After months of tight range ping pong trading markets managed to eek out new closing highs on the occasion of another monthly options expiration (OPEX). Markets haven’t had a correction since 2011 and 2015 hasn’t even produced a basic closing pullback of 5%. The autopilot program continues so it seems silly to even have the notion of a bear case in a headline. Yet there are some very unusual things going on under the surface that warrant attention.
In this edition of weekend charts we then want to highlight the merits of the bear versus bull case at a time when markets appear to be breaking higher.
The Bull Case
Price is ultimately a function of supply and demand and in the arranged marriage that is TINA (there is no alternative) aside form earnings expansion price has benefited from 3 principle drivers of demand:
1. QE and ZIRP driven by central banks. Since 2007 over $11 trillion of central bank easing have made its way into capital markets. M1 money supply is continuing to expand and has had a close correlation with stock prices:
With low interest rates money otherwise allocated elsewhere is forced to engage in a desperate search for yield. And for lack of alternatives money keeps being allocated into stocks.
And this trend is continuing. The BOJ and ECB are running QE programs, and dozens of central banks have cut rates since the beginning of 2015. As David Tepper recently said, don’t bother fighting 4 central banks, or in reality all of them.
2. Central banks buying stocks: Not only are central banks forcing money into stocks, but in many cases they themselves are a driver of demand by building large stock portfolios. The SNB, for example, has a stock portfolio of over $100B and went on a big buying spree of individual stocks in Q1 of 2015:
3. Buybacks, enabled by ZIRP and by strong corporate cash flow generation has resulted in a historic expansion in buybacks and hence demand for select stocks:
The next big argument in favor of bulls: None of the above demand drivers appear to be changing any time soon. Any notion of the US Fed raising rates in 2015 amidst continuing disappointing economic news seem out the door as Art Cashin outlined on CNBC.
With this backdrop then it should perhaps be of little surprise that markets simply do not move lower on any bad news: The demand and bid remains, independent of any fundamental backdrop.
The bullish argument can be further supported by key index charts:
1. The $SPX may be breaking out following a similar path of RSI consolidation seen in 2014 coinciding with the same time frame as now:
Such a breakout scenario is finding support in a breakout to new highs in the $NYA following a year long consolidation:
After all the $NYA has been trending steadily higher also similar to 2014.
So the bullish case has merits and I understand the concluding arguments highlighted here for example by Ralph Acampora:
As far as where the market is heading, the so-called godfather of technical analysis sees another 7 to 8 percent upside in the S&P 500 by the end of the year. “I see the market going anywhere from 2,250 to 2,300,” he said.
In any event, to Acampora, the message is clear: “Don’t fight the trend. This [market] looks very, very good.”
Yes people get bullish when prices move higher. That’s basic psychology.
So then a fair question to ask might be: But if the demand equation in form of central bank policies, buybacks and TINA persist why would this result in corrective activity if it still hasn’t?
So here then let me give you the broader bear case that you won’t hear from Ralph, CNBC or anywhere else as far as I can tell:
The Bear Case
Let’s start with the nature of the recent market action and resulting prices. A persistent bid, particularly in overnight low volume trading, has generated all market gains over the past month. It is of note that weekly closing highs have tended to occur during recents Fridays erasing all mid-week weakness and any potential chart damage. Why is this noteworthy? Because it speaks to price discovery. Higher prices are not informed by broad market support, but by the least amount of participants and volume.
This observation extends into open market hours. As soon as price exceeds $211 on the $SPY volume simply dries up:
This speaks to a market that finds no new organic buyers above a certain price level. Yet, with no discernible alternative to move toward, sellers appear to disappear on the smallest of pullbacks. But are they? There is actually evidence that this market is vastly different than 2014 despite the similarities in the earlier charts.
And this goes to the core of the bear case: There are signs that the supply and demand equation is changing.
First off some key differences to this time in 2014:
Transports are getting hammered as opposed to rising:
So are utilities:
And the monthly autopilot chart of the $SPX still shoes a negative MACD crossover versus a positive one in 2014:
But all this could be attributed to a rotation of capital and the chart points to a move toward the 2170 area. Yet there are some other happenings that are highly unusual.
1. The $BPSPX has completely diverged from price:
As far as I can tell this has never happened before. Steadily attached to the hip the $SPX and $BPSPX have had a very cosy relationship. All of a sudden they have moved in polar opposite direction. In my mind it speaks to an extremely divergent narrowing of leadership. Fewer and fewer stocks are supporting price.
2. There is selling. Lots of it, but it’s done under the surface and is benefitting from overnight gap up action. Some may refer to it as distribution. You can see it in the bullish/bearish asset allocations which suddenly have also diverged from in addition to a relative decrease in money flows:
The message: Somebody is selling and very quietly so and index prices remain elevated driven by a narrowing basket of high cap stops supported by large buyback programs and central bank buying.
And this comes to the very core of the bear argument: Years of artificially influencing markets to achieve a recovery has produced the following:
1. A massive inflation of debt and balance sheet expansions shouldered by all of society.
2. An unprecedented transfer of wealth to a select few individuals who have disproportionally benefited from such policies.
3. $11 trillion in QE since 2007 and massive debt expansion has produced flat GDP growth and ever lower sales growth. One can only imagine what reality would look like without the artificiality of the above mentioned demand creation machine:
4. A job recovery that been biased toward low income, low benefit jobs without a recovery in median wages.
And Americans are already seeing the writing on the wall:
Results of the University of Michigan’s Consumer Confidence survey came out on Friday and showed an unexpected drop of 7.3 points to 88.6. Analysts had forecast that the index would stay roughly the same, at 95.9.
What’s more, people appear to be more worried about losing their jobs. Respondents to the survey reported the highest probability of losing their jobs since 2009.
So here we are, massively in debt and still ever more so, everybody all in on stocks, and demand artificially still induced but not producing organically driven growth. The lack of capital investment in favor of buybacks and financial engineering is setting up the world for the next downturn. Global debt can be sustained as long as rates remain low and the game can continue as long as nothing breaks.
History shows that upward trends in stocks can be sustained for months on end, but not reflect the underlying reality until later. We saw a very similar structural playbook in the year 2000 and we are still very much watching this chart:
From a trading perspective we’ve had tremendous success trading the chop in both directions, markets such as Germany also had tremendous volatility with its recent 10% correction. In fact, US markets seem to be the only remaining asset class that has not undergone any type of serious volatility. Everything from bonds, currencies, commodities and international markets are moving in large swings, but US markets are the last man standing. For now.
NEAR TERM OUTLOOK:
Recent OPEX peaks have produced quick contained pullbacks lasting around 5-6 days. A similar scenario would fit in with short term seasonal weakness before moving higher in low volume summer trading toward a short term peak in early July. If markets simply ignore all the underlying cautionary factors a repeat of 2014 may also lay in store:
We have been selling strength and buying weakness during the chop and this has worked extremely well. For now we note further downside risk in the $VIX into an 11 handle, but as I like to say: Friends don’t let friends buy stocks with the $VIX at 11:
But I know Ralph disagrees:
Of the lull in volatility, Acampora said it doesn’t bother him that the VIX remains low….”That’s not a sign of complacency, that’s a sign of strength.”
Well then. We shall see.
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