S&P 500: Tall shadows warn of selling pressure

The S&P 500 is recovering after Wednesday’s sharp fall but tall shadows on the last two candles indicate selling pressure. This is supported by a bearish divergence on 21-day Twiggs Money Flow, signaling medium-term selling pressure. Respect of resistance at 2400 is likely and would warn of another test of primary support at 2330.

S&P 500

Bellwether transport stock Fedex [FDX] has consolidated in a broad rectangle over the last six months. Bearish divergence on 13-week Twiggs Money Flow indicates long-term selling pressure. Breach of support at 185 would signal a primary down-trend, warning that economic activity is slowing.

Fedex

Sell in May and run away?

Markets fell sharply today. But before we look at the charts, let’s examine three fundamental measures of market stress.

A yield differential near zero indicates bank margins are being squeezed. Lending normally slows, leading to a recession. But the current yield differential of 1.45%, calculated by subtracting the yield on 3-month T-bills from the yield on 10-year Treasuries, is reasonably healthy.

Yield Differential

The yield spread between the lowest investment grade corporate bonds (Baa) and 10-year Treasuries is a useful measure of market risk. The risk premium widens in times of uncertainty. Since 2016 the Baa spread has fallen by more than one percent, to 2.25%, indicating low market risk.

10-Year Corporate Bond Spreads

The above indications are supported by the St Louis Fed Financial Stress Index which is at a record low of -1.451 since its commencement in 1994.

St Louis Fed Financial Stress Index

The St Louis Fed Financial Stress Index measures the degree of financial stress in the markets and is constructed from 18 weekly data series: seven interest rate series, six yield spreads and five other indicators. Each of these variables captures some aspect of financial stress. Accordingly, as the level of financial stress in the economy changes, the data series are likely to move together.

The average value of the index, which begins in late 1993, is designed to be zero. Thus, zero is viewed as representing normal financial market conditions. Values below zero suggest below-average financial market stress, while values above zero suggest above-average financial market stress.

Real GDP growth dipped to 1.9% for the first quarter 2017, compared to 2.0% for Q4 2016. While growth is modest, hours worked by nonfarm employees improved to 1.55% in April 2017 from a low of 1.03% in February, suggesting that growth is likely to continue.

Real GDP & Hours Worked

There is little sign of stress in financial markets other than the latest Trump turmoil.

Trump Turmoil

Discussion of a possible impeachment action against President Donald Trump is rife in the media and seems to have spooked financial markets.

The Dollar Index fell through support at 98.50, signaling another decline. The long-term target is 93.00.

Dollar Index

Gold rallied, breaking through resistance at $1250/ounce. Follow-through above $1300 would signal another advance, with a target of the 2016 high at $1375.

Spot Gold

Dow Jones Industrial Average retreated from resistance at 21000. Expect a test of medium-term support at 20400. Reversal below 20000 would be cause for concern.

Dow Jones Industrial Average

The S&P 500 is headed for a test of medium-term support at 2320. Breach would likewise signal a strong correction.

S&P 500

We are likely to get a secondary correction but I expect the bull market to continue. Impeachment of Trump would be a temporary setback and would make me more bullish on the long-term outlook.

It’s probably better to have him inside the tent pissing out,
than outside the tent pissing in.

~ President Lyndon Johnson on FBI Director J. Edgar Hoover whom he mistrusted

The Only Question Investors Have Is About Trump | Bloomberg

Barry Ritholz sums up the impact President Donald Trump will have on your investments:

….We start with an overlooked truth: Presidents, regardless of party, get too much credit for when things go right and too much blame when they go wrong.

….Yes, Donald Trump can and will affect the economy and the markets. But we should not put all of our focus on the marginal impact of the president while giving short shrift to more important things such as corporate revenue and earnings, the Federal Reserve, interest rates, inflation, congressional spending, employment, retail sales, Supreme Court decisions, and, of course, valuations.

Quite right. Janet Yellen probably has more power over your investments than Trump does.

….I think we all hoped that once the election was over, we could go back to our normal lives without the incessant parade of campaign news.

No such luck.

Investors need a way to sequester the noisy news flow out of the White House. It is too easy to let the relentless and disturbing headlines throw off long-term financial plans. Investors must read the news, but not let it interfere with thinking clearly.

Look, let’s be honest about the commander-in-chief: He is the world’s leading Twitter troll, a man whose main goal is to interrupt your thinking, misquote and insult other people, engage in rhetorical sleight of hand, and impugn the integrity of those trying to do honest work. What all trolls want is a reaction, something Trump has achieved to great success.

Rule No. 1 on the internet is “Do not feed the trolls.” No one can really ignore the president of the United States, but it’s probably best to view much of what he says or tweets as minor background noise.

