Summary…..This week has been filled with a lot talk about concerns about U.S. and global economic growth….as well as concerns about the Transportation stocks (which are obviously quiet economically sensitive). Since the Federal Reserve is not cutting rates or engaged in QE right now (despite all their dovish jawboning), we believe “growth” is going to be an even more important factor than it usually is for the stock market going forward. With this in mind, we want to focus on one key sub-group within the Transports…the railroad stocks…because the S&P 500 Rails Index is at a key technical juncture.
We find it interesting that a lot of people are have finally been saying recently that the Federal Reserve is being ruled by the markets…and that the only reason they changed their tune recently was because of the big moves in the markets. Well, long time readers know this is something we have been saying (and proving) for many years now. As we have been describing it for a VERY, VERY long time, the Fed is much more “market dependent” than they admit to….and they’re at least as much “market dependent” as they are “data dependent”…..We’ve been thinking (and hoping) that had changed under Chairman Powell, but that hope has obviously faded in a major way.
This all started when the Fed had to implement QE2…soon after QE1 came to an end. The markets fell out of bed shortly after QE1 ended…and the Fed jumped back-in quickly with another QE program (QE2)…because the economy was still very fragile. The same thing happened after QE 2 ended…as the stock market fell hard IMMEDIATELY after that second QE plan came to an end. They then came up with QE3 (but this time they didn’t put an end-date on it.)
We saw it once again in September of 2013. This time it was the bond market that caused the Fed to change their plans. In May of 2013, they said they were going to “taper” back on their bond purchases in September of that year…as long as the economic data stayed on it was on during that spring. Well, the economy DID stay on that path over the summer…and yet the Fed had to delay the time table due to the “taper tantrum”. This tantrum involved a major decline in the bond market…which took the yield on the U.S. 10yr note from 1.63% to 2.95% in just four months!!! (The Fed tried to claim that the data had changed over that summer…and THAT’S why they delayed the “taper”, but the evidence showed that the economy did remain on the same path.)
It happened once again in the 4th quarter of 2014. The Fed was going to completely end its QE program…and it was assumed that the ECB would take-over the “QE baton” from the Fed. However, the ECB got some major push-back from Germany in the second half of that year…and it looked like there wasn’t going to be anybody to take over the “baton”. This led to a decline in the stock market (with a larger decline for the European and Japanese markets). The Fed tried to “jawbone” the markets higher that October…by saying they would either re-engage in their QE3 program…or start a new one (depending on which Fed member was doing the jawboning).
However, this did very little to stem the tide. Luckily, the BOJ was able to come-in and announce (and implement rather quickly) their own QE program….and the ECB finally came around in January of 2015……So in this example, instead of a new QE program from the Fed, the BOJ & ECB came to the rescue when the markets became dislocated.
We should note that the BOJ and ECB had no choice to come to the rescue…because the Fed could no longer engage in an ever increasing QE program at that time. The reason for this is that the Fed had bought so many Treasuries that the Treasury Borrowing Advisory Committee had to warn the Fed that a shortage of Treasuries was developing. Of course, a “shortage of Treasuries” meant a “shortage of collateral”…and the markets cannot function with a shortage of collateral.
As time went on, the system continued to heal itself and become less fragile. This led the Fed to think they could finally begin to tighten. This began with a well telegraphed increase in short-term rates in late 2015. However, the oil market began to crash…which absolutely killed the high yield market. Therefore, due (once again) to a disruption in the market place, the Fed had to step aside…and it stopped raising rates after just one hike.
Once things calmed down in the credit markets…and after things had stabilized, the Fed began raising rates once again…in the following December (2016). This did not disrupt the markets immediately like it had in the years immediately following the credit crisis…because the system had become more stable. (Some would say it was still not very stable, but it was certainly stable enough to keep the tightening from having an immediate negative impact).
Instead, the tightening did not impact the markets/economy for some 18-24 months (just like it usually did in the decades before the credit crisis). However, not only did the Fed continue to raise rates throughout 2017 and 2018, but in late 2017, it ALSO began to shrink its balance sheet at an ever increasing rate throughout 2018. Therefore, it was inevitable that it would have a negative impact on the markets and economic growth.
