The market has been on hold since gapping up on Monday while it waited for this afternoon's FOMC announcement. The announcement of October as the start of the Great Unwind was initially met with selling in the stock market but the dipsters were ready and waiting to drive the indexes back up to save the day, maybe.
Today's Market Stats
Following Monday morning's gap up in the stock market it marched sideways while it waited to get through this afternoon's FOMC announcement. An initial negative reaction to the news that the Fed was going to start reducing its balance sheet in October (some were hoping not until December or next year) was followed by dipsters jumping back in and the market closed near the flat line, leaving us guessing what tomorrow's reaction might be.
It's been nine years since the Fed started its rampage through the forests in a reverse Robin Hood move by taking from the poor and giving to the rich. Today they announced that the rich need to start giving back some of its ill-gotten gains so that the Fed can start reducing its bloated $4.5T balance sheet. As a token of their appreciation they kept interest rates unchanged at 1.00%-1.25%.
The Fed intends to start small by rolling over its monthly expiring debt except for $10B of it each month. To put that into perspective, that's a reduction of 0.22% of its balance sheet each month, or 2.7% per year. At that rate they'll get back down to their pre-crisis level (about $600B) in a little over 32 years, or about the maturity of the 30-year bond. Well, it's a token amount and I'll bet the reduction program will be halted before this time next year as the market tumbles back down from being overly indebted and out of gas. The Fed will have to once again ride to the rescue of the rich.
If the stock market does start to falter and we enter a bear market, one has to wonder how long the Fed will tolerate that. They've made it their mission to rally the stock market so that people feel wealthier and spend money. A huge consequence of all the money the Fed created since 2009, along with abnormally low interest rates, is a huge increase in debt levels. It has become the MOAB -- the Mother of All Bubbles (some would say Mother of All Bombs and they would not be far from the truth).
Companies borrowed huge sums of money for dirt-cheap prices and then bought back large portions of their outstanding stock. Whether or not the company was improving earnings through higher sales/lower costs, the P/E of their stock was brought down through the buy-back programs. It was all smoke and mirrors to make it look like their stock was still fairly valued.
The consequence of all this, as stated in an article in the Wall Street Journal on Tuesday, is that "Financial assets across developed economies are more overvalued than at any other time in recent centuries." [Emphasis mine] We're not talking more overvalued since 2000 but instead more overvalued than in the past couple of centuries. That should be an eye-opener to many.
There are many examples of how badly out of whack the companies' stock prices have become. Exxon Mobil (XOM) is one example -- in 2006 (the last full year before the Fed started its monetary expansion policies) XOM reported $365B in revenue, profit of almost $40B and free cash flow (available to pay shareholders) of nearly $34B. In 2016 full-year revenue was $226B (down nearly 40%), profit was a little less than $8B and free cash flow a little less than $6B (down about 80%). One would think the share price would suffer accordingly. Nope, XOM's stock price is up 20%, from about $75 to $90.
General Electric (GE) is often thought of as a proxy for the economy and it has done terribly over the years (although it recovered nicely from its 2009 low). It reported free cash flow of nearly $14B in 2006 but last year its cash flow was negative. Its net worth dropped 37% from $122B to $77B. Its stock price in 2016, near $33, was roughly the same as it was in 2006 but up significantly from 2009's low at $5.73.
McDonalds (MCD) is another good example. The rise in its stock price has been steady since the low in March 2003 and it looks like the picture of health. But in the 10 years between 2006 and 2016 it has reported only a slight increase in revenues. It did well cutting costs because its profit improved by 30% over that time period. But it tripled its debt load from a little more than $8B to almost $26B. Its book value dropped from almost $16B to -$2B (in the hole by $2B). And over this time frame its stock price tripled (and was the strongest stock in the Dow 30 today, up +1.6%).
These are mere representatives of a stock market gone crazy and much of it has to do with too much money (from global central banks) chasing too few assets. It's all fake (like fake news) and the debt needs to be repaid. When the Fed tries to let tide water recede they will likely find the stock market reacting negatively. Lowering the water level exposes the rocks just below the surface that most investors have been ignoring.
