Surprises From Market Breadth with Record Margin Debt

Surprises From Market Breadth with Record Margin Debt

As we discussed earlier, heading into the third quarter earnings season, we have above average level of positive guidance in terms of both top line sales and earnings as well as lower-than-average negative earnings guidance. We  pointed out yesterday, however, that an uncomfortable portion of that guidance is driven by gains from a weak dollar and we are seeing signs that may be reversing course.

 

In the last quarter, companies that delivered on or beat expectations didn’t get much of a reward for their efforts. We looked at the current market conditions to get a feel for what the earnings reactions could be this reporting season.

 

Margin Debt

Margin debt has reached $550.9 billion, a record high for the second consecutive month and the sixth record high in the past eight months.  Anyone who recalls just a tad bit of market history can see that rapidly rising margin debt has preceded the beginnings of both the March 2000 and July 2007 bear markets. However, nearly one in four monthly margin debt readings since 1959 have been record highs, so to assume that a pullback is imminent based on a record high is folly at best. Instead, we like to look at the rate of change over a 12-month period. Here we can see that the rate of change recently hasn’t been nearly as dramatic as the wild moves we saw around the 2000 and 2007 crashes. This metric does not indicate a market that has been wildly laying on the leverage, despite reaching yet another record high.

Market Breadth

Another measure of the health of the market is the Advance/Decline line which has been well above its 50-day and 200-day moving average. This indicator is showing a market that appears rather robust, but the value of this indicator may lessened by the rapidly rising use of ETFs. When an investor puts money into an ETF, those funds are used to buy all the companies in the ETF indiscriminately, which can give the appearance of greater robustness than would otherwise exist.

 

To further assess breadth, we look at the ratio of equal weight versus market cap weighted for the major market indices. What we found is the S&P 500 and the Russell 2000 equal weight indices underperformed their market cap weighted indices by a material amount year-to-date. This metric indicates that the indices upward moves have been driving by larger cap high-flyers, which indicates weaker breadth than we’d like to see.

 

High Fliers Losing Some Altitude

Amazon (AMZN) tried to carve out a head and shoulders pattern this week, down by over 2% during the week, but closed the week back in the black by Friday. If it moves below the neckline where it is currently perched rather precariously, the shorts will go for the jugular and this is one of those mega cap stock that has been helping to keep the indices up. Another high flier that has driven a good portion of the market’s gains, Apple (APPL), has dropped below both its 50-day and 100-day moving averages and is now down in 13 of the last 18 days as the new product line doesn’t exactly have consumers busting down the doors.

 

Facebook (FB) is also feeling the pain with all the bad press surrounding is ad platform that Ivan and his Russian buddies have been abusing to stir up domestic strife here in the U.S. Who knew Putin’s team may not play fair! The stock suffered its worst day this week since last November, falling over 5% at one point during the week and closing below its 50-day moving average for the first time since July 6th. By week’s end the shares had moved back to neutral territory in this Teflon market, but the warning flares have been fired. Netflix (NFLX) joined in falling as much as 5.5% this week to waver right arounds its 50-day moving average.

 

With the performance of the equal weight indices below that of the market cap weighted, weakness in the big guys are cause for concern. The end of the week saw a rebound in most, such as Alphabet (GOOGL) but we’ll be watching to see if the rebound holds.

 

Another Breadth Indicator

We then looked at the percent of companies above their 50-day moving average in the S&P 500, Nasdaq and the NYSE Composite. We found that the number of stocks trading above their 50-day moving averages has been rising, so from this metric, the markets are looking to have decent breadth, which limits the damage from those high fliers weakening.

 

When assessing either the markets or a stock we always want to find confirming or discordant data points to increase our confidence. While we have conflicting indicators here, our assessment leans more towards a bullish view based on this data for the near term.

 

Volatility

 

What about that wacky VIX that appears to be on a IV drip of some sort of powerful sedative? No matter what gets thrown at it, the index continues to be like Fonzi. The recent Commitments of Traders report from the CFTC revealed that the net speculative short position on the VIX has once again reached a new record high at 171,187 futures and options contractions, taking out the prior 158,114 peak in early August. This is a 63% increase! Talk about the calm before the storm. Yeah, we know, been saying that for a while. This has been a seriously impressive run!

 

Of all the days the VIX has been below 10 since its inception, 70% those have been in 2017. We can’t help but shake our heads, (and remember to stock up on Alka Seltzer) when we consider the likely impact on the markets when the reversion to the mean rule kicks in.