The President is not a conciliatory figure who is going to govern from the middle. The acrimonious feud with Democrats and the media is likely to continue for most of his term. So long as the GOP have a majority in Congress and the Senate, Trump has a fair shot at tax reform and infrastructure programs. If that should change, expect Obama-style gridlock.

Source: The Only Question Investors Have Is About Trump – Bloomberg

US inflation falls, Personal Consumption grows

A dip in the latest consumer price index (CPI) growth figures brings the inflation measure back in line with the Fed target of 2.0%. Inflationary pressures appear contained, easing Fed motivation to implement restrictive monetary policy.

Consumer Price Index

Personal consumption continues to grow at a modest pace. The down-turn in expenditure on services would be cause for concern — this normally precedes a recession — if not for a strong rise in expenditure on durables.

Personal Consumption

Manufacturers new orders for capital goods display a similar recovery.

Manufacturers New Orders: Capital Goods ex-Defense

The housing recovery continues at a modest pace.

Housing

Construction spending as a percentage of GDP remains soft, suggesting that the recovery still has plenty of room for improvement.

Construction/GDP

S&P 500 Price-Earnings Ratio rises

With 84.4% of S&P 500 index constituents having reported first-quarter earnings, 302 (73.84%) beat their earnings estimates while 77 (18.83%) missed. Forward estimates for 2017 contracted by an average of 4.6% over the last 12 months but not sufficient to raise the forward Price-Earnings Ratio above 20. That is the threshold level above which we consider the market to be over-priced.

Forward Price Earnings Ratio for S&P 500

Comparing the forward estimates for 2017 to actual earnings for 1989, we see that the market is expected to deliver a compound average growth rate of 6.0% over almost three decades.

With a dividend yield of 2.16%, that delivers a total return to investors of just over 8 percent.

Price-Earnings ratios fluctuate over time, so any improvement in the ratio should be considered temporary.

Buybacks have averaged just over 3 percent since 2011. The motivation for buybacks is that they should accelerate earnings growth but there is little evidence as yet to support this. As Reported Earnings grew at an average rate of 3.2% between December 2011 and 2016, below the long-term average.

A spike in earnings is projected for 2017 and 2018. Hopefully this continues. Else there will be a strong case for restoring dividends and reducing stock buybacks.

Oil price fall is caused by tighter monetary conditions | Lars Christensen

Lars Christensen is one of the founding members of the Market Monetarism school of economic thought, having coined the term himself. Market Monetarists advocate that central banks target nominal GDP, instead of inflation, in order to achieve more responsive monetary policy and more stable economic growth.

Nasdaq buying pressure

The Nasdaq 100 continues its impressive climb, shown here on a monthly chart. Rising troughs on Twiggs Money Flow signal strong buying pressure and a test of 6000 is likely.

Nasdaq 100

Dow Jones Industrial Average continues to test resistance at 21000 after a shallow correction. Elevated troughs on Twiggs Money Flow again signal buying pressure. Breakout is likely and would signal a fresh advance, with an immediate target of 22000.

Dow Jones Industrial Average

Echoes of the Past: Syria, Chemical Weapons, and Civilian Targeting

Everyone should read this as a reminder of the brutality that states may employ for political ends, whether Ethiopia (1935), Chechnya (1995), Iraq (1998) or Syria (2017). Chemical weapons such as sarin or mustard gas leave horrific injuries, but any deliberate targeting of civilians — such as bombing of hospitals and residential neighborhoods — should IMO be treated as a war crime.

Luke O’Brien is a U.S. Army officer assigned to Aberdeen Proving Ground and is currently a Countering Weapons of Mass Destruction Graduate Fellow at National Defense University:

…..Perhaps the most notorious example of this from recent memory, however, was the Iraqi chemical attack on the Kurdish town of Halabja in March 1988, as part of the Anfal Campaign at the end of the Iran-Iraq War. This attack struck the small Kurdish village with both conventional and chemical bombs, including sarin, just as Assad’s forces would nearly 30 years later. The first attacks used normal high-explosive bombs, which both drove civilians into basement shelters as well as broke open the villages windows and doors. These initials attacks were then followed up with chemical munitions, which quickly filled the basement shelters and killed their occupants.

Such brutality was intentional. The attacks were intended to break the back of the Kurdish peshmerga militia by depopulating its support. Commenting on the matter at the time, Iraqi Gen. Ali Hassan al-Majid bragged that he would “kill [all the Kurds] with chemical weapons.” The chemical bombardment of Halabja had its desired effect, with a stream of surviving civilians abandoning the town and fleeing to nearby Iran. This use of chemical weapons, moreover, had another added benefit: driving away civilians and insurgents who had become numb to the effects of conventional weapons…..

