Friday, April 25, 2014

Weekly Market Summary

Most weeks have ended with a clear set up for the week ahead. That wasn't the case last week. In the event, SPY, NDX and DJIA ended only slightly lower, while RUT lost more than 1%.

Our main conclusion from last week was that risk/reward in the US indices is skewed to the downside in the months ahead until the market experiences a washout. Nothing transpired this week to change that perspective. Read the full post here.

Our main short-term tells for the indices played out to the downside this week. For SPY, the key was to hold the 187 level. It failed and is now back in a well travelled zone where it has not had a meaningful reversal until price has reached 184.5 or lower. Note the very minor positive divergence in RSI.

For both RUT and NDX, the key this week was to form a higher high above the April 9-10 inflection point. Both failed to do so. Both have potential head & shoulder patterns forming (yellow). RUT also backtested and failed at its broken 1-year trend line.

NDX's failure to form a higher high was particularly stunning, with AAPL, its largest component (12% weighting), rising 8%. A full write up on the impact of AAPL's corporate finance plans can be found here.

The problem with a pattern of lower highs is that trapped longs become increasing anxious to sell into subsequent rallies; and the problem with lower lows is that buyers are less eager to step in, waiting instead for better prices lower down. This is the situation facing both RUT and NDX.

RUT and NDX are now negative for the year. Equities have been struggling under growth that is positive but tepid and below expectations. These higher expectations are misplaced.

Sales growth in the 2000's bull market (about 6% per annum) was more that twice the pace experienced over the past three years (about 2.5%).  Slower growth is not a recent phenomenon; it's been a feature of the corporate and economic backdrop for the past several years.

We have been highlighting macro data that supports this outlook every week in this summary. This week, core durable goods new orders showed an annual growth rate of 2.5%. In comparison, it was nearer 5-10% during the prior bull market.

That bull market was also driven by wealth created in real estate. Data this week on new house sales showed sales declined by 3% from 1Q last year.

Mortgage originations at the major banks are in decline. If there is a turnaround in new house sales ahead, it should become visible in this data. So far, not yet.

The rate of slow growth has been recognized by the bond market. 30 year yields this week fell to their lowest since June 2013. There is some technical support here (dashed line) but the declining 50-dma (arrows) depicts the major trend.

Similarly, the yield curves continue to flatten as growth and inflation expectations decline. This has been the clear trend so far in 2014.

What is stunning is not just that continued slow growth has taken many by surprise but how bearish the consensus remain on treasuries in spite of their strength.

Every one of 67 economists expects 10-year yields to rise in the next 6-months. The last time sentiment was this lopsided was in May 2012: yields fell 50bp in the next 3-months. Moreover, the percentage of fund managers underweight treasuries is the highest in seven years (from the WSJ).

Moreover, yields have a seasonal tendency to weaken over the next several months.  According to the Stock Almanac, this has been the case 70% of the time in the past 36 years; 2013 was notoriously not one of them (post).

The pattern of low growth and falling yields is fully reflected in the equity market. SPX is dead flat since early March; during this time, cyclicals have been crushed. The index has been carried by outperformance in utilities, energy and staples. Treasuries have outperformed SPX by over 500bp.

1Q14 earnings reports support the slow growth outlook. With half the SPX having now reported, sales growth is tracking 2.4%; earnings are tracking just 0.2% growth. If this is the final EPS growth rate for the quarter, it will mark the slowest growth since 3Q12.

May starts this week. Equities tend to be flat in May and negative in June. This is particularly true in mid-term election years.

The week ahead
Bear in mind that that the main trend in equities is lower until the market experiences a washout. The last four mid-term cycle lows occurred in July 2010, July 2006, October 2002 and October 1998. In each case they created the low price for the year.

However, if there is an opportunity for strength in the weeks ahead, it will be this coming week. The end of April and the beginning of May tend to show the most strength (chart from SentimenTrader).

What we will be looking for:
  • The ideal set up would be weakness on Monday that brings SPY down to the 184.5 area (see chart at the top): again, the major inflections have so far not taken place between 184.5 and 187. The 60' RSI is already oversold. 
  • CPC closed Friday 1.14; a close above 1.2 would be the highest since October. 
  • Trin closed at 1.5 on Friday; a close above 2, while not extreme, would be sufficient for a bounce. 
  • Treasuries also have a tendency to reverse, short term, when they hit their Bollinger; and TYX is near its June/July pivot. 
  • Finally, strength on Tuesdays is renowned, to the point where traders may anticipate it on early Monday weakness.
The economic calendar this week is full: GDP and an FOMC are on Wednesday and NFP is on Friday. NFP days have been up 15 of the last 17 months.

Our weekly summary table follows: