Monetary Policy -- Gravely Compromised
By Frank Barbera CMT. December 18, 2007
In last week's update, we noted the high probability of a post-Fed announcement stock market sell off, and what a sell off we have seen. Since last Tuesday, the stock market has been loathe to sustain a rally, even on the heels of two separate Fed announcements which should have engendered confidence. All investors take heed, you are staring at a market that is NOT responding well to “Good News.” Markets that cannot rally on Good News tend to accelerate downward on any type of bad news, and that is the kind of market which appears to be taking shape.
Speaking of bad news, there has been a lot of it making headlines in recent days starting with the report on New Construction of Single Family Homes which was announced this morning. The report revealed that construction slowed to its weakest pace in 16 years in November with Housing Starts falling 5.4% to a seasonally adjusted rate of 829,000, the lowest since April 1991. Starts of Single Family Homes are now down 35% in the past year and have fallen in four of the last five months. In addition, the Commerce Department announced that Building Permits fell for the sixth consecutive month to a seasonally adjusted rate of 1.15 million, the lowest rate in 14 years with Permits falling 34% during the last 12 months. An astonishing figure, the drop off in Permits represents the largest year-over-year decline seen since the recession of 1991. On Monday, the Home Builders Survey was announced at market index reading of +19 for the third month in a row. Compiled by the National Association of Home Builders and Wells Fargo, the reading of +19 is deeply pessimistic, hovering for the third month at a 22 year low.
Even more recently, a number of surveys have pointed toward an expected slow Christmas spending season, with sales of women�s apparel, usually a major bellwether for Christmas spending, already targeting a 6% year-over-year decline. Yet against the wide spectrum of bearish reports, perhaps the most negative report in recent days was the disastrous report on Inflation released in the form of the PPI last week. Soaring at a rate of 7.67%, PPI surged to the highest monthly reading seen since
September 30th, 1980. That's the highest rate of wholesale price inflation since the Carter Administration and we all remember just how bad inflation was in the late 1980's.
Precisely how does the Federal Reserve now go about easing monetary policy further, when even the cryptic government data is showing a tidal wave surge in domestic price inflation? Your guess is as good as mine, but one thing is for sure; it certainly places Mr. Bernanke in a very difficult position as markets had written off inflation as a concern months ago. Well, guess what? Stagflation has just walked in the front door, sat down and put its feet up on the living room couch. Slow Growth and Accelerating Inflation -- a very bad combination for the stock market which has had hopes pinned on a monetary miracle, a Greenspanian easy money, rate-cutting milieu which now seems about as compromised as a cupcake with no icing, a cop without a gun, a hot dog with out a bun, �well, you get the idea -- gravely compromised. No wonder the market has run into a brick wall of selling with each rally attempt.
At least today the ECB announcement that it is making 501 BILLION dollars available for banks to draw on using an anonymous loan facility probably ensures that banks will likely close their books “OK” at year end. And thus, will allow most of us to go home and enjoy the holidays with a lesser threat of imminent collapse overhanging year end, which was cause for modest celebration today. However, as Rob Kirby pointed out yesterday, the weakness resounding through British and European Banks appears to be quite striking, with the likes of Barclays (BCS), UBS (UBS) and Credit Suisse (CS) still acting very poorly. In fact, if we take a moment and review the charts for the major European Stock indices, we see none of them acting well. In London, the FTSE-100 took a real �pasting� as Brit’s would call it, when the market fell 4.38%, and in the process downside penetrated a now flattened 200 day moving average.
In Paris, the Caceron 40 has been underperforming for months and was never able to confirm new highs in the FTSE in October. With last week's sharp decline, the CAC-40 is now looking like a massive Head and Shoulder Top about to break its important neckline at the 5280 level. Perhaps the brightest star among major European Bourses has been the German DAX, which until recently was at least hovering near all time highs. Yet, even for the DAX, the loss of upside momentum on the weekly chart is clear on gauges like RSI and MACD, with the rally attempts of October and late November now looking like “right side” failing rallies setting up a larger Double Top.
