"Buy the highs" keeps the S&P buoyant

With all the previously mentioned negative currents plaguing the stock market, what’s keeping the major large cap indices afloat?  One factor is increased M&A activity.  As I alluded to earlier in tonight’s report, the pharmaceutical industry is experiencing a plethora of mergers.  Other industry groups represented in the S&P 500 are experiencing the benefits of swelling interest in M&A as well. 

There is also the simple psychological impact of Wall Street’s “buy the new highs” mentality.  In what has essentially become a self-reinforcing feedback loop, traders have been conditioned this year to buy stocks making new 52-week highs.  This trend can be clearly seen in the following graph, which shows the cumulative performance of the S&P 500 during the opening hour of trading. 

 As you can see here, traders have been extremely bullish at the opening of the trading session for most of the time since February.  With the Dow, NYSE Composite and S&P 500 indices so close to all-time highs, it doesn’t take much force to keep the indices buoyant.  A bullish news headline – be it an earnings surprise, a merger, or other bullish event – is sufficient to keep the indices above their immediate-term trend lines. 

Even with all the negative cross-currents out there, as long as trader psychology remains ebullient, the market will be subject to the whims and vagaries of short-term momentum traders who buy the bullish headlines.  Remember that even when the technical picture is negative, investor psychology can trump all other considerations – at least in the short term.

[Excerpted from the Apr. 28 issue of Momentum Strategies Report]

Russia/Ukraine and the volatility factor

Earlier on Friday, Ukrainian officials demanded that Russia explain the presence of troops massed at the border of the two countries. President Obama also spoke with allies in France, Germany, Italy and the UK, agreeing to introduce another round of sanctions against Russia for its failure to observe the Geneva accord, which was signed last Thursday.  The re-emergence of tensions between Russia and Ukraine will contribute to increased broad market volatility if the situation isn’t soon resolved.

As I pointed out in the April 14 report, the Russia ETF (RSX) still looks weak in the immediate-term and isn’t far above its March low.  Keep in mind that the last time RSX dropped in March it helped trigger the U.S. stock market decline.  As I wrote in the April 14 report, “Investors can ignore Russia for now, but if Russia’s stock market makes a new yearly low in the coming days it’s doubtful Wall Street will simply shrug it off.”  This assessment is particularly important entering next week, when RSX will most likely test the key 21.00 level and may even penetrate below it.

The latest geopolitical concerns led to some safe-haven flows into Treasuries and gold, both of which posted gains on Friday.  The 20-Year Treasury Bond ETF (TLT), which confirmed a Coppock Curve buy signal in February, was up 0.14% on Friday to make a new high for the year, while the gold ETF (GLD) gained 0.70%.  The recent firming of the gold price is another subtle indication that serious investors are starting to worry about the broad market outlook in view of increased geopolitical tensions, not to mention the continued slowdown of both China’s and Japan’s economies.

Excerpted from the Apr. 25 issue of Momentum Strategies Report]

Gold searching for a fear catalyst

Our theme in recent reports has been the correlation between investor anxiety and gold demand.  For most of the last 13+ years, gold has benefited from what has been a near-constant climate of uncertainty.  The post 9/11 and post credit crisis years were indeed bountiful ones for the precious metals.  They served to underscore the attractiveness of gold as a safe haven investment.

Without another fear catalyst, however, gold is unlikely to regain investors’ attention in a meaningful way.  What the next catalyst might be is anyone’s guess.  Whether it takes the form of geopolitical turmoil, a financial crisis in the emerging markets or an economic slowdown, the next “black swan” event is exactly what gold needs to blast off into a new bull market.

The big question of course is when the next fear climate will emerge.  While this is ultimately a matter of conjecture, the most likely time frame for a flare-up of financial market tension is the June-September period.  It’s then that the final descent of the long-term deflationary cycle will be underway.  This is the same series of cycles that was instrumental in galvanizing the 2001-2011 bull market for gold. 

Gold is sensitive to both ends of the economic long wave of inflation/deflation.  It performs best during the final inflationary portion of the cycle as well as the final deflationary end of the cycle.  These two ends correspond to approximately the 1970s and the last decade, respectively.  Thus gold has still a chance of feeding off the last vestiges of the long wave deflationary currents between now and this fall. 

