ONE-TWENTY TWO - A collection of personal articles on financial markets including analysis you can use
Feb
8

The Bank of England’s Recent Retreat On Rate Hikes (A Blueprint for the Fed?)

written by Dr. Duru
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What a difference 19 months make.

It was June, 2014 when Bank of England (BoE) Governor Mark Carney confidently warned financial markets that rate hikes could come earlier than implied at that time by the market. Less than a month later, the British pound (FXB) (or sterling) peaked against the U.S. dollar (DXY0). Peaks against the euro (FXE) and the Japanese yen (FXY) did not come until 2015. However, reality was soon clear: the Bank of England was in full retreat from its threats of rate hikes. This realization crystallized and received confirmation when a steep slide against all major currencies began in early December, 2015. The pound’s slide against the euro was particularly notable and has no doubt given the European Central Union (ECB) cause for pause.

One of the confirmations of the Bank of England’s intention to retreat from rate hikes came from Minouche Shafik, Deputy Governor, Markets & Banking. In a speech tellingly titled “Treading carefully,” Shafik explained why she hesitates to raise rates anytime soon (emphasis mine):

“…there is residual uncertainty about the relationship between the real economy and inflation – something economists refer to as ‘model uncertainty’ – which in this instance augurs for caution in setting monetary policy.4 The most likely outcome is that wage growth will soon resume its recovery, but there are alternative states of the world in which it takes longer for that to happen. So I judge it prudent to tread carefully, and refrain from voting for an increase in Bank Rate until I am convinced that wage growth will be sustained at a level consistent with inflation returning to target.

Shafik noted that wage growth had recently plateaued, but acknowledged that the UK economy is generally well past the point where in previous cycles tightening would have begun:


Despite various economic strengths in the UK, wage growth and inflation remain lower than previous tightening cycles.

Despite various economic strengths in the UK, wage growth and inflation remain lower than previous tightening cycles.


Source: “Treading Carefully”, Bank of England.

On top of emphasizing a reluctance to raise rates, Shafik provided some revealing theory on the impact of the exchange rate on inflation. Given that the previous strength of the British pound will apparently suppress inflation in the United Kingdom for “several years to come,” I am assuming the BoE has an ingrained bias to avoid making moves to rekindle strength in the currency. All else being equal, the British pound could stay biased for weakness for much of the time it takes to wear off the disinflationary pressure from previous strength. From Shafik:

“Since 2008 we have learned more about how movements in the exchange rate, in particular, affect inflation. Contrary to the body of literature developed during the period of Great Stability, changes in the exchange rate do have a large and persistent effect on inflation through their effect on import prices. That means that the 18% appreciation of sterling which began in early 2013 (as the prospects for the UK economy improved relative to those of our trading partners) is currently exerting significant downward pressure on inflation and is likely to continue to exert some downward pressure for several years to come as lower import costs pass through the supply chain.”

Interestingly, Shafik still felt the need to remind the audience that rate hikes could come relatively quickly once the Bank of England finally got started. The quote contained echoes of Carney’s 2014 declaration (emphasis mine)…

“But once I am convinced, absent further shocks, I can see Bank Rate rising more quickly than the path implied by the market curve at the time of the last Inflation Report…

Personally speaking, should the downside risks from the world economy fail to materialise, and absent further shocks, once wage growth has returned to a level consistent with inflation returning to target I would expect the economy to warrant a path for Bank Rate that increases more quickly than implied by the market yield curve used to condition the November Inflation Report.”

Overall, Shafik clearly communicated a bias to avoid rate hikes in the short-term while attempting to maintain inflation-fighting credentials for the long-term. I am unclear on how to untangle the expectations of disinflationary pressures from the previously strong currency that will linger along with expected inflationary pressures from future economic performance.

A subsequent hint of a no-hike bias from the Bank of England came from a January 18,2016 speech at the London School of Economics by Gertjan Vlieghe, External MPC member. Vlieghe created the title “Debt, Demographics and the Distribution of Income: New challenges for monetary policy.” This speech was fascinating from beginning to end and for much more than just the interest rate implications. Vlieghe observed that today’s monetary policy goes beyond cyclical adjustments and now has been compelled to address structural issues and the fallout from global, macroeconomic pressures.

For addressing structural issues, Vlieghe wants central bankers to pay more attention to the “3 Ds”: debt, demographics, and distribution of income. Vlieghe points out that economists struggle to understand the persistence of low rates specifically because they are still using models that assume “…debt does not matter, there are no demographics and there is no distribution of income.” An examination of these 3 Ds suggests that the UK economy (and likely all other developed economies) will not revert to pre-crisis levels. This assumption rides within existing monetary models. Mean reversion is NOT in our future anytime soon.

Vlieghe uses this sober assessment of future economic performance to recommend caution and patience before proceeding with rate hikes:

“…for a given level of growth, real interest rates may remain significantly lower than in the past. The possibility of this scenario makes me more patient, other things equal, before raising rates, because we may not have to raise rates very much once we start. Moreover, the fact that, at very low interest rates, policy cannot respond as effectively to bad news as it can to good news also makes me more patient before raising rates…”

Vlieghe’s condition for hiking rates rests on a return of stable economic performance and upward trending inflation…

“…in order to be confident enough of the medium-term inflation outlook to justify raising Bank Rate, I would like to see more evidence that growth is stabilising after its recent slowdown, and that a broad range of indicators related to inflation are generally on an upward trajectory from their current low levels.”

With these conditions established, Vlieghe moves on to describe how the structural forces from the 3 Ds impact monetary policy.

Debt matters because the deleveraging process can limit the ability of the central bank to encourage more spending in the economy. Less spending in turn tends to depress inflationary pressures. A debt overhang thus generates “persistently weak recoveries” as consumers focus on bringing debt levels down instead of fueling economic activity through spending. With a lower bound on rates, the central bank can do little but wait out the deleveraging and avoid extending the process by hiking rates too early.

Demographics matter because longevity motivates more saving to the extent that retirement ages remain the same and declining fertility produces fewer workers who then require less investment. Higher savings and lower investment reinforce lower interest rates. However, since retired consumers save less and spend more, relatively speaking, they act against lower interest rates. The net balance of these forces is not formulaic, so it is a wildcard for the central bank to monitor over time. Demographics also evolve over long periods of time and could of course cross multiple business cycles.

Distribution of income matters because monetary policy can shift resources toward wealthier consumers who are more likely to save than spend. I believe Vlieghe is talking about the impact at the margins. More well-off consumers have fewer urgent spending needs than poorer households; this is especially true in the wake of a severe economic downturn. To the extent monetary policy does not help lower-income consumers, savings rates could increase further: these workers are forced to reduce spending in order to preserve future spending power. Vlieghe does not provide a novel prescription for dealing with an unbalanced income distribution. He merely suggests that rates must stay lower for longer to support lower income workers. The irony occurs when these same lower rates bolster the value of assets held by the wealthy which in turn can drive substantial income gains which finally further widen income distributions.

Vlieghe summarizes by integrating these forces in a way that points to slower economic growth:

“A high debt economy faces headwinds and needs lower interest rates. A high debt economy with adverse demographic trends needs even lower interest rates. And a high debt economy with adverse demographic trends and higher inequality … well, you get the picture.”

These reinforcing dynamics demonstrate why mean reversion is not likely coming out of the last financial crisis. Moreover, real interest rates “…will remain well below their historical average for a very long time, even with economic growth that is close to or only somewhat below its historical average…I think it is plausible that the appropriate real interest rate for the economy might be very low for years to come.” These policy implications have convinced Vlieghe that the Bank of England can stay patient ahead of raising rates.