The bottom line for the Fed and the stock market is that there has been an enormous positive impact on stock prices over the past 10 years from the Fed's supportive easy-money policies. It's hard to imagine that reversing those policies will go unnoticed by the stock market.
One of the big problems with the debt loads taken on by so many companies is that a lot of it is considered junk status. Think of the sub-prime mortgage market on steroids as many companies use "covenant-lite" loans, meaning they're not meeting the requirements of the loans but the banks look the other way. Not meeting profitability requirements, debt-to-asset requirements, etc. are violations that can trigger a loan recall by the bank.
The trouble with violations of a loan's covenants and a bank calling in the loan is that the company might not be able to come up with the money to pay off the loan (think Greece as an example of this). The bank doesn't want to have to report a non-performing loan on its balance sheet and so everyone makes believe everything is still OK. Multiply this by hundreds, perhaps thousands, of companies, large and small, and you have a debt pot that's boiling and ready to blow the lid.
The problem with much of the junk bonds is that many of them are coming due in the next couple of years. The Wall Street Journal warned investors in yesterday's article to be cautious about both companies and their junk bonds that are rolling over between now and 2020. The market could soon freeze up as more and more companies experience tightening lending standards, especially if the Fed is drawing money out of the monetary system.
This week's announcement by Toys R Us that they're declaring Chapter 11 bankruptcy (another retailer bites the dust) is actually being done before they need to. It is believed management is trying to get ahead of others who will be doing the same thing. The chart below shows the amount of money involved in junk bonds that will be rolling over in the next three years -- $1.3T coming due by 2020. As the WSJ said, Toys R Us is "a canary in the coalmine" for the broader credit markets.
Whether or not Toys R Us will be able to refinance their debt under Chapter 11 bankruptcy, and perhaps more importantly, under what terms, will be watched carefully. It could start a stampede by other companies if they too sense the market is tightening. The bond market dwarfs the stock market and how it reacts could have a huge impact on all markets. As Wilbur Ross, the billionaire investor, commented, "Refinancing is the real issue because you have a wall of maturities starting 2018, building up through 2021 to 2022... but [this wall of maturities] really reflects in the market a year or so earlier... so it's really a 2017 issue."
Keep an eye on HYG since this is the junk bond ETF that will provide fair warning to stock investors. HYG typically leads the stock market and for a long time it's been showing caution while SPX throws caution to the wind with a "what, me worry?" attitude. I've shown the HYG weekly chart before to point out this year's broken rising wedge, with bearish divergence, and at the moment it has bounced back up to the bottom of the wedge for what could be a bearish back-test. If it drops away from here it will likely drop quickly and I'd use that as a warning signal for the stock market.
The weekly chart below compares the performance of HYG vs. SPX (the green line) and you can see how SPX continued to rally strong from last November while HYG had a shallow climb higher in a small rising wedge with bearish divergence. I don't believe SPX will be able to ignore a further drop in HYG, if in fact one is coming.
High Yield Corporate Bond ETF, HYG, vs. S&P 500, Weekly chart
I mentioned above that one consequence of all the cheap money the Fed has provided is that companies have borrowed huge sums, much of it used to pay dividends to shareholders (nice but not productive use of the money) and to buy back the company's own stock. That has provided the bulk of the buying pressure for the stock market and I've often discussed in the past that it will be difficult for the market to sustain its rally if the buybacks slow down significantly. There's still a lot of buying going on but as you can see from the chart below, it has been slowing since peaking in mid-2016.
S&P 500 stock buybacks vs. S&P 500 index performance, Quarterly chart 2006-2nd Quarter 2017, chart courtesy Eric Pomboy, @epomboy on Twitter
Interestingly, following the November elections we've seen a much higher participation rate by investors. Bullish sentiment, even among retirees, is hitting highs not seen since 2000. It seems the public is finally involved in the rally and likely a great contributor to the rally in the past year. This in turn has compensated for the loss of buying pressure from companies buying their own stock. But the last time bullish sentiment from the masses reached current levels they were buying the top. Only time will tell if they're doing the same thing again.
