Federal Reserve Chairman Ben Bernanke dropped a "taper talk" bomb on the stock market and equities erased all of their May and June gains in less than two days. It was not a good week for investors. U.S. stocks delivered their worst week of the year. European markets posted their worst week in over 12 months. Yet the bond market witnessed its worst week in 50 years.
Last week I warned readers that "everything depends on the Fed statement and Bernanke's press conference... If the Fed disappoints the market we could see a painful sell-off."
The major U.S. indices lost about -2% for the week. While that might seem painful the real pain is overseas. The Stoxx Europe 600 index fell -3.7% for the week and posted its fifth weekly loss in a row. The German DAX stumbled -4.2% lower for the week. The French CAC-40 is down -3.9% for the week and the British FTSE 100 lost -3.1% for the week. China plunged -4.9% for the week. Meanwhile countries like Brazil and Turkey, which are facing widespread protests, saw their markets fall -7.7% and -8.9%, respectively, for the week. Emerging markets have crashed -15% in the last five weeks and Brazil is off -20% in four weeks.
Bernanke's comments on Wednesday sparked a rally in the U.S. dollar and that yanked the rug out from under commodities. Oil had been breaking out higher but reversed sharply. Silver lost -8.8% for the week and closed below $20 an ounce. Gold fell -6.6% for the week, losing almost $100 on Thursday alone. Gold's sell-off was probably exacerbated by news that the CME raised margin requirements on gold futures by 25%. Falling economic data out of China also played a key role in the commodity sell-off. We'll talk more about China in a moment.
Monthly chart of the GLD gold ETF:
Monthly chart of the SLV silver ETF:
It is worth noting that volume surged on the market's sell-off. Depending on your bias that's either a good thing (capitulation) or a bad thing (confirming the reversal lower). The rush of volume was likely due to a quadruple witching option and futures expiration on Friday. There was also a quarterly rebalancing for the S&P 500 large cap index, S&P 400 midcap index, and S&P 600 small cap index.
Economic data in the U.S. was mostly positive for the week, which is a nice change of pace. Consumer prices in the May CPI report showed a +0.1% increase. That's the first rise since February's reading. The core-CPI, which excludes more volatile food and fuel prices, rose +0.2%, which was in-line with expectations.
Housing starts hit an annual pace of 914,000 in May. That's up from 856,000 in April. Building permits ticked lower to an annual pace of 974,000 in May, down from April's 1.0 million.
The regional Fed survey's were positive. The New York Empire State Fed manufacturing survey rose to a three-month high. Meanwhile the Philly Fed business outlook survey rebounded from -5.2 in May to +12.5 in June. That's the high reading since April 2011 and way above expectations.
Looking across the Atlantic ocean to Europe there was improvement in economic sentiment. Both the German ZEW and Eurozone ZEW economic sentiment surveys improved. Manufacturing data was mixed. The German PMI manufacturing index fell from 49.4 to 48.7. The Eurozone PMI manufacturing index rose from 48.3 to 48.7. Numbers below 50.0 indicate contraction. This isn't a surprise since most of Europe is in recession. Standard & Poor's expects the recession to last throughout the rest of 2013 and adjusted their forecast last week suggesting any European recovery may not occur until 2014.
Europe is plagued with a number of sinking EU members. The International Monetary Fund (IMF) just issued a new report on Spain that suggested the country's banking system remains fragile and likely a drag on the economy. The situation in Italy is not improving as the nation's retail association said the recession is so bad that 134 retail stores close every single day and more than 200,000 retailers have closed since the recession began.
Greece continues to flounder. The small European country just announced that they found a new 1.2 billion euro budget shortfall and they needed more help from the EU or their largest healthcare provider would go crash. Meanwhile Cyprus, another tiny EU member, appears to be in a death spiral as the country deals with the aftermath of its recent "bail in" when the Cyprus government and the EU regulators stole cash from bank depositors to help pay for a bank rescue. Cyprus businesses are going bankrupt. Unemployment is skyrocketing. Money is rushing out of the country in spite of government capital controls. The Cyprus president is asking the EU to reverse the "bail in" (a.k.a. bank robbery) before his country implodes. Good luck with that!