Vlieghe’s conditions for hiking rates are very consist with Shafik’s conditions:

“With growth still slowing, and inflation pressures either easing outright or disappointing relative to forecasts, I do not believe the conditions are in place to warrant a rise in Bank Rate. I need to see further evidence that growth is indeed stabilising, and that a broad range of indicators relating to inflation, inflation expectations and pay growth are generally on an upward trajectory from their current low levels before being confident enough in the outlook to justify a rise in Bank Rate. In order to be confident enough of the medium-term inflation outlook to raise Bank Rate, I would like to see evidence that growth is not slowing further, and that a broad range of indicators related to inflation are generally on an upward trajectory from their current low levels.”

With commentary from the Bank of England like that from Shafik and Vlieghe, Mark Carney’s speech to set the direction for the Bank of England for 2016 was practically anti-climactic. On January 19, 2016 Carney delivered a speech called “The turn of the year” given at Peston Lecture, Queen Mary University of London. In this speech, he gave the official acknowledgement that the Bank of England put rate hikes on the shelf for 2016:

“Last summer I said that the decision as to when to start raising Bank Rate would likely come into sharper relief around the turn of this year.

Well the year has turned, and, in my view, the decision proved straightforward: now is not yet the time to raise interest rates. This wasn’t a surprise to market participants or the wider public. They observed the renewed collapse in oil prices, the volatility in China, and the moderation in growth and wages here at home since the summer and rightly concluded that not enough cumulative progress had been made to warrant tightening monetary policy.”



Note that Carney fully recognized that the market had already concluded that the Bank of England had to retreat from rate hikes. In classic form, the currency market also responded with a lack of surprise: the British pound finally stopped going down. For example, against the U.S. dollar, the pound (GBP/USD) began an upward climb. Essentially, for the short-term at least, everyone who wanted to play the rate hike news against the British pound was already in the trade. The official news is a time to close out positions, take profits, and relish being correct. This bottom is still holding against the U.S. dollar although its has given way to other major currencies like the euro and the Japanese yen (FXY).


The British pound (FXB) bottomed on Carney's speech. Yet, it remains in a definitive downtrend and has not yet broken out.

The British pound (FXB) bottomed on Carney’s speech. Yet, it remains in a definitive downtrend and has not yet broken out.


Source: FreeStockCharts.com

The Bank of England continues to fascinate me with all its talk about taking action to drive inflation in one direction or the other. In reality, the BoE has done little but talk (outside of macroprudential policies) about inflation moving one way or another. The Bank has been in the business of trying to verbally guide market and consumer expectations about an inflation process that unfolds based on present economic conditions. This speech was no different:

“At present, the MPC is seeking to return inflation to the target in around two years and to keep it there in the absence of further shocks. We don’t want an overshoot of inflation.”

Carney reiterated the considerations in play for future monetary policy that would drive rate hikes. The Monetary Policy Committee wants to see actual and prospective progress on all three points before “…the initiation of limited and gradual rate increases”:

  • The prospects for growth momentum in excess of trend consistent with eliminating spare capacity in the economy.
  • Evidence of and expectations for a sustainable firming in domestic cost pressures.
  • Developments in core inflation consistent with a reasonable expectation that total CPI inflation will return to the target in around two years’ time.


The Bank of England now worries about the sudden decline in wage growth despite the continued decline in the unemployment rate (shown inversely above)

The Bank of England now worries about the sudden decline in wage growth despite the continued decline in the unemployment rate (shown inversely above)


Source: Bank of England

Global disinflationary pressures are weighing on the UK. China is of course right in the center of this storm. Carney noted that UK exports to China have dropped by 1/3 year-over-year from November, 2014. Carney expects these pressures to continue and to weigh on domestic demand via the wealth effect and the financial tightening that comes from panicked markets. Like Shafik, Carney referenced past appreciation of the currency as a weight on inflation. Carney reminded the audience that “…around two-thirds of the effects of a currency move are estimated to appear in CPI inflation at horizons beyond one year.” According to the chart provided below, the trade-weighted British pound peaked just last November. Presumably then, currency-related disinflation will last at least through most of 2016.


The British pound has declined against the U.S. dollar for 18 months off the post-recession peak. However,  on a trade-weighted basis, the currency has only recently begun to cool off (mostly thanks to the euro).

The British pound has declined against the U.S. dollar for 18 months off the post-recession peak. However, on a trade-weighted basis, the currency has only recently begun to cool off (mostly thanks to the euro).


Source: Bank of England

The members of the Bank of England were so effective in talking down the prospects of rate hikes that the most interesting moment of the latest Inflation Report (February 4, 2016) came when Carney had to address market odds of 30% that the Bank’s next move would be a rate CUT. From Ed Conway of Sky News:

“Governor, the markets are now pricing in the possibility – about a 30% possibility – of there being a rate cut rather than a hike in the next year. You’ve said repeatedly that you feel that the next move is likely to be up rather than down. Do you still stand by that?”

Here is the most important snippet of Carney’s response (emphasis mine):

“Absolutely. The whole MPC stands by that. We’ve just released our forecast which, as I mentioned in my opening remarks, is conditioned on a market path of interest rates…that 15-day average of the path of rates is rates sustained at current levels for a little while longer, and then gradually increasing father out over the horizon…

And in using that market forecast, based on our central view of the economy, we actually don’t achieve our objective. Let me put it a different way. Inflation gets back to target, but then it rises above it. So there’s not quite enough tightening in that market path that we used in order to do what the MPC is very clear – has been very clear about – is its objective, which is to return inflation to target in around two years and to keep it there – not to have an overshoot…

So as I said, again, and we said in the Minutes and in the Monetary Policy Summary, and was clear in the letter to the Chancellor, the view is that more likely than not, the next move in rates is up, and that is consistent with the forecast, yes.

In other words, Carney is claiming that if rates stay at current levels for the next two years or so, inflation in the UK will get too high. So, at some point over this time period, the Bank of England needs to hike rates. This prospect is far enough into the future that the currency market is certainly not worrying about it. Instead, the more immediate concern for currency markets rests with the looming fear that the Bank of England could eventually join the growing number of its peers on retreat on rates.

Oh how far expectations have dropped in 19 months! I cannot help but wonder whether the Bank of England has developed a blueprint for the U.S. Federal Reserve. Financial markets have priced away any rate hikes in the U.S. for 2016


The U.S. dollar index has started to stumble as markets once again start to lose faith in Fed rate hikes.

The U.S. dollar index has started to stumble as markets once again start to lose faith in Fed rate hikes.


Source: FreeStockCharts.com



Be careful out there!

Full disclosure: long and short various currencies against the British pound

Feb
7

T2108 Update (February 5, 2016) – The Fallen Ones

written by Dr. Duru
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(T2108 measures the percentage of stocks trading above their respective 40-day moving averages [DMAs]. It helps to identify extremes in market sentiment that are likely to reverse. To learn more about it, see my T2108 Resource Page. You can follow real-time T2108 commentary on twitter using the #T2108 hashtag. T2108-related trades and other trades are occasionally posted on twitter using the #120trade hashtag. T2107 measures the percentage of stocks trading above their respective 200DMAs)

T2108 Status: 26.8%
T2107 Status: 16.2%
VIX Status: 23.4
General (Short-term) Trading Call: bullish
Active T2108 periods: Day #6 over 20% (overperiod), Day #24 under 30% (underperiod), Day #40 under 40%, Day #44 below 50%, Day #59 under 60%, Day #400 under 70%

Commentary
The bad news is that tech stocks and growth stocks in general got crushed on Friday, February 5, 2016. The good news is that T2108, the percentage of stocks trading above their respective 40-day moving averages (DMAs), hung in there for the day and barely reflected the carnage in tech. In other words, the broader market has not yet broken down like tech stocks have in the past week. In between the good and the bad news hangs my prediction and expectation that the S&P 500 (SPY) will hit resistance at its overhead 50DMA before dropping into oversold conditions yet again. That prediction is looking a little more precarious.


