Review & Update
After almost two months of an “eerie” calm, the markets hit some turbulence last week. While “fake news” from the media has become quite a common occurrence as of late, the latest batch came courtesy of the New York Times.
“As suspected, it did end with a bang on Wednesday as markets dropped sharply on the news of a “leaked” memo to the New York Times which suggested an attempted ‘obstruction of justice’ charge by the President. James Comey, former head of the FBI, will now be questioned by Congress next week and asked to provide that memo. In the meantime, the Justice Department has now appointed a special prosecutor to investigate the “Russia Connection.”
As I discussed on “The Lance Roberts” show on Thursday and Friday, such a memo is unlikely to actually exist, and even if it does, is likely to be innocuous at best. Comey would potentially have a high degree of liability considering he already has stated, under oath, that he was not aware of any such attempt to impede an investigation. Perjury is a serious issue.
The problem for the Washington Post, The New York Times, CNN, and other major media outlets, the rush to try and “pin the tail on Trump,” has led to a consist dump of #FakeNews which continues to impugn the journalistic integrity of those institutions.
However, while the Washington intrigue is certainly interesting, the question is “why after all these months did it matter to the markets now?”
The answer is simple. It potentially stalls all the legislative actions the markets have been banking on for the “Trumpflation” trade from tax cuts to infrastructure spending. A look at the bond market gives you a clearer picture of the “fading” hopes on an inflation-driven economic boom.
Importantly, as shown below, the market quickly recovered from Wednesday’s sell-off and remained above the 50-day moving average for the week.
That’s the good news
The not so good news, in the short-term, is the daily “SELL” signal was triggered (lower panel) which often denotes periods of increased volatility and corrective actions until they are complete. Despite the rally on Thursday and Friday, I suspect the “shot across the bow” on Wednesday was just that and suggests reflexive rallies should be used to rebalance and de-risk portfolios for now.
However, as shown below, on a longer-term basis the backdrop is more indicative of a potential correction rather than a further advance. With the initial intermediate-term (weekly) “sell” signal triggered at historically high levels, the downside risk currently outweighs the potential for reward…for now. Furthermore, the secondary (lower) weekly “sell” signal is also very close to triggering from an extremely high level as well.
For a bit of context, the chart below shows the 20-year history of the market with the combined weekly “sell” signals. The vertical red shaded bars highlight the periods when both weekly “sell” signals were triggered from very high levels as we are currently at risk of doing.
Furthermore, the underlying internal have continued to weaken over the last week which has remained a concern over the last couple of months.
The 10-year chart below, while a bit cluttered, shows several very important things worth considering currently. First, the top part of the weekly chart is essentially a buy/sell indicator. Each sell signal previously, has been indicative of a correction. The middle of the chart is a combination of internal strength indicators from the number of stocks on bullish buy signals, advancing vs declining issues and volume, and the percent of stocks above their 200-day moving average.
With all the internal indicators currently on the decline, when combined with a stochastic “sell signal,” there is a higher probability of a correction in the weeks ahead. While this time could certainly be different, it is probably worth noting that making such a bet with your retirement money has not often ended well.
Rich Breslow summed the current environment up well on Friday:
“Markets can trend, range trade, and correct. But one thing they can’t do under the current scenario is time-correct. The minute they stop moving, a powerful, even if short-lived, impulse takes over to reevaluate, cherry-pick and average down. Even if you’re sure the story hasn’t run its course, it takes real moxie to remain exposed to the other side of trades you were very comfortably holding for the previous weeks and months.
We’re all leery of getting caught in over-crowded trades. Nothing feels more teeming than new trades predicated on emotion. Even if you feel very strongly about the subject. This is a be nimble, very nimble, environment when we’ve been rewarded time and again for buying and holding. Traders will need skills that have atrophied over years. Another reason we are years away from ‘normal.'”
I suspect he is right.
Gold – Still No Buy
Back in early 2013, I made a recommendation to sell gold entirely and move into stocks.
The call was an easy one to make. Ben Bernanke had just kicked off QE3 in fear of the impact from the “fiscal cliff” and $85 Billion a month was pouring into the market from the Fed.
