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Oh, How Quickly The Narrative Pendulum Swings!

Take two minutes and watch this video I clipped together contrasting the intros to Bloomberg’s Real Yield show which is a weekly panel discussion with some of the biggest fixed-income managers in the world. The first half is from August 30th and the second September 13th. What a difference two weeks makes…

There is nothing like price to change sentiment. In a market where the narrative pendulum swings back and forth faster than a politician flip-flopping on a key issue, it’s paramount to track the sentiment cycle and Play the Player.

And, really, this all just goes to show that nobody actually knows anything. We’re all just making up grand stories to tell each other so we can disguise our uncomfortable ignorance as we play this incredibly complex game.

 

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A Monday Dirty Dozen [CHART PACK]

Opinion is like a pendulum and obeys the same laws ~ Arthur Schopenhauer

Good morning!

In this week’s Dirty Dozen [CHART PACK] we look at technical and sentiment indicators showing short-term overbought levels in US equities, incredibly low hedge fund exposure to stocks, the ‘pain points’ for CTAs in bonds, really cheap European banks and more. Here we go…

  1. We saw the bullish thrust in stocks that we were expecting but now things are overstretched and odds are we see a slight pullback in the coming week(s) before the next leg higher, though we can’t rule out the possibility of a short FOMO pop higher either. Dow Transports (IYT), Russell Small-caps (IWM), S&P 500 (SPY), and Semis (SMH) are all knocking on significant resistance on a weekly timeframe.

  1. Supporting the above, my short-term indicators for overbought/oversold technicals and sentiment show that the market is going to need a breather soon. The 3-day MA of Calls/Puts (thin red line) is beginning to signal complacency and 14-day RSI is becoming stretched.

  1. Nomura’s Equity Market Sentiment Index is also showing that sentiment has quickly flipped from uber-bearish to bullish in the US — too quickly for my liking and tells me that we’re likely to see a bumpy trend higher or another severe washout to cement enough pessimism for a smooth run-up. Also, check out Japan. Its bullish sentiment is over the 2 sigma level. I wrote the other week (link here) about why I’m bullish Japanese stocks but, like the US, it’s technically overbought and sentiment is a little too hot. Gotta wait for a pullback.

  1. Here’s the average pattern of Nomura’s global equity sentiment index following a drop below the -1 sigma level. If we follow the historical pattern then we should see sentiment flip over on September 20th.

  1. I’m bullish looking out past 1-2 weeks and one of the BIG reasons is positioning, which I’ve been noting nearly weekly here in these pages over the last month. Here’s a great chart from Sentiment Trader showing that hedge funds are grossly under positioned considering the macro backdrop. That’s a LOT of fuel for the next leg higher.

  1. The run-up in stocks has put the squeeze on crowded bondholders who’ve suffered one of their biggest routs in years. Nomura’s nifty CTA positioning tracker breaks down the likely ‘pain points’ of systematic trend followers in the UST 10-year. The next measured liquidation area is at 1.93% (yields ended the week at 1.90%).

  1. Sentiment Trader’s Bond Optimism Index fell below 50 for the first time in over four months on Friday. The backtest shows that bonds on average experienced a snapback rally over the following 2-weeks before resuming their downtrend (note: this would fit well with our expected short-term retrace in stocks and offer an excellent entry to get short bonds if you’re not already).

  1. I thought this chart was interesting. BofAML recently pointed out that the main risk to US IG isn’t supply but rather demand. And that’s because the ownership share of bond funds and ETFs has risen sharply to 21.4% from just 12% a decade ago. The bank points out that the issue is that “this segment tends to be returns-sensitive, as retail investors chase performance.” The chart on the right is case in point. There’s the possibility that a bond tremor sets off a further bond tremor as traders clamor for the exits.

Also, I highly recommend taking two minutes and watching this short video (link here) I clipped together comparing intros from Bloomberg’s weekly Real Yield show. The first half is from the Aug 30th and the second part is from this weekend. I love this… I mean, just two weeks and look at the change in sentiment. The narrative pendulum swings so incredibly fast in this environment, if you don’t pay close attention you’re likely to get steamrolled.

