The Wall Street-Main Street Paradox
By Frank Barbera CMT. August 25, 2009
These days, many folks are feeling justifiably befuddled, as the contrast between Wall Street and Main Street is perhaps as striking a divergence as what was seen before the 2008 Credit Crisis bust. To be sure, the stock market continues to perform well, and at least on the surface the economic headlines appear to have reached a plateau. Yet below the surface the outlook for 2010 is taking on a grimmer and grimmer profile. Going back to December of 2008, I wrote a piece entitled “Tracking the “Official” Recession.”
I stated that the odds would be high that the current ‘great recession’ would take the shape of a “W”, implying a “Double Dip” contraction. Back then, I stated,
“In my view, a more accurate forecast might suggest that a “35 to 40” month economic contraction makes more sense, implying that the present period of great financial turmult may not end until early 2011. Yet, in contemplating these figures, a repeat of the 1980 to 1982 scenario in my view is starting to make the most sense. This is the so called “Double-Dip” recession outcome, where we may see an important economic “statistical low” in the early portion of 2009 (say April, May 2009), followed by a lengthy statistical rebound (perhaps 12 months – i.e. May 2010), followed in turn by a second, even more strongly declining contraction phase beginning in the latter half of 2010. It would not surprise me to see that second phase last a good 20 months in its own right implying that the final contraction bottom may not be seen before early 2012.”
Of course as it happened, the economic data began to turn up in March – April of this year, and has been on an understated bounce over the last few months. In today’s headlines, we learned that Consumer Confidence as tracked by the conference improved to a reading of 54.1 in August, up from a revised reading of 47.40 in July. Within the Consumer Confidence report, the Present Situation Index increased to a reading of 24.90 in August, up from 23.30 in July. At the same time, the Consumer Expectations Index rose to 73.50 in August, up from 63.40 in July. In the chart below, I show the steady increase in the Forward Expectation chart along with the 12 month Rate of Change in Forward Expectations (see lower clip for ROC). At present, I find that their remains a lot of upside momentum behind the current resurgence in the consumer outlook, which in my view implies that the current trend is likely to be maintained for another two to three months. In fact, in my view, the Forward Expectations component -- the leading component of the survey -- is likely to rise toward a value in the 88 to 96 range (see little dashed box) before the current advance is complete. Once Forward Expectations have reached a value in that zone, I believe things will be in the neighborhood from which point a renewed downside contraction may emerge.
Above: Consumer Confidence Forward Expectations (top clip) and Rate of Change on Expectations lower clip.
Elsewhere, the Case-Shiller Index for June showed that the prices for single family homes rose a non-seasonally adjusted 1.40%, the second increase after falling every month for the last three years. In addition, the Federal Housing Finance Agency reported that its index of home prices fell .7% in the second quarter, with prices down 6.10% from the prior year. Like the economy as a whole, housing seems to be trying to find a temporary plateau but has an overall forward looking outlook that is still quite bearish. Not only are home inventories as reported still at record levels, but in many markets banks are holding REO properties off the market in a huge shadow inventory that will likely continue to put downside pressure on housing for some time to come. In addition, I strongly believe that long term interest rates are near another important low, and that upside pressure on long term rates will depress housing in 2010. Thus, while we remain on track for a positive Q3 GDP report as “Cash for Clunkers” will likely have a substantial one off positive affect on sales, the odds remain very high that as 2009 draws to a close, the early going in 2010 will see the return of recession. As a result, investors need to remain very nimble and cannot take their eyes off the stock market charts. This is not an investors “Buy and Hold” market; it is a traders market that needs to be evaluated at least once a day.
As I see it, the overall trend for the equity market continues to remain positive with prices underpinned by a strong under current of positive momentum. Normally, this kind of momentum would take several weeks at least to dwindle down to the point where a larger, more powerful correction could take hold. As can be seen in the chart below, as the S&P has been moving steadily higher, the GST Advance-Decline Line for Operating Companies has been moving in 100% lockstep. That means that the underlying trend remains healthy.
Above: S&P 500 with GST Cumulative Advance-Decline Line (Operating Companies Only)
In addition to the positive action in the A/D Line, the McClellan Summation Index for the US equity market is also in very strongly positive territory. Last night the Summation Index ended at a reading of +7,348.30, and that is only a few points down from a recent peak at +7,626.78 seen on August 13th, 2009. Looking back at prior history when the Summation Index is over +4,000 it is usually a sign of strength, with readings above 7,000 denoting unusually strong climates. Notice that going back on the chart we saw a reading of +7730.19 back on June 17th, 2003. Some analysts would go so far as to claim that these kinds of readings always denote a bull market condition. On that point, I would defer and simply make the case that they almost always denote a market that is a reasonable distance in terms of time (i.e. number of weeks) from an important high. To this end, with the Summation Index at such lofty levels I am less concerned about the approaching seasonally negative September and October time periods. In fact I would actually argue that this year, these months have a good chance at being positive months with the equity market trend likely to begin deteriorating in November, and then potentially really deteriorating from December on. In my view 2010 will be another major bear market year, and I would not be the least bit surprised to see the equity markets wipe out the entirety of this year's advance (660 to 1150-1200(?)) and possibly even make new multi-year lows below 660 on the S&P.