Above: Major European Bourses, London, Paris and Frankfurt
For the German DAX, a close below 7830 would be very bearish, while a close below 6030 on the FTSE would also represent a major breakdown in price. Elsewhere, we also note consistent weakness in Asia and the Emerging Markets, where Shanghai has now seen the 50 day average roll over with both Singapore and Hong Kong looking equally toppy. In Shanghai, we still believe that a crash is underway and the market is easily capable of moving all the way back down to the 3,000 to 3,200 zone in the weeks and months ahead. From a high of 5900 in mid-October, a sell off toward 3100 would equate to a roughly 48% decline and at that, prices could still ultimately head much lower. Longer range, we would not be surprised to see Shanghai move back down into the low 2000 area, or even under 2000 as a global slow down exposes a bloated growth rate still tied to US consumption and a rotten banking system loaded with bad debt.
Above: Asian Equity Markets � Bubble Shanghai atop, with Singapore and Hong Kong.
Elsewhere, formerly super hot emerging markets are also catching the first signs of a chill as Mexico appears to be completing a major Double Top, with key support at 27,800 on the IPC Index. For Brazil, the undisputed heavy weight champ of emerging markets, Sao Paulo�s mighty Bovespa is sporting a distinctively bearish broadening top formation and would be made to founder on any close below 58,800. On the daily chart, the 14 day Wilder RSI shows clear cut bearish divergence with the Bovespa, very often a good leading indicator for the major trend in capital markets.
Above: Emerging Markets, Mexico, Brazil and India, are all within a plateau at the current time, and showing a noticeable loss in upside momentum.
Above: the Sao Paulo Bovespa Index, with a very bearish broadening top and a clear cut failure on the 14 day RSI, -- these are the ingredients of a major top.
Above: Crude Oil appears to be topping out, and with a close below $87 would confirm a breakdown in price.
Finally, we also note that commodities prices also appear to be running into real resistance, with the metals and energy stalling in recent days. Of greater concern is the price of Oil where a small but potentially powerful top looks likely to generate some downside fireworks heading into year end. On some of short term daily oscillators, price has been diverging and from here, any new lows below $87 in Light Sweet Crude would be unequivocally bearish and would likely target prices back down into the low $70 area.
Over the last few days, the 20 day average has crossed below the 50 day average, with the 50 day average now flattening out. For Oil, the next few weeks look like a period of rough sledding ahead, where investors with energy exposure are cautioned to tighten up stops and adopt a defensive posture. In the chart below, I plot my GST Large Cap Oil and Gas Index going back to 1970 with 200 day Bollinger Bands. On the bottom clip, I plot a Time Span Counter which totals the number of days the large cap Oil and Gas stocks have gone without tagging the 200 day lower band. At present, that lower band is 28% below current levels for the Oil and Gas Index, and while the gap will likely narrow in the weeks ahead, if the price of Crude begins to decline in earnest, the E&P sector, long a Frank Barbera favorite, could be in for a very nasty decline.
Above: the GST Large Cap O&G Index with Time Span Counter
Like so many other sectors, momentum in the E&P stocks just appears to be dissipating by the day, with pronounced divergence now present on most medium term momentum oscillators. While we remain huge fans of the Energy Sector for a continuing secular bull move, the current market climate looks like a foul storm brewing up rough seas ahead, and demanding the use of trailing stop loss positions.
Above: the GST Large Cap Oil and Gas Index with Medium Term Momentum Oscillator, pronounced bearish divergence now in place suggests tightening up trailing stops.
At the close, the S&P 500 ended higher with a gain of 9.08 index points to finish at 1454.98, with the DJIA ending higher by 52.43, for a close at 13,219.63. For the DJIA, 12,800 remains very important medium term support. Finally, NASDAQ ended higher at 2596.32, up 21.86 index points while the 10 Year Bond, remarkably, remains near record low territory with a close today of 4.12%.
I want to wish all our regular readers a very Happy Holiday Season with Best Wishes for a Happy New Year in 2008,
© 2007 Frank Barbera