  1. Another troubling trend for bonds over the near-term is the recent jump in inflation. The 3-month annualized growth rate in core CPI just hit its highest level this cycle.

  1. If you’re wondering where this jump in inflation is coming from, well, look no further than the trade war. This spike is being entirely driven by the rise in core goods CPI which is a direct result of tariffs (chart via Wells Fargo).

  1. Just think what could happen to bonds once the policy baton gets fully passed from monetary to fiscal. Negative yields in Europe have been helping to drag down those in the US. If fiscal spending picks up in Europe and yields there begin to rise, then there goes the anchor…

  1. Speaking of Europe, banks there are trading near all-time lows relative to ‘fair value’. According to Morgan Stanley, similar instances in the past have led to periods of extended outperformance. Deutsche Bank (DB) is up more than 30% over the last month…

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A Monday Dozen [CHART PACK]

I’m also a firm believer in predicting price direction, but not magnitude. I don’t set price targets. I get out when the market action tells me it’s time to get out, rather than based on any consideration of how far the price has gone. You have to be willing to take what the market gives you. If it doesn’t give you very much, you can’t hesitate to get out with a small profit.~ Linda Bradford Raschke

Good morning!

In this week’s Monday Dozen we look at the historical magnitude of the current tech bubble, the incredible financialization of our economy, the best-performing assets year-to-date, the end of an era, and much much more. Let’s begin.

  1. The S&P is within spitting distance of all-time highs but investors aren’t buying it. AAII Bull-Bear sentiment remains in the gutter. This is bullish and makes it odds on we see new highs in US equities very soon.

  1. Here are the subsections of the AAII survey broken down. See the chart in the bottom right-hand corner. Investors are holding their lowest levels of stocks relative to cash and bonds since January of 13’. This can mean two things (1) there’s a lot of potential fuel to drive this coming bull leg higher or (2) there’s trouble ahead because we need investors to eventually start buying in.

  1. At least one would think so because how much longer can this lopsided equity demand trend continue?

  1. If equities are about to rally like I think they will then crowded bond longs may be in for a world of hurt. The US Citi Economic Surprise Index (CESI) just turned positive for the first time in nearly 150 days. Bondholders, MIND THE GAP….

  1. When I reference the financialization of the economy, this is what I’m referring to. This is why investor confidence is so critical to the economic cycle. The financial asset tail now wags the economic dog (chart via BofAML).

  1. While I’m expecting a large pullback in bonds (jump in yields) over the coming months, I ultimately think US yields go lower. All the way to zero. Demographics are the reason why. We’re seeing the Japanification of the world.

  1. The majority of my liquidity/fin-stress indicators are healthy and giving little cause for alarm. But, the Chicago NFCI is close to hitting multi-year highs (chart is inverted). I think we’ll see this turnaround but if it doesn’t then we’ll want to pay attention. Note the strong correlation between the NFCI and the SPX.

  1. Raise your hand if you came into 2019 predicting Greek stocks and bonds to be amongst the best performing assets globally. If your hand is up then you’re a liar :). Also, notice there’s quite a lot of European assets in the top 10 which is funny because they’ve been universally shunned by investors.

  1. There’s been constant negative coverage of the European economy over the last year with the manufacturing recession in Germany and fears over Brexit and all that. But it doesn’t look like anybody has told the European consumer. European households appear to be the most optimistic about their financial situations in a very long time.

  1. And inflation-adjusted retail sales are still growing at a healthy clip.

  1. The FAANG HODL trade may be nearing its end as things are looking a bit… much? This chart from BofAML shows that Tech as a share of profits vs. prior bubbles is at historic extremes.

  1. The end of an era. Deglobalization is going to reshape the world in ways we can’t even begin to imagine. This trend is only just beinning and will play out for a looong time.

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A Monday Dozen [CHART PACK]

One of my strengths over the years was having deep respect for the markets and using the markets to predict the economy, and particularly using internal groups within the market to make predictions. And I think I was always open-minded enough and had enough humility that if those signals challenged my opinion, I went back to the drawing board and made sure things weren’t changing. ~ Stanley Druckenmiller

Good morning!