Incredibly, the NASDAQ (QQQ) has made a new 16-month closing low even though T2108 did not tumble into oversold territory

Incredibly, the NASDAQ (QQQ) has made a new 16-month closing low even though T2108 did not tumble into oversold territory

T2108 fell but is still in a small uptrend from its recent historic lows.

T2108 fell but is still in a small uptrend from its recent historic lows.

The S&P 500 is marginally better off than the NASDAQ. The S&P 500 made its third lowest close since pulling out of the January bottom.

The S&P 500 is marginally better off than the NASDAQ. The S&P 500 made its third lowest close since pulling out of the January bottom.


The relative resilience of T2108 suggests that the broader market is still hanging in there even as the (former) leaders of the indices are stumbling. And my are they stumbling. They are becoming the new fallen ones. Facebook (FB) is doing its best to drop from “full bull” status with three days of high-volume selling that has reversed all its incremental post-earnings gains. FB now faces a critical retest of 50DMA support.


Is the full bull celebration coming to a rapid conclusion for Facebook?

Is the full bull celebration coming to a rapid conclusion for Facebook?


Google (GOOG)? Forget about it. Not only did GOOG quickly erase ALL its post-earnings gains that sent the stock to a fresh all-time high, but also it sliced through 50DMA support like butter. With a fresh closing low for 2016, GOOG is once again on the edge of filling the post-earnings gap up from October. Support at its 200DMA is also in play. I placed a limit order on Friday that got filled near the close….{gulp}.


The market has forgotten all about Google's (GOOG's) earnings in a flash.

The market has forgotten all about Google’s (GOOG’s) earnings in a flash.


I have not posted about Tesla (TSLA) since I pointed out the very bearish 50DMA breakdown early in January. I also dared not trade TSLA from the bearish side because I assumed it would be one of the first stocks to enjoy a sharp relief rally whenever the market popped out of its funk. Instead, TSLA has traded nearly straight down ever since and is now at a 2-year low. TSLA is no longer teflon and could even be losing its cult-like appeal. Earnings on February 10th after-market should provide a key tell for residual commitment to TSLA.


Tesla (TSLA) is clearly losing favor with speculators and momentum types.

Tesla (TSLA) is clearly losing favor with speculators and momentum types.


There were two significant earnings-related collapses that completely blew me away. These ring out like loud alarm bells for all growth and other (former) momentum-type stocks. LinkedIn (LNKD), a former trading favorite of mine, dropped a gut-wrenching 43%. Tableau (DATA), a stock I assumed would be on the mend after its next earnings report, collapsed a whopping 49%. These types of massive one-day drops of well-known names with good, solid businesses are extremely rare. So, they have my attention big-time.

As readers know, I like buying stocks which drpo well below lower-Bollinger Bands (BBs). THESE drops were no-brainers to try. I was able to flip LNKD call options for a day trade, and I still have the stock on my buy list for swing trades this week. I also want to believe that over the longer-haul LinkedIn is just fine.

I was not as fortunate with DATA. First of all, I had a pre-earnings call spread going that completely blew up on me. Ironically, I preferred to buy shares and put options as a hedge, but I thought the put options were too expensive. Silly me! My hedged bullish position would have turned into huge profits with this kind of decline. Post-earnings, I bought shares rather than call options, but DATA lost a little more going into the close.


LinkedIn (LNKD) collapses and sellers keep up the pressure almost all day. Trading volume was 29x the 3-month average!!!!

LinkedIn (LNKD) collapses and sellers keep up the pressure almost all day. Trading volume was 29x the 3-month average!!!!

The weekly chart for LinkedIn (LNKD) shows a 3-year low that could eventually turn into something much worse.

The weekly chart for LinkedIn (LNKD) shows a 3-year low that could eventually turn into something much worse.

@BullBear_DD @nitehawk @TraderMike – so I assume poor EPS guide and OK rev guide means slash (expensive) prices to push volume? $DATA

— Duru A (@DrDuru) Feb. 4 at 02:19 PM

The panic and stampede out of Tableau Software, Inc. (DATA) was as bad as LNKD. At least trading volume was "only" 14x the 3-month average.

The panic and stampede out of Tableau Software, Inc. (DATA) was as bad as LNKD. At least trading volume was “only” 14x the 3-month average.

The weekly for DATA shows a stock at an all-time low. It was at an all=time high just last summer. The IPO priced at $31.

The weekly for DATA shows a stock at an all-time low. It was at an all=time high just last summer. The IPO priced at $31.


Splunk (SPLK) dropped in sympathy with DATA. Again, I cannot even remember when I last saw a stock drop this much in sympathy with an industry peer’s bad news. While I have long been bearish on SPLK, I did not have a short position going at the time. This drop was deep enough to make me try to play a bounce from here. Nerves will certainly be running thin when the company reports on February 25th after-market. For now, I am assuming DATA suffered some company-specific issues that are likely competitive in nature. So, I am looking for excuses to finally get bullish on SPLK.


Splunk (SPLK) loses 23% and closes around a 3-year low... all thanks to DATA and what is clearly a mass exodus from these kinds of expensive (former) growth and momentum stocks.

Splunk (SPLK) loses 23% and closes around a 3-year low… all thanks to DATA and what is clearly a mass exodus from these kinds of expensive (former) growth and momentum stocks.


Like T2108, the volatility index, the VIX, did not move as much as I would have expected given the carnage in tech stocks. This kind of divergence is a slight positive, BUT the VIX seems to have confirmed 50DMA support and a growing uptrend from the last lows.


The volatility index does not tell the true tale of spreading panic and fear in growing pockets of the stock market.

The volatility index does not tell the true tale of spreading panic and fear in growing pockets of the stock market.


While growth and momentum stocks have received a pounding, money SEEMS to be rotating over to the truly beaten up stocks in cyclicals, especially commodity-related. I believe this rotation will be short-lived. I used this opportunity to double down on my favorite hedge against bullishness, Caterpillar (CAT), and to reload put options on BHP Billiton Limited (BHP). These stocks could have an additional tailwind or at least respite this week given the slowdown of economic activity and reporting for the Chinese New Year.


Caterpillar (CAT) is at a critical test of 50DMA resistance. This is a fight that has failed consistently since last summer.

Caterpillar (CAT) is at a critical test of 50DMA resistance. This is a fight that has failed consistently since last summer.

BHP Billiton Limited (BHP) has bounced sharply since a debt downgrade. 50DMA resistance loom directly overhead.

BHP Billiton Limited (BHP) has bounced sharply since a debt downgrade. 50DMA resistance loom directly overhead.


Amid all this doom and gloom, gold continues to sneak its way higher. Perhaps traders are running to gold for a “safe haven.” I think safe havens are just temporary refuges for false hopes. I can better accept GLD as a bet or hedge against the U.S. dollar. SPDR Gold Shares (GLD) experienced strong buying volume: 2.3x the 3-month average. The current 200DMA breakout is the strongest and most impressive since January, 2015 when the Swiss National Bank capitulated on its currency floor against the euro. GLD now needs to break above the last highs (set in October) to get a breakout from the current downtrend.


