Archive for April, 2016

Manufacturing Recession?

Friday, April 22nd, 2016

Markit ManufacturingBy this point, most readers of this blog know that I am in a very defensive posture relative to portfolio construction.  We are holding money markets and fixed income in an effort to have some dry powder available to buy our favored holdings when we get a correction.  I thought we would have had it by now given that corporate earnings are down 8% year-over-year and that valuations for the stock market are at their highest level since the last recession.

Fundamentally, stocks are over-valued and the US economy is slowing appreciably.  US GDP growth was 0.3% in the first quarter of the year according to the Atlanta Federal Reserve Bank.

Today, the Manufacturing PMI was released which shows the US manufacturing sector headed to recessionary levels not seen in several years.  Chris Williamson, chief economist at Markit said:

“US factories reported their worst month for just over six-and-a-half years in April,      dashing hopes that first quarter weakness will prove temporary.

     “Survey measures of output and order book backlogs are down to their lowest since the height of the global financial crisis, prompting employers to cut back on their hiring.

“The survey data are broadly consistent with manufacturing output falling at an annualized rate of over 2% at the start of the second quarter, and factory employment dropping at a rate of 10,000 jobs per month.

You can see in the graph above from Markit that manufacturing activity is just about to head into recession.

Below is a graph of manufacturing employment from Markit:

Markit EmploymentYou can see that this is seriously impacting employment in the manufacturing sector as well.

The stock market has been going up in spite of the fundamentals deteriorating.  However, even though it has tried multiple times to break out to new highs, it just has not been able to do it.  Check out the graph below:

S&P 500 2016.l04.22Over the past year, the market has dropped, recovered, then dropped again. The general pattern is for the market to fall, recover but not as strongly as before, then to fall again even further, recover but not as strongly – wash, rinse, repeat.

You can see that the market looks like it has rolled over but we need to see some follow-through before we determine if we’ve entered a correction or not.

From a technical standpoint, we are in a bear market correction until it can break above the horizontal blue line and start a new leg higher.  I have trouble believing it can continue higher in the face of falling earnings and a slowing economy – but given that the computers are now making most of the trades based upon momentum strategies, the index will go further in each direction than makes sense before it switches and moves in the opposite direction.

Happy Earth Day!


Lower Highs and Lower Lows

Tuesday, April 12th, 2016

SPX 2016-04Its been a few weeks since the last post on the blog – the market has meandered up and down and we are just now seeing the pattern that is developing.

In the graph above, you can see the formation of a series of lower highs and lower lows with investors unable to move the market to a new high.

From a technical standpoint, this is not a good sign for the market.  But lets take a step back and remember what chart reading is really all about.  The charts are just graphic representations of investor behavior and sentiment.  This chart shows that there was positive sentiment that lead to a new high almost a year ago.  Since then, investors have been in a tug of war with part of them in a glass half full mood and part of them in a glass half empty mood.

The glass half empty crowd:  (1) sees a stock market that is overvalued at 25 times earnings, (2) sees corporate earnings that have steadily been falling over the past year and a half,  (3) sees a slowing economy with the manufacturing sector already in recession and the service sector bouncing on either side of zero growth, (4) see a Federal Reserve that is in a rate increase mode, even if that mode is projected to be slower than originally forecast, and (5) believes we are headed into a recession later in the year.    Their view is that the market needs to correct so that valuation comes in line with these headwinds.

The glass half full crowd:  (1) sees the US economy being stronger than any of our trading partners, (2) sees a potential for strengthening of the Chinese economy, (3) believes that the steps taken in Europe to stimulate its economy should begin to produce dividends, (4) sees the dollar weaken against foreign currencies, which should be a positive for corporate earnings, and (5) sees a Federal Reserve that is putting the brakes on rate increases.  Their view is that the market can push to new highs.

When you look at the graph, you can see that the investment crowd with a negative view is winning this battle.  They have been able to drive prices down, then those with the positive view jump in to buy the dip.  Unfortunately for them, they do not have enough strength or conviction to drive prices higher.  You then have another selloff to a lower level before the dip buyers jump back in but lose steam before moving to a higher point.

Given the forecast for falling earnings and the current valuation at 25 times earnings compared to the historic average of 15 times earnings, caution is warranted.

Based upon this, we have adopted a conservative strategy in our portfolio management.  There is a time to be aggressive and a time to be conservative, and given the fundamental landscape for earnings and the slowing economy now is a time to be conservative.