Tuesday, August 18, 2015

The Morning Call--More turmoil in China

The Morning Call


The Market

The indices (DJIA 17545, S&P 2102) started the week on an upbeat note.  However, the Dow still ended [a] below its 100 and 200 day moving averages, both of which represent resistance, [b] in a short term trading range {17385-18295}, [c] in an intermediate term trading range {15842-18295} and [d] in a long term uptrend {5369-19175}.

The S&P did a bit better, finishing [a] back above its 100 day moving average; if it remains there through the close on Wednesday, it will revert back to support, [b] as well as above the upper boundary of a very short term downtrend, [c] within a short term trading range {2043-2135} and [d] within an intermediate term uptrend {1886-2650} and a long term uptrend {797-2145}. 

Volume fell; breadth was mixed.  The VIX was up (another of those unusual sessions, being up on an up Market day), but remained below its 100 day moving average and within a short term trading range, an intermediate term downtrend and a long term trading range.

The long Treasury remains strong, ending [a] above its 100 day moving average, now support, [b] within short and intermediate term trading ranges and [c] above the lower boundary of a very short term uptrend.

GLD was up, but closed below its 100 day moving average and in short, intermediate and long term downtrends.  However, it appears to be developing a short term trading range.   That is no reason to go Buy GLD, but it could potentially be signaling that a bottom is being made.

Oil continues to crash, finishing below its 100 day moving average and within short and intermediate term downtrends. The dollar rose, closing right on its 100 day moving average, which is resistance, and within short and intermediate term trading ranges. 

Bottom line: the S&P’s pin action turned a bit more mixed yesterday.  Having just re-set its 100 day moving average from support to resistance, the boundary is now under a challenge back to the upside.  Together with the close above a very short term downtrend, it brings the potential for some optimism back into the technical picture.  Nevertheless, there remains a good deal of work on the part of the bulls to undo the damage that has been done.   

This is not a technical environment in which I would be buying stocks.  Indeed, any move higher in prices I believe represents a gift to allow investors to sell.

Bonds continue to point to no Fed rate hike and/or a weakening economy.  They are receiving support from oil, which seems to be screaming deflation.  Here too it is a too soon to make that call.  But for the first time is some time, stocks, bonds and oil are pointing in the same direction---slowing global growth accompanied perhaps by a whiff of deflation.

            Technical summary from Fat Pitch (medium):

            The best risk adjusted returns ever? (medium):

            Does copper portend a recession and a bear market (short)?



            Two US economic datapoints were reported yesterday: one really bad---the NY Fed manufacturing index; one OK, the August National Homebuilders index came in as anticipated.

            Overseas, the tune was the same: one really bad---Japanese second quarter GDP fell 1.6%; one OK, the Chinese yuan traded flat.

            ***overnight, the Chinese stock market tumbled 6% as both stocks and yuan declined, but the government chose to only support the yuan; an EU official said that Greek bank deposits would no longer be guaranteed after 1/1/16.

            Nothing above warrants any alteration of our forecast; and nothing relieves my concerns about the potential for a further slowdown in economic growth and/or deflation.

            The ongoing Market narrative appeared to pick up a new/old major theme yesterday---the upcoming September Fed meeting and the likelihood of a rate increase.   I expect this horse to be beaten to death over the next couple of weeks, especially if nothing dramatic hits the headlines. 

That said, I will repeat my mantra---QE (increased liquidity and lower interest rates) did little to nothing to improve the US economy’s growth, so any move to extract liquidity or raise rates is not likely to have much impact the other way.   Indeed, this whole Fed gnashing of teeth routine over whether or not a rise in rates will impact the economy is a smoke screen.  What these guys are really worried about is that they recognize that they have once again remained too loose for too long, that it has led to distortions in asset pricing and allocation and that a move to tightening could precipitate a massive unwind of that asset mispricing and misallocation.  And since the problems in China, Japan and Brazil are hitting the headlines every day, it offers a perfect excuse to do nothing (and then continue pray for a miracle delivery). 

Bottom line: how long investors will buy the Fed’s act is anyone’s guess.  The pin action in the bond market of late appears to suggest that the bond crowd has had enough and curtain is about to be raised on the Wizard of Oz.

That said, even though I spend time and ink fretting about the ill effects of Fed policy, China devaluation, a Grexit, etc., my primary investment point for the last eighteen months has been that stocks are extremely overvalued by almost any measure.  While political and economic events are interesting to speculate about, they are secondary to the process of price mean reversion except in as much as they could act as a trigger to it. 

Not being a rocket scientist, I have no way determining exactly how overvalued stocks have become. However, I developed our Pricing Discipline so that it forces our Portfolios to Sell stocks when those stocks reach historically high absolute and relative valuations.  Can those Sell Half prices be exceeded?  Sure.  But if stocks advance another 10% then mean revert by 50%, so what?  Missing that last 10% is meaningless unless a superior timing mechanism exists and I can catch another 5% before prices decline.  However, I haven’t found one, nor am I aware that anyone has either.

The point is to build a Discipline that (1) establishes a reasonable probability that profits will taken at pricing extremes (2) relieves me of having to figure out the timing or the trigger for mean reversion---because I know that I not smart enough to do that anyway, even assuming that it could be done, (3) still provides the insurance of price stability when it does occur, and (4) also establishes a reasonable probability that cash reserves will be invested at lower prices.

In short, the key investment thought is that stocks are extremely overvalued; the economic/political narrative is just a search for the trigger event.

I continue to believe that the key investment strategy today is to take advantage of the current high prices to sell any stock that has been a disappointment or no longer fits your investment criteria and to trim the holding of any stock that has doubled or more in price.  They may not be available later on.

            How much more bad news can this market take? (medium):

            The implications of debt financed stock buybacks (medium):

            MLP’s are not bonds (short):


   This Week’s Data

            The August National Homebuilders index (homebuilder sentiment) came in at 61.0, in line.

            July housing starts were up fractionally, in line.


            A strong dollar and emerging market growth (medium):

            China and emerging markets (medium):

            The continuing damage wrought by the Fed (medium):




            The political fallout from the Greek bailout will likely continue to stay in the headlines (medium):

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