[Excerpted from the Apr. 22 issue of Gold & Silver Stock Report] 

Stock market update

As we talked about in the previous report, the stock market won’t be completely out of the woods until we see most of the six major indices back above their 30-day and 60-day moving averages. 

As of this writing, only the Dow Industrials and the NYSE Composite (NYA) have managed this feat (below).  The NASDAQ 100 (NDX), the S&P 400 Midcap (MID) and the Russell 2000 Smallcap (RUT) are all currently below both moving averages.  I would point out that the damage reflected in these three indices since March is far more indicative of the true state of the stock market this spring. 

While the large-cap weighted Dow and SPX are near their all-time highs, most stocks have taken a pounding in recent weeks.  It therefore hasn’t been a good time to own stocks, contrary to what the mainstream media has said.  This is why it’s important to follow closely a technical discipline instead of the fundamentally-based pronouncements of the Wall Street PR machine. 

[Excerpted from the April 16 issue of Momentum Strategies Report]

Still no fear catalyst for gold

Press reports blamed this week’s decline in the gold price on high frequency trading programs (what else?), which allegedly shook out the weaker gold positions.  Ever since the publications of Michael Lewis’ latest blockbuster book, Flash Boys, HFT trading has become the media’s favorite financial villain.  Every pullback or short-term market hiccup is now blamed on HFTs, and while there’s undoubtedly some truth to the allegations, the underlying technical structure of the market is being overlooked. 

The most dominant factor governing gold prices isn’t HFT trading algorithms, but lack of a major fear catalyst.  Without the necessary level of anxiety – be it geopolitical or economic in nature – investors are likely to continue ignoring gold in favor of riskier assets, or else assets with sustained forward momentum prospects (such as Treasuries).  For now the gold price continues to languish as fears over Ukraine, China, et al, take the back burner to more upbeat news concerning positive U.S. corporate earnings and economic headlines.

For example, news headlines touted the strong recovery in the U.S. job market.  New claims for jobless benefits are now near their pre-recession lows, according to a Reuters report on Thursday.  Meanwhile the latest manufacturing data for the Md-Atlantic region accelerated in April.  Earlier this week the latest retail sales and industrial production data gave equity investors reason to cheer.  Conversely, it was all the more reason for gold traders to liquidate positions as a defensive stance was viewed as counterproductive in such a positive news environment.

From a technical perspective, the price of gold (basis June futures) has not only slipped back below its 15-day moving average but is now also below both the 30-day and 60-day moving averages.  The short- and intermediate-term trend lines for the gold price have now been broken and gold is in a vulnerable position.  As you can also see in the following chart, our special stochastics indicator (below) has confirmed the recent sell signal….

[Excerpted from the Apr. 17 issue of Gold & Silver Stock Report]

Keeping an eye on China and Japan

Meanwhile in China, it was announced that the country’s exports fell -6.6% in March versus the year-ago period.  This frustrated Wall Street’s expectations of positive growth for China.  

Imports to China also declined -11.3% in March, which follows the -18% drop in exports February.  As Shiraz Mian, research director at Zacks puts it: “This is bad news, but interpreting Chinese economic data is never straight forward. The widespread perception among economists who closely follow the Chinese economy is that the export data from the year-earlier period was artificially boosted by over-invoicing, an illegal practice that Chinese exporters use to dodge tough capital controls and bring capital into the country.”

China’s industrial production in the first two months of 2014 increased at its slowest pace in two years and retails sales have also been declining. Chinese authorities recently announced a stimulus package in response to this slowdown.  Experts believe this may not be enough to nudge growth higher since bank lending remains restricted. 

Another looming problem for China is the possibility that the country’s housing market could crack.  Tighter lending and homeownership restriction’s by China’s government in recent years could lead to defaults among China’s 90,000 developers, according to a recent Bloomberg report.  China’s central bank initiated a liquidity injection on Thursday, the first in more than two months.  The rally in China’s stock market in recent days was likely in anticipation of this action.  We’ll find out in the next few days how helpful this action really was for China’s economy once March bank lending data is released.

China isn’t the only region of the globe experiencing deflationary headwinds.  An article appearing in Reuters suggested that U.S. stock market weakness is spreading to Asian markets.  Actually, the opposite is the case.  The Japanese Nikkei Index has been a notable laggard since the start of the year, as the following chart shows.  Moreover, recent upward pressure in the Japanese yen has caused financial institutions to react by unwinding the yen carry trade.  This in turn puts downward pressure on equities owing to the general need to raise cash.