There were two major stories last week for Wall Street. One of them was the Fed meeting and Bernanke's press conference. The other was China. The Chinese economy appears to be slowing down and the banking system is freezing up. The latest HSBC manufacturing PMI reported showed activity falling from 49.2 to 48.3. That's even deeper into contraction (recession) territory and a new nine-month low. The internal components suggested a sharp drop in new orders and back orders. Officially the country's growth rate has fallen from +9% in recent years to +7.5%. Yet there seems to be a growing camp of analysts that suggest the real growth rate in China is significantly less. Some of the outliers peg Chinese growth at +4.5% instead.
What really scares investors is the action in the Chinese banking sector. The band new Chinese leadership is squeezing the credit system in an effort to reduce bank leverage and stop a real estate bubble. Part of the problem is the huge "shadow banking" system. Many of China's banks are extremely leveraged. Private debt has ballooned to +168% of Chinese GDP. A number of these are non-performing loans. The banks have been unloading these into offshore entities to hide them from the government. Unfortunately, no one trusts the Chinese banks anymore and inter-bank loans are freezing up, which has produced a liquidity crunch.
The overnight interbank interest rates spiked to 25% a couple of days ago. If that happened here in the U.S. it would be Armageddon for the banking system. Unofficially there are reports that the Chinese central bank finally stepped in to inject $8 billion worth of liquidity into the system but overnight rates are still above 10%. The U.S. and Europe experienced a similar banking freeze during the 2008 Lehman Brothers crash. None of the major U.S. and European banks trusted each other so interbank leading stopped. Lehman Brothers, one of the largest and oldest U.S. banks at the time, was eventually forced into a bankruptcy that many have suggested almost brought down the entire U.S. banking system. Now we're witnessing similar stress on China's banking system. According to the Fitch credit rating agency the "shadow" banking system is "out of control" and the credit bubble in China is "unprecedented in modern history". Investors don't want to stick around to see what happens next. The China Securities Journal reported that money is rushing out of Chinese equity funds at levels not seen since 2008.
Federal Reserve & Ben Bernanke
The other big story was Federal Reserve Chairman Ben Bernanke and the FOMC meeting. For weeks the only thing Wall Street talked about was the future of QE3 and whether or not the Fed would "taper" their QE program. Everyone know that eventually the Fed would have to taper their asset purchases but expectations were for a change in the official Fed statement in September this year and maybe a slowdown in QE purchases in 2014.
There were hints in the latest Fed minutes from the prior meeting that the Fed might begin tapering sooner than that, which is what started all the taper talk in the first place.
Everyone claims that they want transparency from the Federal Reserve, especially after years of "Greenspeak" thanks to Alan Greenspan's cryptic statements. Well, Bernanke was pretty clear about the Fed's QE plans and the market didn't like what they heard. Bernanke essentially said that the risks to the U.S. economy have lessened and if the trend continues the Fed could begin tapering their QE3 program later this year and hope to completely end QE3 by the middle of 2014.
He reiterated that the Fed wanted to see unemployment fall to 6.5% as a starting point to consider Fed tapering. Yet market participants continued to ignore Bernanke's conditions to begin any QE taper and instead focused on the potential time frame for any QE reduction.
There were several analysts that pointed out some trouble spots for the Fed. First of all Chairman Bernanke suggested the U.S. economy was getting better but that very same day the Fed actually lowered their U.S. growth forecast for 2013. Currently the U.S. economy is growing at about +2%. Yet the sequestration budget cuts are expected to shave off -1.5% to -1.9% off U.S. GDP in Q2 and Q3 of this year. I fail to see how the economy is "improving" when the next GDP estimate is likely to contract sharply.
Some have suggested that Bernanke's taper bomb may have been a good bye gift to his boss, President Obama. In a recent interview Obama all but fired Bernanke suggesting Obama would not renew Bernanke's term when it expires January 2014. There was also speculation that Bernanke's strategy to end QE is part of his legacy planning before he leaves office. Whatever your beliefs about Bernanke and the taper talk his
comments ignited a firestorm in the equity markets but it was nuclear bomb for the bond market with the worst week in decades for U.S. bonds.
chart of the 10-year U.S. bond Yield:
It was a rocky week for the S&P 500 index with a -2.1% loss by Friday's close. The pre-FOMC meeting breakout higher proved to be a bull trap. The index reversed sharply and broke down below technical support at its simple 50-dma and below its multi-month trend line of higher lows (see chart).
