Putting it All Together
Looking at earnings last season, the technical picture, the macro environment, and the economic indicators, it looks like the stars have aligned for a correction of significant magnitude. Recent data is reinforcing that idea this week. To make a long story short: the risk-off trade is in full effect again. The next trade will be a risk-on trade when the market gets clarity from Europe, Greece, Spain, and Ireland and/or monetary policy response from the Fed and the ECB.
You Reap What You Sow
The earnings season was okay. 55.38% of companies in the S&P 500 had positive sales surprises and 69.09% of companies had positive earnings surprises. Recall in 2010 we had earnings surprises but top line beats were hard to find. During the first quarter earnings season, the issue I saw quite frequently after a company announced positive earnings and revenue beats was lower guidance. Many companies guided lower for the current quarter. That was enough to send individual names down. Enough of those individual names falling after lower guidance was enough to cap the markets in April. We won’t know if companies were sandbagging the numbers to “play” analysts heading into the second quarter earnings season, or whether things are truly going to slow. My guess is that weather will be the big excuse in the second quarter during the earnings season as a mild winter possibly shifted demand forward in the first quarter. We’ll just have to see in July as the earnings season kicks off, but lower guidance was a big shift from the fourth quarter of 2011 when many companies were guiding higher.
The technical chart of equities indicates a top was formed on May 11th when the S&P closed at 1338 below the April and March low all at once. We had the makings of a short-term bottom last week through Tuesday this week when the S&P closed at 1332, but the failure to get back above 1340 has reinforced the outlook of a major top. Today, rumors that the IMF is talking about a contingency plan for Spanish banks was enough to rally the S&P. The intraday rally will need to be followed up with another advance, but as of yet, no new trend has formed and the intermediate-term sell signal on May 11th should hold.
The percentage of stocks within the S&P 500 above the 50-day moving average is a good intermediate term gauge. That gauge is telling us that stocks are oversold with only 21.4% of stocks above the 50-day average. A buy signal will be given if the gauge closes above 30%.
The dollar continues its upward pilgrimage and so commodities must suffer. The CRB index hit a fresh 52-week low this week as the dollar hit a 52-week high. Despite a better economic outlook and accommodative policies in China that look promising for commodities, the macro environment in Europe is steering the euro lower and the dollar higher. This has more leverage over commodity prices than improving conditions in China. China’s stock composite is essentially flat in May and one of the world’s best performing markets in the month. Gold and silver bullion continue to hold significant support zones, but oil has broken down. There is the possibility of a safety trade in Gold if both gold bullion and the U.S. dollar rise – a possibility here as the markets clamor for policy response from the Federal Reserve and the ECB.
The macro environment began deteriorating a couple months ago when yields began to climb again on sovereign bonds. Recall that Greece was due another bailout and Spain lowered its fiscal targets for 2012. Requiring more austerity, Greece was granted more funds by the Troika—that’s the combined International Monetary Fund (IMF), European Central bank (ECB), and the European Commission (EC). However, sentiment is changing on austerity measures in Europe. Hollande was elected on a more socialistic platform calling for growth, not austerity. Likewise, Greek elections showed us that they too do not want any more austerity. So the question now is whether the EU lets Greece go if they don’t want to make the cuts the Troika is demanding. The uncertainty of Greece leaving the EU is causing the euro to fall, the dollar to rise, and Treasuries to rise.
Right now, the market continues to respond to headlines out of Europe more so than anything else in particular. We rallied Tuesday on rumors a European bank capitalization fund is going to be proposed. We are getting rumors from overseas articles that Germany is giving the nod to such proposals as opposed to the crossed arms such ideas would have received six months ago.
Wednesday, the ECB shot down Bankia’s recapitalization plan at the same time an Italian bond auction was weak, causing equities to fall. If the ECB won’t come to Spain’s aid, that means they would likely have to tap the bailout fund which could cause another downgrade of their debt, forcing rates higher, and making their budget problems even bigger. Not to mention such a bailout would likely severely drain the funds of the European Stability Mechanism (ESM) and the European Financial Stability Facility (EFSF).
Today, we saw the markets fall in the morning, but as I’ve already said, news that the IMF was talking with Spain to form a contingency plan for Spanish banks reversed the down tick today and turned it into a positive close for U.S. equities. The headline came after European markets had already closed so we’ll see how they respond overnight.
Going forward, it is clear that Europe made the monetary changes they needed to in 2012 to calm the credit markets. Now they need growth and the message is being sung loud and clear from the populace at the ballots. However, even in Greece, the populace wants to stay within the EU and the euro—they’re just tired of the cuts. But Germany has made it clear, that if cuts aren’t made, Greece can leave the union and go their own way. Will they make the same statement to Spain? Not likely. Banks and financial institutions are much more exposed to Spanish debt.
Events Just Ahead
There will be a lot of events in June to look forward to for potential catalysts. Today, Ireland is voting on a referendum whether to ratify the European Union’s deficit-fighting treaty. I haven’t seen the results posted but it will be interesting to see how voters respond to two difficult situations: more austerity or bankruptcy.
