Growth Scare

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At a time when the Federal Reserve Bank has been debating how to end QE, recent developments in the economy have shown a deceleration in activity that has also transmitted into lower commodity prices. Stocks have been extended for some time, but have recently pulled back to support; while internally, many sectors have already exhibited sizeable corrections since February and March. There have been few places to hide recently, all conservative areas to invest like Treasuries, staples, health care, and utilities. The question posed to investors is whether the deceleration has momentum. If this is the case, I expect another 5-10% correction in store for equities; however, we’re likely to see the Fed respond with more accommodative Fed-speak as it has in the past four years and recent comments from St. Louis Fed Chief James Bullard confirm this sentiment.

The last few weeks have been brutal for growth and risk-on investments. The decline in PMIs from Europe, China’s disappointing GDP figure, and slower manufacturing growth in the U.S. have caused commodities to correct, the dollar to rally, and Treasuries to rise again. Here’s a list of disappointing U.S. announcements as of late:

  • Richmond Fed Survey (March) 3 – Previous: 6
  • ISM Chicago (March) 52.4 – Consensus: 56.5 and Previous: 56.8
  • Kansas City Fed Manufacturing Survey -5 – Previous: -10
  • ISM Manufacturing (March) 51.3 – Consensus: 54 and Previous: 54.2
  • ISM Services (March) 54.4 – Consensus: 55.8 and Previous: 56
  • March BLS Employment 88,000 – Consensus 200,000 and Previous: 236,000
  • U. of Michigan Consumer Sentiment (April) 72.3 – Consensus: 78 and Previous: 78.6
  • NY Empire State Manufacturing (April) 3.1 – Consensus: 7.0 and Previous: 9.2
  • NAHB Housing market index (April) 42 – Down three months in a row
  • Industrial Production (March) 0.4% - Beat consensus but below Previous: 0.7%
  • Philadelphia Fed Survey (April) 1.3 – Consensus: 3.2 and Previous: 2.0
  • March Leading Indicators -0.1% - Consensus: 0.0 and Previous: 0.5%

So as you can see, March weakness is translating into April weakness as well. Next week we get some more regional data from the Chicago Fed National Activity Index, Richmond Fed survey, and the Kansas City Fed survey in addition to home sales, Q1 GDP, and consumer sentiment. So far, April is tracking lower so any divergences from this pattern on next week’s results would be unexpected.

The risk-on versus risk-off trade reversed in February and that trend continues despite expectations for a massive increase in money supply from Japan. In years past, the yen carry trade powered big investments in commodities and commodity currencies, but when you borrow Yen, who says you only have to buy commodities? It’s a funding currency and those funds will pour into what’s “working” and that continues to be the high dividend-paying stocks, Treasuries, and European bonds as investors seek yield – not growth.

Despite the current weakness in commodities, the drop in oil, copper, cattle, hogs, corn, wheat, and coffee bode well for U.S. consumers down the road. If you follow and believe in Jim’s petro-dollar cycle, falling commodity prices add money back into the pockets of consumers. This leads to more consumption and an improving economy. Here is a chart from Jim’s article that shows the relationship of inflation-adjusted gasoline prices versus Real GDP.

gas prices
Source: Bloomberg, EIA, Stifel Nicolaus format.

There has been a disconnect between higher highs in the equity indices—on the basis of portfolio rotation and new money entering conservative stocks the likes of health care, staples, and utilities—while economic activity decelerates. Monday’s selloff was the first actual sign of distribution. On Monday, 98.4 percent of the S&P 500 closed down and down volume was 92.7 percent of total volume. There were 2632 declining issues on the NYSE which was the most since the November 14th bottom. The market answered back nicely on Tuesday with 2437 advancing issues, but volume was a weak.