In this week’s Monday Dozen we look at bitcoin’s technicals, small-caps nearing a relative performance 70yr+ trendline, easy Q3 earnings hurdles, spiking global economic uncertainty and more. Let’s dive in.

  1. Bitcoin (BTCUSD) is at a critical level having consolidated near the lower support of its triangle. BTC has proven to be one of the purest charting markets. Typically, you want to sell if price breaks below this support level as it means a continued downtrend is likely.

  1. But Peter L. Brandt (@PeterLBrandt) offers another interesting possible path for the cryptocurrency. Here’s a chart he shared suggesting that $BTC may be entering its “fourth parabolic phase”.

  1. This is a great chart from @waltergmurphy showing the 100-year history of US small-caps relative to large-cap stocks. Large-cap outperformance has driven the index down to its long-term 70yr+ trendline. The question now is, will we see small-caps begin to outperform (bounce off the trendline) or will we see a relative performance overshoot similar to what we saw in 2000?

  1. Consensus earnings expectations for Q3 have fallen considerably over the last two months. Average analyst expectations now call for EPS growth to fall by -2.6% Y/Y. Similar to Q1 and Q2 this negative sentiment is setting the earnings bar pretty low, which means an easy hurdle that the market should have no problem clearing.

  1. This chart from @MacroCharts of Citi’s FX Positioning Indicator shows that traders are extremely short US dollars. This could drive a further pop in the dollar which would not bode well for commodities or EM stocks, especially gold which is extremely stretched on a technical basis.

  1. The NYSE Advance-Decline Line made a new all-time high on Friday (chart via Sentiment Trader). This is not bearish. A new high in the A/D line typically leads to higher highs in the market in the following months.

  1. People are nervous. The Economic Policy Uncertainty Index shows that uncertainty over future economic policy is pervasive. In the past, a high index reading like the one we’re currently seeing has often preceded enduring gains in the market.
  2. This chart from Sentiment Trader is wild. ST notes that “Not only is the 4-week total outflow extreme, we can see that it’s been consistently negative. So much so that the 52-week total is nearing 2% of total fund assets, the most since the end of the 2002 bear market.”

  1. Via Bloomberg, “For the first time since 2009, dividend yields exceed 30-year Treasury yields”.

  1. The Aggregate Cash Flow Statement for MSCI US Large Cap 300 stocks via HSBC.

  1. Spec long positioning in the S&P 500 has fallen to levels that marked the Dec 18’ bottom and not far from those which marked the 16’ bottom in the market.

  1. A NASI buy signal was triggered on Friday. While my base case is for more chop ahead in US stocks, the odds of an impending bull run are increasing.

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A Monday Dozen [CHART PACK]

I have a friend who has amassed a fortune in excess of $100 million. He taught me two basic lessons. First, if you never bet your lifestyle, from a trading standpoint, nothing bad will ever happen to you. Second, if you know what the worst possible outcome is, it gives you tremendous freedom. The truth is that, while you can’t quantify reward, you can quantify risk ~ Larry Hite

Good morning!

In this week’s Monday Dozen we check out short-term sentiment (still too bullish!), longer-term sentiment (getting pretty bearish), indications of a weakening US economy, credit stress, a long opportunity in the pound, a crowded consensus, and 250-years of stock and bond correlations…

  1. When trying to gauge the durability of a potential market bottom we need to observe how quickly the dominant narrative flips. A sustainable rally needs to climb a wall of worry and general disbelief. When we see market participants quickly switch from bearish to bullish on a small bounce in price, it means that the market is likely to inflict more pain on the downside. Our NAAIM Extreme Exposure Index which measures the number of respondents who say they’re leveraged long the market saw a significant bounce this week. This along with my other sentiment/positioning indicators tell me we likely have more downside and chop ahead.

  1. With that said, the longer-term sentiment and positioning backdrop is potentially setting up for another significant bullish advance. The chart below via Sentiment Trader shows the 3-week average of AAII Bulls is near extreme lows, which in the past has often led to big gains over the following three months.

