Bond yields take center stage

Bonds continue to take center stage as equities remain in limbo following the 6% decline in the S&P 500 Index (SPX).  The 30-year mortgage yield rose by some 62 basis points recently to 4.18%. As economist Ed Yardeni points out, “The most immediate impact has been a sharp drop in mortgage refinancing activity.”

According to the Investment Company Institute (ICI), there were significant net cash outflows from bond mutual funds totaling an estimated $13.5 billion during the week of June 12.  This followed a $10.9 billion outflow the prior week.  Yardeni points out that those funds weren’t rotated into equity mutual funds, which had small net outflows totaling $2.0 billion those same two weeks.  So much for the theory espoused by many analysts that the mass unloading of bond funds would be good for stocks.  

As we’ve discussed in recent weeks, rising Treasury yields are rarely good news for stocks, at least on not on a short-term basis.  Indeed, the damage done to stocks by rising bond yields is palpable.  In just two days last week the equity market lost $775 billion in value, which was equal to nine months of Fed bond buying.  Japan’s Nikkei index lost 20% in just two weeks while China’s Shanghai Composite Index lost a comparable amount in value this month after a spike in short-term rates.

In the immediate-term, rising yields are still a problem for stocks.  TNX remains above its rising 15-day and 30-day moving averages, which collectively delineate the dominant near term trend for Treasury yields.  A decisive close below the 15-day MA would be a preliminary sign that the yield uptrend is turning while a close below the 30-day MA would formally break the trend.  This in turn would presumably bring relief for stocks.

Is a gold bottom imminent?

On Thursday the bearish headlines started flashing across the news wire: gold breaks below $1,200.  I cautioned in the previous report that gold would likely experience spillover weakness in the coming days after breaking down from a descending triangle chart formation.  While the minimum downside target for this pattern projected to $1,250, breakdowns that are accompanied by heavy institutional bearish sentiment – like the kind gold experienced – are apt to overshoot the downside target.  

I have no price target for a bottom since I don’t believe in “catching the falling dagger.”  I’ll leave that to the bottom pickers.  For now I recommend that we simply wait for gold to exhaust its selling pressure, which it likely will in the next few days, then wait for the inevitable reversal before evaluating the near-term technical prospects for a tradable rally.  The good news (besides the latest Goldman Sachs report) is that the important 10-month price oscillator for gold should turn up on July 1, which will give us the first technical indication that a worthwhile bottom is in the making.

A stock market addicted to stimulus

Was former Fed Chairman Paul Volcker correct when he said concerning quantitative easing that its “beneficial effects…appear limited and diminishing over time”?  That’s the $85 billion question that Wall Street is asking right now.  An honest answer to this question by current chairman Bernanke will do much to allow the economy to heal itself of the wounds inflicted by the excesses of the last 10 years.

It became clear starting in May that the bond market is pricing in, by way of increasing yields, “the complete elimination of quantitative easing, even though elimination is the ultimate goal” in the words of Barron’s columnist Gene Epstein.  The Fed thus finds itself confronted with a paradox: it commenced its quantitative easing (QE) policy to help the economy stabilize and regain its strength, yet the mere threat of withdrawal of stimulus after more than four years has spooked investors.  Judging from the reaction of the stock market since last month, it’s clear that Wall Street can’t live without QE.

This begs the question of how effective QE has been in allowing the economy to build structural strength since the job market is still weak and middle class incomes haven’t recovered since the credit crisis began.  The middle class is the backbone of the economy and without its active participation no economic recovery can be considered effectual.

After four-and-a-half years of QE we can draw some conclusions about QE’s usefulness.  First, QE can be likened to a stimulant administered to an auto crash victim who needs time and rest, above all, to regain health.  The stimulus may trick the body into thinking that recovery is happening faster than nature intended, but the attempt at short-circuiting natural processes only provides a temporary metabolic boost and does nothing to address fundamental health issues. 