How will gold respond to global deflation?

With economies slowing down in China, Japan, Eastern Europe and other regions of the globe, many investors wonder if 2014 will deliver another global deflationary epidemic.  As I’ll explain in this commentary, the next six months have the potential to be the most exciting period for investors since the 2010 financial crisis in Europe.

 

After the disappointment of last week’s European Central Bank (ECB) meeting, investors continue to wait in vain for a policy shift announcement from the bank’s president Mario Draghi.  Without a major news headline to sink its teeth into, the gold price has been slowly hovering above its recent low of $1,280 after finding support above its 90-day moving average.

 

Meanwhile the European Union’s producer price index dropped 0.2% in February and was down 1.7% year-on-year, as reported Wednesday.  The year-over-year decline was the largest since late 2009 and is part of a growing body of evidence that deflation is rearing its ugly head in Europe and in other regions of the globe.  “The PPI report puts more pressure on the ECB to ease its monetary policy in order to jumpstart economic growth in the EU,” according to Jim Wyckoff of Kitco News.  Yet the ECB’s Draghi refuses to act to head off the growing specter of deflation.

 

The Markit data firm has reported that the EU’s composite purchasing managers index fell to 53.1 in March from 53.3 in February.  A reading above 50.0 suggests expansion.  The survey said businesses reduced their prices for the 24th month in a row, however, further underscoring the increasing deflationary pressure.

 

Larry Elliott of The Guardian observed that Draghi rejected the International Monetary Fund;s call for immediate action to combat growing deflationary pressures as the ECB has adopted a “wait-and-see approach” before taking drastic measures to stimulate growth.  “Despite warnings from the fund and the Paris-based Organisation for Economic Co-operation and Development of the risks to the eurozone's fragile recovery,” wrote Elliott, “the ECB president said it was still thinking about whether to embrace the unconventional approach to monetary policy used by the Bank of England, the US Federal Reserve and the Bank of Japan.”  It’s precisely that kind of hesitation that will allow the final “hard down” portion of the deflationary Kress cycle to bottom with maximum impact later this year.  This should have definite repercussions for the gold price, as we’ll discuss later in this report.

 

Last week, China’s government announced a $24 billion economic stimulus plan in the form of railway construction spending.  The move was in response to recent data which show a noticeable slowdown in China’s economic indicators.  The country’s GDP is forecast to decline again to 7.4 per cent in 2015, even though the rest of the world is expected to recover and increase its demand for Chinese goods, according to the Asian Development Bank.  Providing some perspective on the China slowdown is a graph published on Thursday by Ed Yardeni (http://blog.yardeni.com). The graph shows just how far China’s manufacturing sector has contracted recently.

 

 

Yardeni also pointed out in an earlier posting that Japan’s government is in the process of making a critical blunder, one that led to a previous bout with deflation in the 1990s.  In 1997, Japan raised its sales tax from 3% to 5%, a move which caused consumer spending to plummet.  “Today,” Yardeni reports, “the government is doing it again, raising the tax from 5% to 8%.” 

 

Recent economic data in the land of the rising sun suggests deflationary pressures are returning.  Household spending in Japan declined 2.5% year-over-year for February; housing starts are down nearly 13% over the past two months.  Industrial production dropped 2.3% month-over-month in February.

 

With central banks all over the world slow to respond to the growing threat of deflation, the chances are increasing that this summer will witness another bout of global market volatility – not unlike the one that spread like wildfire in the summer of 1998.  That mini-global deflationary crisis, you may recall, occurred during what was an exceptionally bullish year for the U.S. stock market and economy.  It affected everything from stocks to commodities to currencies.  By the time the ‘98 global deflationary wave hit U.S. shores, the Dow Jones Industrial Average topped in July and was on its way to an almost 20% drop in a 2-month period in what was one of the shortest bear markets on record. 

 

The lesson learned back then was that deflation can spread very quickly in a reticular, interrelated global economy.  And that was in 1998, a time when the 30-year cycle was still peaking.  With the 30-year cycle down until October of this year, deflation won’t need much prodding at all to do its worst, especially if the world’s central banks fail to act in a timely manner.

 

Earlier this year, gold reaffirmed its status as a safe haven du jour when it benefited from emerging market volatility as well as geopolitical instability in Eastern Europe.  At the next outbreak of global market turbulence, gold should be in a good position to once again benefit from investor uncertainty.

