Archives for November 2017

New Highs Abound But a Few Cracks Developing

Suffice to say that the bulls have basically stampeded any and all attempts to take stocks lower since mid-August. However, for most of that period, the market’s foundation was rock solid and bears were just fighting against strong momentum. Recently, that has changed. Because I have been traveling since late last week and a bit on the sick side, I haven’t spent the time to create the charts to support my point. The Dow, S&P 500, S&P 400 and NASDAQ 100 are all at new highs. Yet with the succession of new highs last week, the number of stocks advancing versus declining on a number of days was actually negative. That means each of those highs was made with less participation, not exactly what you normally see in a healthy uptrend. However, keep in the mind that this behavior can and has continued for days, weeks, months and quarters before the market lost steam.

Turning to high yield bonds, we can see that they are not confirming recent new highs and have actually experienced a little pullback. It’s nothing big or significant yet, but it’s worth noting.

The NYSE A/D Line tells a similar story and looks a lot like JNK above. While the level of participation is diverging from the new highs in the indices, it is certainly not at an alarming level. Additionally, as with junk bonds, we have seen and can see this kind of behavior to last as long as 20 months before it matters to the market.

The bottom line remains the same. While there are a few cracks in the pavement with stocks very extended, momentum has been historic and difficult for the bears to easily end.

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The Next Fed Chairman & Post Fed Market Decline

Trump to Announce Fed Choice This Afternoon

Love him or hate him, Donald Trump certainly is not behaving like his predecessors when it comes to most things, but definitely not the selection of the most powerful banker on earth. During the campaign, Trump harshly and unfairly criticized Janet Yellen for keeping interest rates too low and creating a “fake stock market”. That was until he became president and miraculously embraced low rates and the surging stock market as a referendum and report card on his presidency.
Right after the inauguration, I published a fairly outside the box list of my Top 8 Shocking Surprises Under Donald Trump plus two bonus surprises.
Yellen Earned a Second Term
Bonus #2 had Trump reappointing Janet Yellen as Fed chair for a second four-year term. When Ben Bernanke, one of my all-time favorites, was not reappointed for a third term by Barack Obama, my choice was the underdog, Janet Yellen. Four years later, I believe she absolutely earned a second term. So I am sticking with her as my choice again although the odds are definitely against her in a huge way.
A Very Public List of Finalists
I don’t ever recall such a public list of potential chairs with so many comments. Former Goldman Sachs president and current cabinet member, Gary Cohn, was a shoo-in until his critical comments of President Trump following Charlottesville. Then former Bernanke right hand man, Kevin Warsh, was all the rage until his hawkish (favoring higher rates and less accommodation) stance became too unpopular. Now, current Fed Governor Jerome Powell is the heavy odds on favorite to be appointed by Trump this afternoon with Stanford professor John Taylor and rules based system for choosing interest rates picking up the rear.
Jerome (Jay) Powell is Heavy Favorite
Powell is the choice the markets are expecting. And I guess that if Yellen loses, I am more okay with Powell than anyone else. Taylor or Warsh would cause the most short-term upheaval, but even then, I don’t think we would see anything significant. Powell is the most similar of the finalists to Yellen although definitely not as dovish (favoring low rates and accommodation). Some have argued that a Powell/Taylor duo would be very strong. I am not convinced although with Powell in the chair role, Taylor’s rules based system would have little chance of implementation.
Don’t get me wrong. I am not against rules based systems, especially since we run our 12 investment models that way. I very much support and endorse, non-emotional, well researched, systematic strategies. However, I believe there needs to be more research and stress testing of a system Professor Taylor backs.
The markets like Janet Yellen. She is the known quantity and has done a good job in my opinion. Let’s not fix a problem that doesn’t exist. It’s not like GDP is growing by 5% and Yellen is loathe to cool it down by raising rates. And she is certainly nowhere near the disasters that Alan Greenspan or Arthur Burns were. Now those two men should headline the Fed’s Hall of Shame as among the worst chairs in history.
I am sticking with Yellen as my choice although Powell is the one that almost everyone expects to succeed Yellen in February. As always, nothing Trump does or says is perfectly as expected. We’ll see in a few hours.
Post-Fed Trend
In yesterday’s update, I discussed the various models and trends from Fed day.
As we saw at the previous meeting and this one, the most powerful trends were muted because of the strong rally into the Fed meeting. Today, we have a rare trend which calls for stocks to trade lower after the Fed meeting. While it’s still only a short-term trade, it does bare watching, especially to see which sectors lead and lag on the downside to properly position for the next leg higher into year-end.
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***Special Fed Day Alert. No Rate Hike. No Surprises***

Behavior Models for the Day

As with every Federal Open Market Committee (FOMC) statement day, there is a model for the stock market to follow pre and post announcement. Certain environments have very strong tendencies while others do not. Eight meetings ago was one of the rare times where the models strongly called for a rally on statement day which was correct as well as a decline a few days later which was also correct.

Today, as with most statement days, the first model calls for stocks to return plus or minus 0.50% until 2:00 PM. There is a 90% chance that occurs. If the stock market opens outside of that range, there is a strong trend to see stocks move in the opposite direction until 2:00 PM. For example, if the Dow opens down 1%, the model says to buy at the open and hold until at least 2:00 PM.
The next model calls for stocks to close higher today and rally after 2:00 PM. That is usually a very strong trend, 80%+, however with the Dow sitting at all-time highs with barely a hiccup in two months, the bulls exhausted a lot of energy, similar to what we saw at the last Fed meeting 6 weeks ago. That trend’s power has been muted significantly to less than 50%. That’s not exactly the kind of trend worth trading.
Finally, there may be a trend setting up for a post statement day decline, but there are a number of rally factors that still need to line up.

No Rate Hike & No Balance Sheet Taper Update

The good news is that short-term interest rates will not be moving higher at 2:00 PM. That will likely happen at the December meeting as the economic evidence certainly supports another 1/4% hike with GDP at 3%, unemployment at new lows and consumer confidence at new highs. I also don’t expect any news on the Fed’s plan to taper the size of its balance sheet.
Six weeks ago, I offered that the Fed would announce the cessation of reinvestment of certain instruments, if not all, to the tune of $300 to $500 billion a year. It turned out that my forecast was too aggressive as Yellen’s plan began last month with a paltry $4 billion in runoff and scales up to only $20 billion per month later in 2018.
Velocity of Money Still Collapsing

Below is a chart I have shown at least quarterly since 2008. With the exception of a brief period from mid 2009 to mid 2010, the velocity of money was, is and will continue collapsing. In the easiest terms, M2V measures how many times one unit of currency is turned over a period of time in the economy. As you can see, it’s been in a disastrous bear market since 1998 which just so happens to be the year where the Internet starting becoming a real force in the economy. Although it did uptick during the housing boom as rates went up, it turned out to be just a bounce before the collapse continued right to the present.

This single chart definitely speaks to some structural problems in the financial system. Money is not getting turned over and desperately needs to. The economy has been suffering for many years and will  not fully recover and function normally until money velocity rallies.

It would be interesting to see the impact if the Fed stopped paying banks for keeping reserves with the Fed. That could presumably force money out from the Fed and into loans or other performing assets. It continues to boggle my mind why no one calls the Fed out on this and certainly not Yellen at her quarterly press conference.

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