By the time the we got to the 4th quarter of 2018 got under way, the markets could no longer hold up under this tightening policy. Again, this should not have been a surprise…because EVERY tightening cycle since WWII has caused a significant decline in the markets. This time, it declined 20%.
The difference between what is going on now…and what took place every other time we’ve had a meaningful disruption in the markets over the past decade…is that the Fed has NOT re-engaged in a new QE program…and the ECB & BOJ have not done anything of substance either. Yes, the FED has stopped raising rates, but they ARE still tightening (via QT). Otherwise, the global central banks have only “jawboned” the markets. Not only is the Fed still tightening…but the ECB has still ended their QE program. Yes, the BOJ is still pumping, but the net liquidity flow from the 3 major central banks is NOT increasing yet…like it has after other market disruptions since 2009.
In other words, the markets are now back to doing what they did before the credit crisis. They’re at the mercy of the economic and earnings growth…at least until these central banks do something more than just “jawbone” about their plans…and actually turn the liquidity spigots back on (and allow multiples to expand again).
We believe this is something that is very healthy…even if it was painful back in the 4th quarter. Therefore, we hope that Chairman Powell has the guts to make us take our medicine (the way Volcker did several decades ago)…so that the markets can go back to moving based on a fundamental basis…instead of based on just liquidity flows. We’ll be much better off over the long-term if they do indeed have the courage to do it.
It probably seems to many that the Fed has indeed thrown in the towel once again…and has cow-towed to the markets. However, as we stated above, they have NOT started easing yet…they have only begun to tighten at a slightly slower pace. So maybe Mr. Powell is still the “next Volcker”…and he only wants to slow the rate of taking us off our addiction to liquidity…rather than giving us more of the drug………….Only time will tell.
There has been a lot of focus on the industrial stocks recently….and Caterpillar Inc. (CAT) has been one of a handful of specific names that continues to get a lot of attention. However, we wonder if investors should be looking just as hard at Deere & Co. (DE). The reason for this is because a divergence has developed between DE and CAT…two stocks that have been VERY strongly correlated over the years. This is something we discussed on CNBC yesterday, Tuesday, February 12th. (Link attached below).
More specifically, DE has out-performed CAT by a wide margin since the early October highs. Actually both began to decline in tandem in early October, but CAT fell much more severely back then. CAT dropped a whopping 29% in just 4 weeks…while DE fell “only” 17%. Since their October lows, CAT has rallied 15%…while DE has rallied 24%!……Right now, DE stands 2.4% above its late October highs…while the CAT stands 18% below its own October highs. So no matter how you slice it, DE has out-performed CAT over the past 4.5 months.
What does this mean for the two stocks going forward? Well, going back to the end of the credit crisis back in 2009, most of the times that either one of these stocks got ahead of the other one by a significant margin, the “out-performing” stock usually rolled over and played catch-up (or should we say “catch-down”) with the other one. In other words, the out-performing stock fell by an out-sized amount until it got back in line with the under-performing stock. This took place when CAT got ahead of DE in 2011, 2012 & 2014…and when DE got ahead of CAT in 2015.
However, we do have to admit that the opposite took place in late 2016. Back then, DE got ahead of CAT, but CAT was able to play catch-up with DE by rallying in a significant way through most of 2017. So like it is with any rule on Wall Street, this one is not a perfect one.
That said, the two stocks ALWAYS move back into line with one another eventually. Usually the one that has been out-performing usually rolls over and re-connects with the under-performing stock to the downside. However, sometimes the opposite happens…but either way, the divergence resolves itself before too long. Therefore, instead of just shorting DE…with the expectation of it following CAT lower…investors should consider engaging in a long/short hedge by shorting DE, but also going long CAT. (Those who cannot go short…should consider under-weighting DE vs. CAT at these levels.)
Of course, there is no guarantee that the divergence will begin to resolve itself immediately. However, given what we said yesterday about the broad stock market, we think the odds that it will indeed start to resolve itself soon. As we highlighted yesterday, the S&P is testing both its 200 DMA and its trend-line from 2009. Therefore, once it breaks away from those lines, the broad market should see a significant move. If it rallies, our guess is that CAT will quickly start to catch-up to DE. If S&P “fails” and rolls over, our guess that DE will decline and move back towards CAT.
The recent bounce in the stock market has been nice, but it tells us very little about whether it will continue…or roll over and make new lows. The biggest problem is that the recent rally is nothing more than what we usually see at the beginning of a bear market, so nobody can say that the worst is behind us.….That said, we readily admit that the recent action does NOT mean the stock market will DEFINITELY roll-back over into a important bear market. It’s just that bear markets ALWAYS see the kind of bounce we’ve seen recently…in the MIDDLE of the decline…and long before we reach the final low….and thus investors need to be careful over the coming days and weeks.
In fact, the action we are experiencing right now is almost exactly what we saw in late 2007 and early 2008! Back then, we experienced EXACTLY what we’ve seen over the past few months. After a fabulous bull market…and after a “double-top”…the S&P saw a strong decline of 18.3%. This was followed by a bounce of 12% (a 50% retracement of the sharp decline)…..The problem is that this action was then followed by a severe decline to lower-lows…and a horrible bear market.
This time around, we’ve seen a similar “double-top”…followed by a very similar initial decline (of 19.8% this time)…and then a sharp bounce which also retraced about 50% of its initial decline…just like it did in early 2008. (On top of this, the 4th quarter initial (sharp) decline had two very-short-term bounces of 6%-8% before it bottomed just below bear market territory…which is exactly what we saw back in 2007 as well. How weird is that???)
Oddly enough, the bear market of 2000-2003 got ALSO got off to a very similar start. It’s initial sell-off was 16.8%…followed by a 8.6% bounce (or a 45% retracement of the initial decline)…but then rolled back over into a horrible bear market. (The initial decline only had one bounce back in 2000…instead of two (like it did in 2007 & now), but the moves are still eerily similar.)
Having said all this, we can ALSO sight with examples of times when this kind of action was NOT followed by a bear market…and instead of rolling back over, the stock market was able to bounce-back in a more sustainable fashion…and avoid a bear market.
In 2010, a 16% initial decline was followed by a 10% bounce (50% retracement)…only to fall to a “higher-low”. That “higher-low” was followed by a nice “higher-high”…and the stock market was off to the races. We saw a very similar situation in 2011…when a 19% decline was followed by a 61.8% retracement…then another “higher-low/higher-high sequence” and the market was again off to the races.
What we are trying to say is that the recent bounce…as impressive as it has been…tells us VERY LITTLE about what is going to happen next. IT CAN GO EITHER WAY!!!.….Therefore, we’re going to have to wait to see what happens over the next few weeks to see which way things are going to go this time around.…(We want to reiterate that the next few WEEKS will be key, not just the next few days. The next 1-2% move won’t tell us much…but the next 5%-7% move should.)
We still worry that it will resolve itself the the downside. During the examples we sighted about what took place in 2010 & 2011 (when the markets bounced back), we had an historically accommodative Fed…but now we’re looking at a Fed who will be providing less liquidity to the system than they have in the past. Therefore we think the odds are high that the stock market will roll-back over and move into a bear market this time. (However, we are NOT looking for the kind of “horrible” 50% bear we saw in 2000-2002 and 2007-2009.)……..The good news is that if we’re wrong, we should know within the next few weeks.
We’re getting more evidence today that the housing stocks have become “washed-out”…and that a lot of bad news has already been priced into the group! This does not mean that the group has seen a bottom that will hold for years to come, but it does seem to be telling us that the group has become quite ripe for a “tradable” rally.
Let’s face it, the news on the housing front has been absolutely HORRIBLE over the past 3 weeks. The earnings out of D.R. Horton (DHI)and KB Homes (KBH)were terrible…and this morning’s NAHB Housing Market survey was the biggest one-month decline since 2014 (and took it to its lowest level in more than 2 years)! HOWEVER, the ITB home builders ETF has actually RALLIED slightly trading slightly over the past 3 weeks…and it’s actually FLAT today (despite a 2% decline in the broad stock market)…..Experience tells us that when a group does not decline further after getting more bad news (especially when it has been as bad as it has for the housing stocks in recent weeks), the group has become “washed-out”.
We think this is particularly true for the housing stocks right now. As we mentioned in late October, the ITB had already become EXTREMELY over-sold after its 35% decline over the previous 9 months…based on both its daily AND weekly RSI charts.