SPDR Gold Shares (GLD) is gathering steam again.

SPDR Gold Shares (GLD) is gathering steam again.


— – —

For readers interested in reviewing my trading rules for T2108, please see my post in the wake of the August Angst, “How To Profit From An EPIC Oversold Period“, and/or review my T2108 Resource Page.

Reference Charts (click for view of last 6 months from Stockcharts.com):
S&P 500 or SPY
U.S. Dollar Index (U.S. dollar)
EEM (iShares MSCI Emerging Markets)
VIX (volatility index)
VXX (iPath S&P 500 VIX Short-Term Futures ETN)
EWG (iShares MSCI Germany Index Fund)
CAT (Caterpillar).
IBB (iShares Nasdaq Biotechnology).


Daily T2108 vs the S&P 500

Black line: T2108 (measured on the right); Green line: S&P 500 (for comparative purposes)
Red line: T2108 Overbought (70%); Blue line: T2108 Oversold (20%)


Weekly T2108
Weekly T2108
*All charts created using
freestockcharts.com unless otherwise stated

The charts above are the my LATEST updates independent of the date of this given T2108 post. For my latest T2108 post click here.

Related links:
The T2108 Resource Page
Expanded daily chart of T2108 versus the S&P 500
Expanded weekly chart of T2108

Be careful out there!

Full disclosure: long SSO call options, long SSO shares, long SVXY shares, short UVXY puts, long CAT puts, long FB calls and short shares, net long the U.S. dollar, long GLD, long DATA, long GOOG call options

Feb
7

January U.S. Jobs Numbers Do Not Boost Rate Hike Odds Enough for 2016 Action

written by Dr. Duru
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The U.S. jobs numbers for January, 2016 were good enough to send odds for the next rate hike from the U.S. Federal Reserve to jump across the scheduled meetings for 2016. Yet, the odds for December as the next month for a rate hike are still well under 50%.


The odds for another rate hike this year remain unlikely with December sitting at 44% as the odds for the next hike.

The odds for another rate hike this year remain unlikely with December sitting at 44% as the odds for the next hike.


Source: CME Group FedWatch

Although the odds still favor no rate hike for 2016, the rise across the remaining months was high enough to help the U.S. dollar index (DXY0) to maintain support at its 200-day moving average (DMA).


The U.S. dollar index had an awful week but ended on a slightly positive note with the January jobs data.

The U.S. dollar index had an awful week but ended on a slightly positive note with the January jobs data.


Still, the trend for the iShares 20+ Year Treasury Bond (TLT) remains definitely pointed upward (meaning long-term yields are going down).


The iShares 20+ Year Treasury Bond (TLT) has trended upward for all of 2016 and was barely dented by the Fed's rate hike in December.

The iShares 20+ Year Treasury Bond (TLT) has trended upward for all of 2016 and was barely dented by the Fed’s rate hike in December.


The message from the markets is VERY clear. Yet, I still hear and read some pundits continue to parrot the Fed’s claim from December that we should expect four rate hikes in 2016. These claims help create lingering uncertainty about the Fed’s plans. Chair Janet Yellen gets an opportunity this week to provide some clarity.

Yellen speaks to Congress this week as part of the Fed’s Semiannual Monetary Policy Report to the Congress. Yellen appears before the House on February 10th and the Senate on the 11th. These appearances will indicate whether the Fed is going to concede to the market’s expectations as it prefers to do, or whether the Fed wants to try to guide markets back to a 2016 rate hike. Given the current odds, Yellen’s speech is not likely to weaken the dollar much further but she could strengthen it a lot.

Despite the apparent asymmetric odds favoring a dollar rally, I reduced my net long U.S. dollar position. This change includes taking AUD/USD off my list of aggressive trades (going short in this case). Note I am still very much bearish the Australian dollar, but against the U.S. dollar I am suspecting an extended trading range is developing. AUD/USD is trending up from the most recent low but it definitely failed 200DMA resistance and broke through 50DMA support all in one day.


The Australian dollar is still in the middle of a bounce off the most recent lows.

The Australian dollar is still in the middle of a bounce off the most recent lows.


Source for charts: FreeStockCharts.com

Stay tuned and be careful out there!

Full disclosure: net long the U.S. dollar, net short the Australian dollar

Feb
6

The Weak Relationship Between Bear Markets and Recessions

written by Dr. Duru
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The February 4, 2016 edition of Nightly Business Report included a segment assessing the ability of the stock market to predict recessions. This is of course a timely piece given the stock market’s current plunge and growing recession fears arising from analyst commentary and softening economic data.

Steve Liesman, chief economist for CNBC, took a crack at this age-old question. He used S&P 500 (SPY) price data going back to 1945, the post-war era. He overlayed these data with the timing of bear markets. This periods covers 13 bear markets and 11 recessions. A bear market occurs after the S&P 500 loses 20% from its last all-time high.


A timeline of bear markets juxtaposed with the timing of recessions.

A timeline of bear markets juxtaposed with the timing of recessions.


Source: NBR

Liesman counted a successful prediction if the bear market occurred within one year ahead of the recession, with some wiggle room for a few days. This definition created a 53% historical fraction of bear markets preceding a recession (7 out of 13 bear markets were followed by a recession). I am purposely not using the term “predict” as Liesman does because the sample is so small. Moreover, Liesman does not consider the false negative: 4 of the 13 recessions were not preceded by bear markets. Regardless, 53% is nothing to write home about; it is not an actionable likelihood.

The link between bear markets and recessions interests traders and investors differently than economists. In so many cases, a bear market is well underway or even almost over by the time an official recession occurs. Moreover, we do not know a recession has officially occurred until at least two quarters after the start. This makes a recession a time for traders to consider closing out shorts and a time for long-term investors to count their pennies and load up on cheap stocks. Traders and investors are much more interested in the precursors of bear markets than recessions.

The S&P 500 is currently down 12% from its last all-time high set on May 21, 2015. A bear market would take the index back to around 1704, a level last seen October, 2013. Given the on-going destruction in commodity-related stocks and now a swath of growth stocks, such an extended sell-off should create a whole host of stocks too cheap to ignore. The all-time high set in the last bull market was around 1575. A retest of that support would mark a 26% decline from this bull market’s all-time high. I consider both 1704 and 1575 in play if the S&P 500 fails to hold its intraday low from the last oversold period.


The edge of danger: The S&P 500 (SPY) prints its second lowest close since the most recent bottom.

The edge of danger: The S&P 500 (SPY) prints its second lowest close since the most recent bottom.


Source: FreeStockCharts.com



Be careful out there!

Full disclosure: long SSO call options and shares

Feb
5

ConocoPhillips: A Cautionary Tale from the Oil Patch

written by Dr. Duru
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ConocoPhillips (COP) announced Q4 and full year 2015 financial results on the morning of February 4, 2016. The news included a capitulation to the on-going deterioration of business conditions in the oil patch: COP slashed its dividend by two-thirds:

“ConocoPhillips (NYSE: COP) today announced it is taking actions to maintain its strong balance sheet in response to both the weak outlook for commodity prices and expected credit tightening across the industry. The actions will position the company to accelerate shareholder value creation as prices recover.

The company announced that its board of directors approved a reduction in the company’s quarterly dividend to 25 cents per share, compared with the previous quarterly dividend of 74 cents per share.”