  1. The Philadelphia Fed Coincident State 1-month Diffusion Index bears keeping an eye on. This coincident index measures four state-level indicators for each of the 50 states. It recently fell to new cycle lows. In the past, similar weakness has often preceded a recession.

  1. The Conference Board’s Leading Economic Index (LEI) on the other hand, just made a new cycle high. The LEI has correctly signaled all eight recessions since its inception in 1959. It turns over and heads lower an average 10.5 months before a recession begins.

  1. Downgrades in high-yield credit are about average Note the uptick in downgrades in 07’ the preceded the GFC (chart via Moody’s).

  1. And Moody’s Liquidity/Covenant Stress Index remains subdued.

  1. The pound (GBPUSD) is bouncing off of long-term support (chart below is a weekly).

  1. Specs are very short.

  1. And sentiment is very dour…

  1. The flows into bonds have been massive since the end of last year (chart via BofAML).

  1. We’re literally nearing the point where not a SINGLE soul thinks long-term interest rates will rise… Pay attention to the consensus narrative! (chart via BofAML)

  1. This great chart from Bernstein Research shows that the correlation of stocks and bonds over the last 20-years is its most negative over 250-years of data. As Bernstein notes “This has been incredibly beneficial to asset owners and is a part of the reason why it has been so desirable to simply hold a passive 60:40 combination of equities and bonds… but if it was a function of the movement lower in inflation and real growth and changes in monetary policy then it might not be possible to rely on such a benign state of affairs continuing.”

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A Monday Dozen [CHART PACK]

Technical analysis reflects the voice of the entire marketplace and, therefore, does pick up unusual behavior. By definition, anything that creates a new chart pattern is something unusual. It is very important for me to study the details of price action to see if I can observe something about how everybody is voting. Studying the charts is absolutely critical and alerts me to existing disequilibria and potential changes. ~ Bruce Kovner

Good morning!

In this week’s Monday Dozen we take a look at anxious markets and discuss the fuss over the inverted yield curve, plus we check in on liquidity, sentiment, and relative valuations and end with a sector that has all three going for it. 

1)  In last week’s Musings I shared a compilation of recent front-page newspaper headlines warning about an imminent recession, a painful bear market, and general hysteria over an inverted yield curve. My weekly copy of The Economist arrived yesterday in the mail with the following cover. I’m not aware of any significant market top in history that was so widely predicted by the mainstream media. #sentimentcheck

 

 

2) This great chart from Sentiment Trader shows just how loud the recession calls have become.

3) I wrote earlier in the year about why the “recession signaling” ability of the yield curve may not be as reliable this time around (link here). Regardless, an inversion of the 2-10 yield curve precedes a top in the SPX by an average of 7.3 months where the SPX averages a gain of 9.52%. It’s important to keep in mind that in markets the more something is closely observed the more likely it is to be altered in the process and/or already priced in.

4) Rather than being prescient in their recession calls, maybe the media is late? NDR’s Global Recession Probability Model has been signaling a high likelihood of a global recession since the middle of last year when much of the world entered a downturn. Global ex. US recessions last 14-months on average which would put the current global slowdown ending sometime in the next few months (chart via NDR and CMG Wealth).

5) BofAML’s Composite Recession model is still showing a very low likelihood of a US recession in the near-term. 

 

 

6) BofAML’s US Consumer Confidence Indicator shows that Trump’s trade war hasn’t been helping with the overall mood of things. But it looks like the latest market vol is getting to the Tweeter in Chief and the odds are rising that he’s going to fold his hand.

7) Liquidity is still very loose… Both Kansas and St. Louis Fed show little financial stress in the system, the 13-week rate-of-change in BAA bond yields is at its lowest point since the GFC (which make stocks more attractive on a relative basis), and BAA/BBB bond spreads are somewhat elevated but still below levels that should cause concern.

8) The MO Composite Sentiment and Positioning Index is now in buy territory (below the horizontal red line). I’d like to see it go negative but as of now the conditions have been met to switch my bias from bearish to bullish/neutral. My base case is that we see a rise from here followed by more sideways chop and vol but the larger macro conditions look to be setting up for another major global rally starting before year’s end. We’re just waiting on a catalyst (European stimulus, Chinese Stimulus, uber dovish Fed etc…).

