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Warning Signs Are Evident For The Market


  • For the past few weeks, there has been an unrelenting short-term surge in relative strength of the Utilities sector relative to the S&P 500.
  • Because Utilities are the most interest rate sensitive part of the stock market, the sector’s movement can tell you a lot about shifting expectations on growth and inflation.
  • The remarkable yield curve flattening of 2s and 10s (largely driven by short-term rate movement) is happening on a part of the yield curve the Fed has far less control over.

"History is a vast early warning system." - Norman Cousins

It would seem that something is wrong.

For the past few weeks, there has been an unrelenting short-term surge in relative strength of the Utilities (XLU) sector relative to the S&P 500 (SPY). The move has been abnormally sharp in the face of a US market which has gone sideways, and a Treasury market (TLT) steadily creeping towards lower yields.


The significance of the move in Utilities matters a lot for us at Pension Partners and our ATAC Tactical strategies run in mutual funds and separate account format. As documented in the 2014 Dow Award winning paper, Utilities tend to outperform on a short-term basis when conditions begin favoring a potential accident in markets. Because Utilities are the most interest rate sensitive part of the stock market, the sector’s movement can tell you a lot about shifting expectations on growth and inflation. That in turn means their movement can be a warning sign that we are about to enter into a risk-off period.

There is confirmation happening in bonds as well. Long duration Treasuries on a short-term basis are also outperforming intermediate. The remarkable yield curve flattening of 2s and 10s (largely driven by short-term rate movement) is happening on a part of the yield curve the Fed has far less control over. As shown in our 2014 NAAIM Award Winning paper, this also tends to be a warning sign of conditions favoring an accident.


Emerging markets (EEM) have been in a severe correction since the peak this year, and it isn’t a story just about China (FXI) or tariffs. Plenty of countries unaffected by policy are feeling the pain. Now, US markets may end up “catching down” to emerging market weakness. As Charlie Bilello

This article was written by

Michael A. Gayed, CFA profile picture
Michael A. Gayed is portfolio manager, and author of five award-winning research papers on market anomalies and investing. He has a BS with a double major in Finance & Management from NYU Stern School of Business, and is a CFA Charterholder. Michael runs the investing group The Lead-Lag Report, focused on helping investors outperform in all market conditions. It offers a tactical, data-driven approach to investing, to achieve long-term success even in the face of uncertainty. With increasing market volatility, it's essential to understand risk-on/risk-off signals, seize high-yield opportunities, and leverage award-winning research to maximize returns. Learn More.

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

Seeking Alpha's Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.

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Comments (45)

Phil Anthropy profile picture
The problem is not the fault of the buyers, nor of the sellers, who both act out of reasonable self-interest. The problem is deeper than that.

It begins with taking the U.S. off the gold standard, after which the 1960s book "Europe on $5 a Day" no longer applied. The minimum wage of $1.25 per hour, which was nearly enough to live on, no longer applied. In the 1960s there were high income taxes, which could be mitigated by investment in domestic infrastructure, a powerful motivator to keep money here at home and not overseas. The Reagan era tax cuts came at the cost of hugely expanding our national debt. Supply side economics only works if the new money circulates in the domestic economy. Globalization and rising oil prices took it overseas.

The deregulation of the stock market and gutting of the SEC led to rampant abuses, which have become commonplace, with no consequences. Unregulated derivative trading and the repeal of Glass-Stiegel led to a financial meltdown, where we bailed out the "too big to fail" banks and other institutions. Monetizing the debt by the Fed, plus the absorption of our Treasury bonds abroad, transfered wealth from the U.S. to producer countries.

The big banks are now bigger than ever, and the Bank for International Settlements (bis.org) controls hundreds of Trillions of dollars in derivatives. High speed traders and so-called "market movers" front-run and manipulate stocks, some might allege. Corporate buybacks of company stock artificially prop up the stock prices in the absence of any revenue increases that would signal actual growth.

It's a long story, and now we and our kids have to face the music. A gradual shift back to the successful policies of the past, slow enough to avoid major disruptions but fast enough to have a positive impact on our national debt and trade imbalance, might seem to some as a wise course of action. If we don't come up with a plan soon, the national debt will eclipse our GDP, the dollar will no longer serve as a world currency despite the machinations of the Fed, and the we will end up like other countries whose greed overshadowed their greatness.
kos47 profile picture
"In a way it is also the Americans fault for buying Chinese goods."
No, it is the Americans fault for selling them.
You do know Donald Trump Daughter Ivanka, gets bulk of her merchandise from China? Maybe he should start at home before making the "America Great Again".
No we dont have to buy them. In a way it is also the Americans fault for buying Chinese goods. Most dont even look to see where it's from and sometimes ya have no choice. I am sure that President Trump would shave done better raising awareness and advertising to the people to be patriotic and bu American made patriotcts. it is also the fault of American companies cause so many are in packages that dont even say " MADE IN THE U.S.A. !. Many times it says on the back of the package and the writing is so small you really would shave to look for it. Makes me mad.
kos47 profile picture
"China dumps $500 billion of junk on us"
That's right. But, we don't have to buy them, do we?
Not all market expectations are rational and forward-looking, especially about Chinese growth.
Phil Anthropy profile picture
It is interesting that the trade policies of Bernie Sanders and Donald Trump are quite similar: restore American's manufacturing base, protect middle class workers, strengthen unionized industries. In an actual "free trade" world, currency equilibration as a consequence of trade imbalances would correct anomalies, but as long as we are selling our debt overseas to soak up the excess dollars, it doesn't work. Instead, producer countries become rich at our expense.