Chairman and chief executive officer Ryan Lance went on to lament that the decision to cut the dividend was a “difficult one.” Essentially the company is coming to terms with the very real possibility that commodity prices stay lower for longer than originally anticipated.

“The dividend has been, and will continue to be, a top priority. We still intend to provide a competitive dividend, while significantly lowering the breakeven price for the company and substantially reducing the level of borrowing in 2016. Our actions also position us to deliver strong absolute and relative performance as prices recover.”

Up until now, COP had worn a very brave face. In doing so, COP’s cautionary tale reminds us that we cannot assume that company management fully grasps and/or is ready and willing to communicate the true range of operational realities facing the business. (For the sake of argument, I am excluding the chance that, in this case, management actually feared a dividend cut but did not want to confront the possibility).

An irony of COP’s capitulation comes from six months ago when the company announced Q2 2015 financial results on July 30, 2015. At that time, COP made headlines by boldly and emphatically pronouncing that its dividend was safe. Here is Lance as quoted in the the Seeking Alpha transcript of the conference call (emphasis mine):

So let me give you the punch line of these comments, the dividend is safe. Let me repeat that, the dividend is safe. The business is running well, we have increasing flexibility and can achieve cash flow neutrality in 2017 and beyond at today’s strip price of roughly $60 per barrel Brent. And we have a unique formula for sustainable performance and a portfolio that can deliver.”

To help prove the point, COP increased the dividend by a small amount as part of “…an important message for our shareholders.” Lance exuded confidence in declaring that the company is managing for the short-term, medium-term, and long-term. The company was firmly committed to growing the dividend as a top priority. The balance sheet and affordable growth came in second and third respectively. A moment of clarity for considering a potential bad outcome came later in the call when COP noted it could use debt to fund its dividend if necessary:

“…we still have really solid access to the capital markets to the extent that we – that it’s necessary to go beyond our cash balances to fund our capital and our dividend in the period before 2016 when we get to cash flow neutrality. We certainly have the ability to do that in a very effective way.”

Perhaps those musings represented a warning sign.

Fast-forward to the Q4 2015 earnings call on October 30, 2015. Oil prices had declined sharply for a month following COP’s July earnings conference call. Prices rebounded sharply from there and had stabilized for the two months going into COP’s call.


For a few months last fall, oil stabilized in anticipation of the next OPEC announcement (hopes the cartel could finally cooperate in manipulating prices higher).

For a few months last fall, oil stabilized in anticipation of the next OPEC announcement (hopes the cartel could finally cooperate in manipulating prices higher).


Source: US. Energy Information Administration, Crude Oil Prices: West Texas Intermediate (WTI) – Cushing, Oklahoma [DCOILWTICO], retrieved from FRED, Federal Reserve Bank of St. Louis, February 5, 2016.
US. Energy Information Administration, Crude Oil Prices: Brent – Europe [DCOILBRENTEU], retrieved from FRED, Federal Reserve Bank of St. Louis, February 5, 2016.

Hope was in the air. COP increased the dividend and again noted this action demonstrated that the dividend remained a top priority. The next set of quotes come from Jeff Sheets as published in the Seeking Alpha transcript of the call. Here is Sheets reminding analysts that COP could fund the dividend from debt.

“We’re going to, we will first use the cash that’s on our balance sheet and then to the extent that cash from operations and asset sales don’t fully fund capital in the dividend we’ll be looking to increase debt. I mean that it’s just a mechanic of what’s going to end up happening for us. And as we said as we look at the amount of debt that we might need to raise even in some continuations of some pretty tough price environments we feel comfortable that that capacity exists on our balance sheet. And it really exists within a single A credit rating as well.”

Debt-funded dividends remained the worst case scenario for COP. The company was not even contemplating the possibility of rolling back the dividend (emphasis mine):

“We think of a dividend as something that really should only go one direction and there can be some variability in the rate at which dividend increases. But the key to a dividend is to have it be consistent and to grow it over time.

So we haven’t really had significant discussion to talk about trying to adjust the dividend. It’s an important part of our value proposition. It puts a lot of discipline into the system to have that dividend. So you’ve heard us talk about it pretty consistently. You’re going to continue to hear us talk about that as a key component of our value proposition.”

As part of the company’s key value proposition, COP had to cling to its plans and had to insist on infusing hope in the investor-base.

Matt Fox further reassured the audience:

“When we look at what it’s going to take to win in a more cyclical and volatile future we think it’s a diverse low decline production base that gives us stable source of funding to sustain the dividend and we have that.”

So no wonder COP described the decision to roll back the dividend by two-thirds as a difficult one. Based on prior statements, the cut undermines the “value proposition” of holding the stock. The cut could cast doubt on the health of the company’s balance sheet and ability to stabilize its financial results.

Going into earnings, COP had suffered heavy losses in parallel to the on-going plunge in oil. I am guessing part of the selling in COP was a recognition of increased dividend risks. Yet, the stock still lost 8.6% in the wake of earnings. Fortunately for the stock, there was already just enough buffer built off the recent 6 1/2 year low.


ConocoPhillips (COP) has not seen prices this low since 2009.

ConocoPhillips (COP) has not seen prices this low since 2009.

Trading volume surged to 49M, 4x the 3-month average, as investors expressed their disappointment with COP's capitulation on the dividend.

Trading volume surged to 49M, 4x the 3-month average, as investors expressed their disappointment with COP’s capitulation on the dividend.


To be fair, forecasting is difficult. Accepting trends that are working against your business, your hopes, and your plans must be just as difficult if not more so. I wrote this cautionary tale as a quick tour through COP’s past three earnings reports just to illustrate the dangers in assuming that management’s task is NOT difficult. Given the experts can fail to notice the train roaring down the tracks of their own industry, one does well to adopt circumspection and to respect the trends.

Be careful out there!

Full disclosure: no positions

Feb
4

T2108 Update (February 3, 2016) – The Waterfall and the Whale: An Oversold Near Miss

written by Dr. Duru
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(T2108 measures the percentage of stocks trading above their respective 40-day moving averages [DMAs]. It helps to identify extremes in market sentiment that are likely to reverse. To learn more about it, see my T2108 Resource Page. You can follow real-time T2108 commentary on twitter using the #T2108 hashtag. T2108-related trades and other trades are occasionally posted on twitter using the #120trade hashtag. T2107 measures the percentage of stocks trading above their respective 200DMAs)

T2108 Status: 28.8%
T2107 Status: 17.7%
VIX Status: 21.7 (faded from a high of 27.7!)
General (Short-term) Trading Call: bullish
Active T2108 periods: Day #4 over 20% (overperiod), Day #22 under 30% (underperiod), Day #38 under 40%, Day #42 below 50%, Day #57 under 60%, Day #398 under 70%

Commentary


Wednesday was a wacky day of trading. The “waterfall” came in the form of the typical market leaders continuing a cascade of weakness that is out-of-step with the stock market’s emergence from oversold trading conditions. Google (GOOG) has already reversed all its post-earnings gain. Amazon.com (AMZN) closed below its 200-day moving average (DMA) for the first time since January, 2015. Netflix (NFLX), which has continued to sell off after a wild post-earnings day, touched its flash crash lows before rallying to a smaller loss on the day. “Full Bull” Facebook (FB) was down as much as 3% before rallying to cut that loss in about half. (Amazing how we have come full circle to put our faith in a small group of out-performing internet-related stocks!)


The post-earnings celebration in Google (GOOG) has ended as fast as it started. The subsequent 50DMA breakdown represents folow-through selling from the post-earnings fade. This reaction is very different from GOOG's last post-earnings fade.