Having spilled a lot of electronic ink above in an attempt to show how vulnerable the stock market is, we of course know that the market can stay irrational far longer than a trader can fight it. The trend is up and that could continue for the rest of the year. There are plenty of reasons to believe the market is nearing an important top but it's been a frustrating battle for the bears who can't understand how this market could possibly be rallying.
One reason for the rally is simply money and lots of it. There's still a lot of money out there chasing too few assets and as long as that's true we'll see the stock market rise higher in spite of fundamental reasons why it shouldn't. There are many who believe we're in the end stage of the bull market but that could mean an explosive move higher in a fit of panic as investors chase prices ever higher. Think late 1990s.
Dow 30000, 40000 and higher are not unreasonable expectations if you think we'll get another melt-up like we did in the late 1990s. Those were some of the best years to be an investor, even while the stock values became extraordinarily high. This must be kept in mind by the bears while watching carefully for signs that the market's rally is going to end a lot sooner than most currently think.
One measure of a rally's strength is the cumulative advance-decline line -- as long as it's increasing with the climb higher in the indexes it means the rally is firing on all 8 cylinders. The NYSE advance-decline line shown below (red and black line) is not showing any negative divergence to the NYSE (black line) and therefore there's a lot of money behind this rally. While it's more or less a concurrent indicator, moving up and down with price, many market tops have been put in place after the a-d line makes a lower high (same with a positive divergence at lows). The divergence is not always required but it's a good leading indicator when it happens. Right now there is no divergence.
NYSE Cumulative Advance-Decline Line vs. NYSE, Weekly chart
Not all is rosy with the picture above. RSI for the a-d line is overbought and as can be seen in the past this has warned of a pullback coming. What kind of pullback, and whether or not it will lead to something more significant to the downside, can only be guessed here.
Moving to my regular charts, since I show the NYSE chart above, I'll start with a weekly chart and work my way in.
NYSE Composite Index, NYA, Weekly chart
The decline in the first half of August had NYSE breaking its uptrend line from February-November 2016 and the recovery off the August 18th low has it making a new high but so far only a back-test of its broken uptrend line. The highs since March are showing bearish divergence. There's a lot of money behind this rally but from a technical perspective NYSE is in a vulnerable position here since it's typically a very good setup to play a reversal back down.
If the bulls can keep things going into October there is the potential for NYSE to make it up to the top of the rising wedge pattern, which will be near 12560 by mid-October. While I wouldn't bet on that outcome right here I'd turn more bullish if it can climb above a couple of resistance levels between here and about 12220.
NYSE Composite Index, NYA, Daily chart
The daily chart of the NYSE shows a closer view of the back-test of its broken uptrend line as the oscillators have reached overbought. It could run out of gas as it completes the back-test but slightly higher is a trend line along the highs for the rally from April, currently near 12220. Watch that level carefully if reached.
S&P 500, SPX, Daily chart
A few price projections for SPX, based on its wave pattern and prior moves, provide us with an upside target zone at roughly 2510-2516. Today's high at 2508.85 is close to the bottom of the zone and therefore any new highs from here bear close scrutiny for signs of topping. A trend line along the highs since March is currently near 2516, which is another reason why the bulls could run into trouble soon if they manage to press a little higher. With oscillators back into overbought it makes it tougher to get the energy to power through resistance. But if the bulls can get SPX above 2520 (and stay above) it would be a stronger bullish statement.
Key Levels for SPX:
- bullish above 2520
- bearish below 2480
S&P 500, SPX, 60-min chart
The 60-min chart for SPX shows some loss of momentum since September 12th as it approaches what I believe will be a tough resistance zone. Two equal legs for its rally from August 21st (August 21 - September 1 and the leg up from September 5th) points to 2509.58. The 127% extension of the previous decline (August 8-21), which is often a reversal level, is at 2510.87. For a longer-term projection, the 5th wave of the rally from 2009 (which started at the January 2016 low) would equal the 1st wave at 2516. The close correlation of several price projections, along with trend lines, tells me to watch this area closely for a possible top. I see a little more upside potential for this rally but not much (unless it can get above and stay above 2520).