Importantly, QE IS NOT INFLATIONARY, because it is an asset swap and does not increase the money supply. This is why there has never been an inflationary push in the economy, nor much of an economic recovery either. This is because such monetary interventions remain primarily bottled up on Wall Street and acts as a “wealth transfer” mechanism between the bottom 80% of the population and the top 20%.
Currently, inflationary pressures have quickly subsided, as expected, due to the stabilization and fall in oil prices, despite the Fed’s belief the pickup was from economic resurgence. The problem with the pickup in inflation from oil prices is that it crimps consumer spending as we have seen as of late in weak retail and personal consumption expenditure reports.
With the inflationary backdrop fading, and gold prices still trapped within a major downtrend, there is NO REASON to own gold in portfolios as of yet. The recent trading opportunity, discussed several weeks ago in this missive, has been closed out due to the failure at resistance.
If, and when, gold breaks above $1300/oz, and confirms the breakout, we will add the metal to portfolio allocation models.
For now, the best return on gold is still coming from giving jewelry to your spouse simply “because.”
Trust me, the return on THAT investment will far exceed any other.
“Gold Bugs” need to remain patient for now.
No…Not Everyone Was Wrong On Bonds
A recent article out this past week by Russ Koesterich via BlackRock noted that bond yields had not melted-up as “everyone expected.”
It’s not everyone, just you guys on Wall Street.
Since 2013, I have been laying out the case, repeatedly, as to why interest rates will not rise. Here are a few of the most recent links for your review:
- April 20, 2017 – Why Bonds Aren’t Overvalued
- March 23, 2017 – The Long View – Rates, GDP & Challenges
- October 24, 2016 – End Of The Bond Bull, Better Hope Not
- August 30, 2016 – Why Interest Rates Are Going To Zero
- August 27, 2016 – Let’s Be Like Japan
As I said, I have been fighting this battle for a long-time while “everyone else” has remained focused on the wrong reasons for higher interest rates. As I stated in “Let’s Be Like Japan:”
“Yellen has become caught in the same liquidity trap as Japan. With the current economic recovery already pushing the long end of the economic cycle, the risk is rising that the next economic downturn is closer than not. The danger is that the Federal Reserve is now potentially trapped with an inability to use monetary policy tools to offset the next economic decline when it occurs.
This is the same problem that Japan has wrestled with for the last 20 years. While Japan has entered into an unprecedented stimulus program (on a relative basis twice as large as the U.S. on an economy 1/3 the size) there is no guarantee that such a program will result in the desired effect of pulling the Japanese economy out of its 30-year deflationary cycle. The problems that face Japan are similar to what we are currently witnessing in the U.S.:
- A decline in savings rates to extremely low levels which depletes productive investments
- An aging demographic that is top heavy and drawing on social benefits at an advancing rate.
- A heavily indebted economy with debt/GDP ratios above 100%.
- A decline in exports due to a weak global economic environment.
- Slowing domestic economic growth rates.
- An underemployed younger demographic.
- An inelastic supply-demand curve
- Weak industrial production
- Dependence on productivity increases to offset reduced employment
The lynchpin to Japan, and the U.S., remains interest rates. If interest rates rise sharply it is effectively “game over” as borrowing costs surge, deficits balloon, housing falls, revenues weaken and consumer demand wanes. It is the worst thing that can happen to an economy that is currently remaining on life support.”
While Central Banks continue to intervene where possible to support asset prices, the recent decoupling of the market from the underlying rate structure, in hopes of “Trumponomics,” is likely transient. The only question is simply how long it will be before “reality” and “hope” reconnect.
The last time the stock/bond ratio (purple line) was this elevated, it didn’t work out well for investors as volatility spiked, equity prices plunged and the “sprint for safety” send bond prices surging.
Unfortunately, the Fed is still misdiagnosing what ails the economy and monetary policy is unlikely to change the outcome in the U.S., just as it failed in Japan. The reason is monetary interventions, and government spending, don’t create organic, and sustainable, economic growth. Simply pulling forward future consumption through monetary policy continues to leave an ever growing void in the future that must be filled. Eventually, the void will be too great to fill.
But hey, let’s just keep doing the same thing over and over again, which hasn’t worked for anyone as of yet, hoping for a different result.
What’s the worst that could happen?