Above: tight shot on the McClellan Summation Index
Above: Long term view of Summation Index with other high momentum values in 97-98.
Above: 20 day Oscillator of Advances and Decline.
But for now, the Return of the Bear will have to wait as the overall chart configuration for the stock market remains positive. Notice on the chart above that over the last few months the 20 day Oscillator of Advances less Declines has been making steadily higher highs, essentially confirming the underlying trend in the S&P. Now, I do believe that as the markets move into late September/October, the trend will begin to thin out and fewer sectors will participate, but I have not reached that point as this time. Another gauge which helps us keep an eye on the current psychology of the market is the Relative Strength Ratio of Consumer Discretionary to Consumer Staples. In my work, I convert this to a medium term trend oscillator which shows that market psychology is still positive as long as the oscillator is above zero. At the moment, the readings remain at reasonably healthy levels, which again suggests that the underlying uptrend probably has further to go in the weeks ahead. On a very short term basis there is support for the S&P at 1007 to 1010, and we could see a small 5 to 7 day correction down to those levels, but that would fall under the header of a minor reaction and should lead to another buyable low.
Above: Relative Strength Ratio of Consumer Discretionary to Consumer Staples, Oscillator is still in positive territory above zero.
Other gauges which continue to trend toward optimism are a swath of sentiment gauges, including the Put-to-Call Ratio, the VIX Index and the Gold to Goldman Ratio. Importantly, sentiment indicators tend to give false signals in the middle phases of a strong advance. In that regard my emphasis at the moment would be more on trend following and breadth-momentum gauges; until these really begin to fall off, the sentiment group is likely to be ‘too early’. For now, the Put Call Ratio is still not down to its lower band, and still not down to the low end of the range of the last few years. Similarly, VIX is trending down but will probably revisit last year's low readings in the 18 to 20 range before this advance has peaked. We also like to watch the Ratio of Physical Gold to Goldman Sachs (GS) as a crisis-optimism proxy. When the atmosphere is starting to turn hostile, Gold begins to out-perform Goldman, and when confidence is gaining the upper hand, money runs at Goldman Sachs and steps back a bit from Gold. In this occasion, that may be a bit tricky as we expect the Gold price to turn in a strong second half on the back of a weaker Dollar, but nevertheless, for now at least, Goldman Sachs is going up at a faster clip than gold, and so we glean a positive environmental signal from this Ratio which is confirming the direction of the VIX.
Above: The Put to Call Ratio
Above: upper – Gold to Goldman Ratio and lower – the VIX Index
Finally, investors should be anticipating some degree of further rotation in the stock market with Healthcare possibly emerging as a more solid performer in Q3 and Q4. In the chart below I show the Relative Strength of Healthcare versus Technology where we see that Healthcare is beginning to outperform. This ties in with a piece I did a few weeks back, when I featured Managed Care Stocks which have done quite nicely since I wrote about them, and which still look to be emerging from a major double bottom base.
Above: GST Healthcare Index versus Technology Stocks
Above: GST Managed Care Index
Where the Manager Care sector is concerned, my focus would be exclusively on the idea of buying pull backs and reactions on the order of 3% to 5% if and when they develop. Overall, volume in the sector continues to act very well, and with the recent developments in Washington, it is becoming more clear that, as I suspected, this sector will not be harmed that much, if at all, by any Obamacare legislation should such a plan even make it to fruition.
Above: Cumulative Up to Down Volume Healthcare Stocks.
Bottom Line: Investors putting money into the stock market at this relatively late stage of the rally need to understand that they must be nimble and must be watching their stocks at all times. While the rally likely continues to have a few more weeks of life and could press toward 1100-1200 as the year wears on, ultimately, we are likely dealing with a very large bear market rally that will be followed by a much more challenging market in 2010. While things on Wall Street are momentarily taking on a better spin (with easy Q4 comps directly ahead), on Mainstreet unemployment remains very high and is unlikely to recover in any meaningful way. Going forward, we note that as the stock market approaches the early phases of 2010, (especially the pre-announcement of Q1 EPS in March) analysts will start looking at very tough potential EPS comparisons, and as April 2010 approaches (and actual announcements begin), we will likely see a swath of conference calls showing a dramatic lack of top line sales growth. At that point life in the equity market will start becoming a whole lot less pleasant. At the moment, the sun is out, and most sectors are moving higher.
That’s all for now,
© 2009 Frank Barbera