Secondly, QE does indeed, as Volcker suggested, provide only diminishing returns.  The recent experiences of China and the U.S. as well as Japan’s 20% stock market plunge bear this out.  QE has also failed to provide the promised boost to employment and has resulted mainly in increased consumption among higher end consumers; its benefits have largely passed over middle and lower class consumers.

Finally, the basic assumption that QE would benefit corporations, which in turn would use the increased revenues to expand their workforce, has proven to be a false.  While QE did indeed expand corporate profits by boosting stock prices, those profits were used by corporations to cut their workforces through various efficiency measures.  Moreover, the profits of the largest multinational firms were hoarded in overseas banks instead of being directly re-invested into domestic production.  America’s working force has seen precious little of those record profits while the corporate state has expanded at the expense of working class taxpayers. 

As if all of that weren’t enough, we’re now faced with the perverse possibility that a “tapering” of the Fed’s stimulus measures may result in considerably lower stock prices down the line.  This in turn would undo a substantial part of the recovery on the high-end of the economic scale, thereby undermining the entire 5-year experiment with QE. 

While it’s true that American households now have a cumulative net worth of $70 trillion, a new record, those gains are mainly due to the benevolent effects of QE in increasing retirement funds and real estate values.  Robert J. Samuelson, writing in the Washington Post, pointed out that before the 2008 financial crisis, Americans tended to spend about 5 cents of every dollar they gained in housing and stock wealth.  They now spend half that amount at best.  The reason for this, said Samuelson, is that households still haven’t recovered from the losses they suffered 5-6 years ago.  Meanwhile house prices are still 22 percent below their 2006 peak values. 

More importantly, psychology plays a major factor in curtailing consumption among U.S. households.  “Careless optimism has given way to stubborn cautiousness,” writes Samuelson.  “Americans learned the hard way that houses and stocks are risky assets,” he says, and they’re no longer borrowing against their wealth the way they used to.  He calls this a “stunning shift in behavior” and points out the predicament it creates for policy makers, viz. how to promote growth when people have embraced a defensive posture while “building barriers against hazards they can’t foresee.”  

Bernanke’s recent suggestion that the Fed may start “tapering” the stimulus later this year throws in sharp relief his failure to recognize not only Wall Street’s addiction to stimulus, but also the deflationary counterforce of the 120-year cycle.  The Fed has succeeded in re-inflating stock and real estate values because it fought relentlessly against this long-term cycle for over four years.  To relent now would be to allow deflation to have its way heading into 2014 when the cycle finally bottoms.

Gold market update

In a recent previous report we examined the gold futures daily chart (basis August) and noted the prominent “descending triangle” formation.  An analyst with Bank of America drew widespread attention to this pattern in a recent forecast, and the triangle projected a downside move to approximately the $1,250 area based on chart measurements.  Gold in fact reached – and slightly exceeded – the $1,250 minimum downside projection as you can see here, hitting $1,245 in overnight trading.   

Keep in mind that the $1,250 area is the minimum downside projection.  It wouldn’t surprise to see additional spillover weakness over the next few days as investors’ emotions get the better of them.  There is still a lot of unloading taking place by smaller investors who loaded up on gold back in April and this is being compounded by the deluge of bearish research reports being released almost daily by major banks (as mentioned above). 

Investors will need to exercise patience and wait for the gold market to bottom out on its own time.  We’ll be closely monitoring the market for clues that the capitulation has finally ceased and a new accumulation phase begun (which will eventually take place once the weak hands are completely out of the market).  

Kress cycle deflation pressure increases

To many observers, deflation was a thing of the past in the wake of the QE3.  The Fed’s asset purchases, which drove down bond yields to record lows, were thought to have tamed the global deflationary problem once and for all.  What they didn’t count on was the floodtide of deflation breaking through the dikes and barriers carefully constructed by the world’s central banks.

The increasing deflationary pressure is most visible in Europe and Asia but will soon wash up on U.S. shores in the near future.  A general deflationary trend is already visible in equity markets in several major countries, a consequence of the final descent of the 120-year Kress cycle.  As that cycle approaches its final bottom in late 2014 we can expect to see an increase in some of the problems we’re just starting to see right now in the global economy.

