Diary of a Financier

Bull v. Bear

In Capital Markets, Economics on Wed 8 Aug 2012 at 19:45

The S&P 500 is trading in a bull channel. This puts me in an anxious bind, because, as I’ve said before:

“The problem with trending channels is you never know when they’re going to end. They’re an indefinite continuation pattern that can reverse without signaling.”

The bull channel leads higher, by definition, but most investors can’t imagine exposing capital to the elements given the macro risks. Plus, the rally has been quick, on the back of low volume. I know most money managers have lagged, which leaves investors in a quandary: chase performance or wait for a pullback.

And thus, markets have reached another meaningful crossroads in my eyes. This calls for another edition of Bull v. Bear

~~~~

Bull

  1. Charts- SPX daily fractal shows a rising wedge within a bull channel.  This should lead risk assets higher, and the rising wedge gives me confidence that the bull channel won’t suddenly collapse until the wedge’s vertex is met <1420.
  2. Housing- Home prices appear to have bottomed. The Street is littered with the carcasses of those who chased this premise every year since 2006, falling for seasonality’s tricks.  This year, the sequential gains in homeprice indices, building, sales, etc. have all persisted through the spring.  Gains are coming off a low base y/y, but were the bleed in homeprices to merely clot–not even reverse the flow–the resonance to GDP would be meaningful and unexpected.  Some warn of the lurking shadow inventory (myself included), but I’m starting to come around to the idea that banks will slowly liquidate REO.  Any behavioral economist would expect banks to hit the housing bid all at once (i.e. herd mentality), thereby forcing a double dip.  But, the 2009 amendments¹ to FAS 157 provide banks mark-to-myth flexibility in valuing some assets, deferring writedowns until losses are realized.  This may keep the supply/demand balance favorable.
  3. Extreme Bearishness- Merrill Lynch’s Quant Team has a “Sell Side Consensus Contrary Indicator” that shows 43.9% of strategists are bullish on equities–the lowest alltime reading.  It’s a contrarian indicator that’s flashing signs of despondency.
  4. Leading Indicators
    • Railroad Traffic- The most resilient of all economic indicators I follow, railroads have consistently reported steady growth this year.  After a warm winter may have pulled forward demand, then [strong] y/y numbers were reported off of a low base (due to supply-chain disruptions from the 2011 Japanese Earthquake & Tsunami), the 3q12 y/y data will continue to provide a critical assessment of economic activity.
    • PMI- While much of the world continues crumpling into slowdowns, the US Purchasing Managers Index still shows expansion in production–albeit decelerating to the lowest level of growth since 2009.
    • Inventories- Private Inventories still have room to run higher from $66b before hitting their historical ceiling ~$80-90b.  This is the logical downstream extension of the growth seen in Railroad Traffic & US PMI.  The challenge for corporations will be to convert these inventories into sales when the stockpiling cycle ends.
  5. Macro
    • QE3 Put- The Fed has vowed to remain vigilant.  The press release from July’s FOMC meeting communicated their intention to deploy more easing measures when necessary, with a focus on longer-dated maturities and MBS.
    • Eurocrisis Grand Plan- Mario Draghi pledged ECB support by any and all means within his mandate.  Many contrarians suggest that Mr. Draghi has taken the first, bold step toward a system-wide infrastructure to foster a recovery.

Bear

  1. EPS Growth- Margin expansion has been the biggest contributor to EPS growth throughout the recovery since 2009.  Now that corporations have cut through the fat, then the muscle, now to the bone, the onus is on revenue growth.  Already, 3q12 is expected to provide the first y/y quarterly EPS contraction (-1.6%) since 2009.
  2. Volume- SPY MFI shows bear divergence that no other technical indicator echoes. Alluding back to bullish point #2 (“Extreme Bearishness”), this rally needs buyers to aid its momentum with volume were SPX to continue much higher.
  3. Fiscal Cliff- It appears that Congress will manage to defer any policy decisions until the new Presidential term in 2013, but a reckoning looms around every turn of the calendar.
  4. Macro
    • QE3 Put- The Bernanke Put is now far out-of-the-money if you consider the Fed’s favorite indicator, 5y5y Inflation Breakevens. If the Fed really does use the 5y5y as a weightier factor than the stock market (as maybe they should), then SPX has significant downside before deflation expectations trigger intervention. This is especially important when considering that 5y5y expectations rose due to the “threat” of QE3, as opposed to the actual implementation of stimulus or organic economic prospects.
    • Eurocrisis- While Eurocrats project a calm, cool & collected facade, they’ve yet to prove that they can make tough decisions and preempt crises with policy measures.

~~~~

Weekly Railtraffic Data & PMI are the two indicators I’ll be tracking closest.  If they continue to post expansionary reports, they’ll give me the bull signal I’ve awaited, prompting me to ratchet up our Beta >1.00.  For now, I’m following the SPY 30-minute chart closely as a day-to-day guide.  The recent intraday breaks above trendline resistance of a rising wedge have me sitting on my hands to wait and see if that resistance can become support after holding on a closing basis:

SPY 30-min- can it close above trendline resistance of its rising wedge (blue), then hold that trendline as support?

For now, the aggregate of my information shifts the balance toward bullishness.  More to come as everything evolves.

–Romeo

¹Wikipedia: “In April 2009, however, the Financial Accounting Standards Board (FASB) voted on and approved new guidelines that would allow for the valuation to be based on a price that would be received in an orderly market rather than a forced liquidation, starting in the first quarter of 2009.” This has already diminished asset efficiency & ROA for banks with a significant amount of REO & non-performing/delinquent assets.  That’s shareholders’ problem.  The systemic threat comes from the next crisis, when a TBTF institution has a liquidity issue that can’t be adequately resolved by liquidating mark-to-myth assets.

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  1. [...] We just saw a heartwarming comeback in US equity markets on Friday.  Down something like 46bps, SPX recovered in the last hour of the trading week (again) to close well into the black.  Due to this resilience, SPX has managed to walk a tightrope strung along the all-important trendline resistance to which I’ve been referring: [...]

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