Read more at: Echoes of the Past: Syria, Chemical Weapons, and Civilian Targeting

Dow prepares for a fresh advance

Dow Jones Industrial Average is testing resistance at 21000 after a shallow correction. Rising troughs above zero on Twiggs Money Flow signal strong buying pressure. Breakout is likely and would signal a fresh advance, with an immediate target of 22000.

Dow Jones Industrial Average

Small Cap stocks are also advancing, with the Russell 2000 Index testing resistance at 14.00. Breakout is likely and would offer an immediate target of 15.00.

Russell 2000 Small Caps

A broad advance across large and small caps, suggests low market risk. Advance of only large caps would indicate that investors are risk averse. Advance of only small caps normally occurs towards the frothy end of stage III of a bull market — when the smart money is taking profits while the dumb money has lost all fear.

Weak Dollar strengthens gold outlook

The Dollar Index broke support at 100 despite strengthening interest rates, warning of a down-trend. Target for a decline would be the May 2016 low of 93.

Dollar Index

China has burned through a trillion dollars of foreign reserves in the last 3 years, attempting to support the yuan. I believe the sell-off is unlikely to abate and plays a major part in the Dollar’s weakness.

China: Foreign Reserves

A falling Dollar would strengthen demand for gold. Spot Gold is retracing from resistance at $1300/ounce and is likely to find support at $1240/$1250. Respect of support would suggest another advance; confirmed if gold breaks $1300.

Spot Gold

Spot Silver displays a more bearish medium-term outlook, however, with a stronger correction testing support at $17.00/ounce. Breach of support would test the primary level at $15.65 and warn of further gold weakness.

Spot Silver

No Plan? No Strategy? No Problem! Syria and Trump’s Russia Policy

Michael Kofman is an Analyst at CNA Corporation and a Fellow at the Wilson Center’s Kennan Institute:

….Past American attempts at coercive diplomacy with Russia have typically lacked actual coercion, and a theory of how to gain leverage over Moscow. It will be rather startling if 59 cruise missiles turn out to be the answer to this problem. Thankfully, the previous administration tested a lot of theories that didn’t work, from empty threats at the United Nations, to disproven assumptions on what influences Russian behavior, to narratives about quagmires. It would be best for Trump’s White House not to set us on this journey, mounted on that very same broken wheel (or one just as broken in a different way).

In a contest of wills, Trump needs a plan to establish coercive credibility rather than hoping to scare the Russians with expensive fireworks. The number one mistake previous administrations made with Moscow is that, rather than deal with the Russia that is, they all imagined a Russia that suited them more, and then tried to have relations with that imaginary country.

The reality is, this administration’s only current leverage with Russia is the notion inside the Kremlin that a cooperative agenda with the United States is still possible. That’s a dubious proposition which offers the U.S. some advantages. Russia still hopes that there are carrots the United States might offer, or at the least it could get respite in the current confrontation and consolidate gains. If the administration is able to drag out this perception, rather than demonstrating that the White House is rapidly reverting to classical archetypes that Moscow anticipates, then there is an opportunity to obtain concessions.

Given that a cooperative agenda between the United States and Russia is well-nigh impossible, where does that leave us?

Source: No Plan? No Strategy? No Problem! Syria and Why Trump’s Russia Policy Is Off to a Rough Start

Inflation surges

Inflation is rising, with CPI climbing steeply above the Fed’s 2% target. But core CPI excluding energy and food remains stable.

Consumer Price Index

Job gains were the lowest since May 2016.

Job Gains

But the unemployment rate fell to a low 4.5%.

Unemployment

Hourly wage rate growth has eased below 2.5%, suggesting that underlying inflationary pressures are contained.

Average Hourly Earnings Growth

The Fed is unlikely to accelerate its normalization of interest rates unless we see a surge in core inflation and/or hourly earnings growth.

Dow consolidation

Dow Jones Industrial Average is consolidating in a narrow band between 20400 and 20800. Narrow bands in an up-trend signal accumulation and breakout above 20800 would signal another advance.

Dow Jones Industrial Average

Declining 21-day Twiggs money Flow is typical of a consolidation, provided it respects the zero line. A trough above zero confirms medium-term buying pressure.

Jobs, Inflation & the Fed | ECRI

From Lakshman Achuthan at ECRI:

Headline jobs growth came in well below expectations, and weather played some part in suppressing job growth, both in construction and retail.

But the jobless rate dropped to 4.5%, its lowest reading since 2007, so the Fed’s “full-employment” mandate has been met.

