April 15, 2014
Here’s a summary of what we are watching and concerned about going forward:
1) NYSE margin debt is at all-time highs as illustrated by the accompanying “Margin Debt” chart (labeled “MARGDEBT”). The “MARGFREE” chart indicates the existing free credit balances of all NYSE margin accounts. Notice the spike in margin credits (cash) in late 2007/early 2008. This is entirely indicative of clearing firm margin clerks forcing liquidation of margin accounts whose holders are frozen in shock like a deer in the headlights of an on-coming semi. The third chart “MARGCRBL” illustrates the cash balances of non-margin accounts. As you can see, the more conservative unleveraged accounts are already exiting long stocks and headed to cash as a defensive cover. What all of this suggests is NOT that the market will, or is about to, crater, it’s purely indicative that “event risk” has an extremely skewed fat-tail! Stated differently, a margin liquidation event has the potential downside energy of collapsing equity prices in excess of 20% quickly.
2) The dollar is under pressure. Will the dollar hold the support zone as illustrated in the chart “DXY CURNCY”? If so, a rally back up to the highs of the recent channel near 81 is in the cards. If not, a drop through USDX of 79.00 signals a re-test of the 2011 lows of 74-76.
3) China is again allowing their currency to devalue in an effort to stem the tide of falling exports which recent trade balance reports have depicted. China is attempting to navigate a “soft landing” for their export driven economy; with huge structural inefficiencies that need adjusting the risks of a hard landing is fairly significant.
4) Bond prices are ticking higher (lower yields) and are receiving the benefit of a “quality flight” from equities along with apparent geo-political event risk from Russia’s intrusion into the Ukraine. Although bond yields are falling, short of an equity collapse perhaps precipitated by insurgencies in the Ukraine, the bonds have two fundamental hurdles to overcome. First, a falling dollar is certainly not friendly to holding fixed-return dollar denominated holdings. This is true simply because currency depreciation proportionately reduces the coupon value especially to foreign holders AND significantly adds to principal risk as yields may adjust higher to compensate for the currency risk. Second, the Fed is clearly targeting higher inflation nearly exclusively now that they have all but abandoned targeting employment levels. Higher inflation always has, and always will be a significant headwind for lower bond yields or higher bond prices.
5) Similar to the bond market reasons, oil has benefited from a falling dollar and the Euro-Asia confrontations. Problems for higher oil prices though are a bit different than bonds in that a global slowdown due to military confrontations in the Ukraine coupled with a potential hard landing for China are demand side bearish for oil.
6) The recent IPO stampeded, or re-stated “risk at any price”, is another potentially bearish indicator longer term for equities. We are keeping an eye on how IPO’s are priced, whether future offerings are withdrawn and how recent offerings maintain their price level debuts. All of these conditions may be indicative of risk appetites going forward.
7) The upward sloping trendline of the S&P 500 is now around 1795. The market is short term oversold. Any test at or near the trendline could provide technicians and machines to switch bullish looking for a technical based rally. A clear break of the trendline at S&P 1795 will target the February lows of 1737.
8) We are watching other indicators such as the IEF and SKEW for either confirmation of a market decline or divergent signals that the equity sell-off is likely to reverse back upwards.
The following table is a sector analysis that we monitor illustrating the sectors respective declines from their recent highs to their closing prices as of Friday, April 11, 2014:
Have a safe, wonderful and happy Easter holiday …
Ronald M. George
William J. Taylor