Since we can't cut spending because of deflationary impact, can't raise taxes for the same reason, and can't cut taxes without somehow increasing productivity to offset the deficit increase, if anyone has a solution other than tariffs, please bring it forward.
The trade picture in a nut shell there Phil, that's why our trading "friends" have one big hissy fit when the dollar starts to devalue.
petz0012 profile picture
Trump is not doing or interested in any of those things. Look at the actual policy. If Trump wanted to help the middle class we'd have more tax brackets not fewer.
Kirgkyboy, you are right. China dumps $500 billion of junk on us and we send them 136 billion dollars in return. Sure a trade war would hurt the USA but it has to hurt them more. And yes , something is hurting out there and it is the Emerging markets. It did ok yesterday compared to the S&P but it is heading for it's 52 week low by next week at tis rate. Surely China is going to hurt more than us. Ever buy a tool from China? Drill bits , other tools are just junk While Taiwan tools are darn good. We send them wheat m they send us kid toys that are in the garbage in one week cause they broke. And I commend Trump for being the first president to do something about it. The rest just shrugged their shoulders. If we would have had even trade for 50 yrs and make our own we would be a lot better off than we are now, although, we are still very well off. They are not ridiculous trade policy when we buy 500 billion dollars of mostly junk and we sell them food. Which is more important? Happy birthday America, America forever!
Well said ihookem, China also likes our t bills, we get tons of cheap, wears out in a year consumer goods, they get food, industrial equipment and 30 year we pay them interest every year t bills.
Let's look at this whole "world trade deal" with a dose of reality thrown in. A world " trade war" will result in less world trade, everybody putting tariffs on the other guy's export to their own country. And what will be the result? Well, less trade I would imagine and also a point no one brings up. Everybody gets more tax revenue from the tariffs. And who will hurt the most? Short answer, the countries that export the most. I'd love to see this "trade war" but it's not going to happen. Trump will chicken out at the last moment, claim victory and actually do nothing. The rest of the world needs us to buy their stuff, stuff we could easily make here, in most cases for virtually the same price. But if we don't help them, they,they will turn communist!! Oh that's right, communism doesn't exist anymore. Oh well there must be some reason we're buying all this world produced junk.
cemanuel profile picture
"I'd love to see this "trade war" but it's not going to happen. Trump will chicken out at the last moment, claim victory and actually do nothing."

Here's the fundamental problem with what Trump is doing - once you set aside the fact that he's determined to fulfill his campaign promises even if they're bad policies - I have some grudging respect for him doing something most elected officials don't in enacting what he ran on, the problem is some of these don't make sense.

But trade actually isn't one of them. There are trade inequities out there. The real problem is that he should have pointed to the most egregious offender (based on rhetoric that's China but I have no special knowledge saying that's right or wrong) and taking action against that country alone. We could win that trade war (skirmish really). Once that's taken care of you go to the 2nd-worst, 3rd-worst and so on.

Instead he's gone after China, Canada (really?), Europe and Mexico, all at the same time. Guess what - we won't win that one. Instead of taking a divide and conquer approach he's decided on a unite and be beaten strategy. Nice that he's fulfilling a campaign promise, be nicer if he picked a fight he could win instead of this, "let's piss everyone off and see how that works."

I'm setting aside the fact that China is so damn rational about everything and plays the long game better than anyone - and doesn't have to worry about the public opinion of its residents.
cemanuel, Trump is too wide in his trade attacks, that's why he'll back off before the tariffs take much effect.
cemanuel profile picture
Actually he'll back off once the tariffs start to have much effect - on us. Hopefully there's enough resiliency in the economy for it to have not set up a snowball effect by the time he does.
leeo268 profile picture
How can bull market survive in these environments?
1. World Trade War II
2. Higher Oil Price. Almost $80 right now
3. Increasing interest rate. Just look at 10 yr now. Corporations will have to sell their kidney to sustain their interest payment.

