Signs of a Gathering Storm
By Frank Barbera CMT. June 26, 2007
It has not been a good week by any measure. In today’s economic news, AP reports that the Case-Shiller Index of US Home Prices fell for the 17th month in a row with all regions reflecting a widespread slowdown in housing. The Index, which covers 10 major US cities, fell 2.7% from a year ago, its steepest decline in 16 years going back to 1991, the last Housing Bear. “No region is immune to the weakening price returns” said Robert Shiller, Chief Economist of MacroMarkets in an interview with AP. In addition, S&P noted that its 20-City Index showed a 2.1% drop in the price of existing single family homes across the US in April, with 14 out of 20 cities showing either flat or lower prices. Elsewhere, the Commerce Department reported Tuesday that sales of new single-family homes dropped for the fourth time in five months, falling by 1.6% last month to a seasonally adjusted annual rate of 915,000 units. The Housing Recession is now well under-way, and for all appearance shows no end in sight.
Elsewhere, Consumer Confidence fell nearly 5 points to 103.90, down from 108.50 according to the Conference Board. At the same time, the Present Situation Index fell to 127.90 in May from 136.10 in April, while the forward looking Expectations Index fell from 90.10 to 87.90 in May. Easily overlooked, most readers probably won’t extract much of a message in today’s Consumer Confidence report. Yet in our view, we note that tucked away in all the rapid-fire headline data is a far more ominous development, a warning of potential recession on the way. In our work, we have always focused on the Ratio of Consumer Expectations to the Present Situation, and over the last few months, even though the Present Situation Index has ‘held up’ well, forward looking Expectations have been deteriorating and showing no rebound capability. This action in the past has spelled R-E-C-E-S-S-I-O-N.
Above: the Conference Board Indicators — The Ratio of Consumer Expectations to Present Situation is now turning bearish, with the single month ratio likely to cross above the declining 20 month moving average next month.
To get a better view of this data, we like to plot the Ratio of Forward Expectations to the Present Situation. Once we calculate the Ratio, we then plot a 20 month simple moving average. When the Ratio moves down, it is a sign of a recovery and a strong economy. When the Ratio moves up, it is a sign that the economy is weakening and is either headed for or in recession. On the chart above, we show with arrows those periods of time where the Ratio of Forward Expectations to Present Situation crossed above the 20 month moving average. In each case, the arrows highlight the start of serious slowdowns and/or recessions. From left to right, we see the cross-over signaling the major recession of 1980-1982, the Gulf War recession of 1990-1991, and the Tech Bubble led slowdown of 2001. Importantly, this month, the Ratio ended at .6874, turning up from the prior month reading of .6619 while at the same time, the 20 month moving average ended at .6927, up slightly from the prior month of .6909. We note that with virtually any additional weakness next month, the Ratio will likely cross-over its now flat to rising moving average, and in so doing, send an important message that a broader slow down is getting underway. We will be tracking this signal for you, and will update the data again next month.
In addition to the Conference Board Data, we would also note that the recent action in the Commerce Department Leading Indicator series has been abysmal. This is the “Greatest Economic Story Never Told?” Fat Chance! Give me a Break! The annual Rate of Change on LEI shown in the lower clip on the next chart has now been below zero six of the last seven months. Does that sound like a healthy economy to you?
Above: the Index of Leading Economic Indicators and lower clip, the Annual Rate of Change on LEI which is now below zero, moving into marginal recession territory.
As can be seen in the chart of the annual Rate of Change in LEI, (lower clip) whenever the indicator has been below zero in the past, we have been in recessions, or growth slowdowns. In 1994-1995 just barely went negative, and that was a growth recession. Note the very painful recessions shaded in 1970, 1974, and the Double Dip recession of 1980-1981. The Gulf War recession of 1990 —1991 is also evident, as is the 2000-2001 Tech Bubble slow down. The point: we are long way from healthy according to LEI, and in fact, have been slowing toward recession for well over a year.
Yet another gauge we watch closely in this series is the Ratio of Leading Indicators to Lagging Indicators, which we have super imposed in the chart above against the Annual Rate of Change on LEI. The thick line is the Ratio of Leading to Lagging Indicators, and like the LEI Rate of Change is also negative. Historically, this gauge has a wider swinging amplitude and tends to turn at key inflection points a bit ahead of the LEI Rate of Change.