 

Given the lack of volatility, investors seem to be going all in. The last week’s Market Vane report found that the bullish share has reached the highest level in the current bull market. The last time it was this high was in June 2007.

 

The bottom line is while equities are clearly expensive at these levels, the market breadth looks decent and volatility is still hitting the snooze button. The disconnect between fundamentals, historical norms and the current market is likely to at some point result in some seriously dramatic moves.  However, we’ve all seen that expensive stocks can get even more expensive and for at least the near term, we are not seeing any clear catalyst for a pullback that would get the attention of this seemingly Teflon market.

Calm Before the Storm?

Calm Before the Storm?

While D.C. is full of fireworks over health care and Russians, the Treasury is scrambling to pay the bills, yet the markets are peacefully awash in Xanax. The spread between the 6-month and 3-month Treasury bills is now pricing in a potential technical default, but given that the rest of the Treasury market looks unaffected, the expectations would be for a quick resolution.

The Treasury yield curve over the past week has adjusted to reflect this pricing. How weird is that to see?

Got to love pricing in a technical default of the U.S. government, not exactly an everyday occurrence, while the VIX has closed below 10 for 6 consecutive days. To put that in perspective, going back to January 1, 1990, the average for the CBOE S&P 500 Volatility Index (VIX) has been 19.5 and the median 17.6. As of yesterday, the average for 2017 has been 11.5 and the median 11.3! In the past 27+ years, the index has fallen below 10 all of 23 times, but 57 percent of those occurrences have been in 2017!

In the past 27+ years, the VIX has fallen below 10 all of 23 times, but 57 percent of those occurrences have been in 2017!

Beware of reversion to the mean.

Treasury volatility is also hitting record lows. Apparently, there is nothing to see here. Thank God it’s Friday.

^CBCB1USTNV Chart

^CBCB1USTNV data by YCharts

 

Manufacturing Goes Bipolar but Yellen is Feeling Good

Manufacturing Goes Bipolar but Yellen is Feeling Good

The recent US manufacturing data has gone biopolar while over in Europe and even Japan, manufacturing is more solidly strenghtening. Then there is Fed Chair Janet Yellen’s recent assurances… this week is shaping up to be full of entertainment outside of yesterday’s fireworks!

ISM Manufacturing data for June indicated solid growth in most areas but was also considerably better than expectations (57.8 versus expectations for 55.3, up from 54.9 in May, a 3-year high) at a time when most economic data is coming in at or weaker than expectations.


source: tradingeconomics.com

  • New orders rose to 63.5 from 59.5
  • Backlogs gain 2 points to hit 57
  • Supply deliveries rose by near 4 percent to reach 57
  • Employment hit 3-month high at 57.2 from 53.5
  • But…. The prices paid index fell to a 7-month low of 55 from 60.5 in May, 68.5 in April and 70.5 in March. Ehh? Production and demand rising but prices are dropping month after month after month?

To further emphasize that this month’s ISM manufacturing report might not be all that telling is the U.S. Census Bureau Construction Spending report which was flat for May versus expectations for a gain of 0.3 percent month-over-month. Given that this one measures what was spent rather than sentiment, we tend to give it more weight. Most of the components saw a month-over-month drop in spending, including manufacturing (down -1.7 percent), residential (down -0.6 percent), commercial (down -0.7 percent), highway and street (down -1.0 percent), lodging (down -0.3 percent), communication (down 1.9 percent), transportation (down -1.2 percent). Overall total private construction dropped 0.6 percent month-over-month while public construction rose 2.1 percent. Other than that all good – sheesh!

Bear in mind that the last time ISM manufacturing came in around 58 was August 2014, after which the annualized GDP growth rate slowed to 2.3 percent. The time before that was early 2011 which preceded a slump to 1.9 percent growth for GDP.

On the other hand, the Markit manufacturing survey told a very different story, one that was more consistent with what we saw in the Construction Spending report, falling to a six-month low of 52 from 52.7 in May. We like to confirming data points and sorry Mr. ISM, your cheese is standing alone this month.

Also contradicting the ISM, June auto sales declined 0.9 percent month over month, dropping to 16.5 million units at an annual rate and making for the fifth decline in the past six months. The first half of the year has seen sales drop at a 20 percent annual rate. A drop of this magnitude occurred last in 2010 when markets were fretting about the likelihood of a double-dip and the Fed was moving towards loser policies.