Dow Industrials, INDU, Daily chart
The Dow is firmly in its up-channel for the rally leg from April and could rally a little further before reaching potential resistance at its broken uptrend line form November 2016 - May 2017, currently near 22515. There's higher potential to the top of its up-channel from April, which will be near 22775 by the end of the month. The oscillators are hinting of rolling over from overbought but if we see only small choppy corrections to its rally it will signal higher highs. A drop below its August 8th high at 22179 would be a bearish heads up.
Key Levels for DOW:
- bullish above 22,179
- bearish below 22,038
Nasdaq Composite index, COMPQ, Daily chart
The tech indexes have been relatively weak this month but the price pattern continues to look more bullish than bearish (even if less bullish than the others). The Nasdaq could rally to trend line along the highs from April 2016 - March 2017, near 6530, and while I don't see it happening, it would be more bullish above that level. There's an ending pattern for its leg up from September 5th and it suggests we could see a top at 6490-6495, about 40 points above today's close. One more new high on Thursday, maybe into Friday, could do it and that would leave a double top with its July 27th high, with bearish divergence, if it happens.
Key Levels for COMPQ:
- bullish above 6535
- bearish below 6334
A big drag on the tech indexes lately has been weakness in the FAANG stocks. F & N have been doing OK but the A's and G have been weak (although NFLX is looking vulnerable to putting in a double top against its July high with a large bearish divergence). AMZN's daily chart below shows a possible H&S top (with a confirming volume pattern) between its left shoulder in June, head in July and now the right shoulder. If it breaks its neckline, near 938, the downside objective for the pattern is 785. There's still time for AMZN to pull out of the dive but bulls can't waste too much time and it ideally needs to hold above its uptrend line from November 2016, currently near 956.
Amazon, AMZN, Daily chart
AAPL's weekly chart shows bearish divergence at its September high vs. its May/June highs and is threatening to break down from its up-channel from May 2016 (daily and weekly oscillators have rolled over). I show the potential for a rally to a price projection near 169 for the 5th wave of its rally from May 2016 but the minimum projection near 159 has already been achieved. Which way AAPL goes from here is very likely to lead the broader market.
Apple, AAPL, Weekly chart
Russell-2000, RUT, Weekly chart
I'm having a devil of a time trying to slap a meaningful EW count on the RUT but it has such a choppy pattern, including for its rally from February 2016, and that makes several different wave count possibilities. Because of its large megaphone pattern, the bottom of which starts from the February 2014 low and the top from June 2007, the legs inside this expanding triangle pattern are expected to be corrective rather than impulsive. In this kind of situation I depend a lot on price projections for 3-wave moves and trend lines.
The rally from the August 18th low would have two equal legs up at 1459, which is just above the top of its megaphone pattern, currently near 1456. The top of the megaphone has been resistance since first tested in December 2016 and I'm expecting it to remain resistance, especially seeing the bearish divergence since last December. Obviously it would be more bullish above 1460 but until that happens I think we're looking for a major top for the RUT.
Key Levels for RUT:
- bullish above 1460
- bearish below 1396
10-year Yield, TNX, Weekly chart
Treasuries sold off sharply on the FOMC announcement, presumably from worry that a less active Fed in the bond market will depress prices from a higher supply. That popped yields higher and TNX has seen a sharp bounce off its September 7th low at 2.034 to today's high at 2.289. Today the rally stopped at its broken 50-week MA at 2.284 and closed at 2.277.
The top of a down-channel for its decline from March is currently near 2.36 so there's a little more upside potential to that line but like the 2-week rally off its June 14th low, there's a good chance this upside reaction is going to falter. If the stock market does in fact roll over soon we could see a flight to safety in Treasuries and drive yields back down. It takes a rally above the July 7th high at 2.396 to suggest something more bullish could be playing out.