Their other mandate is on inflation, and over the past year I’ve discussed our U.S. Future Inflation Gauge, which anticipated the inflation cycle upturn shown by the chart. Today the forward looking USFIG remains near an 8¾ -year high.

The chart shows the year-over-year PCE inflation rising sharply to a 5-year high, and breaching the Fed’s 2% inflation target which is defined by this inflation measure.

For those who might think this is just about oil prices, please note that core PCE inflation, ex-food and energy, has also been rising, and now above 1¾%, the highest reading in over 2½ years.

This is what a cyclical upswing in inflation looks like.

Moreover, the U.S. economy has a good tailwind from rising global growth.

All of this helps explain why the Fed is finally able to implement a full-fledged rate hike cycle.

Source: Jobs, Inflation & the Fed | News | News and Events | ECRI

Is the Donald long gold?

Don’t know if he is long, but Donald Trump is doing his best to drive up demand for gold.

From the FT overnight:

Donald Trump has warned that the US will take unilateral action to eliminate the nuclear threat from North Korea unless China increases pressure on the regime in Pyongyang.

In an interview with the Financial Times, the US president said he would discuss the growing threat from Kim Jong Un’s nuclear programme with Xi Jinping when he hosts the Chinese president at his Florida resort this week, in their first meeting. “China has great influence over North Korea. And China will either decide to help us with North Korea, or they won’t,” Mr Trump said in the Oval Office.

“If they do, that will be very good for China, and if they don’t, it won’t be good for anyone.”

But he made clear that he would deal with North Korea with or without China’s help. Asked if he would consider a “grand bargain” — where China pressures Pyongyang in exchange for a guarantee that the US would later remove troops from the Korean peninsula — Mr Trump said:

“Well if China is not going to solve North Korea, we will. That is all I am telling you.”

Nothing like the threat of nuclear war to drive up the price of portable assets. Not that it would do much good if you are on the receiving end.

Spot Gold broke resistance at $1250 an ounce. Follow-through above $1260 is likely and would signal an advance to $1300.

Spot Gold

Theresa May had a calmer, less belligerent approach: “….encourage China to look at this issue of North Korea and play a more significant role in terms of North Korea … I think that’s where our attention should focus.”

Dow Descending Wedge

Dow Jones Industrial Average displays a descending broadening wedge on the daily chart. Thomas Bulkowski describes this as a “mid list performer ….found most often with upward breakouts in a bull market. Downward breakouts are quite rare.”

Dow Jones Industrial Average

The correction seems mild and lacks urgency from sellers. It is very likely to end with an upward breakout, above the wedge at 20800, signaling another advance. Watch for a failed down-swing within the wedge pattern. According to empirical testing done by Bulkowski, a partial decline has a high probability (87%) of resolving in an upward breakout.

Latest GDP numbers confirm that low growth of the past decade continues.

GDP & Forecast

The quick rule-of-thumb forecast — Private sector employee payroll x Average Hours Worked x Average Hourly Rate — has proved remarkably accurate and has become one of my favorite indicators.

More evidence of a bull market, except in Australia

One of my favorite indicators of financial market stress is Corporate bond spreads. The premium charged on the lowest level of investment-grade corporate bonds, over the equivalent 10-year Treasury yield, is a great measure of the level of financial market stress.

Moodys 10-year BAA minus Treasury yields

Levels below 2 percent — not seen since 2004 – 2007 and 1994 – 1998 before that — are indicative of a raging bull market. The current level of 2.24 percent is slightly higher, reflecting some caution, but way below elevated levels around 3 percent.

The Financial Stress Index from St Louis Fed measures the degree of stress in financial markets. Constructed from 18 weekly data series: seven interest rate series, six yield spreads and five other indicators. The average value of the index is designed to be zero (representing normal market conditions); values below zero suggest low financial stress, while values above zero suggest high market stress.

St Louis Financial Stress Index

Current levels, below -1, also indicate unusually low levels of financial market stress.

Leading Index

The Leading Index from the Philadelphia Fed has declined slightly in recent years but remains healthy, at above 1 percent.

Philadelphia Fed Leading Index

Currency in Circulation

Most recessions are preceded by growth in currency in circulation falling below 5 percent, warning that the economy is contracting.

Currency in Circulation

Current levels, above 5 percent, reflect healthy financial markets.

Australia

On the other side of the Pacific, currency growth is shrinking, below 5 percent for the first time in 7 years. A sustained fall would warn that the economy is contracting.

Australia: Money Supply

Further rate cuts, to stimulate the economy, are unlikely. The ratio of Household Debt to Disposable Income is climbing and the RBA would be reluctant to add more fuel to the bonfire.

Australia: Household Debt

There is no immediate pressure on the RBA to raise interest rates, but when the time comes the impact on the housing market could be devastating.