One of the most conspicuous victims of the deflationary Kress cycle is China.  China has in fact led the recent malaise in global markets starting with an 11% surge in short-term interest rates in China.  China’s overnight repo rate increased by an incredible 25%.  As analyst Bert Dohmen commented, “China is extremely important for all business leaders and investors….Because whatever happens to China will tremendously influence the world economy and your investments.  Many large U.S. and European companies depend on China for a significant portion of their sales and profits….A crisis in China will have global repercussions.” 

China’s Shanghai Composite Index has been in a bear market since peaking in mid-2009.  It’s remarkable when you consider that as the rest of the world has experienced a measure of recovery for the last four years, China’s stock market has been in decline.  In fact the Shanghia index is on the verge of testing its 2008 credit crisis lows, as you can see here.

One of the most fundamental pillars of market analysis is that the stock market always predicts future business conditions.  What is this telling us about China’s business and economic future?  The message can’t be interpreted as anything but negative for the nations of the world that depend on China’s manufacturing sector.

Then there is Russia.  Not that Russia is of any great importance to the global economy by itself, but Russia has long been a benchmark for deflationary pressures.  Since much of Russia’s economy is tied to oil and natural resources, any sustained decline in the price of oil will automatically exert a negative impact on the country.  Remember back in 1998 when oil prices collapsed to $10/barrel?  Russia’s financial sector went into collapse and its economy was in shambles.  It took an oil price recovery in the last decade to allow Russia’s economy to bounce back and grow for nine straight years.  Without the artificial oil price inflation, thanks in large part to the Fed and other central banks, Kress cycle deflationary forces would have long since wiped out Russia. 

Here’s what the Market Vectors Russia ETF (RSX) looks like over the last four years.  Note the bear market pattern visible in this chart since 2011.  Any further decrease in the price (and demand for) oil won’t bode well for Russia and will only hasten the country’s economic demise.

What about the other BRIC countries?  India’s stock market is currently probing a 4-year low and the country’s debt market had to be shut recently as yields increased beyond trading bands.  Brazil, which was the rising star of the emerging markets not long ago, is slowing economically and has been described recently as “dysfunctional.”  Not surprisingly, the natives are growing restless.  As Reuters reported on June 24, “More than a million Brazilians have taken to the streets this past week in the largest mass demonstrations since the impeachment of President Fernando Collor de Mello in 1992.” 

Brazil’s stock market, as reflected in the MSCI Brazil Capped Index Fund (EWZ), has broken down from a bearish triangle pattern – a pattern much similar to the one visible in the Russia ETF shown above.  This could be a preview of what’s to come for other emerging markets in the not-too-distant future as we draw closer to the 120-year cycle bottom.

Bond market crisis continues

Is the bond market anticipating a stronger economy in the months ahead or is it pricing in the eventual end of quantitative easing?  That’s the debate among many bond market watchers, but it appears the latter is most likely the case. 

Soaring bond rates the world over have created turbulence for equity prices and are also exacerbating an economic slowdown in several major countries.  China is the latest – and potentially largest – casualty in the rate increases.  On June 20, short-term interest rates in China jumped 11%; on the same day China’s overnight repo rate increased by an incredible 25%. 

Meanwhile the rally in the 10-year Treasury Yield Index (TNX) continues to exert an inverse effect on stock prices here at home.  The Dow Jones Industrial Average (DJIA) was down more than 200 points on Monday in response to the 4% (intraday) rally in TNX. 

As we’ve discussed in previous commentaries, the transition to higher rates doesn’t bode well for stocks.  Nor, if it continues, will it do any favors for the economy.  

U.S. economy hangs tough, but for how long?

In the face of the uncertainty that’s currently roiling the financial market, and despite growing economic weakness in Europe and Asia, the U.S. economy remains firm against all odds. 

