In Search of Shelter

In Search of Shelter

Last month, in ‘The Correlation Conundrum’, I noted that stocks and bonds have been rallying together since the 2009 lows and delivering strong positive returns for both equity and fixed income investors over the last decade. This trend, however, peaked in 2016, has drifted lower over the past two years and is now at risk of breaking meaningfully lower. With the recent weakness in both stock and bond markets in October, the chart below, measuring the relationship between the S&P 500 and the US 10-year yield has broken lower by -8% from 95 to 87 in the last four weeks.

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2018 v 1987

2018 v 1987

In my last post - A Look Back to Black Monday - I reviewed the performance of US equities, bonds and USD in the run up to the 1987 stock market crash. From 1981 to 1986, US equities and bonds went on a tear. The S&P 500 rallied +237% from 1982 to 1987, while bonds surged +84% higher. The USD ran up +68% and then collapsed -42%. The combination of an overvalued stock market, overly bullish investor sentiment, a collapsing currency and automatic trading programmes in place at the time resulted in the panic now known as Black Monday.

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A Look Back to Black Monday

A Look Back to Black Monday

In the run up to the 1987 stock market crash, from 1981 to 1986, US equities and bonds went on a tear on the back of sharply falling interest rates. Federal Reserve Chairman Paul Volcker had successfully tamed inflation by ratcheting up the Fed Funds rate from 4.7% in February 1977 to 19.1% in July 1981. Once inflation was brought under control, Volcker dropped the Fed Funds rate all the way back to 5.9% by October 1986. Cheap stocks and plunging yields led to a surge in equity prices. The S&P 500 rallied +237% from 1982 to 1987.

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Another Shoe Drops

Another Shoe Drops

Another shoe drops. Despite US equities continuing to deliver on the positive side of the ledger in 2018, market breadth is thinning out. Fewer and fewer stocks are trending higher and the majority have now flipped into bearish mode. Today, just 41% of the 3,000+ stocks on the New York Stock Exchange are trading above their long-term 200-day moving average. The stock market declined by -5% during the first two weeks in October. It has rallied in recent days but if this rally fails, the market could be in serious trouble.

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Got Gold?

Got Gold?

Regular readers will know that I am quite bullish on the outlook for precious metals, given the macroeconomic landscape, which we must navigate today. I have not always been a ‘gold bull’ and I look forward to the time again when I am not. Today however, I most certainly am and believe gold will prove to be one of the best investments over the next 5+ years. At times, stocks have been a better investment than the barbarous relic, and at other times, gold has outperformed all other asset classes. A glance the the chart below will provide a good guide as the the future path of both asset classes.

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Trend Reversals

Trend Reversals

US equities have acted as a port in the storm in 2018 while the majority of other asset classes have delivered negative returns for investors. Unfortunately, it looks like the US stock market is now joining the herd and rolling over after putting up an incredibly strong relative performance in recent years. The S&P 100 Index made a slightly higher high in October 2018 but the underlying trend has weakened sharply.

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Trouble Brewing!

Trouble Brewing!

Trouble is brewing across global equity markets, as I have been highlighting for months now. Dams are starting to break and risks are running high. European equities, measured by the STOXX Europe 600 Index, have been consolidating in a range for the past three years but look to be breaking lower now out of that range. There is a lot of room to fall.

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As Good As Gold

As Good As Gold

There should be no doubt of China’s long-term intentions to replace the US as the world’s global superpower. Part of that process is providing an alternative to the US dollar as the world’s reserve currency. Chinese policymakers have a long way to go in this regard but they are making progress. In 2015, China announced that the renminbi would no longer be managed against the USD but instead against a basket of currencies.

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Tech Leaders Retreating

Tech Leaders Retreating

The US Technology sector has been on fire in recent years. The tech leaders have accounted for the vast majority of the gains of the entire US stock market. Today, Apple, Amazon, Google, Microsoft and Facebook are worth a combined $4 trillion or 20% of US GDP, a remarkable achievement. Outside the US however, the picture is a little less favourable. SOCL, the Global Social Media Index ETF has corrected by -23% since the start of 2018.

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Implosion in US Home Construction Stocks

Implosion in US Home Construction Stocks

US Home Construction stocks have lost one third of their value in just nine months. The steep decline is reminiscent of the collapse in this sector in 2006/7, ahead of the last financial crisis. The recent rise in interest rates are taking their toll in the debt-laden US economy. Warning signs are flashing everywhere and the stock market is pregnant with risk. It may take another 6-12 months before the broader market rolls over, or it could happen much sooner.

