The SPHB:SPLV ratio chart is showing a compelling setup for small cap stocks. The SPHB:SPLV ratio chart tracks high volatility (high beta with tendency to be small cap) stocks to low volatility (tendency to be large cap) stocks. This ratio chart is another barometer for the risk on versus risk off trade.
In a risk on market, higher growth and higher beta stocks are the name of the game. Investors go on the offense for maximum profits and their less concerned about the economy and a recession. In a risk off market, investors go on defense and move into safer and more stable (low volatility) large cap stocks.
SPHB:SPLV Ratio Chart
The market has consolidated a little over the last week and that was the swing long signal we were waiting for. Notice that SPHB:SPLV has broken through resistance at 0.8050 and now is pulling back to retest that level. This is a classic set up we can trade. If the 0.8050 level holds, it means previous resistance has become support and we can take a beautiful entry off that level (green arrow). Make sure to review this lesson on trading for beginners so that you know which stocks to screen for to take advantage of a turn in the SPHB:SPLV chart.
Following high yield debt is an excellent way to time market swings. A high yield bond (non-investment-grade bond, speculative-grade bond, or junk bond) is a bond that is rated below investment grade. These bonds have a higher risk of default and so they pay a higher yield than better quality bonds. Bonds rated below BBB− are called speculative grade bonds, or “junk” bonds, and fall into the category of high yield debt.
Recessions increase the possibility of default in speculative-grade bonds.
The number of companies issuing high yield debt is abnormally high for August. What is happening is that investors are anticipating higher rates from the Federal Reserve and so the higher yields of safer investment grade bonds start to come into greater competition with junk bonds. It's the crowding out effect.
Tesla and other debt heavy corporations are front-running the crowding out effect by issuing as much junk bonds as they can before more interest rate hikes occur. You can read about rising junk bond issuance here.
You have to be careful not to equate junk bonds in foreign countries with those issued in the US. In emerging markets like China and Vietnam, bonds have become increasingly important as financing options because access to traditional bank credits is limited, especially if borrowers are non-state corporations.
High Yield Debt Chart
Junk bonds act as a barometer for risk on versus risk off. In a risk on environment, investors chase after maximum yield and so they buy high yield debt. Junk bond investors are not too worried about a recession or default on their junk bonds. In a risk off environment, investors sell out of high yield debt and move to safer, lower yielding assets.
When non-investment-grade bonds spike up or down, the S&P 500 has a tendency to follow within 3 to 5 days.
Last week the high yield debt chart (HYG) spiked higher which is a bullish signal for the S&P 500 over the next 3 to 5 day period.
The US economy is healthy enough to absorb gradual rate increases and the reduction of the Federal Reserve's balance sheet, Fed Chair Janet Yellen testimony before Congress on July 12, 2017.
Federal Reserve Chair Janet Yellen told Congress on Wednesday that the bank hopes to keep raising a key interest rate and also intends to begin this year, the reduction of its bond holdings.
Yellen took note of several factors, such as household wealth and job gains that she said should fuel growth.
In what could be one of her last appearances on Capitol Hill, Yellen portrayed a market that, while growing gradually, continued to add jobs, gained from continuous household consumption and a recent leap in business investment, and was currently being supported too by stronger economic conditions overseas.
She blamed the economic slowdown in the first half of 2017 on inflation. She said Fed officials are watching developments closely to be certain price gains go back toward the 2 percent inflation target of the Fed.
Janet Yellen Testimony Freak Out Over Inflation
Janet Yellen seemed a little freaked out over the big drop in inflation over the last few months.
I take Yellen's comments on inflation to mean that the economy should not have the CPI plunging in this part of the economic cycle. In fact, just the opposite should be occurring. But she added that it was considered by officials as an anomaly; inflation is predicted by the Fed next year.
Many economists believe the Fed, which has raised rates three times, will increase rates yet another time this year.
The Fed continues to anticipate that the development of the market economy will justify gradual increases in the federal funds rate over time while reductions in the Fed's holdings of more than $4 trillion in securities will probably start “this year”.
In her prepared testimony before the House Financial Services Committee, Janet Yellen testimony repeated the message she's been sending: the market has improved enough that it no longer requires the support the central bank began providing in 2008 in the aftermath of a serious financial crisis and the deepest recession since the 1930s.