Surprising weakness in the New Economy Index (NEI)

The New Economy Index (NEI) is on the brink of sending its first confirmed “sell” signal in four years. 

The index is a blend of the leading U.S. retail and business service stocks.  NEI is based on the concept that these component stocks are accurate reflections of changes within the real-time U.S. economy (as opposed to the lagging economic statistics favored by the Labor Bureau).  Except for a brief period in the spring of 2010, NEI has confirmed a firming economic picture for U.S. retailers since 2009.  As you can see in the following graph, though, the index has made a series of lower highs and lows – the first in well over two years.  Moreover, the important 12-week moving average (red line) has crossed below the 20-week MA (black line) and both moving averages are in the process of decisively turning down. 

The weakness reflected in the NEI suggests that U.S. retailers are experiencing what could be the early throes of spillover weakness from the uncertainty and economic weakness in China and the emerging markets.   Economists this year have persistently played down the slowing economy in China, but there’s no ignoring the fact that China’s stock market is now in its fifth year of a bear market.  That’s a negative sign for China’s economic outlook and there’s no glossing over it.  Equity markets always reflect future business conditions in the interim to longer-term outlook.  What the Shanghai Composite Index suggests is that China is in for some increasing economic head winds.

Back to the U.S. economic front, if the NEI continues to weaken we’ll likely have a confirmed “sell” signal later this month.  That in turn would serve as a warning for investors and business owners to beware a retail sales slowdown in the coming months.  

Stocks in the month of April

The month of April is statistically the best month for the Dow Industrials with average gain of 1.8% since 1950, according to Stock Trader’s Almanac.  STA points out that April is rarely a dangerous month “except in big bear markets (like 2002).”  It’s worth pointing out, however, that even in the devastating bear market year of 2008 the month of April saw a gain for the Dow.  The so-called “Best Six Months” of the year end with April (i.e. “Sell in May and go away”). 

There are a couple of minor cracks in the edifice still in need of repairing, but I’m encouraged by the market’s overall technical.  One of those “cracks” is of course the NASDAQ 100 (NDX), which is still below its previous high from early March and which took the brunt of the March correction.  NDX did manage to find support above its technically significant 90-day moving average, however, which is a positive sign. 

[Excerpted from the Apr. 2 issue of MomentumStrategies Report]

A look at the 4-year presidential cycle

For all the bullish 2014 expectations among Wall Street analysts, few if any consider the impact of the long-term cycles.  After all, it’s in late 2014 when several major long-term yearly cycles are scheduled to bottom in unison, from the widely followed 4-year cycle to the well-known 10-year cycle and on to the even bigger 40-year and 60-year cycles.  Each of these cycles tends to stamp its unique presence on the stock market when they bottom individually.  How much more then can we expect to feel their presence when they’re bottoming contiguously? 

Putting aside the bigger implication of the long-term inflation/deflation cycle of 60 years, let’s examine just the 10-year cycle.  This is one of the components of the long-term “super” cycle.  As long-time readers of this report will recall, the last time the 10-year cycle bottomed was in 2004.  This cycle always bottoms in the “four” year of each decade. 

When it’s bottoming by itself the 4-year cycle doesn’t always create bear market conditions, but it does tend to increase stock market volatility – especially as the bottom draws closer (late September/early October).  You’ll recall that 2004 was essentially a lateral or sideways trading range for the stock market with stocks making no net progress that year.  While the year 2014 is still young, it’s worth noting that already the S&P 500 Index (SPX) has made no net progress to date while the Dow 30 Index is below its 2013 high.  It’s too early of course to establish any intermediate-term patterns, but the makings of a trading range are already evident.

Even if you’re not a proponent of Kress cycle theory, consider that we’re in the second year of the 4-year presidential cycle.  The second year following a U.S. presidential election year is almost always marked by increased market volatility.  Not uncommonly the second year of a 4-year presidential cycle witnesses a bear market.  Let’s examine the “second year curse” of the past few presidential cycles for some examples:

·         The second year of President Regan’s first term in 1982 witnessed a volatile market environment with the S&P declining through the first half of the year; it marked the bottom of the 1970s/early ‘80s bear market.  The second year of Regan’s second term in 1986 saw the S&P rally in the first half of the year; in the second six-month period of ’86 the stock market went nowhere and was range-bound until stocks took off again in 1987….