 

9) Relative sector valuations show that materials and energy are trading on the cheap (chart via BoAML).

10) Speaking of energy, according to Sentiment Trader “The oil services fund is showing a pretty drastic drop in optimism over the past 2 weeks. According to the Backtest Engine, it’s only been this bad twice before.”

11) Jesse Stine shared the following in his latest market letter (link here),“Oil servicers nailed it to the penny on Thursday.  Sure smells like a cycle low is close.” I agree. 

 

12) Also from that same letter and via Sentiment Trader is this great chart showing the difference between Hedger positioning in copper relative to gold as a % of opening interest. A reversal in the key copper/gold ratio would spell trouble for long bonds. To understand why you can read my writeup on the hierarchy of markets here. 

 

 

 

 

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A Monday Dozen [CHART PACK]

The nature of investing is that a very small percentage of the people take money, essentially, in that poker game, away from other people who don’t know when prices go up whether that means it’s a good investment or if it’s a more expensive investment.  Too many investors are reactive decision-makers. If something has gone up, they say, ‘Ah, that’s a good investment.’ They don’t say, ‘That’s more expensive. ~ Ray Dalio

Good morning!

In this week’s Monday Dozen we take a look collapsing manufacturing around the world, yield curves signaling higher volatility in equities ahead, the makings of a currency war, and a popped parabolic top in a major EM market along with much much more…

1) Global PMI and New Orders are both in contractionary territory for the first time this cycle (chart via MS).

2) Manufacturing is a small part of the US economy but it’s the making of physical goods that drives the business cycle. If the manufacturing ISM keeps trending lower at this pace, it’ll end up in negative territory before the year is out and consumer confidence will then likely follow suit.

3) Keep an eye on this one. The S&P 500 may be forming a textbook Broadening Top. My baseline is increased volatility and sideways action with a downside bias over the next month.

4) Is the yield curve signaling higher equity volatility ahead? Again, my money is yes… (chart via MS)

5) This 20-year seasonality chart of the S&P 500 shows that August and September have a tendency to be rough months for the market.

6) Asset manager’s equity exposure through S&P e-minis hit post-crisis highs recently (chart via BoAML).

7) First trade wars now currency wars? The USDCNY is moving above the critical spot 7-level. The Chinese yuan is now trading at its lowest point against the dollar in over a decade. Expect many a tweets about the dollar from the White House in the coming weeks.

8) EURUSD is also at a significant level. The euro came down and bounced off its downward sloping support line last week (chart is a weekly).

9) The EUR-short-funded carry trade is at risk of unwinding should volatility pick up. Positioning and risk-reversals are still pointing to a move higher in EURUSD.

10) NDR’s Recession Watch Indicator is ticking up but still well below levels that have indicated an impending recession in the past.

11) And despite the contraction in global growth and rising geopolitical uncertainty, credit conditions in the US remain very loose (chart via NDR).

12) “Three reasons why #Nifty 50 $Nifty could enter bear market phase #India

  1. Mkt. challenging 16-year parabolic advance – potential targets 9120 & 6420
  2. Possible 19-mo. right-angled broadening pattern
  3. Mar-Jun ’19 surge now completely reversed” ~ Chart and text via @PeterLBrandt.

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A Monday Dozen [CHART PACK]

Charting is a little like surfing. You don’t have to know a lot about the physics of the tides, resonance, and fluid dynamics in order to catch a good wave. You just have to be able to sense when it’s happening and then have the drive to act at the right time.   ~ Ed Seykota

Good morning!

In this week’s Monday Dozen we take a look at CROWDED trades, some of the worst earnings guidance in a decade, the US joining in on the manufacturing recession and more…

1) According to a recent study by BofAML and reported in the WSJ “The overlap in the top 50 stock holdings between mutual funds and hedge funds — two types of investors whose styles typically differ — now stands at near-record levels.”If you’re buying companies like Salesforce (CRM) at these valuations, this late in the game, you may find yourself eating like a bird and crapping like an elephant. Just saying…

2) Third-quarter EPS guidance is the worst it’s been since 2011 with 60% of companies revising guidance, revising lower (chart via Bloomberg).