Technically speaking, topping formations are beginning to form for the major U.S. indices. Many of the indices are already trading below their 50-day moving average like the Russell 2000, S&P 400 Midcap Index, the NASDAQ Composite, and the Dow Jones Transportation Index which makes it easier to form tops now. Despite the near-term weakness none of the indices have technically completed a top; however, internal strength has waned as I’ve been showing over the past few weeks. For the first time this year, there are more securities hitting 52-week lows than there are hitting 52-week highs across all of the U.S. exchanges:

highs lows
Source: Bloomberg

Looking at just the stocks in the S&P 500 (all operational companies), there are still more 52-week highs than lows, but the gap is narrowing:

sp500 42 week highs for companies
Source: Bloomberg

The percent of stocks above the 50-day moving average has been diverging from the rise in the S&P 500 since January. The indicator has since produced three sell signals in the last two months and has finally broken down past previous lows with 46.40 percent of the S&P 500 trading above the 50 DMA as of today. At 46.4 percent, this indicator is probably on its way lower over the next month towards oversold territory.

spxa50r 17 apr 2013

While the percentage of stocks above the intermediate-term moving average (50 DMA) has produced sell signals the long-term breadth indicator, the percentage of stocks above the 200-day moving average, is at support. As I’ve shown in the past, this is probably the most powerful individual indicator I have in my arsenal at predicting market tops and bottoms. Over the past few years, the completion of a topping formation in this indicator has been helpful in predicting major corrections in equities.

spxa200r 17 apr 2013

Today, there were some short-term signs of a bottom in oil and copper, just as natural gas broke out above a two-year trading zone. $85 was support for oil while copper played touch-and-go from the 2011 low of $3.06. Today was an intra-day reversal for copper and in spite of weak economic results. The metal is oversold and due for a rally. Watch copper especially tomorrow for trading to confirm the intraday reversal. I believe this is a technical rally that will not reverse the long-term trend until economic activity turns around.

There were a number of reasons why the dollar was down today, and why commodities should have rallied despite the weak economic activity. The dollar has been trading as the strong economy currency. If our economic activity weakens, than it would make sense for the U.S. dollar to weaken. Additionally, heads of the Federal Reserve Bank have been changing their tune on monetary accommodation. In the first quarter, tapering QE or outright selling assets was being discussed. Last week Charles Evans talked about lowering the target on the zero interest rate policy (ZIRP) from 6.5% to 5.5% which would prolong the policy. Yesterday at the Levy Economics Institute of Bard College, James Bullard said “inflation is running low…I’m getting concerned about that”. Right on cue, we are hearing a change in Fed-speak as jobs data and inflation as measured by the CPI don’t go the direction the central bank wants it to go. Finally, Spanish bond auction results were robust, helping to lift the euro.


As whippy as this market continues to be over the past few weeks, the setup for a spring swoon in the economy has developed. Commodities have been for sale for some time, ever since Chinese stocks peaked in April of 2011. Even though China’s PMI production data is up for the fifth month in a row, according to Markit data, commodity investors are having to readjust to the smaller, yet more sustainable 7.5% GDP growth rate the country is targeting. As one senior Chinese adviser has said recently, “the target is 7.5% growth and the first quarter was 7.7%...Why would we need to stimulate growth?” according to Dow Jones newswires.

Many commodities have hit oversold conditions and were due for a bounce. Oil continues to find support near $86/barrel, natural gas had a breakout day, and gold has been crawling back from $1350 with clear resistance near $1400.

As I mentioned, we’ll get some more economic data on conditions in April next week with existing homes sales Monday, the flash PMIs on Tuesday (China out Monday night), durable goods Wednesday, and then U.S. Q1 GDP and Consumer Confidence on Friday. PMI data continues to improve for China with leading components up nicely in March. Despite the GDP disappointment this week, another rise in the PMIs would be a big welcome for growth-concerned commodity prices.

hsbc china manufacturing pmi

The setup for a technical correction in stocks is here. We merely need one day to break through support and stop-losses will trigger. It’s clear that a rotation has been underway from growth to safe-haven type investments in anticipation of a spring/summer swoon in economic activity and that move has been justified. The light at the end of the tunnel, however, is that this sort of weakness in economic activity and commodity prices ends up helping consumers down the road. With a little help from our accommodative friends at the Fed, things should pick up again after yet another mid-year correction.

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About Ryan Puplava CMT