We’d point out that this lack of pricing power isn’t just here, as the Eurozone and Japan are experiencing the same phenomenon, with Japan experiencing a 43-year high for labor shortage without much in the way of upward pricing pressures.

In contrast, the Markit Nikkei Japan Manufacturing PMI continued to improve in June, extending the current sequence of expansion to ten months with gains in both production and new orders.

IHS Markit Spain Manufacturing PMI revealed that Spanish manufacturing completed a strong second quarter with growth of output, new orders and employment remaining elevated. June saw further sharp rises in output and new orders with the rate of job creation at near-record highs. Purchasing activity increased at the fastest pace so far in 2017.

IHS Markit Italy Manufacturing PMI saw sharp and accelerated increases in output and new orders in June with output picking up on the back of robust export orders. Even employment rose amid a rebound in business sentiment.

IHS Markit France Manufacturing PMI saw new orders increase at a sharper pace in June with output growth moderating. The index rose to 54.8 from 53.8 in May and was only just shy of April’s six-year high.

IHS Markit/BME Germany Manufacturing PMI rose to a 74-month high with the fastest growth in new orders since March 2011 as input prince inflation slowed to a 7-month low. The 12-month outlook for production remained strongly positive.

Back in the U.S., on top of the contradictory manufacturing data, there is the ECRI leading indicator which has fallen now for three consecutive weeks, with a decline in six of the past seven and now sits at its lowest point since December 9th, 2016.

Mr. Market seems utterly unimpressed with continued trend for economic data to disappoint relative to expectations as the CBOE VIX net speculative shorts is now at the highest level ever – so apparently there is nothing of concern here.

Fed Chairperson Janet Yellen seems to agree, “Would I say there will never, ever be another financial crisis? You know probably that would be going too far but I do think we’re much safer and I hope that it will not be in our lifetimes and I don’t believe it will be.”

Really? That’s quite a statement, but then…

“But, we think the odds favor a continuation of positive growth, and we still do not yet see enough evidence to persuade us that we have entered, or are about to enter, a recession.” Alan Greenspan, July 1990

“At this juncture, however, the impact on the broader economy and financial markets of the problems in the subprime market seems to likely be contained.” Ben Bernanke, March 2007

via GIPHY

Falling Dollar as Trump Trade Tumbles into Investor “Meh”

Falling Dollar as Trump Trade Tumbles into Investor “Meh”

The U.S. dollar got hit hard again today as the Trump Trade continues to reverse and investor sentiment becomes more neutral – a big “Meh.”

The U.S. dollar is continuing its steep decline today as the AMEX U.S. Dollar Index makes new lows for 2017 and is nearing the lowest point over the past year, pushing down towards 94.

^DXY Chart

This represents not only an unwinding of the so-called Trump Trade, but speaks to how weak economic data has been coming in relative to expectations, (we’ve talked about this extensively which you can read about most recently here and here) AND relative to what we are seeing outside of the country. This decline has been driven primarily by the euro, the Mexican peso and the Japanese yen.

The dollar fell as the European Central Bank President, Mario Draghi, delivered a talk conveying more optimism for the European Union, citing growing political tailwinds, and the emergence of reflationary pressures. This came as Monday’s Durable Goods report showed the American economy is treading water, with Shipments and New Orders both dropping 0.2 percent month-over-month versus expectations for 0.4 percent gains. Core Capex has basically stagnated since February and despite all the euphoria in tech stocks, booking for new computers and electronics also declined 0.2 percent month-over-month and has now declined in 3 out of the past 4 months, which translates into a 6.5% decline on an annual basis: a long way from the 10 percent annual growth rate we saw at the start of 2017.

The Chicago Fed National Activity Index declined in May, the second decline in the past 3 months with the 3-month moving average essentially flatlining.

Looking over at France, with the recent win by Macron the economy there is looking much more upbeat as single-family housing permits rose 17 percent year-over-year versus 6 percent in the U.S. Single-family housing starts rose 19.4 percent in France and 8.5 percent in the U.S. In addition, mortgage purchase applications in the U.S. have fallen in 6 out of the past 7 weeks.

In Germany, the lfo business sentiment index recently hit a record high and across the Eurozone a collective sigh of relief can be heard as Italy is addressing its NPL (non-performing loan) problems. The latest was with a mix of state bailout, to the tune of €17b, on Banca Popolare di Vicenza and Veneto Banca that has equity and junior bondholders wiped out, protecting only senior note holders and depositors. More is likely to follow.

