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Puritan53
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I'm an invester and trader who combines a fervent passion for the financial markets with experienced trading skills. My business experience spans three decades and covers multiple disciplines: sales, financial services and management. As a small business owner and salesman on Long Island I... More
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  • Emerging Markets & Treasuries Rally?

    Stocks had another choppy week and most major indices finished lower. The uptrend hasn't been violated and the "experts" are speaking of a sector rotation into cyclicals and there is some indication that that is occurring. However there are also indications that this market is losing momentum and that we may be setting up for some type of corrective price action. Determining the severity of such a correction is impossible, especially with an incredibly accommodative central bank supporting the market. Additionally, traditional inter market relationships that have served as a compass to market direction have gone haywire due to a confluence of geopolitical and economic events. I'll be outlining my concerns and attempting to read the market "tea leaves" in this commentary.

    Here's a chart of the Wilshire 5000 which represents the total US stock market:

    (click on chart for larger image)

    US stocks are in a clear uptrend but the two panels above the chart reflect waning momentum and the Wilshire presently sits on a trend line established from the November 2012 lows.

    Small cap stocks were pummeled this week and finished a whopping 3.51% lower as measured by the Russell 2000. Here's a daily chart of the Russell as of Friday's close:

    (click on chart for larger image)

    Notice the very bottom panel under the chart. The Russell's price relative to the S&P 500 has fallen off a cliff!

    As I had commented yesterday on Twitter, the Russell tends to overshoot to the upside and undershoot to the downside because of the volatile nature of small cap stocks. However, as we look at sector ratio charts we can see a clear movement by investors into defensive issues. Here's a daily ratio chart of the Utilities Select Sector SPDR (XLU) and the Materials Select Sector SPDR (XLB). Utilities are seen as a safe haven as they are low "beta" (not volatile) and return higher dividends than the general market. Additionally, they weather market corrections fairly well. The Materials ETF is a bet on stronger economic fundamentals:

    (click on chart for larger image)

    Utilities have been outperforming Materials since the beginning of March as investors seem to be migrating away from economically sensitive stocks. Here's another ratio chart of the Consumer Staples Select Sector SPDR (XLP) and the Consumer Discretionary Select Sector SPDR (XLY). The thesis behind this ratio chart is that when economic activity picks up consumer discretionary stocks tend to outperform as the public simply has more money to spend for items other than what they need to subsist. Conversely, when they are feeling pinched they stick to what they need (consumer staples). We can also see here that consumer staples are outperforming their discretionary counterparts:

    (click on chart for larger image)

    Lastly, here's some evidence of the sector rotation that many on the street that they say explains the market choppiness of the past few months:

    (click on chart for larger image)

    This chart is a ratio of the Industrial Select Sector SPDR (XLI) and the S&P Biotech Index ETF (XBI). The Biotech sector has been responsible for leading the entire market weakness over the past few weeks after their incredible run up over the past year. Many on the street attributed "bubble like" qualities to the sector which engendered a wider discussion on the excess liquidity which continues to "float all boats" in this market. Well, it would appear that some air is being let out of the Biotech bubble and that capital may be moving into Industrials. The problem with the chart is that everyone is bailing out of the Biotech sector and if I substitute any of the other ETFs for XLI in the chart above I get the same result. However, in comparing different economically sensitive sectors it does clearly show there is a movement into industrial stocks. Here's the Select Sector Industrials SPDR ETF (XLI) and the Select Sector Consumer Discretionary SPDR (XLY) which I used in a comparison above:

    (click on chart for larger image)

    The chart clearly shows that there has been a steady movement into industrial stocks over the past year and that it has accelerated in the last month.

    The take away from all this is that investors and traders are concerned about present valuations but not concerned enough to be "running for the hills". Positioning in defensive sectors and economically sensitive sectors tend to be running in tandem.