Next week the ECB meets but Draghi’s preview today in a speech didn’t help much. He said he doesn’t believe the current crisis is not the ECB’s problem; he said that the ECB “can’t fill the vacuum left by the absence of political action.” He also said that he doesn’t believe the current market environment is as bad as it was at the end of 2011. This suggests we aren’t likely to see much policy shift.
Also on Wednesday the 6th there's an EU meeting to discuss ways to resolve failed banks. This might also include plans for a pan-European deposit guarantor fund—each a potential catalyst to move the market.
June 13th – Germans discuss a growth pact
June 17th – Greek elections
June 18th through June 19 and again on the 28th through 29th – G20 Leaders Summit to discuss some of the same measures the EU discuss next week.
Finally, on June 20th, we’ll get the Federal Open market Committee meeting to discuss policy. As I’ll show in a minute, U.S. economics have plateaued and could be decelerating.
Finally, we need to discuss U.S. economics. While China and Europe have been slowing for some time, the U.S. turned a corner in September of last year. We have been treated to better announcements almost daily leading up until April, but things have changed. Recession Alert released a flash update of their Leading SuperIndex today ahead of the jobs report tomorrow. While it’s still in positive territory, it has shown three monthly declines in a row as of late. Manufacturing data has been mixed. The ISM manufacturing index shot up on May 1st which led to the top of the S&P 500 near 1405, while the ISM non-manufacturing index disappointed two days later. The nail on the coffin was struck on the second disappointing monthly BLS jobs report, given on May 4th, that rolled the market over with conviction.
On the flip side of the coin, we continue to get mostly positive news that the housing market is continuing to recover. The Case-Shiller index has shown that price decreases are decelerating with three months of improvement in a row. Some areas, like in Phoenix, where the courts aren’t holding up foreclosures are showing prices are rising.
It’s the first week of the month when the jobs numbers come out in addition to important ISM data. Today’s Chicago ISM manufacturing and jobless claims data disappointments were used to liquidate in the morning but Europe trumped economics in the afternoon to cause a mid-day rally.
Tomorrow is a big day for economic news. Vehicle Sales, the BLS non-farm payrolls report, construction spending, ISM manufacturing, and the ECRI’s leading index will be released. Tomorrow will be influential in making investors hit the buy or the sell button over the short and intermediate term, all in one day.
Summing it Up
Earnings have been great over the last few quarters. This season, we got lower guidance from most companies which caused many of them to turn south over the intermediate term as analysts revise their recommendations, price targets, and estimates. Technically speaking, if you ask any technician about the market, they’ll tell you the top is in for the year, or something as bearish. We clearly formed a top in May with the break below the March low. That number was 1340 for the S&P 500. Like in 2010 and 2011 when similar events occurred, the market sold off ruthlessly. We hit short-term oversold conditions two weeks ago and the market has consolidated sideways ever since. As I've already said, I think tomorrow’s economic numbers will be very influential in shaking us out of the short-term consolidation. We’ve had growth in the economy as depicted in good housing, good earnings, and good jobs numbers earlier in the year. That appears to be slowing, but a downtrend hasn’t formed. We could merely be feeling the after effect of a mild winter in which demand was pushed forward and we are now in the wake of that. China’s improving economics are important, but we need to see Europe swing back again as well. Without any catalysts for Europe in the growth department until the end of the month, we aren’t likely to see a near-term change any time soon.
So there you have it. The investment environment is clear as mud and that may be why we see 10-year Treasury yields hitting 52-week lows. Sentiment hasn’t been this bearish towards investing in equities since March 2009 for institutions. Retail investors continue to flock toward bonds as fund flow data has shown over the past two years. That’s causing some contrarians to buy stocks now, but without a catalyst like the long-term refinancing operations from the ECB in December, it might be for naught. There are plenty of possibilities in the near future for a catalyst, though, so keep your eyes on the financial papers. We’re bound to hear about policy shifts, interventions, and accommodation in the weeks and months ahead as the Sovereign Debt Crisis is proving hard to ring fence. Greece can be let go of, but Spain? I think not. Something will have to be done and the IMF seems to agree. We’re expecting policy intervention soon.
About Ryan Puplava CMT
Ryan Puplava CMT Archive
|05/20/2013||Positive Outlook Change for Chinese Stocks Could Have Bullish Implications for Commodities||story|
|05/16/2013||The Taper Trade||story|
|05/09/2013||Industrials and the Return of Alpha||story|
|04/25/2013||Catching A (Golden) Falling Knife||story|
|04/04/2013||Rotation and De-risking||story|
|03/28/2013||The Broken RORO||story|
|03/21/2013||Housing: This Bull has Room to Roam||story|
|03/14/2013||Too Late to Buy and Too Early to Sell||story|
|03/07/2013||Removing Dollar Catalysts||story|