Looking at yesterday’s Consumer Confidence Survey, while the overall index rose from 117.9 to 118.9, it didn’t make up for the decline of 7.3 during April and May. That’s not terribly concerning, but this other bit in the details is. While the index for the Present Situation rose from 140.6 to 146.3 and is at the highest level since June 2001, Expectations fell again for the third consecutive month and are now at the lowest level since January. This type of divergence typically precedes a recession and if we look at these moves over the years, a recession typically hits 9 months after Expectations peak. That peak, so far, looks to have been in March.

Yes, but those Fed guys sound oh so confident despite tightening into an economy with slowing growth, declining inflation, weakening credit growth and a flattening yield curve.

  • Since World War II, the Fed has engaged in 13 tightening cycles
  • During 10 of those cycles, the economy slid into a recession
  • In the 3 where a recession did not occur, GDP growth fell by 2 to 4 percent. With current GDP growth struggling to get above 2 percent, that’s worth noting.

Meanwhile, the equity market is mostly yawning.

The VIX has now dropped below 10 eight times in 2017. To put that into perspective, in the 22 years from 1994 through the end of 2016, the VIX saw that level all of 7 times!

VIX Chart

In the past month, short position contracts on the VIX have doubled to now sit at a record level.

Over in the bond market, the view of the economy isn’t all that rosy. As of June 20th, the net longs on the 10-year Treasury hit a level we haven’t seen since December 2007.

Today’s AAII Investor Sentiment report showed that neutral sentiment is at its highest level since last August at 43.4 percent while bullish sentiment declined from 32.7 percent to 29.7 percent. This market is seriously astounding with a record 130 consecutive weeks where half the investors surveyed were not bullish, while we’ve had such a smooth melt up in the first half of 2017. Only one other year have we seen even less of a pullback during the first half! Meanwhile, the Bears are also scratching their heads with bearish sentiment falling from 28.9 percent to 26.9 percent, the lowest level since the first week of the year.

With economic data coming in well below expectations while the market has continued its melt up (today notwithstanding) despite bonds telling a worrisome tale with falling long-term rates and a flattening yield curve, it is no wonder investor sentiment is increasingly a neutral “meh..” or perhaps more of an “Eh…?”

 

Market Narrative Makes for Record Gap between Hope and Reality

Market Narrative Makes for Record Gap between Hope and Reality

There is just no escaping the reality that markets are driven by narratives and people are highly trainable – just ask Dr. Ivan Pavlov. For years investors have been trained to believe that markets cannot go down because central bankers will step in and do something that will prop them back up. This has essentially become a self-fulfilling prophecy. The most recent narrative has been the Trump reflation and economic acceleration trade in which narrative versus reality has reached a whole new level of wackiness.

As reported in the Financial Times recently, Morgan Stanley has found a record gap between the hard and soft US economic data, which is the difference between sentiment and reality.

 

The difference between quantifiable data and reports based on sentiment has never been so wide, prompting a sharp divergence in expectations for first-quarter US economic growth, according to an analysis by Morgan Stanley.

Source: Morgan Stanley flags ‘record gap’ between hard and soft US economic data

The prevailing narrative, as we head into earnings season, is that businesses are full of optimism and animal spirits are taking hold of the economy with robust growth right around the corner.

Apparently, those animal spirits aren’t looking to borrow to pay for that accelerating growth. It is possible that some businesses are holding off on borrowing until we learn what changes might be made to the tax code, but such a profound decline in borrowing does not support the assertion that businesses are gearing up for accelerating growth. This does support our Asset-Lite Business Models investing theme, as in such uncertain times, businesses look to limit long-term investments and focus just on those areas they can deliver value with minimal investment risk.

Investors have learned since the financial crisis that betting on the market going down is a fool’s errand as central bankers have stepped in every time to prop asset prices back up. We learned, oh did we learn. The markets now trade within a very tight band, with median volatility in 2017 lower than 95% of all trading days going back nearly 30 years and yet there is this. Note that the red line denotes the level on April 3rd, 2017. Only two other times in the past 5 years has uncertainty been this high yet the VIX is lower than 95% of all trading days over the past 30 years? I’d say those bears have learned to ignore the bell of weakening fundamental data.

 

Those watching the fundamentals and thinking that meant something had their shorts handed to them as the bulls smugly wagged their knowing fingers. The market will not go down, it will not go down I say… until the day the market sees what is behind that magic curtain.

