Magic indeed. From last week’s brief: “For next week bulls have the opportunity to ramp markets anew for OPEX week as these weeks tend to be more favorable than not. The goal would have to be to take another run at the 200MA and above.” My upper risk range last week extended into 2730-2760.
Markets indeed closed above the 200MAs during OPEX week and even above my risk range. Does this now mean the bull trap case is over, markets are safe and nothing but clue skies ahead for the rest of the year? This is certainly what is appears like at the moment after 8 weeks straight up:
The complete lack of 2 way price discovery remains impressive. Yet the all clear cannot be rung. In my 2019 Market Outlook I had postulated the following:
“Only a sustained close above the daily 200MA and the weekly 50MA can give investors comfort that perhaps a major low is in play and markets can head to higher pastures.”
I stand behind that and as of this moment this rally remains completely untested, indeed it’s the most vertical and narrow rally in 70 years by some measures:
Did I mention magic?
Before I go into technicals further below let me just make some statements of principle: This channel will not sustain for the rest of the year, it will break and it will get challenged. Let me further suggest that the larger structure we are witnessing here is not that of a stable bull market. It’s a complete mess, it’s unstable, it’s got all kinds of technical issues one of which being the mechanism by which price discovery is achieved and I want to address some of this today, both structurally, philosophically, but also technically, so bear with me.
Let’s talk valuation process:
In a former life during the Nasdaq bubble I was heavily involved in international M&A projects and greenfield opportunities (Asia, Europe, Africa, South America) for a multi-billion corporate entity. Our task was to not only identify and pursue value creating opportunities, but to develop a well founded perspective on how to value these opportunities. We needed to know how much we could reasonable bid for these opportunities (in many cases these were multi-billion dollar opportunities), but also what our cut off point was. To that end we needed solid business plans founded not only on a solid understanding of future revenues, expenses, but also future EBTIDA, free cash flows, debt to equity, WACCs (weighted average cost of capital) and a whole host of valuation metrics. Yet, at the end of the day, no matter how realistic one thought a business plan was, there were unknowables and uncertainties. Worse, any final valuation could easily be changed by one variable, the terminal value multiple. Frankly it was a wag (wild ass guess), largely influenced by how confident or skeptical senior management was in regards to a specific opportunity.
And before you knew it what was a months long rigorous valuation exercise, including on site and in country research, quickly became secondary to the terminal value multiple. We want in, or we don’t want in, and in a competitive field of players playing the acquisition game valuations suddenly disconnected farther and farther from the original business plans creating a reality gap.
The point of all this? As I’m watching stock markets these days I sense a similar process of disconnect. How do you value what a stock should be worth? Earnings growth right? Which earnings? GAAP or non GAAP? GAAP accounting has long taken a backseat to non GAAP accounting. We don’t account for bad news here, things we don’t like are shoved into non GAAP accounting. It’s just a one time thing. And the next thing is just a one time thing too. And so on. And hence things we don’t like get pushed aside.
When stocks report earnings prices often react favorably when stocks beat on EPS. What makes an EPS beat these days? Well, firstly it’s all about expectations and Wall Street generally takes EPS estimates down during any given quarter, making it easier for companies to beat. “Oh look they beat EPS it’s bullish”, no matter that EPS estimates were originally much higher at the beginning of the quarter. That negative trend is not accounted for. What matters is that they beat lowered expectations.
But are we even get a real view of EPS these days? Fact is buybacks keep reducing the float and EPS look better and better by the simple virtue of math as the same earnings divided into fewer shares show a higher EPS result. Magic.
And buybacks have been soaring again:
Earning growth can simply be driven by increased buybacks. CEOs look better, stock prices rise and shareholders are happy. Again we are setting up a process where expectations and perception is managed.
For example we’ve been told that profits were oh so awesome on 2018. Were they actually?
That’s less than Q3 2014 from what I can see. But tax cuts right, that must have made a huge difference in corporate profit growth?
You tell me:
Doesn’t look all that impressive to me. But hey.
Let’s take our non GAAP results, add massive buybacks and throw in a whole bunch of optimism and let’s justify very high valuations for stocks.
And that’s what markets did twice in 2018, first in January 2018 and when that went off the rails buybacks gave the momentum to push the $DJIA to new all time highs in October. And then the bottom fell out. What changed? The valuation metrics changed. Growth started slowing down and suddenly confidence waned and high valuation multiples became smaller ones and nothing changes terminal value multiples faster than confidence right? Markets actually went through a price discovery mechanism once known as corrections.
But it lasted only hours and days.