3) Upward analyst revisions as a percentage of total revisions for the S&P 500 dropped to 41.3%. You want to see negative expectations being revised higher to sustain a bull run (see 1/16 – 12/17), not this (chart via Citi).

4) There are a LOT of people who are bullish on bonds, which may not be so bullish for, errr, bonds… (chart via Bianco Research and @MacroCharts)

5) Meanwhile, the market’s “implied probability of a large increase in inflation over the next five years” just hit a record low. Maybe the expectations pendulum has swung too far? (chart via @MacroCharts)

6) Shipping rates are trending up and nobody seems to care… The Baltic Dry Index (BDI) recently hit 6-year highs. Here’s a writeup I did earlier in the year laying out the reasons why I’m so bullish on shipping stocks.

7) And we’re seeing up-trending shipping rates even though global trade is contracting. Just wait until global growth bottoms… (chart via MS)

8) The US dollar (DXY) is being driven by 2y and 10y rate differentials. For the dollar to roll over, the Fed needs to get ahead of the market’s dovish pricing and do a surprise 50bps cut this week or strongly signal more willingness to aggressively cut into year end.

9) So keep an eye on this.

10) 2Q GDP came in at a 1.2% annualized rate and downward revisions reigned in near-term momentum. Morgan Stanley notes that “The slowdown in investment looks even more stark beginning in 1Q18. Net trade, inventories, and profits have also declined… we initiate our 3Q19 GDP tracking at 1.7%” (chart via MS).

11) Revisions versus previous (chart via MS).

12) The world is in a manufacturing recession and the US is about to join ‘em. Markit’s US manufacturing flash PMI shows the first negative manufacturing PMI print for the US since it clawed its way out of the 09’ recession (chart via MS).

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A Monday Dozen [CHART PACK]

Economic history is a never-ending series of episodes based on falsehoods and lies, not truths. It represents the path to big money. The object is to recognize the trend whose premise is false, ride that trend, and step off before it is discredited. ~ George Soros

Good morning!

In this week’s Monday Dozen we ask the question: Is FX volatility the last shoe to drop? Plus, we have wage growth and rising margins in the eurozone, fund managers pulling money out of EM, and a big-data machine-learning analyzing the US economy.

1) Back in March, I wrote a piece titled “There’s a Big Macro Move Brewing in Markets” noting the compressed volatility across the wide range of macro instruments; from rates and precious metals to major FX pairs. Since then, we’ve seen bond volatility rip (chart via MS).

2) And then precious metals vol followed… Vol compression regimes tend to lead to expansionary regimes (ie, big trends).

3) Now we’re waiting for the last shoe to drop (major USD pair FX volatility). EURUSD 6-month vol has only been this low two other times (2007 & 2014). Both compression zones led to massive trends. Vol compression doesn’t dictate direction, it just signals that a major move is coming. But… gold does tend to lead USD at major turning points and rising gold points to a lower dollar.

4) There are a lot of good looking long-term USD pair charts out there (USDJPY, EURUSD, USDMXN, USDCAD, USDCHF etc…). Here’s a weekly of the Brazillian real. If this were a stock, would you want to buy it or sell it?

5) The US dollar is one of the most overvalued currencies in the world right now, according to a number of valuation measures. Here’s The Economist’s Big Mac index, showing that the euro is over 20% undervalued relative to the dollar.

6) The history of the dollar in 7-year cycles. The early 80s bull market in USD lasted 1,650 days. The late 90s bull, 1,719 days. If the current dollar bull market is, indeed, still alive, it’ll be the longest at 2,063 days and counting.

7) Euro area wage growth is picking up while inflation breakevens are plummeting. I’m guessing this divergence closes with breakevens ripping higher — think what that may do to European bonds currently yielding sub-zero (chart via Credit Suisse).