The market is only propped up now by currency flight to US bond and equities, but that just inflate asset prices because fundamental is deteriorating. When the market finally correct, things will be pretty ugly, not sure if US gov can still bail out the world again.
If your not in the know, you'll never know. If your not connected to the 1 % club you'll never know. The powers that be are ruining this World. Greed and Religion and Ethics are so perverted now it's a sad shame. Look at the history of the world... We are in ancient/modern Babylon and will have the rug pulled out once again. The divide has started and that weakens US. Don't Tread On Me
Instead of panic selling based on FUD Strategy.

Let the Winners Run.

<< Strength Begets Strength Part I: drive.google.com/...
>> Strength Begets Strength Part II: drive.google.com/...

>> Weakness Begets Weakness: drive.google.com/...

Excellent performance of $UTY from 2002 to 2007 with 192% rally in 5 years vs. only 107% by SnP500. Utilities went vertical and traders/investors kept chasing it for it's out-performance in 2002 to 2007. Amazing strength vs. SnP500. That's how you can make money the fastest way - by chasing momentum.

- SnP500 was a 'dog' particularly in 2004 to 2006.

Until of course $UTY got 'killed' by the divergence sell signal. Ditto for SnP500 as it topped out in October 2007 then collapse very badly to March 2009 bottom with -57% loss. The weak got slammed to the floor.

$UTY collapsed less by -48%, not bad at all.


For momentum traders, they prefer markets to keep gaining strength.

- Strength begets strength.

The weak ones will under-perform.

With extremely high success rate of New Momo Highs (RSI) for the markets to rally into new highs - after temporary rest periods; i don't know why far too many traders and investors are afraid of the markets when they become stronger and stronger. They must have been brainwashed by the FUD Specialists.

They should be afraid when markets become relatively weak (RSI).

Of course you can always invent as many reasons why markets will go Up or Down on the short-term based on day-to-day newsblasts.

- 93% of day-to-day newsblast traders go bk'ed w/in 3 years.

Tough luck.
Tim.barnes9 profile picture
I’m thinking the market has been incredibly resilient through the headline risk.

I’m interpreting that as bullish.
Along with declining sentiment.

Think the surprise is upside short term.

Although mid term and long term I’m bearish.
jprizzuto profile picture
4 years and ur still talking abt ur 'award winning paper'...please stop!
Deep Time profile picture
"Something is bothering the market."

And that something is Donald Trump and his ridiculous trade policies.
Deep Time wrote:

"And that something is Donald Trump and his ridiculous trade policies."

Yes, it's odd that an article titled "Warning Signs Are Evident For The Market" doesn't mention that the U.S. president has started an international trade war.

When you have a loose cannon rolling around on the deck of the ship, it's only a matter of time before something bad happens.
That's probably the biggest thing. but is it the only thing though?
dpeterson5620 profile picture
I don't think our presidents really have that much control or influence over the markets. The central bankers are the real kingpins here, as Pompano Frog is pointing out.
Pompano Frog profile picture
Dear Reader..

There is no doubt that for the last 6 months the Federal Reserve has been tightening the yield curve. They justify this by referring to the coming expansion of the budget deficits and the need for high real interest rates on government bonds to finance the expanding deficit.

I find the timing curious.

They are well aware that global markets are weakening. Prior to the BREXIT vote you can see that the FRB was actively pouring liquidity into the markets. The FRB is well aware that there is a roughly 4 to 6 month lag in business activity after movements in the equity market.

I think the evidence is that the U.S. central bank is attempting to weaken the U.S. economy just prior to the November congressional elections to hamstring the Trump trade agenda. Most central bankers, regardless of political party, are in favor of the fantasy of "free trade."

I expect the FRB to begin to reverse course once they can see it will impact the real economy after the elections. This will cause a revival in the equity markets.

The White House needs to carefully vet FRB nominees on their trade views.
Investing Doc profile picture
Wait. For years, conservatives railed against the ZIRP regime. Now that the Fed is unwinding its balance sheet and raising interest rates as requested, it’s now a sleeve of the liberal interests? Funny that.

It could also be that the Fed is executing its mission in a nonpartisan way— much as intended— and that the problem, my dear Frog, is not in our Fed, but in ourselves. Inasmuch as we are responsible for the leaders we elect.
Investing Doc profile picture
*slave, not sleeve. Also, SA, an edit button for posts on the iOS app would hit the spot.
Pompano Frog profile picture
Investing Doc..

The Federal Reserve Board is a reflection of Western economic theories. "Free trade" is a major part of those theories. After world war II the U.S. represented 50% of global GDP in manufacturing. Our politicians traded access to our markets in an attempt to gain global support against communism and other international agendas.

"Free trade" theories have hurt the majority of Americans by suppressing their wage growth. Global corporations have been major beneficiaries as they have been able to borrow domestically and invest globally. This is what has been behind Japan's inability to breakout of their slump.

Europe and China have been major beneficiaries of the rape of the American worker over the last 30 years.

As you can notice from my previous comment I expect China to win this.
Summer crash of '11 redux?
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