Inflation and Money
One consistent theme that is being seen in every report I read, other than what the OECD data shows, is that prices are rising across industries on almost all raw materials. I know for me it is very true in my personal life. For example, my home insurance renewal invoice arrived this month. The annual premium was 16.4% higher than last year. I did not change the policy or file any claims, it was simply a pure price increase. In other areas of my home life, I see property taxes, broadband services, varied subscription based services, and food all rising more than 5% year-over-year. Inflation is alive and well. A single slice of pizza cost me $3.50 last week. New home prices are now greater than they were in 2007. With rising prices evident and more anticipated, I must ask, where is the income growth to meet the rising expense growth? From my vantage point, U.S. household incomes have just recovered to the level that existed in the year 2000. Leverage and Central Bank Quantitative easing have fueled price increases, but the flow-through to incomes is generally lagging, and with the CBs reducing their monetary accommodation, a large and unknown outcome exists, which is what happens when the historic monetary stimulus is no longer there as a support after trillions of dollars have been pumped into the world economies. Present expectations for the Federal Reserve tightening are focusing on a reduction of reinvestment in debt assets over the next twelve months to the tune of $300 billion; split $180 billion in treasury securities and $120 billion in Mortgage Backed Securities.
Continuing with the comments on the Fed, a look at the money supply growth and the velocity of money show tightening that the market has ignored. Consider the downward trajectory of M2 money supply growth over time and the recent inability to break above 2% growth for the past 52 weeks as measured in quarterly change:
The chart above is a weekly snapshot going back to before the 2008 financial crisis. The green line is the upper band of the DJIA measured over a 16 week period. The red line is the lower band. The yellow line is the weekly close of the DJIA.
Looking at the green line during the collapse of the equity markets in 2008/09, the market moved significantly below the upper band in a manner that was unique. When the market hit bottom and started to reverse to the upside, it proved its bottoming was complete when the upper band was forced to move dramatically lower to meet the weekly closing index. That was an incredibly important buy signal.
Since then, the upper band has tracked closely to the DJIA weekly closes.
Since 2009, the lower band has at times shown gaps away from the Index, gaps that were ultimately closed by downward corrections in the index (see the red line gaps from the Index and the trigger points that caused the lower band to move up to meet the weekly close). Now focus on the most recent data. Starting 40 weeks ago the lower band and the index began to separate once again. This time the separation spread continued to widen beyond what historically would indicate a small correction was due. If you look at the most current point, the spread is roughy equivalent to the spread that existed in 2009 when the market finally reversed to the upside (4,000 vs 4,500 point spreads). Additonally, the magnitude of the spread for both periods are outliers, and in 2008/09 it preceded the bottom. This inidcator tells me we are close to a top and a sustained move lower, a move that will not be a typical correction in size, but will reflect a bear market.
Equity prices have led economics and it is catch-up time, but what if the economy does not show up? Have the volume of shares bought in rising stocks proven to be the right backdrop for continued confidence in more equity gains? What risk premiums would you attach to this market? Cash, Gold and Crypto-Currencies have been winners this summer, but will that continue? Is it time to batten down the hatches as the horizon shows greater instability with each passing day?
The year 2017 has seen the DJIA rise by 2,200 points through August 31, 2017. An impressive positive performance. With this magnitude of a gain, over 11%, would you expect the volume of activity in 2017 to confirm the gain by also showing higher volumes and much greater positive volumes, indicating broad participation and engagement in the market? I would want to see that. If we look at the same period in 2016, the DJIA index rose by 1,067 points, roughly half of what we have gained in the YTD 2017 period. Now I really expect the 2017 data to be much better than 2016, given the greater Index gains.
What does the activity on the NYSE reveal?
Shares traded by month on the NYSE for 2016 and 2017 (in billions of shares):
It is surprising that in every month the volume of shares traded during 2017 are below the monthly shares traded in 2016.
What about the composition of the shares traded? I would expect that the net volume in stocks that advanced in price for 2017 would be much higher than the net volume in 2016. If this is the case it would make me less concerned about the overall volume decline that we see above. So what happened? In the YTD period through August 2017, advancing volume exceeded declining volume by 2.15 trillion shares. In the YTD period through August 2016, advancing volume exceeded declining volume by 7.5 trillion shares. WOW! There is a disconnect here that is astounding to me.
What happens if we move away from stub periods that are less than 12 months in length, and look at the comparisons between years using the fiscal years September through October, from 2011/12 through where we are in 2017, with one month left to go in the fiscal year. Will that help alleviate the concern that the one-off comparison above revealed? Let’s see.