You will notice that the index managed a bounce off its simple 100-dma on Friday (near 1577). This also happens to coincide relatively closely with the market's prior all-time high from 2007 (near 1576).
On a short-term basis the S&P 500 index looks poised to bounce. I am expecting the index to rebound back to the 1620 area. Unfortunately the 50-dma, which was prior support, is now new resistance. It is very common for an index or a stock to bounce back just enough to "kiss" the prior supporting trend line and then reverse lower again.
Look for overhead resistance at 1620 and 1650. Watch for possible support in the 1550-1540 zone. If that level fails then look for possible support at the 200-dma (currently 1506) or the 1500 level.
chart of the S&P 500 index:
Weekly chart of the S&P 500 index:
The NASDAQ composite lost -1.9% for the week and also broke down below its 50-dma. The breakdown below 3400 is bearish the NASDAQ may still find support near its 100-dma, which coincides with the trend line of higher lows dating back to November. Don't be surprised to see a bounce near 3300. At the same time I would not be surprised to see any rally fail near 3450.
chart of the NASDAQ Composite index:
The reversal in the small cap Russell 2000 index ($RUT) was dramatic with a failed rally at round-number resistance near the 1000 mark. The $RUT broke down below its 50-dma but bounce near its trend line of higher lows (see dotted line on the chart). This also coincides relatively closely with its prior highs from March earlier this year.
I do expect a short-term bounce. If you're feeling optimistic you could argue the $RUT is still building a potential bull-flag consolidation pattern but we would need to see a confirmation breakout past the 1,000 level. If the weakness continues and we see the $RUT break support then the next significant support level is probably the 900 area, which will soon be bolstered by the simple 200-dma.
chart of the Russell 2000 index
Economic Data & Event Calendar
The pace of economic data slows down this week. The highlights will probably be the durable goods and consumer confidence numbers. The real estate sector might move on the home sales reports.
We're less than a month away from the launch of Q2 earnings season.
Economic and Event Calendar
- Monday, June 24 -
- Tuesday, June 25 -
Durable goods orders
Case-Shiller 20-city home price index
new home sales
- Wednesday, June 26 -
Q1 GDP estimate
- Thursday, June 27 -
Weekly Initial Jobless Claims
EU Economic summit
personal income and spending
pending home sales
- Friday, June 28 -
University of Michigan consumer sentiment (final June reading)
Additional Events to be aware of:
July 4th, U.S. markets closed for holiday
September - U.S. debt ceiling deadline
The Week Ahead:
Technically the stock market looks short-term oversold. I am expecting a short-term bounce. Odds are good the S&P 500 may find resistance near its 50-dma and the 1620 area. It's also worth noting that we've hit the last week of June. That means it is the last week of the quarter and last week of the first half of the year. Stocks could see some window dressing. Yet the last twelve years there has been a pattern of weakness the last week of June. It's sort of a post-Fed meeting depression followed by a small rebound the first week of July.
It's also worth pointing out that in spite of all the damage done last week the longer-term, multi-month trend for stocks is still up. At the same time, we've been overbought for a while and way overdue for a correction. The U.S. market has finally seen a -5% correction. History will tell us that normally the correction doesn't stop at just -5%. Typically a market correction is in the -8% to -12% range. That would suggest the selling isn't over yet. While I expect a bounce traders could use it as a new entry point to reload shorts. A -8% correction from the S&P 500's close of 1669 would be about 1535. That's pretty close to support near 1540. Meanwhile a -10% correction would be a drop to about the 1500 mark.
Most of this year the driving force behind the stock market's rally has been the Fed. Now that the market thinks the Fed could be out of the QE business 12 months from now (most likely an incorrect assumption) then bulls will need to find a new catalyst to drive stocks higher. I suspect that we could see stocks trend lower or chop sideways until the Q2 earnings season begins in mid July. Investors will be looking for corporate results and guidance to provide a new reason to buy stocks (or sell them).