Not only has the group become quite oversold, but sentiment on the group has turned decidedly negative over the past few weeks…with several Wall Street firms turning negative over the past three weeks. We’re not sure where these people have been over the last 10 months (while interest rates were rising and the sector was falling 35%), but we turned negative on the group in February…..No, we did not top-tick the housing group, but the ITB has fallen more than 20% since we turned bearish on the homebuilders.
Again, we are NOT saying that the group has bottomed for this cycle. We’re just saying that its oversold and over-hated condition…combined with its pretty good action in the face of VERY negative news over the past few weeks…tells us that the group is very ripe for a “tradable” rally (one that lasts a few weeks, not just a few days). This should be especially true if the broad market can finally bounce in a more sustainable way.
No market moves in a straight line…and we just think that those who want to sell these names will get a better chance to do it at higher prices in the coming weeks. (Also, we would not short the group down here for tickets to The Masters…or anything else!!!!)…..Even in the worst bear market in the housing group in a generation (that bottomed in early 2009) saw SEVEN rallies of more than 10%!!!!! In fact, four of them were between +20% and +55%!!!
There is no question that the fundamental picture stinks for the group…and we’ll get a few more data points on this group over the next two days…so we could/should get some more negative news rather quickly. However (and to repeat), when a group acts positively in the face of a lot of negative news, it’s almost always a sign that the short/intermediate-term picture for the stocks is more positive than most people think!!!!….(As we’ve all heard a zillion times in the past, there is sometimes a big difference between a company/group…and the stocks of those companies/groups.)
We turned negative on the housing stocks back in February…after long-term interest rates broke out to the upside (above it’s key 2.6% resistance level)…which was followed by a very feeble bounce in the ITB home construction ETF compared to the broad market. Don’t get us wrong, we’re not trying to claim that we turned negative right at the January top, but the ITB has fallen more than 20% since we turned bearish on the group (while the S&P is actually up about 1% since then…even after its recent decline).
However, we’re starting to see some indications that the group could/should finally see a meaningful bounce…..Again, it has been a rough year for the group, but until recently, a lot of that of its poor performance was simply on a relative basis (in the spring & summer months). The ITB did not continue to decline in a meaningful way after the February lows, it just began to “drip” lower in a downward sloping trend-channel. However, since the broad market continued to rally, the group’s performance continued to be very poor on a relative basis. (So the group’s performance wasn’t good, but it SEEMED worse than it was due to the continued rally in the broad market.)
More recently, however, as interest rates broke-out above another key resistance level (the 3% level), the housing stocks saw another significant down-draft. Over the past month, the ITB has fallen 17 out of 19 trading days (and one of those two down days saw a rally of only 5 cents!!!). The decline has take it down another 15% (in less than a month)…and it now stands more than 30% below its January highs!
When a stock or an ETF (or even an index) falls 17 out of 19 days, it’s usually reaching a point where the sellers get tired…and the shorts get crowded. (We have to admit, however, the most recent short interest readings on most of the stocks in the ITB are not very high. PHM and TOL were relatively high when the last reading came out two weeks ago, but not at crazy levels…and few of the other names had high short-interest. The readings should all be higher after the further sharp decline in the group, but it’s hard to say that we’ll be the kind of readings that will lead to a massive short-covering rally.)
However, just because the upcoming bounce might not be a massive one…does not mean it won’t be a meaningful one. When you combine this “straight-line” decline over the past 4 weeks…with the oversold condition of the ITB is starting to see in its RSI charts…it leads us to think that the group is getting ready for a bounce….To be more specific on the RSI charts for the ITB…it’s daily (14 day) RSI has fallen to 16 today…and its weekly RSI has fallen to 25.5. This is the most extreme readings on both of these RSI charts since their mid-2011 lows (when they reached 12.3 on the daily chart and 22.8 on the weekly chart). Therefore, their oversold readings are getting quite extreme…and thus the group should be getting ripe for a short-term bounce.
ANOTHER reason why we think the group could bounce right here is because the ITB is testing its 200 week moving average (that week MA, not day MA). That line provided excellent support for the ITB back in 2016…when it bounced off that line on two different occasions.………It might break below this line eventually…especially if interest rates continue to move higher over time. However, we think it will probably see a successful test of this key moving average on its first try.