    Now, the bond market is telling us another story and it's interpretation is not kind to stocks. Bonds are being stubborn at present levels and prices refuse to drop. If the economy is truly gaining momentum we should be seeing a commensurate rise in interest rates across the yield curve. Instead, interest rates dropped week over week on longer duration maturities as the short end gained because of Janet Yellen's pronouncements the week before last. Trying to understand why longer duration bonds are rallying would require an explanation which would keep me typing all weekend and so I'll just posit some reasons why this is happening:

    1. China is buying Treasuries in order to continue to devalue their Yuan

    2. Geopolitical events are keeping a bid under Treasuries

    3. And this is an outlier, the Fed may be getting a new customer, the ECB (European Central Bank).

    I'll be discussing point number three in my analysis below but the primary thematic take away from the three points above is that mammoth disinflationary and deflationary forces still reign in the global economy.

    Here's a daily chart of the iShares Barclays 20+ Year Treasury Bond ETF (TLT) and we saw a significant short to intermediate term breakout this week on the chart which speaks to even lower interest rates going forward:

    (click on chart for larger image)

    TLT penetrated gap resistance this week and although it's performance was weak on Friday it did manage to decisively bounce off of gap support.

    The bond market has traditionally been inversely correlated with stocks since 1997-1998. Whenever it runs in the same direction with stocks there has to be a resolution and that resolution is normally resolved in bonds favor. Remember, lower interest rates signal economic weakness and is not good for equities.

    Commodities seem to be telling us a different story relating to the prospects for global economic growth. Much has been made of the rally in the CRB Index (The Reuters/Jefferies Commodity Research Bureau Index). I've dismissed this rally in the index as largely due to "one off" events in the agricultural commodity space because of weather or geopolitical issues which are disrupting supply and demand in certain key commodities such as wheat. I've taken some "heat" for holding to my thesis but I still stand by it. I will say this: if my thesis is wrong and we don't start to see a reasonable uptick in global economic activity in the spring then the specter of "stagflation" confronts us as central banks will finally have accomplished their mission of perpetuating "cost-push" inflation. However, I will stand be my thesis and that is still that deflation remains the primary danger to the world economy.

    Here's two charts; one of the CRB Index and right below it is the SPDR Gold Trust Shares (GLD):

    (click on chart for larger image)

    There was a potential Island Reversal pattern on the CRB chart but that has been reversed. At the same time, I've been looking for Gold to start it's turn around to validate all these inflationary pressures everyone seems to be emphasizing. So far, no cigar.

    Industrial metals had a good week mainly because Copper recovered from multi year lows. Here's a monthly chart of "Dr. Copper" which clearly shows it "has returned from the abyss":

    (click on chart for larger image)

    I don't want to minimize the incremental price pressures we have seen in the industrial commodity space. Another notable mover has been nickel. But even nickel has been rallying on supply/demand issues as Indonesia, a major nickel exporter, has placed export restrictions on the metal. My point is that just because we're "coming back from the abyss" doesn't mean all is well. As a predictor of global industrial activity, we need to start seeing some significant upside pressure in industrial commodities. So far, this has not been the case.

    All was not neutral to negative this week. Emerging Markets came alive as things seemed to stabilize in China after it's major banks reported strong earnings. The Shanghai Composite has stabilized above the 2000 level as rumors of additional government stimulus run rampant in the market:

    (click on chart for larger image)

    And the Chinese banks as a ratio to the broader Chinese stock market are making a comeback:

    (click on chart for larger image)

    The main concern in China has been the smattering of defaults that the Chinese government has recently started to allow in order to address "moral hazard". Investors want to know who will be left holding the bag if/when their shadow banking system implodes and the banks have been primary candidates, in investors minds, to "hold the bag".

    The fact that copper stabilized this week and we're seeing strength in the Chinese banks is an indication that things in China are not liable to get out of control. But you never know! Chinese markets are not exactly transparent.