As of Friday’s close $DJIA is right back to where it was in January 2018. Despite negative earnings earnings growth in Q1 and soon to be flat on the year, despite now negative GDP growth versus last year, despite everything having changed since January 2018. The terminal value multiple was suddenly adjusted upwards. Not because of earnings, or revenues or anything, only because of confidence, confidence that bad news no longer has to be accounted for.
It’s the point i highlighted in bears had been right about everything. And it’s a point that Guy Adami clearly picked up on and articulated well on Fast Money on Friday (thanks for the shout out):
And, as a result, markets again have not been able to not account for the realities of the underlying fundamental picture and hence my urging of caution. As with non GAAP accounting, buybacks, etc, central banks act as a backstop disrupting again the price discovery process. Bad news is not accounted for, a few hours at best, hence markets become ever farther disconnected from reality and the price discovery process is left broken and further and further removed from an economic and fundamental foundation.
So far it has worked time and time again:
Yet central banks went dovish for a reason and that reason remains very much active in the global economy: Slowdown.
In context of all of the above let’s have a look at some technicals and structural aspects of markets.
Firstly as strong as this rally has been it still shows a broken trend on a log basis, indeed Friday’s close managed to show a move toward the under belly of the broken trend line:
Nothing here, so far, is unusual in context of an aggressive bear market rally, not even an untested overthrow above the 200MA.
Why? Because of the nature with which prices are achieved. Just consider the last week:
Price levitation is almost exclusively achieved with overnight gap ups and open 30 min ramps. Gap, ramp & camp we call it as price then settles in a very tight range of a few handles for hours on end. Friday’s overnight low of 2728 is not even visible on the chart. Too powerful proved the headline driven environment turning futures positive before open and causing yet another ramp to highs of the week on a Friday, a now repetitive program for 2019:
Magic Fridays we call them.
Is there any evidence that this rally is associated with growth or expanding earnings? The answer is no, yields have remained completely unimpressed by the levitation in equity prices:
Technical reasons to be cautious here:
Indices keep getting more overbought.
$BPSPX RSI is nearly as overbought as following the initial 2015 lows. Back then price extended above the 200MA before new lows came in early 2016:
Other signal indicators show similar extreme readings which is no wonder after such an aggressive rally.
Indeed the rally has become so steep and uninterrupted is it setting up for a volatility jump:
In context of the extreme wedge patterns we are seeing markets can hardly afford a misstep. Indeed similar $VIX compression patterns have led to sizable jumps and the current level of complacency is similar to what we’ve witnessed before within larger compression patterns.
Also of note: Potential massive topping patterns, 2 examples here:
And take $GOOGL as one of its components:
Now, in a market that does nothing but go up none of these patterns or readings may mean anything, but I can only caution everyone about a key reality here: Big momentum moves can exacerbate and stretch in either direction, but they often have absolutely no meaningful predictive value about the future in terms of continuation. Indeed often these moves often produce moves in the polar opposite direction. After all prices frustrated in early September after Lying Highs, and they frustrated during Christmas during Imbalance.
Hence, until the momentum move breaks it can continue.
For example, while other indices have already exceeded their 200MA, $RUT has so far not been able to achieve this feat and its RSI is already at an overbought reading of 74+:
But here too we can observe a volatility wedge that suggests a retest of lower MAs to come even if a move higher is still to emerge first.
Bottomline: As long as the tight price channel on $SPX can be sustained momentum risk can continue higher, the next risk zone being 2800-2820, in essence the fall price resistance zone:
However this rally remains untested, has relied on central bank and potential China deal jawboning and continues to extend into overbought conditions amid weakening fundamentals making this rally highly susceptible to a risk off event, especially considering that this rally is relying heavily on open gaps and sudden headline driven price ramps. Given this market structure price support on any serious test may prove to be fleeting. As of this writing the 2009 trend remains broken on a log basis.
Hence I view this rally with a great amount of caution. As of this point markets are engaged in an inside year and central banks have once again proven they exert awesome power over the price discovery process. It may well be that no real selling emerges until there is clarity about a China deal. Such a deal keeps being priced in over and over again to the point that the entire global slowdown appears solely blamed on China trade tensions. A China trade deal resolution certainly would provide relief and clarity, but it may ultimately prove to not be the holy grail that it is made out to be at this stage.
We’ll know more after this rally has been tested. As of now it hasn’t and hence caution is the operative word at the moment.
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Categories: Weekly Market Brief
Appreciate your analysis,good job.
Who are these “caution to the wind” people that so easily sustain overnight levitation?
And, what is the mechanism used to drive it?
If not just one entity is driving this phenomena, seems to me only a matter of time until one of the players decides to be the first to get on the other side of boat.
As for the rest of us, we’re just along for the ride.