The post-earnings celebration in Google (GOOG) has ended as fast as it started. The subsequent 50DMA breakdown represents folow-through selling from the post-earnings fade. This reaction is very different from GOOG’s last post-earnings fade.

Amazon.com (AMZN) continues to lose favor in rapid fashion. Even with the bounce from lows, AMZN could not manage to hold 200DMA support.

Amazon.com (AMZN) continues to lose favor in rapid fashion. Even with the bounce from lows, AMZN could not manage to hold 200DMA support.

Netflix (NFLX) remains trapped with a downtrending channel as post-earnings selling continues.

Netflix (NFLX) remains trapped with a downtrending channel as post-earnings selling continues.

Facebook (FB) is the last of the leaders to hold onto post-earnings gains. Is one last coattail enough to keep buyers interested in the market?

Facebook (FB) is the last of the leaders to hold onto post-earnings gains. Is one last coattail enough to keep buyers interested in the market?


A whale jumped into the pool around 2pm: sellers went scrambling for cover and buyers rushed in to enjoy the uplift of water from the bottom and onto safe ground at the close. The 5-minute chart of the S&P 500 (SPY) shows that one 5-minute block completely changed the feel and sentiment of the market.


A whale of a ride as the S&P 500 churns its way to a positive close.

A whale of a ride as the S&P 500 churns its way to a positive close.


The S&P 500 (SPY) has struggled to generate follow-through bullishness ever since its convincing exit from oversold conditions last Friday. Monday was a stalemate day. Tuesday generated a loss that almost reversed all of Friday’s gain. And today, Wednesday, took the S&P 500 all the way back to the bottom of the base that preceded the breakout. At THAT point, buyers finally showed up and were carried into the close by the whale…


The S&P 500 is struggling to maintain post-oversold momentum.

The S&P 500 is struggling to maintain post-oversold momentum.


Note that the S&P 500’s move created a bullish hammer candlestick pattern that was replicated across many stocks. Follow-through buying should set the index back on course for the rendezvous I expected with overhead resistance at the 50DMA. As a reminder, I am expecting this retest before the next oversold period begins. Astute traders will notice a Bollinger Band squeeze is developing on the S&P 500. Resolution of this squeeze should form the next major move for the index.

More potentially good news: through all of this churn, T2108, the percentage of stocks trading above their 40-day moving averages, somehow managed to avoid returning to oversold conditions. In fact, with a close at 28.8% near the recent highs, T2108 is actually relatively stronger than the S&P 500. This slight divergence is once again showing that more stocks are starting to participate in the buying action. Think again of the waterfall of leaders getting pushed out the way by the whale or the bulk of the market.

The volatility index, the VIX, put on quite a show, almost the exact opposite of the S&P 500. The VIX surged as high as 27.7, but overhead resistance once again exerted its powers of rejection. The VIX not only turned around but also closed just about where it started. This move almost looks like another exhaustion of panic and fear.


The volatility index, the VIX, exhausts itself trying again to punch through resistance.

The volatility index, the VIX, exhausts itself trying again to punch through resistance.


I can best describe the wackiness of the trading by providing a bullet list of all the explanations provided in one article for the action on the day. Multiple catalysts converged on traders to send heads spinning and necks twisting. The following are all quotes from various pundits, analysts, and the author in CNBC’s “Dow, S&P stage sharp turnaround as oil rises 8%” (note that I do not endorse using the Dow Jones Industrial as an indicator of anything real except perhaps market sentiment):

  • If you look at the relationship between the the Dow and the S&P, it’s a little off today, meaning that the Dow is leading the S&P…That’s got to do with what’s going on in oil.
  • I … believe oil will dictate stock prices…I think it’s safe to say we are highly dependent on oil.
  • The lions share of the U.S. economy is services…If we see a slump in [ISM], we’re going to see a sell-off in the market.
  • The Dow opened 100 points higher, but fell over 150 points amid the weak ISM reading and the rise in crude inventories. In afternoon trading, however, the blue chips index recovered and closed over 180 points higher.
  • We’re in a textbook transition from a bullish environment into a bearish environment…What’s happening now is strength is being sold, not weakness being bought…The inability to make a meaningful bounce off the January lows signals, to me, … we’re in the early stages of a bear market…
  • There’s some level that marks the right intersection of where the economy is…The equities market is in the process of finding it.
  • …when you start getting more people talking about production cuts…oil has a greater potential to climb back from its lows.
  • I think the oil bounce is more of a technical bounce…We’ve had a pretty steep sell-off in oil recently. Equities and oil are very correlated right now, whether right or wrong…At some point, we’re going to have to break from that.
  • The problem is that we’ve got generally lousy [earnings] numbers with no hopes of them getting any better
  • U.S. futures held near the flatline for most of the morning on Wednesday, before rising on remarks made by New York Fed President William Dudley.

The United States Oil ETF (USO) dipped at first on the oil inventory report but quickly spun around to rally. A close above $10 resumes the rally off the lows and would give me more confidence in my call for a more sustainable bottom.


The United States Oil ETF (USO) made a strong bounce off its lows in a bid to maintain its recent bottom.

The United States Oil ETF (USO) made a strong bounce off its lows in a bid to maintain its recent bottom.


The U.S. dollar index (DXY0) was wild. In one fell swoop, the dollar index made a convincing plunge below its 50DMA and retested its 200DMA.


The U.S. dollar index suffers its second large whack in two months.

The U.S. dollar index suffers its second large whack in two months.



The Canadian dollar versus the U.S. dollar combines oil and weak U.S. data all in one punch. This convincing 50DMA breakdown may be the beginning of the end of USD/CAD's uptrend?

The Canadian dollar versus the U.S. dollar combines oil and weak U.S. data all in one punch. This convincing 50DMA breakdown may be the beginning of the end of USD/CAD’s uptrend?



Oops! There go all the gains for USD/JPY engineered by the Bank of Japan's negative rate surprise.

Oops! There go all the gains for USD/JPY engineered by the Bank of Japan’s negative rate surprise.


Related to the currency moves, SPDR Gold Shares (GLD) has broken out from 200DMA resistance for the first time since October.


SPDR Gold Shares (GLD) is trying AGAIN to break free of 200DMA resistance.

SPDR Gold Shares (GLD) is trying AGAIN to break free of 200DMA resistance.


Finally, the market has taken rate hikes completely off the table for 2016. This move is making me rethink my dollar bullishness for the first time in a long while. The market’s reaction to Friday’s U.S. non-farm payrolls may deliver the final tipping point for me.


The market tells the U.S. Federal Reserve to forget about hiking rates this year.

The market tells the U.S. Federal Reserve to forget about hiking rates this year.


Source: CME Group FedWatch

My trading on the day was just as mixed as the market action. I sold my put options on iShares Nasdaq Biotechnology (IBB) in a trade I described in the last T2108 Update. Most of the profit came on the selling this day. Given IBB was not as weak as I expected to start the week, I decided not to hold through Thursday’s Congressional hearing on drug pricing. The good news for bulls and buyers is that IBB managed to print a neat little hammer bottom after the selling ended.


The iShares Nasdaq Biotechnology (IBB) has yet to enjoy the market's emergence from oversold trading conditions. Today's hammer may finally mark the beginning of some kind of recovery.

The iShares Nasdaq Biotechnology (IBB) has yet to enjoy the market’s emergence from oversold trading conditions. Today’s hammer may finally mark the beginning of some kind of recovery.


