Unfortunately I was sick the
past few weeks and I am just now getting back into the swing of things.
Similar to the demand pull that the warmer than usual spring has had on
macroeconomic data, the warmer spring caused me to have an earlier than usual
sinus infection as well as some horrific allergies.
I suppose I am pushing it a
bit far when I am comparing my health concerns to economic data, but alas I
fly my nerd flag proudly.
Recently I have been advising
members of my service to be cautious as the market appears to be at a major
crossroads. The U.S. Dollar Index is on the verge of a major breakdown. If a
breakdown occurs it will be clear that the Federal Reserve will have
officially stopped any potential rise in the U.S. Dollar. Over the past few
months the Dollar has been producing a series of higher highs and higher
lows, however the current cycle may break the pattern as can be seen below.
If the U.S. Dollar pushes down
below the recent lows and we get continuation to the downside, we will break
the recent bullish pattern. Furthermore, if the Dollar starts to weaken it
should benefit equities and other risk assets such as oil. Higher energy
prices would not be long term bullish for equity markets so there is concern
if the Dollar really starts to extend lower.
However, if the Dollar finds a
bottom and rallies it clearly would create a headwind for equities. We should
know whether we have a major breakdown on the daily chart in the next few
weeks. Until then, the Dollar could go either way and obviously the price
action in the Dollar will have a major impact on risk assets and stock market
returns in the near future.
From a macroeconomic
viewpoint, risk assets such as the S&P 500 Index could be in trouble in
the months ahead. U.S. gross domestic product (GDP) came in lower than
expected with revisions likely in the near future. Unemployment claims appear
to have bottomed and are rising week after week even though the major media
fails to report it appropriately as it would appear that the Bureau of Labor
Statistics has stumped media pundits with data revisions.
Additionally, there are two
other macroeconomic data points which need to be mentioned. The Citigroup
Economic Surprise Index has moved below zero and is showing a negative
reading. This index is generally a leading indicator regarding equity prices
and the recent decline shown below is problematic for the bullish case.
Chart Courtesy of Morgan Stanley
As can be seen above,
fundamental data is starting to skew towards the downside which is likely a
result of the recession that is in the process of developing over in Europe
and potentially in China. Time will tell if the index can reverse, but the
bulls need to see a major reversal in the near future.
The chart below illustrates
the relationship between metal prices and industrial productivity. Demand for
metal increases when economies are expanding and prices generally contract
when economies retract. The chart below demonstrates global metal demand. The
chart speaks for itself.
Chart Courtesy of Morgan Stanley
Clearly if industrial
production contracts (reduction in Global Manufacturing PMI) the impact on
the global economy will be felt across multiple countries' economies. The
chart below illustrates the MSCI World Index compared to global manufacturing
PMI. Similarly to the chart above, this chart also tells a significant story
about what investors and traders should expect if the PMI numbers come in
light against expectations.
Chart Courtesy of Morgan Stanley
As quoted from the
zerohedge.com article entitled What
do Metal Prices Tell us About the Future of the Stock Market, "In
other words, for those who still believe in logical, causal relationships
(even in a time of ubiquitous central planning) unless something drastically
changes to push fundamental demand of metals higher, one could say the the
outlook for equities is not good."
Essentially, the data shown
above is certainly not bullish in the intermediate to longer term. However,
it generally takes time for macroeconomic data to permeate all the way
through to equity markets. For right now, the story regarding global growth
is at the very least questionable based on the data illustrated above.
In the short term anything is
seemingly possible. The S&P 500 Index closed above the key 1,400 price
level on Friday. I would not be shocked to see prices extend up to the recent
highs near 1,420. Ultimately I think we are in a long term topping formation
that might require another higher high up to around 1,440 before we see a
deeper correction.
The past few weeks have
produced a very mild correction compared to the monster rally we have seen
since October of 2011. This is a bullish signal, but we need to see prices continue
higher and climb a serious "wall of worry" that is coming out of a
variety of places. The European situation continues to worsen overall and we
have lower than expected GDP numbers in the US paired with concerns about
growth in China.
The S&P 500 has some
negative headlines to deal with, but so far it has been able to shrug off
poor economic data and we could see an extension higher that would shake out
the shorts and run stops above the recent highs. However a move lower remains
possible. The daily chart of the S&P 500 illustrates the recent
correction and the 1,420 highs.
I believe that the next few
weeks are going to be critical and the S&P 500 may trade in a
consolidation zone between recent lows and the 1,420 highs while traders
await more economic data. Fundamental data is starting to indicate that a
slow down may be beginning. In contrast, the topping pattern that we appear
to be carving out may require higher prices to suck in more longs before
moving into a deeper correction.
In the short run, the Dollar
will likely hold clues regarding the immediate future for risk assets.
However, the longer term picture for equities is quite murky based on the
economic data points we are seeing paired with additional concerns stemming
from the European sovereign debt crisis. Right now I am looking at time decay
based strategies in the near term and will likely stay away from directional
biased trades. I would urge readers to be cautious regardless of which
direction they favor.
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