Fed Exit Strategy and the Bears

View from the Hill 10 October 2014

by J. Clinton Hill

Last Call For Alcohol: Growth or Value? As predicted, the U.S. Dollar is giving the Fed and its corporate constituency some cause for concern. However, with inflation running below targeted levels (hat tip to Crude Oil’s demise) and economic weakness abroad in Europe and Asia, Fed Chair Yellen has the latitude to be dovish regarding interest rates. The Fed is expected to end its tapering in October and attention will shift to its much awaited “exit strategy”.

Investors have enjoyed 5 ½ years of easy money and have known all along that the punch bowl used to entice animal spirits would be taken away. Well, that moment has arrived and this sober reality is akin to a cold splash of water across the face while recovering from a terrible hangover or market correction, which is what we are presently experiencing. At this juncture of the business cycle, I suspect investors will be much more judicious with their capital and whatever courage they found from the punchbowl must now be derived from strengthening employment, increased production and legitimate demand. Madam, will you have Growth or Value on the rocks?

Market Condition

The market closed the week @ 1906.13, which marks double bottom territory in an extremely oversold condition. Aggregate weekly volume for the SP­500 was 29% higher than average volume. Bears took another swipe at the 1925 ­ 1928 support levels and this time were able to halt the advance of the bulls. As mentioned last week, the SP­500 was clinging to its weekly lower channel (see chart below), which it has violated and thereby downgrades its status to bearish. With a wider breadth of stocks deteriorating below key 50 and 200 day moving averages, the longer term outlook does not bode well. Although October is a seasonally bad month, I am beginning to see more signs of bear droppings and less bullsh*t. If the benchmark index cannot surmount resistance at the September or at least the August lows, then a 11% to 13% correction from the high of 2019.26 towards @ 1800 to 1750 becomes a higher probability.

Bullish Events

• Central Bank Monetary Policy / Bank of Japan : As pretty much anticipated, the bank of Japan left interest rates unchanged @ 0.0%. It sees a best a trend for a “moderate economic recovery”. Incidentally, the BOJ’s balance sheet has now expanded to 52% of Japan’s GDP. This will be interesting as it is frighteningly unsustainable.
• Central Bank Monetary Policy / Bank of England: There was no disappointment from the BOE as it delivered another announcement of “no change” in key interest rates which remain @ 0.0%. As long as inflation remains tame and the uncomfortable exchange rate with an economically weaker EU persists, rates will probably remain at this accommodative level.
• Employment / USA: The JOLTS report indicated a record high for job openings in August 2014 @ 4.835mm vs. prior @ 4.673mm and estimates @ 4.710mm. Jobless Claims for the week of 10/4/2014 also improved better than expectations @ 287k vs. estimates @ 293k and prior revised @ 288k.
• Energy / USA / EIA Petroleum Status Report ­ Week of 10/3/2014: Crude Oil inventories jumped to 5.0mm bbl vs. previous week @ ­1.4mm bbl. The increase is attributed to both rising domestic output and imports. Energy prices have fallen significantly due to a combination of less demand and growing supplies.
• Services and Manufacturing / China / PMI Composite ­ Sept­2014: China still remains in expansion mode while showing some slight signs of deceleration. The Services component of the report was @ 53.5 vs. previous @ 54.1 (a 17­month high). The Composite numbers, which represent both manufacturing and services, came in @ 52.3 vs. previous @ 52.8.

Bearish Events

• Industrial Production / Germany ­ Aug­2014: Delivering one of its worst reports in 6 years, Industrial Production contracted Mth/Mth @ ­4.0% vs. previous revised @ 1.6% and estimates @ ­1.1%. Year/Year numbers were not much better with actual results @ ­3.0% vs. previous @ 2.4% and estimates @ ­0.3%.
• Outlook for Global Economic Growth /IMF: The IMF lowered its forecast for 2014 global economic growth to 3.8% vs. July’s estimates @ 4.0%.

*For your reference, “TWS” is a proprietary indicator that measures relative strength in a weighted manner over various time frames. “Vol %” compares weekly volume to average weekly volume and changes are expressed in percentages. At times, our investment bias indicator may temporarily display conflicting views between ETFs and the underlying indexes or securities they are designed to mimic or represent, but such divergences are temporarily short­term and may be due to variances in price, volume and investment allocation to their component assets.

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