In light of the continuing expansion, the Fed plans to keep raising its benchmark rate of interest and to lower its investment holdings, Ms. Yellen said in prepared testimony. She did not offer details concerning the time of the next actions of the Fed. Analysts expect the Fed to begin shaving its bond portfolio before the end of 2017.
The economy began the year with a slow growth rate of just 1.4 percent, it has regained momentum in recent months, aided by strong job gains, a revival of business investment and a strengthening of international markets.
Bottom line: the market is at full employment and the Fed is moving rates. As the Fed reinvests some of the bond holdings which mature monthly, they will decrease that reinvestment to reduce their balance sheet which will mark the beginning of QT (quantitative tightening). Many believe that QT began this year when the Fed did a series of rate hikes.
The Fed needs to keep policy accommodative to keep on supporting the recovery, but may hit a “neutral” rate quicker than anticipated. Estimates are that inflation has been dropping so fast that we could be near zero right now. Yellen has said the Fed expects estimates of the inflation rate to grow over time.
Yellen said in her testimony that as it stands rates “might not need to rise all that much farther” to reach neutral.
Yellen said growth remains moderate with business investment and consumer spending picking up, and the US economy is benefiting from growth in other countries too.
A strengthening in economic development abroad has provided significant support for U.S. manufacturing production and exports, Yellen said.
The Fed slashed its key policy rate to near zero to fight the worst economic recession since the 1930s, and kept it there for seven years before nudging it higher in December 2015. It left the rate unchanged before increasing it again in December 2016, March 2017, and June 2017 of this year.
At its June meeting, the Fed indicated that it expected to start decreasing its $4.5 trillion balance sheet after this year, a measure that could put slow upward pressure on longer-term prices for such things as home mortgages.
Yellen said, the market seemed to be in a virtuous loop of hiring, investment and spending which should increase resource usage somewhat further, thereby fostering a quicker rate of wage growth and price increases.
The Janet Yellen testimony was fairly uneventful except for her comments on falling inflation which seemed to baffle the Fed as to why this was happening at this point during the economic cycle.
If the economy is booming tax revenues rise as companies generate greater revenue, resulting in them paying more in taxes. If the market is rolling over, the effectiveness of corporate taxation drops as companies close up shop and stop paying taxes.
Corporate Tax Revenue By Year Shows Economy is Rolling Over
In 2014 tax revenues were about $55 billion. In 2015 tax revenues were about $57 billion. In 2016 tax revenues were about $60 billion. In 2017, tax revenues have plunged to about $50 billion.
The last time we saw local and state tax revenues roll over like this was in late 2007 and early 2008.
Corporate tax revenue by year has turned down prior to every post-WWII recession. It suggests that America's corporations are experiencing a deterioration in earnings.
With financial indicators flashing warnings signs, it seems like the US market is heading toward big trouble rather than revival.
Corporate tax revenues by year are difficult to fake. The money either came in the door, or it didn't.
Despite a surge in optimism after the election of President Trump, nominal GDP growth in 2016 was just 2.95% making it the second-worst year on record since 1959.
Each time corporate tax revenue by year declines, the stock market sells off.
In its latest report, the Congressional Budget Office said the tax income of the government is currently currently running -3% below projections within the previous eight months, which works out to a shortfall of as much as $70 billion.
Low gas prices are not good for consumers or the US economy. Remember back in late 2015 and early 2016 when oil prices fell which pushed down the price of gas?
We had headlines in the MSM that lower oil prices were a big boost to consumers and so consumer spending was going to rise. It didn't happen that way.
Gas Prices and Jobs
Lower gas prices mean lower profits for the energy sector which provides good paying jobs for millions of Americans. It's not just direct energy sector companies either. Real-estate in and around major oil fields saw a crushing drop and mortgage default rates surged when oil drilling rigs went idol back in 2015 and 2016.
Lower gas prices are a net loss for the US economy because of the loss of jobs that accompanies the price drop. While we fell for the MSM headlines back in 2015 and 2016, let's not fall for it again. Lower prices at the pump do not result in a meaningful increase in consumer spending.
Gas Prices Pull Down The Stock Market
Lower fuel costs pull down the stock market and not just in the US either but around the world. If oil prices were to average $40 a barrel this year, oil-exporting countries would have to sell upwards of $100 billion in various investments to cover their balance of payments deficits. We know this because it's exactly what happened in late 2015 and early 2016 when oil fell.