So, this is a kind of Leading Indicator on the Leading Indicator, and the message is essentially the same. At the present time, the Ratio of Leading to Lagging Indicators resides at a value of -4.22% with readings below zero consistent with slow-downs or recessions. In the past, readings much lower than —6% have ONLY been seen in association with MAJOR PROBLEMS, i.e. a full blow recession or in the case of 2000-2001, a major corporate recession (profits recession) and a major bear market. Below —6%, things get really ugly and the stock market has not done well in that climate. While the Ratio of Leading to Lagging Indicators has not yet moved below —6%, going forward this is another gauge we will be watching closely as we suspect that a major recession signal lies directly ahead, something we have not seen now in 25 years.
Above: the Ratio of Leading to Lagging Economic Indicators with —6% ‘zero line’, below —6% things get ugly, and Below: the same gauge with the DJIA going back a number of years. Stock Markets do not like slow growth or no growth climates, and that is the message within this data.
Capital Market Update
In addition to the onsetting weakness we see taking shape in the broad economy, our work remains very bearish with respect to the outlook for capital markets. Over the last week or so, we have noted the S&P’s return to the area near 1540, whereupon prices ‘double topped’. Importantly, as the S&P moved back to the 1540 area on June 15th, our 20 day Moving Average of Advances less Declines Oscillator produced an even wider, more bearish divergence. Since then, the S&P has reversed lower and is now threatening to close below the all important lows seen on June 7th at 1490.
Above: the S&P 500 with the GST 20 day Average of Advances minus Declines.
Since last week's report, three of our Top Ten Signals have been rendered, Signals #10, #8, and #5, with Goldman Sachs breaking down below its $218 support, the Homebuilding Index plunging below its trendline from 224.80 to 210.50, and with the S&P undercutting its 50 day average and rising trendline. Four other signals are close at hand, #1, #2, #3, and #7. China’s Shanghai market moved down and touched the 50 day average and then bounced, the S&P is very close to a move below 1490, and the Korean Kospi Index is very close to moving below its 20 day average. In addition, Signal #7, the NASDAQ , is very close to breaking its trendline and moving average. As a result, with almost any additional weakness, 7 out of 10 signals would be flashing bright red. The only signals that will need more time are Signal #9, the Bombay Index, which has held up well so far, Signal #6, the PYZ Proshares ETF has also held up well, although there is a potential double top there and lots of bearish divergence hinting at a turn, and finally, Signal #4, the Bovespa has not yet shown enough weakness to cross-over its moving averages. We are continuing to watch the list and will update accordingly.
Of course, with almost each passing day, we have seen more signs of trouble building within the Financial World. Way back on June 5th, we did an article entitled “Will the Real Slim Shady Please Stand Up” at which point in time, we noted that some of the large Brokerage Companies showed stock prices that were not acting well. We singled out Bear Stearns and Lehman Brothers in that article, stating,
“While not as immediately bearish, we also are drawn to the charts of both Lehman Brothers (LEH) and Bear Stearns (BSC), both of which have very oddly lagged behind the brokerage group and the market in general. In fact, not only have they lagged behind, the share prices for these two Wall Street behemoths have been positively atrocious performers since the March lows. Perhaps someone knows more than we do? To be sure, your guess is as good as mine, but with profits at record levels for the industry and these companies, why are the shares prices still residing in the basement?
June 1 — Bloomberg (David Evans): “Bear Stearns Cos., the fifth-largest U.S. securities firm, is hawking the riskiest portions of collateralized debt obligations to public pension funds. At a sales presentation of the bank’s CDOs to 50 public pension fund managers in a Las Vegas hotel ballroom, Jean Fleischhacker, Bear Stearns senior managing director, tells fund managers they can get a 20% annual return from the bottom level of a CDO.(Source: Bloomberg/PrudentBear.com, Credit Bubble Bulletin by Doug Noland)”
Above: Bear Stearns & Co. (BSC) from Financial Sense Article June 5th
Since then, we have subsequently learned of major problems at Bear Stearns and one of its high yield hedge funds, and with that the stock price has begun to collapse, falling from above $150 to below $140 during just the last few weeks. Somehow, with prices now below the neckline of a major top, we are long way from convinced that the ‘worst is over’ when it comes to bad news in the area of ‘creative finance.’
Above: Bear Stearns today…
In our view, the technical damage sustained by major markets over the last few days goes a long way to cementing in the case for a major top, especially in China where the Shanghai Composite Index still appears very close to a major crash. We have no changes in our advice to investors where we recommend holding high levels of cash, and reducing exposure to what appear to be dangerous markets ahead. At today’s close the major averages ended slightly lower, with the S&P finishing at 1492.89, the DJIA at 13,337.90, and the NASDAQ at 2573.90. The 10-Year Bond Yield finished at 5.10%.
That’s all for now,
© 2007 Frank Barbera