We’d have more confidence on this call if the short interest was higher…but with the broad market getting somewhat washed-out on a near-term basis (for reasons we mentioned in our “Morning Comment” this morning)…a bounce in the S&P could/should finally give the housing stocks some relief.
(We will get the updated readings on the short-interest for these individual names tonight. With the ITB down more than 9% since the last reading…just two weeks ago…it’s a pretty good bet that the shorts have grown. In fact, we almost waited to see them tonight before we made this call. However, given our belief that the broad market is oversold and due for a pop…we think the housing stocks should bounce as well. So we didn’t want to wait for those numbers. If those short-interest reading do indeed increase by a lot, it should be something that will allow the group to see an even bigger bounce than we’re thinking right now.)
In other words, the whole thing could feed on itself. The broad market could help the housing stocks bounce back…but because they are more oversold than the broad market, the ITB could/should rally in a more meaningful way. If THAT happens, it could actually give the broad market a boost as well…and thus they just might feed on one another.
With mortgages rates rising, we are not calling for the beginning of a major bull market in the housing stocks. We’re just saying that could/should see a sharp bounce over the coming weeks. Either way, we would NOT want to be short the housing stocks right now!!!
Yes, the tech stocks are THE key group in the stock market right now, but the housing stocks could be a very important group to watch over the next couple of weeks as well.
People (including the President) should not be blaming the Federal Reserve for the recent swoon in the U.S. stock market. Yes, higher interest rates are part of the reason for the decline, but so are the rising tensions with China (which the President himself has created). Either way, what the Fed and President are doing NEEDS to be done….even if it has a negative impact on the stock market! Therefore, people need to stop playing the “blame game” and they also need realize that just because certain actions by the Fed or the President cause the stock market to go down, it does not mean they are mistakes!
Who says that the stock market HAS to go up 100% of the time??? Pull-backs and corrections (and even bear markets) are normal AND healthy. Sometimes things are done that cause the markets to correct…but occasionally those things are actually the right things to do!!!
Again, the recent actions by both the Fed and the President have caused the stock market to pull-back. Let’s take the Fed first. Ten years ago, they lowered rates to “abnormally” low levels in order to help asset prices rise. Their (stated) goal was to create a situation where rising asset prices would help keep the financial system from collapsing…..Now that things have stabilized in the U.S., one could argue that they need to raise rates back up to the “normal” level (the “neutral” level). That neutral level is probably higher than the perma-bulls realize. Also, as rates are “normalized”, it will probably have the opposite effect on stocks (at least to some degree) than it did when these rates were pushed to “abnormally” low levels. Again, now that things ave stabilized in the U.S….and the U.S. economy is strong…it can be argued that the Federal Reserve NEEDS to raise interest rates back to the level where they would normally stand given today’s strong level of economic growth. (In other words, normalize them back to the neutral level.)…..This should be done, some would argue, EVEN if it hurts the stock market and/or other asset prices.
Similarly, one could argue that President Trump is doing exactly the right thing with China (in terms of trade). Most everyone on both sides of the political isle agree that China has been cheating for a long time on trade. Therefore, President Trump NEEDS to stay strong in his negotiations…in order to level the playing field with China (at least some-what). Again, some would argue that this should be done EVEN if it hurts the stock market.
Ok, we’ve used the terms, “it can be argued” and “one could argue” several times. We’d just like to say that we agree with these arguments. The stock market has rallied more than 330% since the crisis and 40% since Election Day 2016…and the U.S. economy is strong. Therefore, this is the right time to implement these tough decisions. Just because these moves might cause the stock market to go down 10%, 15% or (God forbid) 20% over the next year or so…DOES NOT mean they are a “mistake”!!!!!! Sometimes actions need to be taken that will cause some pain over the short-term…so that the situation will be better over the longer-term. Doing these things when the economy and markets are strong is the best time to do them!
In our opinion, the economy would have rolled over in a major way in the first five or six years after the credit crisis of 2008. In other words, the stock market moved away from being a leading indicator for the economy when the Fed and other global central banks began influencing the markets via QE. (It became a tool to help the economy…instead of an indicator for the economy.)