U.S. Dollar contract, DX, Daily chart
The US$ snapped to the upside this afternoon following the FOMC announcement. The Fed's decision to reduce its balance sheet and raise rates (presumably in December) strengthens the dollar. This afternoon's rally bounced the dollar up to the top of its narrow down-channel that it's been since May, as well as its broken 20-dma at 92.23. It would be more bullish if the dollar can continue its rally and break out of the down-channel but then it would soon have to fight through price-level resistance, the bottom of a previous down-channel from January and its broken 50-dma, all of which are currently near 93.
If the dollar can fight through all that resistance near 93 and then get back above its August 16th high near 94 I'd turn more bullish the dollar sooner rather than later. I think the dollar is setting up for a big rally into next year but I've been looking for a low near 90 before starting the rally. We'll soon find out whether or not the dollar has one more new low or if instead it will start its rally from here.
Gold continuous contract, GC, Daily chart
Gold has pulled back to price-level support near 1300 and its uptrend line from December 2016 - May 2017 that it had recovered with its rally from July into the September 8th high. A drop below 1298 would likely see a test of its 50-dma, which is climbing and currently near 1290. There are multiple support levels between here and 1200 to catch a fall but ideally gold bulls will get a rally off support here. The bearish price pattern suggests gold has started the next leg down, one that will take it below 1100. If the dollar starts a larger rally that could put pressure on gold.
Oil continuous contract, CL, Daily chart
With today's rally and this evening's jump higher oil has now made it up to two price projections that I've been watching for, which are based off its bounce pattern from June, one at 50.75 and the other at 50.84 (this evening's high so far is 50.79). That's not to say oil should turn around from here but that's the bearish setup.
Its bounce pattern from June suggests it's just a bounce correction and not something more bullish (although there's certainly additional upside potential for the bounce, such as to the price projection at 53.96 for two equal legs up). If oil can get above 52 I'd look for it to continue higher to the 54 area. But the bearish potential is for a little double top against its August 1st high.
Today's existing home sales report, which came in lower than expected (Hurricane Harvey got the blame), continues to show weakness in sales but primarily due to lower inventory levels and higher prices. That's a mixed message since we're seeing the same thing in the new home sales. Home builders are trying to control how much they build so that they don't get stuck with inventory in the next slowdown. It's currently more of a seller's market than a buyer's and as long as rates stay low the higher prices can be more easily absorbed.
There are no major economic reports on Friday and Thursday's reports include unemployment numbers and the Philly Fed index, which is expected to show some slowing from August. There are more signs of a slowdown in the economy and that's another worrisome sign for a bull market that's long in the tooth.
The VIX is back down in the weeds with today's close below 10, at 9.78, and fear has once again left the building. The CNN Fear & Greed index is now back into Extreme Greed territory. Retail investors have jumped back into the market in a big way, which often happens when the market is hitting the last of its new highs. There's obviously a lot more upside potential but this excessive bullishness comes when the indexes are showing waning momentum and that's usually not a good combination.
Keep in mind this is a year ending in 7 and you can think whatever you want about the silliness of such a thing, but years ending in 7 have not been kind to bulls in the fall. Octobers have a reputation for being bear killers as the stock market typically swoons in August-September/October, finds a bottom in October and then rallies into the end of the year. But October 1987 (big crash), October 1997 (little crash) and October 2007 (the top before a monster crash into 2008) could easily be described as bull killers. I think we're facing something like October 2007, or who knows, maybe a combination of 1987 and 2007.
Another common occurrence is for a market to turn on the spring and fall equinox, which is Friday, September 22nd. With a market looking vulnerable here I'm thinking this October is not going to be kind to bulls and kicking them in the teeth might not wait until October arrives. Just keep a close eye on the market's signals (and watch AAPL). While we're in an uptrend and you don't want to try catching rising knives, this is a potentially dangerous time of the year to be a complacent bull, especially with the number of new bulls who have joined the party. Don't be caught without a chair when the music stops. Keep in mind that portfolio insurance (LEAP put options anyone?) is real cheap right now.
Good luck and I'll be back with you next Wednesday.
Keene H. Little, CMT