A Critical Juncture For Mr. Market

Includes: ACWI, EEM, SPY
by: Macro Economist

Upcoming economic data will be crucial in understanding the short-term direction of the economy and hence the markets. The following two calendars outline the deluge of US economic data investors will see over the coming 48 hours - sensory overload! Two of the most important data points happen to fall on the same day this month as the first Friday of the month also happens to be the first day of the month. Expect Friday to be a volatile day, either up or down.

Figure: Economic Calendar:

Source: Bloomberg

Having already established the broken nature of global markets ranging from Europe to the Emerging Markets in previous articles (if you are new, please read those for context), the key linchpin is now the U.S. Let's not forget, the U.S. is the largest economy in the world and is still the biggest exposure within popular global indices such as MSCI World. Before I present the bearish case, let me say, to be fair, U.S. data has been markedly better than global data and the S&P500 (NYSEARCA:SPY) has acted accordingly, as it is one of the few markets which is up YTD and above its 40 week moving average. However, 2008 (and 2011) should have established that decoupling is a myth and in my opinion, a string of economic misses in the U.S. would seal the nail in the coffin for global markets sending the MSCI World All Cap World Index (NASDAQ:ACWI) to substantially further declines. Emerging Markets (NYSEARCA:EEM) could be doubly vulnerable due to correlations to both commodity prices and global activity, as well as being highly susceptible to massive capital flight given the sheer volume of money which chased the BRIC story in the past decade. One of the best EM hedge fund managers told me many years ago that EM is first and foremost a levered global growth/commodity play. I never forgot those words of wisdom, particularly at important tipping points, and hence my personal bearish portfolio posture focusing wholly on the region.

In the below chart, I have shown the lowest level of major support at a further 8%-12% decline in ACWI. A move of this magnitude in the "here and now" is entirely possible should markets begin to see substantive deterioration in the U.S. economic data (with further declines possible based on the trajectory of subsequent data). In my mind, this mini-crash would happen quite quickly, not unlike last summer, as only until recent weeks have markets begun to price in a hard landing.

Source: Bloomberg

Given the poor technical condition of the market and various market indicators which are correlated to these releases, I believe it is likely that the Phd's will be proven wrong for the third time in three years, as the higher probability lies in a string of data disappointments. Why?

First, the trusty Citigroup Economic Surprise Index shows that we have already been witnessing a string of disappointing economic releases which continued unabated through May, with regional manufacturing indicators such as the Richmond and Dallas Fed showing marked declines and missing estimates. Yet Economists are calling for an ISM Manufacturing reading of 53.8 which is actually higher than their estimate for last month (if you remember, actual ISM beat big in the U.S.).

Source: Bloomberg

Second, the job market. The Bloomberg Staffing index is an index of companies involved in staffing and recruiting within the U.S. The recent deceleration mimics the turns we saw in 2010 and 2011. What troubles me, however, is the massive divergence in highs between 2011 versus 2012. These are not the sort of divergences which occur in a healthy, expanding job market, but rather, one which is "late-stage," decelerating, and heading into hard landing or worse yet, recession. Given this sort of market action, is a payroll estimate of 150,000 - up from last month - realistic? My guess is no! As an aside, wouldn't it be fitting if the recent public lashing of ECRI by the talking heads represented the economic peak?)

Source: Bloomberg

Next is the price action in industrials during May. To me, the decline to the 200 day moving average implies a market based estimation of a PMI which should be at or around the historical median, not above it as the Economists are predicting. Since 1982, the historical average is closer to 52.8. A significant miss would pull the Industrials, and hence US stocks, below their 200 day moving average much like we saw with the huge July 2011 PMI miss (reported BD1 in August).

Source: Stockcharts

Finally, I would remiss to not mention bonds. The following chart is self-explanatory. Don't say I didn't tell you so.

Source: Stockcharts


Predicting high frequency data points is more an art than a science. And indeed, I do not place a 100% probability of outsized misses in the upcoming data. But the subtext of what I am saying is important: there is no doubt that the U.S. is currently holding the global house of cards together, and a substantial miss in forthcoming macroeconomic data would be a huge blow and exacerbate the market downdraft, potentially even leading to a Market Catastrophe.

Disclosure: I am short EEM.