·         The second year of President Bush’s term in 1990 was a bear market and witnessed the worst part of the S&L crisis; most of the damage was done in the July-October period when both the 4-year and 12-year cycles were bottoming.…

·         The second year of President Clinton’s term in 1994 saw a mini-bear market.  The S&P was down for the year after a number of extreme gyrations as the 4-year and 10-year cycles bottomed.  The second year of Clinton’s second term occurred during the final “blow-off” phase of the ‘90s bull market, yet it witnessed the shortest bear market on record: a 20% Dow decline over two months in the summer of ’98 as the so-called Asian Contagion and the LTCM meltdown roiled global markets….

·         The second year of President GW Bush’s first term witnessed a major bear market; the second year of his second term witnessed at least one major bout of volatility in the spring and early summer of the year 2006….

·         The second year of President Obama’s first term saw the infamous “flash crash.”  One can only guess what the second year of his second term will bring later this year.

The above overview of the presidential cycle reveals some common denominators.  The first one is that years in which the 4-year cycle bottomed along with a bigger cycles, such as the 10-year or 12-year cycle, saw unusual periods of market volatility and selling pressure, particularly in the second half of the year.  The second is that volatility tended to increase during the second year of a president’s second term.  Both of these factors apply to 2014. 

Based on our survey of the last 30+ years we can conclude that the second year of the sitting president’s term is typically a year when bad things happen.  Why this should be is self-evident; a presidential administration has a vested interest in implementing policies designed at “juicing” the economy in the first year of the term in order to consolidate political support.  The second year of the 4-year term is when most tax and regulatory increases are implemented.  It’s assumed by presidents that they will be able to again juice the economy in the third and fourth years, and that voters will likely forget the bad times of the second year by the time the next election rolls around.  Incidentally, the second year of a president’s term always coincides with the down phase of the 4-year Kress cycle. 

The reason for taking pains to review the 4-year presidential cycle in tonight’s report is because there are strong reasons for believing it will come into play at some point this year.  Maybe not in the next couple of months, but certainly by the summer we should see signs of increasing market volatility and accelerating selling pressure, especially as we head closer to the final bottom of the 60-year deflationary cycle this fall.  If China and/or other emerging market countries are experiencing turmoil (as I expect) it will likely only serve to exacerbate the volatility. 

Already we’ve seen a brief preview of what the next global market crisis could look like.  The problems have originated in China and Russia with other countries (e.g. Brazil, Chile, Turkey) playing supporting roles.  This is very similar to what happened in 1998 with the financial crisis that rolled across the globe beginning with Asia and extending to South America, Russia and finally hitting the U.S. like a tsunami.  Few market analysts in 1998 (a super boom year) believed the “Asian contagion” would infect U.S. markets, but they were dead wrong.  It happened very quickly in ’98 with most of the damage occurring in July through September – the final “hard down” phase of the 4-year and 8-year cycles. 

Again, this summer the 4-year, 8-year, 10-year, 12-year, etc. cycles through the 60-year cycle will also be cascading into their final bottoms around late September/early October.  It would be surprising indeed if the financial market somehow emerged unscathed by this crescendo, especially given the fragile state of the global economy.

NYSE internal momentum improves

NYSE internal momentum is…starting to show signs of improving as the latest cycle bottom draws to a close.  It’s worth noting that at no time in the last few weeks did the number of stocks making new 52-week lows rise above 40.  This is a sign that internal selling pressure was contained during the March internal correction. 

There are also preliminary signs that the number of new 52-week highs is starting to expand; on Monday the new highs rose to 144, which is the highest number we’ve seen since March 18.  If this number continues to expand we’ll soon have a confirmed cycle bottom signal.  The NYSE short-term directional indicator turned up today as well for the first time in weeks.  Another 2-3 days of rising will also be interpreted as a bullish confirmation signal. 

Finally, I would bring your attention to the dominant longer-term NYSE internal momentum indicator.  This is the longest of the components of the NYSE Hi-Lo Momentum (HILMO) index, and until a week or so ago this indicator had been declining for months.  The longer-term component of HILMO isn’t as important as the dominant interim indicator or the short-term directional component, yet it’s still fairly important in its own right when it’s rising on a sustained basis.  The recent turnaround in this indicator is another technical sign pointing to a potentially bullish month of April.

[Excerpted from the Mar. 31 issue of MomentumStrategies Report]