Seeing NFLX break quickly to the downside while the S&P 500 was still up at the open made me rush for put options on NFLX. I have not traded NFLX to the bearish side in a very long time. I took profits quickly on the position. I decided to keep my puts in Caterpillar (CAT) as my main hedge and doubled down near the close. CAT closed at a fresh post-earnings high. I also opened a fresh position in Direxion Daily Russia Bear 3X ETF (RUSS). In forex, I decided to make a play for a rebound in USD/CAD back to the 1.40 pivot. But like my earlier play for USD/CAD to come back down to 1.40, I think I raced too far ahead of the market in my thinking. As the above chart shows, USD/CAD made a substantial breakdown move! On the bullish side, I took advantage of the dip in FB to load up on call options as planned.

In the mistake (so far) column, I tried to play a bounce in AMZN from 200DMA support.

I end with a monthly chart of Deutsche Bank AG (DB). I heard several times during the day about the trouble in financial stocks in the U.S. and in Europe. My antennae are up again as I see that DB is now trading BELOW its 2008-2009 crisis levels – in fact, this is an all-time low!


Deutsche Bank AG (DB) is in serious trouble as a multi-year sell-off is now producing all-time lows.

Deutsche Bank AG (DB) is in serious trouble as a multi-year sell-off is now producing all-time lows.


— – —

For readers interested in reviewing my trading rules for T2108, please see my post in the wake of the August Angst, “How To Profit From An EPIC Oversold Period“, and/or review my T2108 Resource Page.

Reference Charts (click for view of last 6 months from Stockcharts.com):
S&P 500 or SPY
U.S. Dollar Index (U.S. dollar)
EEM (iShares MSCI Emerging Markets)
VIX (volatility index)
VXX (iPath S&P 500 VIX Short-Term Futures ETN)
EWG (iShares MSCI Germany Index Fund)
CAT (Caterpillar).
IBB (iShares Nasdaq Biotechnology).


Daily T2108 vs the S&P 500

Black line: T2108 (measured on the right); Green line: S&P 500 (for comparative purposes)
Red line: T2108 Overbought (70%); Blue line: T2108 Oversold (20%)


Weekly T2108
Weekly T2108
*All charts created using
freestockcharts.com unless otherwise stated

The charts above are the my LATEST updates independent of the date of this given T2108 post. For my latest T2108 post click here.

Related links:
The T2108 Resource Page
Expanded daily chart of T2108 versus the S&P 500
Expanded weekly chart of T2108

Be careful out there!

Full disclosure: long SSO call options, long SSO shares, long SVXY shares, short and long UVXY puts, long CAT puts, long FB calls and short shares, long RUSS, long AMZN calls, net long the U.S. dollar, long GLD, short put options and long and short call options on USO, long FXC

Feb
3

One Chart That Rings An Alarm For Future Chinese Consumption

written by Dr. Duru
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“…emerging markets experienced a more recent run-up in indebtedness, which started around the time of the crisis, and is still continuing. In other words, their deleveraging has not even begun. This has the potential to create persistent spending disappointments, if monetary policy is unable to stimulate other spending sufficiently.” – “Debt, Demographics and the Distribution of Income: New challenges for monetary policy” – Gertjan Vlieghe, Member of Monetary Policy Committee, Bank of England, January 18, 2016.

This observation from Vlieghe of the Bank of England (BoE) should ring alarm bells for anyone expecting further increases in Chinese demand and consumption in the near future. China is reportedly transitioning from an export-driven to a consumption-driven economy. This economic adjustment is supposed to lead to more sustainable and stable economic growth. Yet, debt levels are exceptionally high in China and still rising. Unless the Chinese government has figured out how to create a perpetual motion machine of debt and consumption, China’s transition to a consumption-driven economy should soon hit a significant roadblock.

The chart below puts China’s debt run-up in global context. Total private non-financial sector debt has increased rapidly since the financial crisis. As a percentage of GDP, China has surpassed even the pre-crisis peak seen in the United Kingdom.


Total private non-financial sector debt has soared in China relative GDP in the past several years. It has now surpassed the pre-recession peak even in the United Kingdom.

Total private non-financial sector debt has soared in China relative GDP in the past several years. It has now surpassed the pre-recession peak even in the United Kingdom.


Source: “Debt, Demographics and the Distribution of Income: New challenges for monetary policy” – Gertjan Vlieghe, Member of Monetary Policy Committee, Bank of England, January 18, 2016.

This high-level of debt help explains why the Chinese government has struggled to get much response out of a long series of stimulus measures over the past year or so. The capacity for piling up yet more debt must be reaching some kind of limit. While that specific limit cannot be known in advance, especially since China’s economy is in a much higher growth mode than its Western competitors, I strongly suspect the limit is near. Companies that are continuing to rely upon the China growth story to support their own growth story over the next few years will (continue to) stumble as China approaches and then breaks down from this debt limit.

Commodity-related companies generally peaked in 2011. Companies trapped in industries where supply has yet to respond to the realty of future Chinese demand, like iron ore, have suffered accelerating pain in the past 18 to 24 months. Apple provided the most high-profile example of a glitch in the Chinese growth story. As most investors and traders knows by now, Apple (AAPL) finally reported some “softness” in China, mainly in Hong Kong. Apple’s observation could be the last sign of the beginning of the end of China’s great debt run-up.


Iron ore giant BHP Billiton Limited (BHP) has suffered a near relentless sell-off for many months now.

Iron ore giant BHP Billiton Limited (BHP) has suffered a near relentless sell-off for many months now.

Apple (AAPL) has been breaking down since last summer. Beyond the 2015 flash crash, AAPL trades at levels last seen in the summer of 2014.

Apple (AAPL) has been breaking down since last summer. Beyond the 2015 flash crash, AAPL trades at levels last seen in the summer of 2014.

The Shanghai Composite Index has fallen by almost 50% from its peak last summer. The index trades at levels last seen in December, 2014.

The Shanghai Composite Index has fallen by almost 50% from its peak last summer. The index trades at levels last seen in December, 2014.


Source for charts: FreeStockCharts.com

These three charts – BHP, AAPL, and SSEC – display an almost alarming convergence of troubles. Time could soon tell whether this is more than a coincidental correlation.

Be careful out there!

Full disclosure: long BHP put options

Feb
2

Far-Reaching Ripples From Japan’s Newly Negative Rates

written by Dr. Duru
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(This is an excerpt from an article I originally published on Seeking Alpha on February 1, 2016. Click here to read the entire piece.)

On Wednesday, January 27th, the U.S. Federal Reserve stared down volatile conditions in financial markets and decided to avoid addressing them directly. {snip}

When the Bank of Japan (BoJ) came up to bat almost two days later, the BoJ made very clear its concerns about global economic and financial developments. From “Introduction of ‘Quantitative and Qualitative Monetary Easing with a Negative Interest Rate’“:

{snip}

This concern convinced the BoJ to add interest rates to the monetary policy formerly called Quantitative and Qualitative Monetary Easing (QQE). The vote was a close 5-4 decision that sent interest rates negative in a tiered fashion similar to the method used by the Swiss National Bank:

{snip}

In other words, the BoJ has added its own confirmation that this is indeed a low-rate world. The ripples from this confirmation are far-reaching and particularly important for traders in financial markets.

The impact on the Japanese yen (FXY) was immediate but yen-buyers tried to put up a fight. After all, the BoJ cannot wipe away all the panic and fear in the market that drives traders and investors to prefer “safety” in the yen.


And just like that, the breakdown for USD/JPY ends.