Granted this could change later this year, especially as the Kress cycle-induced deflationary wave makes its way from Europe and Asia to U.S. shores.  For now, though, the U.S. retail economy is a picture of stability as reflected by the New Economy Index (NEI).  

The NEI is a real-time measure of how the U.S. economy is performing.  It’s comprised of the stock prices of the leading retail, business service and transportation companies and employment agencies.  It measures every vital aspect of the domestic economy; it’s shifting fortunes are gauged by the relationship of the NEI price line to the 12-week and 20-week moving averages.

Presently the NEI remains above both key moving averages and also above the intermediate-term uptrend line, as shown in the following graph.  The index hasn’t given an economic “sell” signal since the spring of 2010 (which was a temporary blip following the “flash crash”).  NEI has so far managed to capture every major and minor turning point in the U.S. economy since its inception in 2007.  

What NEI is showing us is that while U.S. consumers as a whole are still spending, especially those in the upper income scale, their aggregate level of spending is somewhat diminished since peaking in January of this year.  Luxury goods sales on the other hand are currently at levels not seen since before the credit crisis, as are new home purchases.  I anticipate this trend will change later on this year as the overseas economic slowdown eventually makes its presence felt in the U.S.  According to the economists at Kiplinger, “Manufacturers will continue to bear the brunt of a global slowdown, with factories likely to shed more jobs and cut more output by summer’s end.” 

For now, the economy’s good fortunes remain intact despite financial market volatility.  The million dollar question is how much longer will it be able to maintain this strength as the super cycle deflationary wave heads closer to home?

Will rising rates ruin the recovery?

The mere hint that the Fed may back off from QE has been enough to send bond yields the world over to their highest levels in over a year.  Bond prices in emerging countries have fallen as investors have pulled their money out of global bonds. The spillover impact of this rise in bond yields was felt immediately in several financial sectors.  Global stock prices were down, with Japan’s Nikkei index falling 20% into nominal bear market territory in just a few weeks.  The Nikkei’s decline was also partly in response to the Bank of Japan’s recent refusal to accelerate its recent efforts at monetary easing.

Global stock markets clearly don’t like the idea of rising interest rates, nor do they like the idea of a slowdown in central bank money printing.  This remains a very interest rate-sensitive financial market, and rightfully so: we’re still almost a year-and-a-half away from the bottom of the 120-year Kress deflationary cycle and markets today are predicated on the idea of low interest rates.  That why an increase in interest rates is bound to upset the apple cart and lead to a sell-off in equities and other assets. 

There is a school of thought among some economists that rising bond yields are actually a sign of economic strength.  One noted economist has gone so far as to state: “Higher rates normally accompany a healthier economy; they only rarely weaken an economy.  This is all very good news.”  I respectfully disagree.  Higher rates in an economy that is still weakened by deflationary undercurrents can only be bad news.  This is especially true when one of the leading sectors of growth within the economy, namely real estate, has come to rely on low rates.  Indeed, we’ve already seen in just a few short weeks the destruction that rising rates can do to rate-sensitive industries such as real estate.  Witness the sharp decline in the Dow Jones REIT Index (DJR), which fell nearly 15% in just over two weeks.

I would also point out that while the rising interest rate trend isn’t sufficiently established enough to be a major threat to the stock market or the economy, it has the potential to create problems down the road if it continues.  In many ways the rising rates (and falling bond prices) are beginning to resemble what happened in 1994 when a bond market sell-off added to the pressure of the S&L crisis to hit equities hard.  Not coincidentally the 20-year Kress cycle, a component of the 120-year cycle, bottomed in late 1994 and is now entering its final “hard down” phase into 2014. 

The celebrated recovery in real estate in the last couple of years has been almost exclusively based on low mortgage rates.  Much of the recovery in consumer retail spending is a direct result of the real estate bounce back.  One could almost say, “As goes real estate, so goes the economy,” so it behooves us to carefully consider the question posed in the above headline. 