Perhaps this might start to lift that curtain just a tad.

HT to Variant Perceptions

This chart shows that in recent years US equity price increases have been driven by rising PE ratios rather than improving business fundamentals, much more so than in years past where PE ratio shifts, in contrast, were often a drag on returns. What we found particularly interesting is the relationship between increases in government spending and PE ratios. The Trump Trade expects an increase in fiscal stimulus. That means increased government spending which has historically been associated with falling PE ratios – something to keep in mind as we watch the battles in D.C.

Looks to us like bonds are also thinking this accelerating growth/reflation story may not be quite right.

10 Year Treasury Rate Chart

10 Year Treasury Rate data by YCharts

Your Tematica team will be watching carefully as this narrative gets tested further and will keep you posted when meaningful events occur, so stay tuned!

America First? When it comes to GDP we get the bronze!

America First? When it comes to GDP we get the bronze!

Yesterday we talked about how the American economy, despite all the euphoric headlines since the election, didn’t deliver much of a performance in the fourth quarter and in fact we saw the weakest full-year GDP growth rate since 2011 which was well below the U.K.’s 2016 growth rate of 2 percent. Today we learned that the Eurozone as well kicked our economic tuckus in 2016.

GDP grows 0.6% in final quarter of 2016, beating expectations and taking annual figure to 1.8%

Yep, that hurt. So much for America being the “cleanest shirt in the economic laundry.” Despite headwinds ranging from the accelerating Greek drama to the mountain of Italian non-performing loans that led to the nationalisation of Banca Monte dei Paschi di Siena, Brexit, failed Constitutional reforms leading to the resignation of Prime Minister Renzi in Italy …. the list goes on, they beat us.

 

Last week talks between the U.S. and Mexico hit a serious bump after a President Trump Tweet led Mexico’s President Peña Nieto to cancel their upcoming meeting, while the administration has been threatening a 20 percent tax on imports from Mexico, which would put serious upward price pressure on, (among other things) fruits, vegetables and auto parts. Today Peter Navarro, Trump’s top trade advisor, accused Germany of currency exploitation. According to the FT, “In a departure from past US policy, Mr Navarro also called Germany one of the main hurdles to a US trade deal with the EU and declared talks with the bloc over a Transatlantic Trade and Investment Partnership dead.”

While last week’s meeting with the British Prime Minister Theresa May ended with some serious hand-holding, over the weekend the President’s sudden implementation of an immigration ban left, “our closest ally flailing after the UK government was openly contradicted by US diplomats over which British nationals were covered by the measure.”

After Trump’s election victory, the Bank of Japan was initially more optimistic about more favourable economic conditions amid expectations for stronger American growth. That enthusiasm has been fading as yesterday, ahead of a two-day policy meeting, officials are less optimistic about the impact on Japan’s economy. According to the Wall Street Journal, “We now realise that we know very little about him.”

Trump’s team has been poking our allies in some uncomfortable ways, making many around the globe nervous, and yet the VIX (a measure of implied volatility) is pretty much yawning.

The 90 percent of the America economy that is not represented by either inventory build or state and local government spending managed to grow at a whopping 0.6 percent annual rate in the fourth quarter.

Amidst all this, the Fed keeps talking about further rate hikes

Under Armour (UA) just released its fourth quarter and full year results and was yet one more citing currency headwinds.

Upon the announcement of Trump’s immigration ban on Friday, the markets started to fall. Monday the S&P 500 fell 60 basis points and is now down 0.76 percent from its most recent closing high last Wednesday. Bespoke compiled headlines over the past few days that reveal concerns the Trump hope trade is starting to fade.

Is this an inflection point? Too soon to tell, but we can say that having an administration with no political history who has pretty much tossed out the rule book is likely to cause heightened volatility, which is not reflected in market pricing. Erecting trade barriers and surprising the market, let alone allies, is likely to induce more caution in the C suite.

This morning we also saw that compensation costs in 2016 rose 2.2 percent, significantly faster than GDP of 1.6 percent, which makes another Fed hike more likely. We’ll be hearing from the Federal Reserve on Wednesday and will be looking to see if the tone from the FOMC meeting is more dovish than we heard in Fed Chair Janet Yellen’s testimony on January 19th. We will also hear from over 100 companies this week on their earnings, putting the relative complacency in the markets to a test.

Source: Eurozone’s economic recovery picks up speed