And just like that, the breakdown for USD/JPY ends.


{snip}


Traders faded the first trigger reaction to the BoJ announcement. The resumption of yen selling should become a defining theme for coming weeks or more.

Traders faded the first trigger reaction to the BoJ announcement. The resumption of yen selling should become a defining theme for coming weeks or more.


Source for charts: FreeStockCharts.com

With the BoJ taking action, the U.S. Federal Reserve is even more isolated on the island of policy divergence. It is hard to imagine that the Fed will continue hiking rates when all its peers in major central banks are officially in or have been in full retreat on monetary policy. {snip}


The market now expects the next rate hike to come in 11 months!  The marginal 52.8% probability represents a dramatic change from just two days ago post-Fed.

The market now expects the next rate hike to come in 11 months! The marginal 52.8% probability represents a dramatic change from just two days ago post-Fed.


Source: CME Group FedWatch

Currency speculators also found themselves trapped on an island – this one an island of yen bullishness. {snip}


The Bank of Japan caught speculators flat-footed: they were in the middle of ramping net longs to levels last seen in late 2012. Since then, not a single week had even featured net long positions.

The Bank of Japan caught speculators flat-footed: they were in the middle of ramping net longs to levels last seen in late 2012. Since then, not a single week had even featured net long positions.


Source: Oanda’s CFTC’s Commitments of Traders

This episode hits the “pause button” on the warning I wrote at the beginning of the year in “The Japanese Yen Flashes Red for 2016.” {snip}


AUD/JPY continues a sharp bounce from recent 3-year lows as market sentiment is trending upward.

AUD/JPY continues a sharp bounce from recent 3-year lows as market sentiment is trending upward.


Source for charts: FreeStockCharts.com

Be careful out there!

(This is an excerpt from an article I originally published on Seeking Alpha on February 1, 2016. Click here to read the entire piece.)

Feb
2

The S&P 500’s Latest Breakdown Echoes the Warning Signal From the August Angst

written by Dr. Duru
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(This is an excerpt from an article I originally published on Seeking Alpha on January 19, 2016. Click here to read the entire piece.)

For a brief moment on January 15, 2016, the S&P 500 (SPY) looked ready to extend the sell-off that ended with the August Angst of 2015. At 1858, the index was trading marginally lower than the lows from the August flash crash and the next day’s confirming close. That move would have marked a new 15-month closing low. Instead, the S&P 500 managed to bounce back and cling to support.


The S&P 500 (SPY) continues down a slide marked by the lower-Bollinger Bands (BB). Buyers just barely nudged the index off a new 15-month low.

The S&P 500 (SPY) continues down a slide marked by the lower-Bollinger Bands (BB). Buyers just barely nudged the index off a new 15-month low.


Source: FreeStockCharts.com

The big question hanging over the market now is whether this correction (10%+ loss from last all-time high) will finally begin a march to a bear market (20%+ loss from last all-time high). In early September, I modified the model of another Seeking Alpha author to demonstrate how to use the 200-day moving average (DMA) of the S&P 500 as one tool for assessing the prospects for this kind of sell-off. {snip}

The last two sell-offs following all-time highs started in 2000 and 2007. The 200DMA signal gave ample warning of further selling in both cases. The two periods are connected in that the market finally re-achieved a new all-time high in May, 2007 only to peak again in just 4 more months. This time around, the market has enjoyed over two years of fresh all-time highs. Thus, I am assuming the market has more latent momentum than it had going into the 2007 peak. {snip}

{snip}


The path of the effective Fed funds rate versus continued claims over the past 50 years. Note the timing of recessions coinciding with lows of claims and rate hiking cycles.

The path of the effective Fed funds rate versus continued claims over the past 50 years. Note the timing of recessions coinciding with lows of claims and rate hiking cycles.


Source: US. Employment and Training Administration, Continued Claims (Insured Unemployment) [CCSA], retrieved from FRED, Federal Reserve Bank of St. Louis, January 18, 2016; and Board of Governors of the Federal Reserve System (US), Effective Federal Funds Rate [FF], retrieved from FRED, Federal Reserve Bank of St. Louis, January 18, 2016.

{snip}

{snip}


The odds of the next rate hike have dropped to 49.8% for June and 53.5% for July.

The odds of the next rate hike have dropped to 49.8% for June and 53.5% for July.


Source: CME Group FedWatch

Assuming the Federal Reserve will continue to follow the market’s expectations in an effort to avoid surprises to financial markets, then it seems reasonable given all the above data to expect a recession is not in the cards for this year. I am even doubtful a recession is in the cards for 2017, but I am not yet willing to make such bets.

{snip}

In other words, an imminent recession is unlikely, but no catalysts are coming on the horizon to rescue market sentiment. On-going recession panic in financial markets will continue rearing its ugly head in the form of selling pressure on stocks… {snip}

Be careful out there!

Full disclosure: long SSO call options and shares

(This is an excerpt from an article I originally published on Seeking Alpha on January 19, 2016. Click here to read the entire piece.)

Feb
1

An Upbeat Reserve Bank of Australia Stays Downbeat On Interest Rates

written by Dr. Duru
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In its February decision on interest rates, the Reserve Bank of Australia (RBA) issued a surprisingly upbeat and rosy assessment of economic conditions in Australia. Outside of mining, I daresay economic conditions look particularly promising:

“In Australia, the available information suggests that the expansion in the non-mining parts of the economy strengthened during 2015 even as the contraction in spending in mining investment continued. Surveys of business conditions moved to above average levels, employment growth picked up and the unemployment rate declined in the second half of the year, even though measured GDP growth was below average. The pace of lending to businesses also picked up.”

Yet, the reality remains that overall inflation is too low (1.7% for 2015) and there is still too much turbulence in China’s economic transition for the RBA to sit comfortably. The Australian dollar (FXA) is finally doing some of the heavylifting for the RBA, so it does not need to cut rates. The RBA can get away with threatening to maybe, possibly, perhaps cut rates if absolutely necessary. So for now, the RBA’s conclusion is sufficient to keep markets on notice. It also keeps the Australian dollar from getting caught in some mild policy divergence away from all the other major central banks that are still in retreat on policy:

“Over the period ahead, new information should allow the Board to judge whether the recent improvement in labour market conditions is continuing and whether the recent financial turbulence portends weaker global and domestic demand. Continued low inflation may provide scope for easier policy, should that be appropriate to lend support to demand.”

The reaction in currency markets reflects the dual nature of the statement. Traders first bought and then sold the Australian dollar.


The market rocks up and then down in response the RBA's mixed messages.

The market rocks up and then down in response the RBA’s mixed messages.


On a daily scale, this quick churn reinforces a struggle at important resistance. Against both the U.S. dollar and the Japanese yen, the Australian dollar is struggling at critical resistance from 50-day moving averages (DMAs). If current trends persist, the test should resolve to the downside. If resolution occurs to the upside, then the move could represent a brand new wave of optimism that chooses to latch onto the good news over the same old bad news in the RBA’s report.


The Australian dollar versus the U.S. dollar (AUD/USD) is bumping up against important resistance the its 50DMA

The Australian dollar versus the U.S. dollar (AUD/USD) is bumping up against important resistance the its 50DMA

The Australian dollar is also struggling at 50DMA resistance against the Japanese yen (AUD/JPY)

The Australian dollar is also struggling at 50DMA resistance against the Japanese yen (AUD/JPY)


Source for charts: FreeStockCharts.com

Be careful out there!

Full disclosure: net short the Australian dollar

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