    Nevertheless, with a seemingly stabilized situation in China the iShares MSCI Emerging Market ETF (EEM) exploded on Monday and never looked back:

    (click on chart for larger image)

    I circled the week's price action and although Friday's price action was a disappointment (a sickly candlestick) the ETF tore through the 50% Fibonacci resistance level and is now poised to assault the 61.8% level. After Friday's price action I expect a bit of a pause here and some consolidation.

    The move in EM this week is certainly a positive for our markets as there is a strong positive correlation between EM and US stocks. They are either coincident to each other or one leads the other. It appears that EM will now play "catch up" with US equities in the weeks and months ahead. That assumes, of course, that we're not going to have the annual Spring "head fake" we've experienced since 2010.

    ANALYSIS

    All the market activity I've addressed above is symptomatic of confusion and indecisiveness in where the global economy is headed. The consensus among many on Wall Street is that we are truly going to see our way out of this mess in 2014 and with that, the commensurate rise in interest rates will take place that will validate a stronger recovery.

    No one is predicting a "gangbusters" year but the positioning into industrial stocks I've illustrated above cannot be denied. Of course, the debate over market valuation in the face of extraordinary monetary stimulus continues to rage.

    In the meantime, leaders in the EU (European Union) have decided to admit and address the deflationary juggernaut they are facing instead of dismissing it as "internal devaluation". This week French, Italian and Spanish inflation numbers came in below expectations (read deflation) as did German inflation numbers. In addition, French consumer spending has deteriorated significantly. Even the inflation fearing head of the Bundesbank, Jens Weidmann, has agreed to some sort of quantitative easing, if only in theory.

    Of course, with all the regulatory strictures placed on the ECB due to a monetary without fiscal union, how QE gets accomplished has been the challenge since the dark days of 2008-2009.

    Many are talking about establishing negative interest rates which supposedly would spur European Banks to lend. The assumption is that banks would lend and that there would be lenders. My position is that negative interest rates, besides distorting Money Markets, would drive liquidity from the EU as banks would simply move assets offshore to other banks that would give them a return on their capital. What is needed is a way around their regulations in order to effectuate liquidity injections. Marc Chandler of Brown Brothers Harriman has suggested what I call "the Swiss solution". In 2010 as the Swiss started facing deflation from a stronger Swiss Franc, the Swiss central bank, unable to pump liquidity in the system by buying up their own debt (the market being too small) went out into the global debt markets and started buying foreign bonds. Buying foreign bonds with Swiss Francs expanded their money supply thereby deflating the value of their currency and easing deflationary pressures. The ECB could do the same as there appears to be no prohibitions to such purchases. Whether the fickle Germans go along with this would be one question although they could not stop Draghi from these purchases if there are no restrictions on these type of purchases.

    If the ECB were to pursue "the Swiss solution" who would be the main benefactor of their purchases? The US Treasury market! This would assist in driving rates lower, regardless of any counter forces that would push them higher.

    My point in bringing all this up is that these deflationary pressures in one of the two largest developed consumer oriented global economies are the predominant danger to the world economic system. And we are right behind the Europeans, regardless of what the "experts" say. Here's the latest update on the Velocity of M2 Money Supply released by the St. Louis Federal Reserve:

    (click on chart for larger image)

    It is still clocking it's lowest readings since the Fed started tracking it in 1958. How strong can an economic recovery be when the pace at which a dollar changes hands has been it's lowest on over five decades?

    Here's another chart that measures the three components of inflation:

    - the CPI (Consumer Price index)

    - Compensation & Salaries

    - Velocity of M2

    (click on chart for larger image)

    chart courtesy of dshort.com

    All three components are headed lower.

    Here's another way to analyze the data. This is called the "High Inflation Index" which tallies Year over Year CPI (Consumer Price Index), wage growth and M2 Money Velocity :

    (click on chart for larger image)

    chart courtesy of dshort.com

    So, what does all this have to do with stocks? In an environment where the world's largest and most powerful central bank is starting to drain liquidity from the global monetary system, Europe is facing outright deflation and disinflationary pressures are mounting in the US.

