolutely right. The poor results from restaurants or consumer good related companies like Apple and Amazon aren’t missing results due to the election, but rather these are early signs of a consumer that is being impacted by they triple whammy of rising borrowing costs, weak wage growth and spiraling health care costs thanks to the “Un-Affordable Care Act."
Of course, this is clearly seen in the report from the National Restaurant Association as consumers are forced to choose between eating out or paying for health care costs.
While no one is watching or worrying about the dollar right now, I can assure you they will be soon if the rise continues.
10-Year Treasury Beats Yellen To The Punch
Wall Street has put pretty high odds on Janet Yellen hiking rates come December. To wit:
The problem, however, is that every time the Federal Reserve has tried to hike rates over the last couple of years some form of “global instability" has cropped up that has kept them on hold. The problem, this time, is the “instability" may be domestic as the recent surge in the 10-year interest rate has front-ran the Fed in tightening monetary policy and putting the brakes on economic growth.
As shown in the chart below, while rates remain in a very defined downtrend, each push to higher levels resulted in an economic slowdown with a bit of a lagged effect. With rates now as overbought as at any prior point, it is likely the“brakes" are already being applied and will show up in weaker retail sales, consumer spending, and capital investment reports in the not so distant future.
As I pointed out in this past week’s report “Better Hope Rates Don’t Rise," there are a litany of problems with higher rates:
You get the idea. The problem is that with economic growth already running at extremely weak levels, it won’t take much of a rise to put the overall economic underpinnings at risk.
Recession Risk On The Rise
Just recently, Deutsche Bank Chief U.S. Economist Joseph LaVorgna, wrote:
I take a little different look at the LMCI by using a 12-month average of the monthly changes. What is notable is despite all of the cheering over monthly labor reports, which has been “quantity" over “quality," what has been overlooked is the declining trend in the data.
It’s not just Deutsche bank that is warning about the fact we are very late in the current economic cycle, but also by former raging bull David Rosenberg in a recent Financial Post article:
This analysis confirms my previous suggestions we are approaching a recession sometime next year. With rising labor costs, interest rates and a stronger dollar, the Fed is on a collision course with a recession. This was noted by ECRI’s Lakshman Achuthan just recently:
As I have repeatedly stated, you can not support higher interest rates, or have an inflationary pickup, without underlying economic growth.
While many are predicting “no recession" in sight, the economic data currently does not support that call.
Why do we care? Because during recessions stocks have historically lost about 1/3rd of their value. After two previous bear markets since the turn of the century, you really can’t afford the risk of going through a third one.
As David said, “forewarned is forearmed."
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