The rally, driven by the highest level of short interest since 2008, has once again ignited “bullish optimism.” As shown in the chart below, the number of stocks on “bullish buy signals” has exploded in recent weeks.”
“While the “bulls” are quick to point out the current rebound much resembles that of 2011, I have made notes of the differences between 2011 and 2008. The reality is the current market set up is more closely aligned with the early stages of a bear market reversal.”
It is the last point that I want to follow up with this week.
There is little argument that the bulls are clearly in charge of the market currently as the rally from the lows has been “breath taking.” However, while the recent correction was indeed deep enough to reset the markets for a year-end rally, one question remains:
“How much room does this bull have left to run?”
Warning Signs Everywhere
Many have pointed to the recent correction as a repeat of the 2011 “debt ceiling default” crisis. Of course, the real issue in 2011 was the economic impact of the Japanese tsunami/earthquake/meltdown trifecta, combined with the absence of liquidity support following the end of QE-2, which led to a sharp drop in economic activity. While many might suggest that the current environment is similar, there is a marked difference.
The fall/winter of 2011 was fueled by comments, and actions, of accommodative policies by the Federal Reserve as they instituted “operation twist” and a continuation of the “zero interest rate policy” (ZIRP). Furthermore, the economy was boosted in the third and fourth quarters of 2011 as oil prices fell, Japan manufacturing came back on-line to fill the void of pent-up demand for inventory restocking and the warmest winter in 65-years which gave a boost to consumers wallets and allowed for higher rates of production.
2015 is a much different picture.
First, while the Federal Reserve is still reinvesting proceeds from the bloated $4 Trillion balance sheet, which provides for intermittent pops of liquidity into the financial market, they are now seriously discussing “tightening” monetary policy by the end of the year.
Secondly, despite hopes of a stronger rates of economic growth, it appears that the domestic economy is weakening considerably as the effects of a global deflationary slowdown wash back onto the U.S. economy.
Third, while “services” seems to be holding up despite a slowdown in “manufacturing,” the service sector is being obfuscated by sharp increases in “healthcare” spending due to sharply rising costs of healthcare premiums. While the diversion of spending is inflating the services related part of the economy, it is not a representation of a stronger “real” economy that creates jobs and increase wages. (via Zerohedge)
Fourth, the strong US dollar, as compared to other currencies racing for the bottom, is having a negative effect on companies with international exposure. Exports, which make up more than 40% of corporate profits, are sharply impacting results in more than just “energy-related” areas. As I discussed recently, this is not just a “profits recession,” it is a “revenue recession” which are two different things.
The chart below shows the S&P 500 as compared to the US Dollar. Since the turn of the century, declines in this ratio below the 18-month moving average, have been coincident with more severe market reversions and economic recessions.
Lastly, it is important to remember that US markets are not an “island.” What happens in global financial markets will ultimately impact the U.S. The chart below shows the S&P 500 as compared on a performance basis to the MSCI Emerging Markets and Developed International indices. I have highlighted previous peaks and subsequent bear markets. Currently, the weakness in the international markets is being dismissed by investors, but it most likely should not be.
Lack Of Low Hanging Fruit
I suggested previously that the “seasonally strong” period of the year may present an opportunity for more seasoned and tactical traders. However, for longer-term investors there is a lack of “low hanging fruit” to harvest currently.
While the recent rally has certainly been encouraging, it has failed to materially change the underlying momentum and relative strength indicators substantially enough to suggest a return to a more structurally sound bull market. (valuations not withstanding)
With price action still confirming relative weakness, and the recent rally primarily focused in the largest capitalization based companies, the action remains more reminiscent of a market topping process than the beginning of a new leg of the bull market. As shown in the last chart below, the current “topping process,” when combined with underlying “sell signals,” is very different than the action witnessed in 2011.
While I am not suggesting that the market is on the precipice of the next “financial crisis,” I am suggesting that the current market dynamics are not as stable as they were following the correction in 2011. This is particularly the case given the threat of a “tightening” of monetary policy combined with significantly weak economic underpinnings.
The challenge for investors over the next several months will be the navigation of the “seasonally strong” period of the year against a backdrop of warning signals. Importantly, while the “always bullish” media tends to dismiss warning signs as “just being bearish,” historically such unheeded warnings have ended badly for individuals. It is my suspicion that this time will likely not be much different, the challenge will just be knowing when to leave the “party.”