It's not just oil-exporting countries that would be selling. Oil is the primary holding of the world's largest sovereign wealth funds. Those oil positions extend margin credit to fund managers who use that margin to buy appreciating assets around the world. When oil goes down, it's like a giant global margin call that goes out and forces fund managers to reduce positions or infuse new money into the fund to meet the margin call.
According to JPMorgan’s estimates, a $40 average Brent price this year would result in the sale of $67 billion in government bonds, $24 billion in equities and another $19 billion in corporate bonds, hedge funds and cash over the course of the year.
Charting margin debt (red line), West Texas Intermediate (brown line), and the S&P 500 (blue line), you can see the effect that oil prices have.
Notice how oil leads both margin debt and by extension the S&P 500.
Not only does the black gold pull down the stock market via the reduction of margin debt, it also results in lower earnings and hence the earnings recession we experienced in 2015. You can see this relationship by charting S&P 500 earnings (green line) over the price of oil and margin debt.
Oil began plunging in 2014 and that drop showed up in earnings about 6 months later. Notice that when oil turned up in February of 2016, earnings again turned up about 6 months later.
Low gas prices are not good for consumers or the US economy. Traders need to watch the price of oil. It's all about the oil. So goes oil, so goes the US economy.
The housing market is in a bubble. I have been saying that for about a year now. The average selling price of a house is around $377K. Right before the housing collapse in 2007, the average selling price was around $330K. New signs are emerging that the housing bubble is dangerously close to popping.
House prices in Manhattan and Brooklyn have risen so fast that they have forced renters to devote a greater share of their income to housing. Today, more than 30% of Americans pay half their income in rent.
As Bloomberg reports here, a luxury condo at Manhattan’s One57 is scheduled for a foreclosure auction, the second foreclosure in a month that a property seizure is being sought at the Billionaires’ Row tower following a mortgage default.
Some ultra-luxury buildings in Manhattan like One57 are struggling with unsustainable vacancy rates of nearly 40%.
We saw foreclosures go up in 2006 right before the collapse of the housing market. The reason is that before a recession, its often better to just walk away from a property that you can't afford the mortgage payment on and let the bank foreclose on it so that then they have to deal with finding a buyer for the depreciating asset.
Two foreclosures in the same building does not make a trend yet but keep your eyes open for more foreclosures in markets where property prices have risen way beyond the wages of the people who live there, which is practically everywhere.
The United States economy is teetering, despite what the stock and job markets are saying. The US economy is consumption-centric. Growth in the current recovery has focused on three sectors that have fed through to consumption in its various forms: autos, energy, and financial services.
The scariest set of financial indicators to emerge in decades reveals what is crushing the dreams of record numbers of young, middle-class and older Americans.
While nationwide unemployment is down to 4.3 percent, policy experts and economists are warning of disturbing signals in the economy.
As any industry veteran can tell you, those on the sell-side are the second-to-last to surrender to a downturn in economic activity. A 401K Advisor or money manager will not produce negative forecasts when their most important objective is keeping its customers completely invested in risky assets.
United States Economy
The Citi Surprise Index shows a big disconnect between the economy and Wall Street.
The disconnect will not last for long as the chart above shows. Either the economy improves a lot over a short period of time, else the stock market comes plunging down to earth. It's easier for the stock market to come down than it is for the Federal Reserve and republicans to somehow get this economy going, a feat that has remained elusive for the last 8 years.
Debt is what has kept the United States economy going for the last 8 years. Debt placed a floor under and then helped commercial property reach for the skies. Debt kept dying retailers alive. Debt also caused back-to-back years of record car sales.
Salaries for the typical American worker have hardly grown for decades, well-paid middle-class jobs are disappearing, and lots of the new jobs are from the low-wage service sector.
Consumers are being crushed by high healthcare costs and it partially explains why the American population grew at a small 0.7 percent this past year, the lowest rise since the Great Depression. As Russ Zalatimo of HudsonPoint Capital said, the tendency around recessionary times is that the birth date really drops like we are now seeing.
