A significant
undercurrent of internal weakness is plaguing the NYSE broad
market. This weakness is primarily visible in the dangerously high
numbers of stocks making new 52-week lows. Lately that number has
exceeded 300 on a daily basis, though it has been above 40 for the last few
months in a sign that the market’s health is less than optimal. The
best way of showing this internal weakness is in the following exhibit which
graphs the cumulative new 52-week highs and lows on the NYSE.
As you can see here, the
new highs-new lows are in a sustained downward trend which suggests
vulnerability to selling pressure in the stock market. A reversal of
this downward trend is required to put the market back on a healthy track.
As potentially dangerous
as this internal weakness is for the broad market in the near term, I still
don’t think it will prove fatal to the secular (long-term) bull market that
began in 2009. This opinion is based on a qualitative analysis of
the new NYSE 52-week lows: most of them are in the energy and natural resource
sectors. The blame for the weakness in this area is mainly due to
plunging prices for oil and other commodities. This in turn has put
strain on firms who produce or market these commodities with spillover impact
to other areas of the broad market.
The residual influence
of weak energy prices has also spilled over into the bond
market. Below is the chart of the SPDR Barclays High Yield Bond ETF
(JNK), which I use as a proxy for junk bond prices. Most of the
weakness reflected in the junk bond market originates in the high-yield debt of
energy companies.
The weakness in the
high-yield bond market is also spilling over into higher yielding corporate
debt, as the Dow Jones Corporate Bond Index also reflects. See chart
below.
I’m reminded of the
1997-98 experience which witnessed a similar scenario. In those days
the U.S. stock market was in the midst of a powerful bull market, yet there was
a negative undercurrent from the so-called “Asian contagion,” i.e. the foreign
currency crisis as well as soft commodity prices. Oil prices had
plunged to $10/barrel while gasoline at the pump was just under $1/gallon. This
proved to be a bonanza for U.S. consumers but put tremendous strain on
countries that heavily depended on energy exports, such as
Russia. The result was an increasing number of U.S. listed natural
resource stocks which put strain on the broad market. The end result
was a quick-but-nasty mini-bear market in the summer of 1998.
When finally the
commodity market weakness was finally resolved in the fall of ’98, the U.S.
stock market entered the final year of the glorious 1990s bull
market. In early 2000, the bull was over and a new bear market
began.
What I’m suggesting is
that we’re probably witnessing something at least remotely
similar. Most key industry groups which comprise the NYSE broad
market are still in decent shape. It’s primarily the commodity-heavy
industries which are showing most of the weakness. If the bear
market in commodities can be “washed out” by early 2016, it’s possible the
secular bull trend for equities can continue at least one more year.
The other major reason
behind the recent broad market weakness is a case of the chills thanks to the
global market weakness. Europe is one such area of global
weakness. The ECB recently cut its deposit rate by the minimum
amount expected, which did little to encourage investors that the central bank
is serious about bolstering continent’s economy and financial
system. One is reminded of how the U.S. central bank responded to
the growing credit crisis threat in December 2007. At that juncture
investors were on edge and looked for guidance from the Fed. Instead
of aggressively attacking the problem, however, Fed Chairman Bernanke announced
a tepid quarter percent rate cut in December ’07 which disappointed investors
and which eventually catalyzed a plunge in equity prices.
Investors had hoped
based on comments ECB President Draghi made in previous speeches that the ECB
would increase its version of QE in order to help stimulate the euro zone
financial markets, in turn helping the economy. Yet the ECB
responded in the tepid fashion we’ve all grown accustomed to seeing in recent
years. This is no way to calm the market and it’s not surprising
stocks, bonds and commodities have responded the way they have lately.
Looking back at a
commentary I wrote on Dec. 8, 2011 I was surprised to find how little things
have changed since then. I wrote, “If Mr. Draghi believes the euro
zone won’t eventually be torn apart by the debt crisis he is sadly mistaken and
would appear to be severely underestimating the severity of the problem confronting
him. And if he believes that ‘budget discipline’ (read austerity) is
the key to successfully dealing with the debt crisis at this stage he is
further mistaken. The time for budget discipline is long since
passed; now is the time for aggressive action. One can only hope
that the central bankers of Europe have learned something from our own credit
crisis in 2007-2008, namely the importance of preemptive monetary policy
action. Failure to take action right now, when Mr. Draghi still has
the option, will result in remorse down the road.”
China didn’t help
matters by slamming on the brakes of its real estate market
boom. China’s leaders enacted their own version of tight money by
increasing strictures on equity and real estate investors. Japan’s
government meanwhile proverbially shot its economic recovery in the foot by
increasing taxes, essentially undermining a successful QE measure.
When will the world’s
central banks get their acts together and re-synchronize monetary policy for
maximum global impact? Your guess is as good as mine, but there are
signs that at least the ECB, and possibly the People’s Bank, are slowly waking
up to the mistakes of recent years. How quickly they act upon this
realization is a matter of speculation, though. Hopefully the New
Year will witness a renewed resolve on the part of both banks to reverse the
damaging austerity and tight money policies which have caused so much grief.
In the meantime, the
only safe remedy for global market instability is continued patience and
prudence in one’s investing discipline. The equity market will work
through the commodity market and global economic weakness and will, I believe,
resume its bullish trend at some point next year. Until the NYSE new
52-week high-low index tells us that the broad market internal weakness has
been completely reversed, however, investors should maintain a healthy
skepticism for what may appear, at first glance, to be buying opportunities in
the stock market. Only when the internal condition of the broad
market decisively improves will the odds favor embracing risk.
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