    As stated above, the debate has raged for years regarding the extent to which the Federal Reserve's extraordinary liquidity programs have effected equity markets. And while there can be no denying that, in their efforts to spur a "wealth effect" there has been an artificial inflation to equity prices the question is, how much? And how much of the current disinflationary pressures we are dealing with will exacerbate a downturn in the stock market when it occurs? For occur it must! The market never goes straight up or down. And these five to six percent corrections hardly qualify as corrections.

    In the meantime, we have an active economic calendar coming up next week culminating with the Monthly Employment report on Friday. Everyone will be watching this report as an indication that the much awaited turn around in poor economic data as a result of the inclement weather in January and February was an aberration. But to me, the ECB's announcement next Thursday may be more important. If they are unwilling to aggressively address the deflationary spiral they are clearly caught up in then inevitably it won't matter over the long haul how well our economic stats are in this country. We're all inter-connected and you can't have a healthy global economy with a major sector of that economy in the throes of deflation. It can be likened to trying to swim with a thirty pound weight around your waist!

    Have a great week!

    Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

    Mar 29 12:31 PM | Link | Comment!
  • The Yellen Effect

    In spite of a midweek hiccup. stocks maintained upward momentum last week with the S&P 500 finishing the week up 1.38% and small caps as measured by the Russell 2000 up on the week 1.04%. The NASDAQ Composite also finished the week 0.74%.

    This will be an abbreviated commentary as I have a busy weekend.

    Some pointed to Friday's price action as an indicator of impending weakness. I won't deny the possibility of weakness, although I would say it was not because of Friday's activity and that any weakness will be short term. On Friday, the S&P went "ex dividend" and went through some sort of re balancing. Additionally, it was a "quadruple witching" Friday which is when stock index futures, stock index options, stock options and single stock futures expire. These settlement days (settlement is actually on Saturday) are notoriously volatile and can go either way. In fact, the percentage of stocks on the NYSE that finished above their respective 50 and 200 day moving averages were higher on Friday than on Thursday when the S&P rallied 0.6% on the day. This told me that Friday's total activity was being held captive to internal market forces that had as much to do with options expiration and settlement than anything fundamentally changing in the direction of stocks.

    Nevertheless, most of the major indices and their sub indexes are exhibiting minor divergences that spell either a consolidation at present levels or maybe another "garden variety" 5 to 6% correction?

    The weekly and the daily charts of the S&P 500 I'm posting below are indicative of the loss in momentum in equities over the past month:

    (click to enlarge)

    (click on chart for larger image)

    Notice the top panel on the charts above and below:

    (click to enlarge)

    (click on chart for a larger image)

    At the same time bonds seemed to have taken it on the chin after the new Fed chairperson, Janet Yellen, dared to give an actual time frame on when short term interest rates would rise. In the Q&A after the FOMC meeting on Wednesday, when quizzed on when the first rate hikes would follow the end of the tapering by a "considerable period," Yellen defined a "considerable period" as "something on the order of six months or that type of thing."

    Whether Yellen's comment was an off hand gaffe (which is what I believe) or a thinly veiled message to investors, the S&P gapped down at least 18 points in the next minute only to recover 7 of those points before the close and short interest rate futures built in another 25 basis point increase into the first half of 2015 as the yield curve flattened.

    Interestingly, although the entire yield curve backed up on Wednesday, by Friday interest rates did drop down again although not below Tuesday's lows. Nevertheless, the concern I have is that interest rates are still hanging at relatively low levels in spite of all the talk that our economy is recovering. Add that this is with all the talk that China and Japan is dumping our debt! Well, someone is buying T-bonds and where there is enough buying to lower interest rates it's still a sign that something is amiss in the US and global economy. Here's a daily chart of the iShares Barclays 20+ Treasury Bond ETF (TLT) used by traders as a proxy for the long end of the yield curve - long duration bonds:

    (click to enlarge)

    (click on chart for larger image)

    It looks like long duration Treasuries are mounting an assault on a level that's failed to have been penetrated three times before. Noticeably, momentum is not backing the move (see upper and lower panels).