It is clear from the above that the current activity in 2016/17 is an anomaly. The volume of net advancing shares per point change in the DJIA Index is significantly below the historic average, and indicates the weakness of money flows into advancing stocks overall during the current period. This is of great concern to me and casts significant doubt as to the equity market’s support for current prices.
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This is an annual view of the market internals. It is a fiscal year chart running from Oct 1 through Sept 30. It measures the change per day of the 24 day moving average in Issues and Volume on the NYSE. Because of the excel set-up it presents itself in a backward fashion, with the most current point on the left side of the chart. Each Oct 1 the chart resets to zero so you get a discreeet annual look at what is going on and the ability to compare years. The downturn that is starting to show now should not be ignored.
There are times when there is a tale of two markets. Now may be one of those times. If we look at the past ten days of stock trading on the NYSE versus the point change in the DJIA for this period, we see an outlier event. Breaking the ten days into two groups of five days, the first being the back-end five days and the other being the front-end five days, we see a complete disconnect of internal stories between the periods. For the back-end five days, the DJIA rose 263 points with 153 net advancing stocks on net advancing volume of 51 billion shares. Sounds impressive until you compare it to the front-end five days. For the most recent five days, the DJIA declined 247 points, roughly offestting the back-end point gain. This is where the stories now diverge in a meaningful way. The number of net declining stocks for the front-end period was 4,084 companies on net declining volume of 1.2 trillion shares. Compare those internal statistics for a moment. It does seem the internal voting machine is heavily pointing toward the exits, even if the Index point change is lagging behind. Invest wisely……..
Every month I document a list of the top 25 equities that my financial models indicate are the most attractive among a portfolio of 187 companies. The June list reflects 17 equities with price gains and 8 with price declines for the period June 30, 2017 through August 7, 2017. The top double digit gainers are Diamond Offshore +12.7%, Orbotech Ltd +11.0%, Lam Research +10.2%, Apple +10.1%, and Netgear +10.0%. The largest double digit decliners are Viacom Class B shares at a minus 20.4%, Mylan -17.6%, and Southwest Airlines -10.9%.
As of this past week, two of the June Top 25 selections have come off the list and have been replaced by two new addtions. Of the remaining 23 companies, 14 companies have moved up or down on the list’s rankings. Lam Research is now number one, displacing Diamond Offshore which fell out of the top 25 after its recent increase in price.
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|Fundamentally, the equity market remains at a level that is historically over-valued. In each prior monthly newsletter, I have written at length about the extended levels of the key fundamental metrics which cause me to believe that we are at a high-risk level for a market correction. In this month’s newsletter, I will focus entirely on the technical measures of the equity market to help assess where we may be in terms of the timing of a stock market correction.
The summary view is that there are two dominant themes evident from the technical data:
1. Many technical indicators are at peak levels that have historically preceded a stock market downturn, and
2. Other indicators have already made the turn lower, indicating a near-term decline has a greater probability than has been the case in a very long time.
After you read and digest this newsletter, please feel free to email me with any questions you may have. The array of technical information may be a bit “wonky” and challenging to understand, so I have included charts to help sort through the numbers that are contained in the paragraphs.
My overall view is that equities are priced at levels that are not supported by the fundamentals. This valuation disconnect has not mattered during the past eighteen months, and the technical side has supported the rise in the equity indexes. Absent signs of fatigue in the technical indicators, or signs of actual underlying weakness within the many key technical variables, the market risk of a decline has been muted. That fact is changing, and the array of information set out below should be clear in providing the signs that the tide is turning and that the recent alignment of market fundamentals and market technical indicators are exposing a great level of risk that a material decline in market prices is not far off.
With this preamble, I wish you all well and prescribe a heavy dose of coffee.
This month we cover a number of topics in our 15 pages of economic and market analysis. The picture of our economy and the market is painted as if it were a Thunder Storm. Being prepared is the key, while also investing for the future. The potential of Crypto-currencies is a meaningful part of the investing discussion, and should not be missed.
The topics covered in this month’s newsletter include:
- Developed economies across the globe are navigating an emerging world of less liquidity, and while economic growth is present, is it accelerating?
- What are fiscal budgets indicating?
- What happened to capital investment?
- Do current stock market valuations make sense?
- Should we be anticipating a continued increase in equity prices?
- Where in this market am I allocating my capital?
- Which equities am I tracking for buying and selling purposes?
- The Imagining the Future section focuses on the world of Digital currencies and attempts to answer the question “Are we interpreting this phenomenon correctly?”
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