8) UBS’s Evidence Lab finds that European corporates are turning more optimistic on their pricing power and subsequent margin expansion over the next 12-months.

9) GEM fund manager weight versus the MSCI Emerging Market index relative to their 5-year average/min/max. The graph shows that fund managers are underweight EM relative to the index and their 5-year average (chart via MS).

10) And investors have been pulling their money out of emerging markets for 10 out of the last 10 weeks (marked by gray vertical bars).

11) BofAML’s big-data machine-learning US Business Cycle Indicator shows that the US economy is moving away from a recession regime and into a “soft patch”.

12) This chart from Barclay’s shows Iran’s exports and key sanction dates. Iran has gone from exporting over 2.5 mb/d in 2018 to less than 1mb/d today. When the current deceleration in global growth bottoms, the oil market may become a bit tight…

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Rough Seas Ahead

***(The following is an excerpt from a recent note sent to MO Collective Members)***

Markets are about to hit some rough seas in the month(s) ahead. I’m not calling for a bear market or major crash but more expecting some choppy sideways/slightly lower action. We’re going to button down the hatches a bit (ie, reduce equity exposure). 

Here’s what I don’t like: 

  • Numerous measures of sentiment/positioning are now showing excessive bullishness and complacency
  • Our indicators suggest US GDP is about to roll over hard and that means lower earnings
  • Consensus earnings estimates for Q4 on are way too high considering
  • Market valuations are at levels that have acted as a brake on further gains in the past
  • I’m expecting earnings beats but bearish guidance this quarter

Starting with sentiment and positioning. 

Our Composite Sentiment/Positioning Index is back above the 50 level (red line) which marks excessive bullishness and complacency.

Sentiment Trader’s “Dumb Money Confidence” indicator is near cycle highs. Forward returns for stocks have been weak following similar readings in the past. 

Investors Intelligence Advisor Bullishness is near 60%. The market has dipped or traded sideways over the following month each time this indicator has crossed the 60% mark.

And then our Total Put/Call 10-day moving average indicator shows that investors are complacent and are not hedging their downside relative to their bullish bets. 

Now let’s look at economic growth. 

I’ve been talking about this one a lot, but our Philly Fed indicator suggests US GDP growth is headed for sub 2%.

The Atlanta Fed’s GDP Now Forecast is tracking just 1.6% growth. 

Our Business Conditions Diffusion Index points to the ISM entering contraction territory in the coming months. 

The Yardeni Boom-Bust Barometer, which is a composite fundamental indicator, is diverging from the uptrend in stocks. 

Service’s growth looks like it’s about to follow manufacturing’s lead and trend lower. 

Remember the Levy/Kalecki Profits Equation?  Net investment is what drives profits in an economy, which is why capex or non-residential private fixed investment is so important to both economic and earnings growth. This is why the following is no bueno.

The fiscal stimulus in the US is rolling off. What was once a tailwind is becoming a headwind. Growth in the US is now “catching down” with the rest of the world. This is bearish US equities, bullish bonds, bullish precious metals, and bearish the US dollar.

Considering this backdrop, earnings estimates following Q3 onwards are way too optimistic and the current Forward PE for the S&P 500 is too high at just under 18x next year’s earnings.

Consensus earnings estimates for this quarter are low so I’m expecting some easy beats. But we’re likely going to get decent beats coupled with bearish forward guidance and management commentary this quarter, commentary like the following from CSX Corp’s recent earnings release (excerpt via CNBC): 

“Both global and U.S. economic conditions have been unusual this year, to say the least, and have impacted our volumes. You see it every week in our reported carloads,” Chief Executive James Foote said on a conference call Tuesday after the earnings report. The present economic backdrop is one of the most puzzling I have experienced in my career

Mark Kenneth Wallace, executive vice president of CSX, said on the earnings call. “On the merchandise … there are signs of slowing economic conditions in both IDP and GDP for Q3 and Q4, pointing to a less robust economy in the second half.

“We’ve obviously seen evidence of this in our own business, and now see a softer industrial environment, with signs in our automotive, chemicals and metals segment,” Wallace said.

Brace yourselves for some higher volatility!