    There's SO much more to cover this week but I just don't have the time. My gut tells me that, outside of an exogenous shock, stocks will either consolidate this coming week at present levels or move higher. With China hinting at new stimulus to bolster their flagging economy and more relatively good economic stats out of Europe we are setting ourselves up for a strong April in the markets. Additionally, there's a lot of pent up sentiment in the US (call it cabin fever) as most of the country is anticipating spring. All we need is some more good US economic stats like we did this past week to vindicate the "weather" alibi of January and February and we're "off to the races".

    I'll leave my readers with an update of a chart I've been "tweeting" all week. This chart speaks to whether the central bank experiment to ignite "cost push" inflation is finally coming to fruition :

    (click to enlarge)

    (click on chart for larger image)

    As I review what I've written above, I've posed more questions than provided solutions. Inter market relationships this week were totally skewed, especially from Wednesday afternoon on. Let's see if next week reveals any answers to the riddles I posited in this commentary.

    Have a great week!

    Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

    Mar 23 12:20 AM | Link | Comment!
  • China, Deflation & Lower Interest Rates

    The Dow Jones industrial Average suffered it's first five day losing streak since May, 2012 and all the major indices took it "on the chin" as diplomatic wrangling over the Ukraine increased in volume as the trading week progressed and more bad news out of China lent impetus to the sell off. The pinnacle of the week was Tuesday when the S&P attempted a renewed assault on all time highs only to be repulsed. From there it was downhill as waning momentum culminated in Thursday's brutal yet methodical sell off. Here's a five minute chart of the S&P showing Thursday and Friday's price action:

    (click to enlarge)

    I've super imposed a five minute chart of the Japanese Yen to show the lockstep inverse correlation between the currency and US stocks. The Yen has been very helpful in understanding the near term direction of stocks and Thursday was no different as stocks popped at the open only to turn down after the first ten minutes as the Yen surged at about 8:40AM. It was all downhill from there.

    All the major averages finished the week down 1.75% or more and gold was the big winner, ending the week up 3.11%. Here's a daily chart of the S&P:

    (click to enlarge)

    We were told the reasons for the sell off on Thursday was events brewing in Russia as well as terrible economic news out of China which I documented in last week's commentary. And while that these two issues were the catalysts that sparked the weakness this week it's never as simple than that. So far as the crisis in the Ukraine goes, events are still very predictable mainly because, short of military intervention, there is nothing the West can do to stop Putin if he chooses to break up the Ukrainian republic. Certainly, at this point, Putin has to be considering the enormous depreciation of the Russian ruble as money exits the country at a rapid clip and this situation, more than any other, may put the brakes on his imperialistic ambitions. But when this is all said and done it will go down in the financial history books a a "splash in the pan". The global economy has much bigger fish to worry about and it is China!

    In the meantime, I'm looking for a bounce next week in stocks predicated on what I see as waning downside momentum in the indexes and Treasuries bumping into some resistance that could only be breached by another major negative news event. In other words, both Russia and China have been priced into stocks at this point. A proof of my thesis can be seen in small caps which also took a drubbing this week but had a surprisingly strong day on Friday before the weekend. Here's a daily chart of the Russell 2000:

    (click to enlarge)

    I circled Friday's price action and while the candlestick doesn't give us much hope in the immediate term the fact that the Russell had an "up" day ahead of a weekend fraught with geopolitical risk told me two things:

    1. Investors clearly understand that events in Russia will have no long term financial reverberations to the global economy and

    2. Investors were "bottom picking" in US stocks that have very little exposure to either global events or the global economy. More importantly, investors were willing to expose themselves to further possible downside going into a weekend where news events were liable to dictate where equity markets could move on Monday.

    Both points indicate to me that, in the short term, the bulk of the selling may be over.

