Fundamentals May Halt Stock Rally: Should I Stay or Should I Go?

At some point during a bear market rally (we remain in a bear market until proven otherwise), market participants have to ask themselves, "Do I believe we have the fundamentals to support the recent move in stocks, oil, etc.?" Recent news continues to point to fundamental weakness, not a fundamental turn. Industrial production in Europe fell 17.3% from the year-earlier month, the largest decline since records have been kept (1986). A number like this does not point to a global recovery in progress.

Too Much Economic Slack: As the chart below shows, it is unrealistic to expect the economy to turn when we have capacity utilization numbers continuing to fall in the United States at an alarming rate. Excess capacity in a business is excess overhead, which cuts into profit margins. Excess capacity means even when we do see some improvement in the economy, businesses will have little pricing power for quite some time. It also means CEOs will have little need to spend money on any projects related to production, which in turn lowers demand for heavy equipment, materials, etc.

Fed Aware of Spare Capacity: Chairman Bernanke is desperately trying to stimulate demand to get idle production equipment and workers back in business. As oil (USO, USL) and commodities in general (DBC) move higher, the excess capacity or “slack” in the system should not be ignored due to the possible long-lasting deflationary effects. Industrials (XLI), such as General Electric (GE), 3M (MMM), Boeing (BA), and Caterpillar (CAT), all face new challenges as deleveraging across our entire economy constrains credit and demand. We have capacity for a highly leveraged world. We no longer live in a highly leveraged world. We will not live in a highly leveraged world again for many years.

Fundamental Problems In Washington: Private capital and private firms are hesitant to participate in the Fed’s TALF (Term Asset-Backed Securities Loan Facility) for fear the terms will be subject to heavy ex post facto modifications. With little respect shown for private contracts and constantly changing rules and regulations, companies, hedge funds, banks, and private equity firms are questioning any discretionary interaction with the government and its programs. The government knows it cannot do this alone. It needs private capital to compliment countless federal “liquidity” facilities. Private capital remains reluctant at best.

Recession vs. Printing Press: As investors, the question in the short-run becomes, "Can the Fed print enough money to overcome the deteriorating fundamentals?" Numerous markets have hit possible crossroads where these questions need to be answered. The S&P 500 may answer the question in a positive manner if it can clear 806. Failure at 806 may mean the answers to the fundamental questions are "we’re not quite there yet". We have discussed the importance of fundamental and technical alignment in past articles. From our perspective, the fundamentals and technicals of this market remain aligned in a negative fashion, the worst possible combination for investors. A clear break of 806 on the S&P 500, would give the technicals some positives to possibly build on. Between here and 806, tread with care.

Disclosure: The author and CCM clients have positions in SH.

Comments

[zermux:]

On Equities I am staying all cash for a bit until the technicals get a little less murky. I expect to go short again, however I'd like to see the nasdaq confirm the Dow and SPX moves.

I am considering shorting 30 yr treasuries - they should have gone higher after the Q.E. announcment. The fact that the 30yrs did not make new highs, and kept within trading limits, means that there are a lot of sellers out there.

Mar 22 05:34 AM

[mrktcap:]

the 806 will break this week. I believe we are out of the gloom and doom faze. I wouldn't hold any short possitions next week.

Mar 22 09:12 AM

[William Cowie:]

Chris, good article, but it would be interesting to see the capacity untilization chat juxtaposed with the S&P index. That would give us an indication whether capacity utilization is a leading or trailing indicator. Given that the market looks forward, while the capacity utilization index, by its nature, is historical, I'd expect the S&P to lead. If so, this chart, while useful, takes place in the rear view mirror of the stock market. And, consequently, the trailing fundamentals will not cut short the true rebound, when it decides to manifest itself.

Mar 22 03:46 PM

[Leandro Taub:]

Great article Chris.

The next point will be around 860.
I think that the S&P will go to trade beetween 850 and 920 for a while. There, depends on how the market interpret the new information, we will se the S&P go over 920, or go under 850 again.

Mar 23 08:31 AM