Written by Macrotides
Editor’s note:This is the third in a series of four articles reviewing the global macroeconomic factors that may affect investors in the coming 1-2 years. The articles are:
- When, Not If, Will Volatility Increase?(Includes global central banking and Eurozone outlook.)
- U.S. Macro Factors Impacting Investors.
- China: Risk is to the Downside, but Hard Landing Not Likely
- Whither Stocks, Bonds, Gold and the Dollar? (This article.)
Stocks
U.S. multi-national companies are going to feel the effects of the recession in Europe, and slowing in developing countries. We would expect an increase in the number of companies that issue earnings warnings. With institutional investors eager to preserve a year’s worth of gains packed into the first quarter, the urge to book some profits may be triggered if a number of key companies temper the bullish outlook. In January, corporate insiders were selling 8 times the dollar amount of their purchases. In February, they upped the ante, selling $6.8 billion of their companies stock, versus $510 million of purchases. February was the sixth month in a row insiders bought less than $1 billion of their stock. For each $1 purchased in February, they sold $13.00. Why are they selling so aggressively, when the majority of investors are uniformly bullish? With sales growth slipping in developing countries and negative in a large part of Europe, profit margins may be pressured. Weak employment growth in 2010 and 2011 allowed companies to keep their costs down and fatten their profit margins well above the historical average of 7.2%. It wouldn’t be the end of the world if margins slipped a little, but it wouldn’t be a positive.
Prior to the sharp sell off on March 5, the S&P had gone 50 days without touching its 20-day average. According to McMillan Analysis, at 44 days, the streak was “one of the five longest of all time.” This statistic quantifies just how rare the trading pattern was during January and February. It is a reflection of strength, but it also underscores the dearth of bad news, which has kept selling pressure non-existent. That will change in coming months, if our analysis of Europe is on target.
In our February 1 Special Update, we suggested selling into strength as the S&P pushed above 1340. The S&P has pushed 5% higher since then, which does not make us happy. The fact it took a trading event that has only occurred on literally just a handful of occasions in the last 80 years is a small consolation.
We expected the S&P to experience a pullback of 4% to 7% based on the high level of bullish sentiment, insider selling, and weakening technical indicators. We thought the correction would be similar to the 5.1% set back in December. Instead, the “decline” was just 2.75%, and reversed after the March 5 sell off. We advised aggressive investors to go short the S&P by buying the ETF SH at an average price of 1345 on the S&P. That trade was stopped out when the S&P traded above 1378 for a 2.45% loss.
The rally from the low on March 5 is completing a 5 wave trading pattern from the December 20 low. The market is again ripe for a pullback of 4% to 7%, which could carry the S&P down to 1340-1350. If selling pressure does not pick up substantially on this pullback, we would expect the S&P to rally back to 1440-1449, which is where the S&P topped in May 2008. There is also a price target of 1493 that we’ll discuss in greater detail next month.
Dollar
Maintain the stop on the UUP position opened in February at $21.70.
Gold
As expected, gold did not rally above $1840, and has dropped from $1792 to under $1650, after posting a monthly key reversal in February. Gold is oversold, so a bounce is due. For now, we’ll see how gold trades, since we think a decline to $1525-$1550 is still possible.
Bonds
The bond market got whacked after the Federal Reserve upgraded their assessment of the economy, and investors concluded that QE3 was off the table. We were a bit caught off guard by the extent of the decline and jump in interest rates. It should be obvious that QE3 is on the back burner as long as job growth is above 200,000 a month. It should also be obvious that QE3 will be front and center if Europe fades and begins to affect the U.S. economy. Looming tax increases in 2013 is the main reason the Fed has said it will keep rates low until 2014. They understand the drag on the economy that will occur if we do our version of austerity. QE3 is their ace in the hole, and they don’t want to play it until they need to wage another battle against deflation.
Honestly, we don’t know if a secular turn in the bond market has occurred. Given our deficits and the fact we haven’t had a budget in three years, it’s easy to see why global investors might start questioning our resolve (lack of leadership) to address our budgetary largesse, and back away from Treasury bonds.
We remain unconvinced the U.S. economy has achieved a sustained growth path and expect Europe’s debt problems to resurface, which should provide bonds a bid. It’s just a question of how long it will take for this to play out. Technically, the decline in TLT since peaking at $125.03 could be an A (down)-B (up)-C (down). The C wave decline would be equal to A at $108.81. If this pattern analysis is correct, Treasury bonds will eventually exceed $125.03.
If a secular turn has indeed taken hold, 30-year Treasury yields could breach 4.0%, as TLT drops to $98.00. Last month, we recommended buying TLT in three stages, $117.23 (open on 2/24), at $113.91 after closing below $115.49, and below $112.85. The average is $114.66. Use a close below $108.50 as a stop. We think TLT can bounce back to $114.00 or higher in coming weeks.
Other Articles by Macrotides
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About the Author
Macrotides is a monthly subscription newsletter written by a wealth manager associated with a major Wall Street investment bank. The author’s firm has requested that he not use his name to avoid any incorrect implication that his views might reflect those of the bank. The author has written investment advisory subscription newsletters based on macroeconomic analysis and market technicals for more than 20 years. Enquiries can be made at[email protected].