    Certainly treasuries were giving us a similar signal in their own way. Here's a daily chart of the iShares Barclays 20+ Yr Treasury Bond ETF (TLT). TLT is a popular ETF traders use to place bets on the direction of long term bonds and interest rates (the long end of the yield curve):

    (click to enlarge)

    As you can see, TLT is at major resistance and has been turned away at this level twice before. My hunch is that after it's incredible surge on Thursday it will at least hesitate here and probably be turned away in the short term.

    For interest rates the line in the sand is 2.6% on the Ten Year Treasury yield. A yield below this level would start to speak to much deeper problems in the global economy. Here's a daily chart of the Ten Year yield:

    (click to enlarge)

    We traded as low as 2.61% intra day on Friday morning but bounced from there to close the week at 2.644%.

    The bond market will continue to give us our clues on the direction of stocks as well as the health of the global economy. The present level of interest rates are telling me that, Russia aside, all is not well with the global economy and even if the US economy is the "nicest house in a bad neighborhood" there are global headwinds which are creating a significant drag on our economy.

    Gold is also sending the market strong messages that, in my opinion, don't have that much to do with geopolitical events or inflation (as some are surmising). Here's a daily chart of the Gold spot price:

    (click to enlarge)

    The impressive surge gold has had is delineated on the chart and while it has bumped into Fibonacci resistance on Friday I expect it will cast this aside and continue to move to the major resistance I've marked on the chart ($1420 - $1430).

    After three months of economic crosscurrents and trying to solve the riddle of gold in terms of inter market relationships, to answer that riddle with cliches about Russia or "inflation" are misguided in my opinion. Gold is verifying the Treasury market's signal. Simply, gold thrives in a low interest rate environment and its recent surge is predicting a lower interest regime going forward. I know, how much lower can rates go? I'm not willing to gander a guess but there is no justification for the "inflationista" argument that gold is responding to future inflationary pressures in the global economy.

    Certainly, I'm sticking my neck out in presenting this thesis but let's look at the evidence that inflation is gaining ground in the global and US economy. It is true that agricultural commodities have had quite a run up in recent weeks. Here's a daily chart of the S&P Goldman Sachs Agricultural Commodity Index ($GKX) which penetrated a multi year down trend line in January and has been in a seemingly relentless bull market ever since:

    (click to enlarge)

    As we look at the reasons for the rally we see that the move in virtually all of these commodities are due to "one off" events, whether it was supply/demand issues due to weather events, geopolitical events in Russia (wheat), or the impact on livestock prices from higher feed prices. And the chart of the Reuters/Jefferies Commodity Research Bureau Index ($CRB) bares out my thesis:

    (click to enlarge)

    The chart above is sporting a classic "island reversal" chart pattern. If this pattern holds up (and I expect it will because it is very reliable) we will consolidate at the present level for the next week or so and then break lower. Admittedly, penetrating the gap support I've marked on the chart is crucial to my thesis. I've learned from past experiences never to be dogmatic when it comes to my opinions but I'm convicted about the correctness of this call. I'll be providing further support for this thesis below.

    I have concerns in the currency market that I believe will be pivotal to understanding the direction of all asset classes later this year and into 2015. However, I am going to delay an explanation of those matters as it's not pertinent to the short and intermediate term direction of financial markets. But I'd like my readers to see a weekly chart of the Euro:

    (click to enlarge)

    Euro zone leaders have been bemoaning the strength of the Euro in the face of the continued malaise the EU economy has been facing for years. Right now the Euro is fighting through a resistance zone I have not highlighted on the chart. If the currency can penetrate the 140 -142 level in coming months it will validate a grand thesis I've been considering that will have vast implications in the FOREX (foreign exchange market) and global economy. Stay tuned ...

    In a week where events in the Ukraine and Crimea took center stage, the real challenge facing the global economy was from China, which took a subordinate position to those issues.

    There are many charts I can display that substantiate the radical slowdown in the Chinese economy over the past few months and I've already highlighted in past commentaries the dangers in their corporate debt market that are only exacerbating that slowdown. In many ways, what is going on in China ties in with the grand thesis I spoke about above in addressing the Euro currency.