It’s worth pointing out that mortgage rates, like all other types of rates, are on the rise.  The average rate for 30-year fixed rate mortgages 4.12% as of June 19, according to Freddie Mac.  One year ago the average 30-year FRM was 3.84%.  After falling for eight consecutive weeks earlier this spring and nearly hitting an all-time low, rates have risen the past few weeks on the back of the rally in Treasury yields.  The Mortgage Bankers Association (MBA), which represents the real estate finance industry, predicts 30-year mortgage rates will rise to 4.4% by the end of this year.  Does anyone dare suggest the housing market will simply shrug off even a minor increase in rates over the next several months? 

The dominant longer-term trend for interest rates is clearly down, however, as you can see in the following graph.  The trend for the 30-year conventional mortgage rate is defined by the chart pattern of lower highs and lower lows which has been established since 2006.  As Robert Campbell said in a recent issue of his Real Estate Timing Letter, “Until the actions of the Fed speak otherwise, Fed policy is currently working to push mortgage rates down.”

The bottom line is that while the longer-term rate trend is down, as long as the intermediate-term interest rate trend is up it can still create significant volatility for both equity and real estate markets.   And as we learned from the lesson of 1994, even a temporary rate increase is nothing to scoff at.

A bear raid on gold

A growing number of asset managers from high profile investment banks foresee a gold breakdown, however.  Could they be correct in their dire prediction?  

Ordinarily we could answer that question in the negative.  After all, fund managers have a historical tendency to be wrong at major inflection points.  But this isn’t an inflection point for gold, at least not yet.  What we’re dealing with here is a possible continuation of a well-established trend that has been in place for almost two years.  The crowd (and by “crowd” we can include fund managers) can be right during the final “hard down” portion of a major bear market, much like they were during the final months of the 2008 credit crisis. 

Also worth pointing out is that downside momentum and negative investor sentiment both tend to feed on itself during the last stages of a major decline.  With so many hedge funds responsible for the short-term moves in commodities like gold, all it takes is for a herd mentality to develop and the next thing you know there can be a self-fulfilling sell-off underway. 

Just how bearish has the crowd become on the yellow metal?  Based on a Bloomberg survey, the number of traders expressing bearish views on gold increased to its highest level this year.  Confirming this widespread bearish sentiment, gold-backed ETP holdings fell to a two-year low of 2,117 metric tons last week.  While some investors looked for the Chinese to lend support to the physical gold market with continued purchases of physical bullion, the cards appear to be stacked against gold in the short term.

Q&A: Kress cycles and inflation vs. deflation

Question: “I’ve long held the view the Fed would rather risk excessive inflation than deflation, so it would be prepared to hold base rates for longer rather than choke off growth, even if inflation is starting to tick up.  What are your views on the Fed raising base rates if inflation returns?”

Answer: Meaningful inflation is unlikely given where we are in the 120-year Kress cycle.  The Kress mega cycle is scheduled to bottom in late 2014 and the implication is that until it does the inflation rate will be low.  Meanwhile, symptoms of deflation should increase in certain areas of the economy as we head closer to that date. 

Question: “I know there’s a debate of inflation vs. deflation (as suggested by the Kress cycles) at the moment.  I think the only way inflation will come is if the liquidity in the system from printing money jumps to commodities (i.e. cost-push rather than demand-pull), which may well happen if the stock market continues to falter (basically a repeat of 2007-08). This may then kill the economy anyway.  I therefore feel the Fed is somewhat backed into a corner and can't raise base rates (even if bond yields are suggesting they will, or that inflation is coming).  What do you think?”

Answer: Let’s say for argument’s sake that stocks take a beating in 2014 as the final leg of the 120-year cycle bears down on the economy.  Is it necessary that commodities benefit from the excessive liquidity provided by the Fed?  Could we not see instead a repeat of 2008 when both stocks and commodities went down together?  Financial crises usually hit both equities and hard assets since investors are forced to liquidate positions in order to raise cash.  Even if the market avoids a crisis between now and 2014 (doubtful), keep in mind that much of the commodities weakness of recent months has been due to slackening demand from overseas as the effects of Kress cycle deflation are felt in Europe and Asia.  This will eventually make its way to our shores.