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Tiptoeing Towards the Exits

The number of stocks trading on the NYSE that are making new lows is on the rise. I have been highlighting this trend for months now and the broad deterioration ‘under the hood’ continues. The trend unfolding is similar to what occurred in advance of the 2008 stock market collapse and also the less severe stock market correction of 2015. The length and depth of the correction is unknowable in advance, but we are headed towards lower stock prices in the months ahead.

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Turning Off the Taps

Turning Off the Taps

The folks over at Incrementum produced this excellent summary of central bank intervention by key participants over the last 15 years. The scale of money printing is mind-boggling and nobody knows the ramifications of their actions. It is safe to say that investment markets have been distorted to an extent never before experienced. I can’t imagine we will come out the other side without having experienced serious adverse consequences to the decades of central banker largesse.

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Hanging in There...

Hanging in There...

European stocks continue to consolidate below multi-decade resistance. A breakout above 400-415 on the Eurostoxx 600 Index would be a very bullish development and I would take a position in EU shares in the Active Asset Allocator if a break higher was confirmed. European shares have so far failed to muster the strength to break out and are losing strength and at risk of breaking down. I have marked on the chart key periods when the Relative Strength Index (RSI) has traded below 50.

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Rolling Over

Rolling Over

Today, 73% of the stocks in the S&P 100 Index trade above their long-term 200-day moving average. That is a healthy majority and a requirement for broad bullish participation in a rising equity market. As long as the bullish percentage is above 50%, the benefit of the doubt should be given to the bullish trend. The risk lies in the rounding top pattern currently forming in this chart.

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Scanning the Indicators

Scanning the Indicators

Each morning I scan a wide range of technical indicators covering the major exchanges in the US, Canada and the UK. As the markets ebb and flow, a range of bullish and bearish technical indicators provide valuable data for investors searching for clues as to the market's overall health and trend. Patterns emerge over time that tip the scale in either a bullish or bearish direction. As of the close on Friday 28th September, the following bullish technical indicators triggered:

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What Are the Bank Stocks Telling Us?

What Are the Bank Stocks Telling Us?

The KBW Bank Index comprises 24 of the largest banks in the US. The financial sector is of fundamental importance to the economy and also tends to lead the stock market. A healthy economy and stock market requires a healthy financial sector. The following chart, therefore, caught my eye. In 1999, banking stocks started making a series of lower highs ahead of the stock market topping out the following year.

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Reversion to the Mean

Reversion to the Mean

Since 1947, US net corporate earnings as a percent of GNP have averaged 6.6%. However, something changed in the early 2000’s when the Federal Reserve embarked on their monetary experiment of unlimited money printing. A combination of ultra-loose monetary policy by the Fed and financial engineering by Corporate America has led to a sustained period of strong earnings growth for US companies and a 65% increase in net margins from 6.6% to 9%. Mean reversion during the financial crisis of 2008 looks like a blip on the chart.

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Golden Catalyst

Golden Catalyst

90-day volatility in the price of gold has reached a 20 year low at the same time as the large speculative short position in gold has reached a multi-decade high. This is a potent combination, which could trigger the next sharp move higher in bullion prices if gold can reverse the recent price decline in the weeks ahead. I cannot think of a more favourable backdrop for precious metals than the current set up.

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Double Tops

Double Tops

With equity valuations at record highs, corporate debt levels at record highs and yield curve inversion close at hand in the United States, rising volatility and, god forbid, declining stock markets may soon follow. Emerging markets are underperforming year-to-date, in a year of diverging trends, and the S&P 500 might have just double-topped! The US Federal Reserve will likely increase interest rates by another 25 basis points this evening. I am watching for trend changes in growth and defensive assets in the weeks ahead.

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The Correlation Conundrum

The Correlation Conundrum

Stocks and bonds have rallied sharply since the 2009 lows, delivering positive returns for equity and fixed income investors. This trend peaked in 2016, has drifted lower over the past two years and is now at risk of breaking meaningfully lower. The chart below shows the relationship between the S&P 500 and the US 10-year yield. When stocks rise and bond yields fall in the US (2009-2016), this chart shows a steadily rising trend.

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