    As China takes the next steps to truly move their economy and country into the mainstream of the global financial system the growing pains are becoming self evident. The questions remains whether their leadership has the necessary finesse to effectuate those changes without plunging their economy into recession. So far the verdict is out as their banking system is taking a hit. Here's a ratio chart of the Global X China Financials (CHIX) to the Shanghai Composite Index ($SSEC). The chart is used to measure the strength of their banking system to the total economy as measured by stock performance:

    (click to enlarge)

    We've broken Fibonacci support but have stabilized in the last week. If we look at the Shanghai Composite we can see that it too, has stabilized above crucial support at the 2000 level but the situation is tenuous at best:

    (click to enlarge)

    For anyone who wishes to see some charts detailing the serious breakdown in the Chinese economy I refer you to an excellent post by SoberLook.com.

    As we get past the noise emanating from the Ukraine, the China problem and Fed tapering will once again move to the fore of the market's attention and hold it captive for the remainder of the year.

    Analysis

    The weather and now geopolitical events have taken the market's attention away from the issues which will be major drivers going forward. While it is true that China got some press relating to their slowdown I don't believe the street has come to grips with the possible implications a radical China slowdown would engender. The latest developments surrounding corporate debt defaults in that country could have a frightening outcome as investors flee that market now that moral hazard has been addressed. More likely, however, the result would be a progressive dry up of liquidity in that market which would only exacerbate an already rapid economic slowdown.

    We have our own problems in this country as inflationary pressures continue to wane. The Producer Price Index (PPI) for February came in on Friday below expectations once again, to which the street decided on a "glass half full" approach, mainly applauding "tame" inflationary pressures. But in a world awash in fiat currency and deflationary forces clearly having a stranglehold on vast sectors or the global economy, applauding waning inflation as "tame" is tantamount to burying one's head in the sand. The China slowdown is going to have a huge impact on these deflationary forces.

    Here's the latest chart of the iShares Barclays TIPS ETF (TIP) - iShares Barclays Seven to Ten Yr Bond ETF (IEF). The chart measures investors inflationary expectations. TIPS are Treasury Inflation Protection Securities tied to the CRB Index (highlighted above). As inflation expectations rise or fall investors will move in and out of TIPS and regular Treasuries that have no inflation protection.

    (click to enlarge)

    The ratio chart clearly shows that inflation expectations have been waning since 2011 while the S&P 500 (black line on the chart) continues to move higher. If inflation is a necessary by product of greater economic growth and velocity (and it is) why the divergence between the ratio and the S&P? This is not a new story and the answer is simple: the Fed has made it so. And this week we have another FOMC meeting which will finally take the market's focus off the Ukraine (good) and China (not good).

    The chart above validates the thesis I've presented above pertaining to the bond market, gold and commodities. While I expect a short term bounce this week in equities for the reasons mentioned above, the China story will continue to haunt us and will eventually slow growth in this country to the extent that it has to impact US stocks. How much will it do so? Much will depend on the Fed's "generosity". They are not going to change direction regarding the tapering of asset purchases at this time and I expect no new revelations from their meeting on Tuesday and Wednesday that will do anything but soothe markets. But if the economic drag that I think the China slowdown will spawn comes to fruition, more Fed stimulus may be needed later this year to bolster equity markets.

    While growth will still be tepid this year our economy is the strongest economy on the planet but to largely explain this bull market in terms of P/E ratios and balance sheet fundamentals misses the point of the divergence on the chart I posted above. I'm not predicting a bear market in stocks but the divergences above must be reconciled at some point. And I think the China slowdown may be the catalyst for this reconciliation.

    In the meantime, I think we will see lower interest rates in the coming months for the reasons I've specified above but look for a short term bounce in stocks this coming week.

    Have a great week!

    Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

    Mar 15 1:22 PM | Link | Comment!
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