As for the recent rally in bond yields, it should be kept in its proper perspective.  It’s not necessarily the start of a new trend but instead is likely a recoil rally from an extremely oversold technical condition.  It may also be the result of investors sensing an improvement in the economy’s near-term prospects as some have suggested.  The long-term Kress cycle tells us to be prepared for continued low interest rates between now and late 2014, however.  It’s highly unlikely that inflation will become a pressing concern until after 2014.

The interest rate obstacle

It had to happen sooner or later.  After several months of near perfect fundamentals and technical strength the stock market is finally showing a couple of cracks in the edifice.  Granted these cracks aren’t yet big enough to completely jeopardize the interim bull market, but they are making their presence felt in the short-term trend.  Moreover, if left unchecked and not repaired, the cracks could eventually grow big enough to breaking the dominant intermediate-term uptrend for equities later this year.

The first crack in the wall is the fact that interest rates for corporate bonds and Treasuries have been rising steadily for the past few weeks.  While the rising interest rate trend isn’t sufficient or established enough yet to be a major threat to the stock market or the economy, it has the potential to create problems down the road if it continues.

The following graph shows the progression of the Dow Jones Corporate Bond Index over the last few months.  This has been the most precipitous decline seen in corporate bond prices in recent memory.  Corporate bond prices typically serve as a proxy for the stock market outlook, albeit with a lag. 

In many ways the rising rates (and falling bond prices) is beginning to resemble what happened in 1994 when a bond market sell-off added to the pressure of the S&L crisis to hit equities hard.  Not coincidentally the 20-year Kress cycle bottomed in late 1994 and is now entering its final “hard down” phase into 2014.

While there is still room for stocks to rally this summer before entering the anticipated volatility phase as we head closer to the 2014 Kress cycle bottom, the rising interest rate/falling bond price trend is a reminder that there’s still plenty that can go wrong between now and 2014 to upset the benign forecasts of the long-term bulls.

Investor sentiment and the "wall of worry"

The latest AAII investor sentiment poll showed some improvement from the past few weeks.  The latest percentage of bullish investors was 29% compared with 36% the previous week.  Among bearish respondents 39% were bearish compared to last week’s 30%.  This marks the first time since May 1 that there have been more bears than bulls. 

The increase in bearish sentiment was a welcome change to the relentless bullish predisposition among traders which should serve to keep the market’s “wall of worry” intact through the current volatility phase.  

Do hedge funds have too much power?

A reader of my book, 2014: America’s Date with Destiny, writes:

“You don't seem to like the fact hedge funds command so much power. You even lament the fact they pose a risk to the financial system. Two points:

“1. Their power is given to them by free agents called investors. Who are we to question their collective decision process? It may be flawed, it may be wrong but it is what it is.

“2. If their power is excessive what can be said about the excessive power granted to governments? What gives legitimacy to governments other than being elected by a majority that is vastly clueless and by default of an average intellect?”

These are both provocative points that require thoughtful answers.  On the first point I’d respond by saying that while individual investors give hedge funds their power in the form of money, the question must be asked as to how reasonable it is to allow individuals to aggregate money power beyond a certain limit.  Is it fair and reasonable to allow fund managers to command billions of dollars – mostly from high-net-worth accredited investors – which in some cases gives them a lever to influence critical commodity markets?  In some cases these operations influence the prices of goods and services which everyone must purchase for survival (oil, gasoline, ag prices, etc.)  When did Americans ever give hedge funds a mandate for controlling their financial destinies? 