Bank of America Merrill Lynch stated autos are headed for a “decisive downturn” that will trough in 2021 at about a 13-million-unit annualized rate, down from last year's blistering record 17.6 million. A week earlier, Morgan Stanley, whose numbers aren't quite as grim, also reduced its revenue forecast, recognizing that the best days of this cycle have come and gone.
With the Trump White House scrambling to advance different measures to fuel economic growth – tax reform, infrastructure spending, maintaining jobs from fleeing abroad, some analysts say more radical steps are desperately needed.
Manufacturing isn't just dead, say analysts. But it's no longer dominated by smokestacks and rudimentary assembly. There are about 360,000 jobs in US manufacturing that are vacant and not being filled and companies are saying, “We need people to fill them.”
Meanwhile, retailers are currently choking on their debt as profit margins implode. Restaurants today employ 10.6 million individuals.
According to the Tax Policy Center, Trump's tax reform could cause overall tax cuts of $6.2 trillion over the next ten years.
Losses on securities backed by automobile loans are piling up even as the unemployment rate has hit 4.3 percent, the lowest since 2001.
Additional evidence that the United States economy is teetering is becoming more and more apparent in credit card delinquencies. Experian reported that the domestic bank card default rate climbed to 3.53 percent in May, a four-year high. There are even nascent signs that families have started to struggle to make their mortgage payments.
David Stockman contra corner man, was interviewed by Boom Bust where he warned of the enormous storm coming that will slam into Wall Street. My notes from the interview are below.
I think the odds by the day are raising that we're going to truly have a government shutdown. Expect the mother of all debt ceiling crisis. The market is utterly unprepared and it really is the black swan event that's about ready to take Wall Street by surprise.
They have not even started on the budget resolution for 2018. Because you will need reconciliation to pass any tax bill, without a budget resolution, there's no tax bill.
We're likely to have a downturn, likely sooner than later, and the market is dramatically overpriced. I'd say sixteen times earnings given all the headwinds.
The Fed is now finally going to start to shrink its balance sheet and not simply a small bit but by $2 trillion within the next a couple of years. The S&P 500 could drop -1,600 points with that all staring us in the face. There is an enormous air pocket between the dream that prevails on Wall Street and the reality of the economy.
Without a clean bill, you are having an enormous fight over what is quid-pro-quo to raise the debt ceiling. That isn't going to end easily. It is likely to end in a complete breakdown like we saw in 2011. They're not going to have the ability to deal with it.
We are in the midst of the biggest political train mess in modern history. We still have no stimulus, no tax bill or infrastructure. I am sure they would like to pass something but they don't have the consensus to do so.
The market today is trading at 25 times S&P 500 earnings that would be $100 a share of earnings for the period ending in March. That represents a tiny growth from $85 a share back in June of 2007, some ten years ago. We're about 1.2% earnings growth over the last decade. Why would you pay 25 times earnings to get one percent increase after a tepid expansion of 100 months that is close to the end of its life because of Fed rate hikes?
David Stockman contra corner man has made a name for himself by always being the contrarian to whatever is the current market consensus. Rather than be a straight up contrarian and get your timing wrong, the better way is to just watch the yield curve. When the yield curve goes completely flat or inverted, we will be months away from the next recession. Until then, keep your eyes on the catalysts that could bring the market down sooner like the subprime auto loan mess and the debt ceiling, but run with the Bulls.
Below is the full interview of David Stockman contra corner man and Boom Bust from RT News:
Tony Dwyer of Canaccord Genuity says that there's this narrative out there that the yield curve flattening is telling you that the economy is closer to recession and the stock market is in trouble. Tony Dwyer disagrees and thinks the yield curve shows that now is a terrific time to buy stocks (link to CNBC article above).
Tony Dwyer says that the U.S. Treasury yield curve as measured by the six month to 10-year spread has historically signaled at least two more years until a bull market peaks and then goes into a recession.
The yield curve could continue to flatten for another two years before going flat or inverted and then once it does, it takes another 3 to 6 months for a recession to hit so Tony Dwyer could be right about the 2 year time-line but his logic is wrong.
The problem with Dwyer's logic is that you can't just look at the spread. You have to consider that the current rate hike cycle is different than any other cycle Dwyer uses on his chart. Never before has the Fed hiked rates in an economy this weak with inflation so low.
To accept Dwyer's argument, you'd need to really embrace tunnel vision and losing sight of the forest for the trees.