Now that the system has stabilized (at least in the U.S.) the steroids can be removed. This, in turn, will cause the stock market to decline (at least some-what). That’s okay…because once the stock market reaches a “neutral” level vs. the underlying earnings/growth, just like the U.S. economy has in recent years.
It comes down to a simple question. Why don’t people realize that if the Fed is going to “normalize” interest rates back to their “neutral” level, it will force the stock market to “normalize” back to its own “neutral” level as well! (Stocks have been trading at a higher-than-neutral level for years…just like interest rates have been trading below neutral for years. If one is going to revert back to its historic norms, so is the other one.)
We HAVE to go back to a situation where the stock market is a reflection of what is going on in the economy…instead of one where the economy is a reflection of what is going on in the stock market (which has been the case for almost a decade)……..This is what Fed Chairman Powell is trying to accomplish in our opinion. It’s NOT a mistake. Just because it could/should cause some pain over the near-term does not make it a mistake…especially since it will help things over the longer-term.
“Calendar issues” are frequently sighted when pundits are talking about the stock market. “Sell in May & go away” and the “January effect” are ones that are well known on Wall Street and beyond. We also hear about individual months being the best and/or worst months of the year for the stock market…and we even somethings hear about how the Friday’s before long weekends tend to be bullish days for the makret.
The problem is that although many of these old sayings can frequently be accurate, there are plenty of times when they break-down. For instance, those who “sold in May” the past two years have been very disappointed…as the S&P 500 Index rallied 8% from May to November last year…and it has rallied over 10% since May 1st this year!
We’d like to focus on two other “calendar proclivities”. First is the fact that the 4th quarter of the year tends to be a bullish one for the stock market and the second one is the well known “Presidential Election Cycle”. The first one is quite bullish, but we do not believe the second one is as bullish as many pundits are trying to portray right now.
On the first issue, and as the chart below shows, we have seen a gain in the stock market in eight of the last nine years in Q4…with only 2012 giving us a very slight decline of just 1%. (The market did see a 7% decline mid-quarter that year, but it finished with only a mild decline.) The average return in the 4th quarter has been 6.2% over those nine years (and +7.1% if you include only the years that had gains). We’d also note that in the five years leading up to the 2007 top, the market rallied every single year in the 4th quarter (with an average gain of +7.1%). So no matter how you slice it, the 4th quarter is usually a very good one for the stock market.
The only consolation for the bears is that the S&P declined 3.82% in the 4th quarter of 2007…which was the start of a brutal 56% bear market into the 2009 lows. (Another similarity is that the top in late 2007 was a “double top”…and that’s what we’d see today if the stock market was to begin to roll-over in an important way over the next few weeks.)…..However, unless the market is at the cusp of a bear market, history tells us that the 4th quarter this year tends to be a good one.
We’ve all heard a lot of people try to catch a falling knife by calling a low in gold in recent weeks/months….and they’ve all been cut-up pretty good in their attempts. We have not attempted to do that…as our work has not pointed to a compelling low for the yellow metal.
HOWEVER, we ARE seeing some indications that SILVER could be close to an important bottom. First of all, Relative Strength Index (RSI) for silver’s weekly chart reached its most oversold level since 2013 (just before it began a 37% rally). Second, bullishness for futures traders in the Daily Sentiment Index fell to just 8% earlier this week. (We’ve seen bullishness drop a bit lower than that over the years, but whenever it gets into the single digits it usually says that at least a short-term bounce is imminent.)
Finally, the Commitment of Traders data (COT) shows that the “positioning” in silver is back down to the record net short positions we saw for the dumb money speculators (the “specs”) back in early April…so a lot of people are on one side (the short side) of the boat on silver. (We’d also note that the smart money…the “commercials”…now have record net long positions!!!).
Of course, none of this guarantees that silver will see a significant long-term (or even intermediate-term) bottom. (Let’s face it, the last time silver got this oversold back in April, it was only followed by a 6% bounce…and then the commodity rolled back over and made new lows.)
However, silver is also close to testing a VERY important support level (its lows from late 2015 and early 2016). Therefore, with so many people on one side of the boat in silver, if (repeat, IF) it can bounce significantly off those 2016/16 lows, it could finally see a rally that lasts for several months (if not longer).