We had planned to produce our next letter after the Labor Day weekend, but with the significant red flag message the stock market has flashed the last couple of weeks we thought the sooner the better. My optimism that we had carried through most of the summer slipped through my hands on August 10th the day when the Fed announced they would continue to support the credit markets with more purchases of Treasury securities. The stock market appears to have taken this message that things are worse than it thought and the action since has been relatively dismal.
We have spent more of this year writing about the work we do with technical analysis (chart pattern reading) then we normally do. We are reluctant to be too technical and bore readers (sometimes when we write and paste the charts we can actually feel reader’s eyes glazing over). The point of this piece is to connect dots regarding investment ideas and concepts for non-investment folks and convey critical information when we feel the financial markets are at an inflection point. With what we see unfolding currently the only way to convey our concerns clearly is to paint the picture with charts. So we believe this is definitely a time to be cautious and vigilant.
First some quick fundamental backdrop info. Our optimism revolved around the balance sheets of our major corporations (flush with cash) and their several quarters of improving earnings. Usually at this point of a recovery those factors would lead to falling unemployment numbers and that has not been the case. The situation with the new healthcare act, the budget deficit, and anticipated tax hikes has left many CEO’s saying they would rather wait and see than hire. Here is a quick list of other headwinds currently facing stocks that you might be familiar with;
1. Credit Growth – Banks aren’t lending and that is a key to economic expansion
2. Consumer Spending – We have recently become net savers and less shopaholics
3. State Deficits – Layoffs and furloughs still coming? Who elected these guys? Oh yeah we did
4. Underfunded Pensions – Low returns lead to inability to pay benefits, Europe also impacted
5. Consumer Sentiment – Lower numbers throughout the summer does not bode well
The first chart is that of the Greece stock market. It bottomed in March of 2009, like most major indices, and a strong rally ensued through the fall. With a more than 100% rally in less than eight months an economic recovery appeared to be in the offing. Recent headlines have revealed the years of mismanagement by their policymakers and the market took out its lows of last year. It is fascinating watching demonstrators demand wages and entitlements from the government that they clearly do not have. We realize we are not Greece, but this chart shows that if things get bad enough there is a possibility for some that the March 2009 lows can be taken out, but hopefully not for our markets.
Below appears a weekly chart of the S&P 500 and the negative Head and Shoulders pattern that is currently unfolding. There is a clear Left Shoulder, Head, and Right Shoulder. As we mentioned in our last newsletter this is one of the more dependable technical patterns (obviously no pattern is 100% accurate) and often proceeds a correction. If you look closely at the arrows you can see a similar H&S pattern formed in 2007 leading to a relatively sharp sell off. In the bottom frame of the chart is the Moving Average Convergence Divergence (MACD) and this is showing that the rallies of June and July were weak. Neither rally was able to move the MACD back above the zero line and that tends to indicate weakness also. The indicator in 2007 had a similar look to the present as well. The Russell 2000, a leading small cap index which often leads the market on the way up and on the way down, has a somewhat similar pattern. Since the recent rally highs to last week’s low the S&P 500 had dropped about 8%, while the Russell had dropped nearly 12% and that is another sign of a vulnerable market.
The next chart is that of the Exchange Traded Fund of the US 20+ Year Treasury Bond (TLT). A couple of weeks ago the TLT broke out of a base at the 102 level and has moved up strongly since. The open that day was much higher than the previous close leaving a gap in the chart. These are know as Breakaway Gaps and are bullish. You can see that the TLT had a breakaway gap back in 2008 and moved higher subsequently. Bonds tend to move inversely to stocks as when the stock market falls investors move to the security of bonds and this is known as a “flight to safety.” This is another data point reflecting the vulnerability of the stock market. Higher bond prices and falling rates are often signs of coming weak economic growth. Japan experienced this the last couple of decades as they dropped the yields on their government bonds to near zero in an attempt to stimulate the economy. Speaking of Japan, the Nikkei this week took out the June lows and also sports an anemic looking chart.
Many of you may know that September is historically the worst month of the year performance wise for the S&P 500 and October has had its frightful periods. The last couple of weeks have brought attention to a little known indicator called the Hindenburg Omen which has preceded every major correction since 1985. It is fairly complicated involving several indicators occurring simultaneously and two Omens occurred recently. There tend to be many false positives, but it is worth watching. There are other issues we could bring up regarding the vulnerability of the market, but we think this is enough for now.
Everything we said could be wrong, as the market always has the last say. It is especially during these periods that we would rather be wrong holding cash than wrong holding stocks. Remember the people who lost 50% of their equity portfolio (twice during the past decade) had to make 100% to get back to even. There are many ways to hedge and protect your portfolio during times like these and if you have not had that conversation with your advisor…this is a good time. If the correction does unfold, Oct. may present a good buying opportunity.
Did You Know
Miscellaneous Mortgage Tidbits - Using last week’s 4.42% average nationwide interest rate on a 30-year fixed rate mortgage (an all-time record low rate) an individual borrowing $100,000 would have monthly mortgage payments of $502. Just 1-year ago, the national average interest rate was 5.12%, resulting in a $544 monthly mortgage payment for 30 years on a loan of $100,000 The deduction Americans receive for the home mortgage interest expense they pay reduces the tax receipts taken in by the Internal Revenue Service by $127 billion a year. Citizens of Britain had a deduction for home mortgage interest expense paid until 1999 when the deduction was eliminated from their tax code (source: Internal Revenue Service). (source: Freddie Mac). A total of 620,764 homes were seized by lenders from delinquent homeowners in the first 7 months of 2010, an average of 2,928 per day (source: RealtyTrac).
No comments:
Post a Comment