When a particularly powerful hedge fund manager, say a George Soros, decides to use his power to attack a sovereign currency (as Soros did with the British Pound), is that a fair use of money?  Should that be allowed simply because “free agents” granted them that power?  At some point I think it’s appropriate for citizens to ask the age-old question as to how much power an entity, such as a hedge fund, is allowed to accumulate.  The U.S. has a long-standing skepticism of corporate monopoly power and has at various times in history broken up monopolies.  When a hedge fund is able to exert the kind of power that influences the currency and/or the economy of a country, I think it’s reasonable to treat it as a type of monopoly power and attempt to curb it. 

On the second point my response would be that while government often tends toward excessive use of power, governments in the free world have their mandate by the assent of the people who pay them taxes, without which they couldn’t survive.  Hedge funds by contrast have accrued power by their own will, and in all too many cases, against the best interests of the people.  It is the power of government – supposedly “of the people, by the people, and for the people” – in a republic that allows hedge funds to exist in the first place.  Doesn’t it stand to reason then that hedge funds should be required not to act against the best interest of the people?  

The tug-of-war over gold

The Commodity Futures Trading Commission (CFTC) weekly commitment of traders report for the week ending May 21 revealed a heavy bearish bias against gold on the part of speculative traders.  According to ETF Daily News, “Large speculators’ net long positions in gold futures and options continued falling to lows not seen in several years,” adding that “Net long gold positions for non-commercial traders such as hedge funds are now at the lowest level since November 2008.”

By contrast, the commercial interests – which are considered the “smart money” in the gold market – have built up a large net long position in gold.  According to the CFTC’s latest report, commercials have increased their net position in gold by over 185,000 contracts, which is the highest level of bullishness since October 2008.

The International Monetary Fund, in a May 27 report, revealed that central banks in emerging countries were big buyers of gold during the recent decline.  The IMF report listed Russia, Turkey, Belarus, Kazakhstan, Azerbaijan and Greece as buyers during the past few months.  ”We expect the trend of central bank buying to continue,” Alexandra Knight, an economist at National Australia Bank, told Bloomberg.  “The longer term trend for central banks to increase gold reserves remains intact.”

The sentiment backdrop for a confirmed bottom is certainly there; it remains only for gold to add to its recent strength by closing at least one more day higher above the May 30 close to show that buyers have taken control of the immediate-term trend.  Even more importantly, however, gold should close above the 30-day MA to prove that buyers have completely regained control from sellers, as discussed previously.  Note that gold is currently testing the resistance at the 30-day MA.

A summer crash scenario

There are several parallels between now and the spring and summer of 1998 which led to the July-October decline.  The year 1998 was an exceptionally strong one for U.S. equities for the first half of the year; that year also witnessed a strengthening domestic economy.  Like this year, however, 1998 saw trouble begin overseas with global weakness reflected by falling commodity prices. 

Another point of concern for the market this summer is the global financial sector.  While U.S. banks are doing well due to improving balance sheets, foreign banks are lagging. The comparison between the SPDR International Financial Sector ETF (IPF, black line) and the Philly Bank Index (BKX, yellow line) illustrates this point. 

As go the banks, so goes the broad market is the old saying.  This applies to foreign banks as well, for as we’ve experienced many times in the past, weakness in foreign markets sooner or later always spills over into U.S. equities, a’ la 1998.  [Excerpted from the June 3 issue of MSR]

Summer doldrums ahead for retail sales?

National chain store sales 0.6% in the first three weeks of May from April, according to Redbook Research.  Sales for the week rose 2.7% year-over-year. 

But are retail sales poised to encounter a summer slow-down?  That possibility is suggested by the recent behavior of the New Economy Index (NEI), which measures the stock price performance of the leading U.S. retail and business economy companies. 

The latest NEI chart, as of May 31, shows that while the dominant intermediate-term trend remains up (see black arrow) the short-term trend is slightly down (red arrow).  NEI reached an all-time high on Jan. 21 and has been making a series of slightly lower highs ever since.  While the overall trend of retail sales as reflected by NEI remains up, it would appear that the retail economy may encounter a period of sluggishness ahead.  That sluggishness would most likely occur during the “summer doldrums” period.