Bad Moon Rising?

By Chris Puplava, February 21, 2007

I see the bad moon arising
I see trouble on the way.
I see earthquakes and lightnin'
I see bad times today

Don't go around tonight,
Well, it's bound to take your life,
There's a bad moon on the rise.

"Bad Moon Rising"~ Creedence Clearwater Revival

I'm not ringing any alarm bells, just pointing out some interesting developments. The current advance after last summer's lows is fairly extended and there are some signs brewing, hinting of a "Bad Moon Rising" where we might be seeing a market correction, or at least a breather coming soon.

Westpac Strategy Group publishes economic data designed to track the evolution of economic data surprises over time. Their percent surprise index and size of surprise index for U.S. economic data can be used to determine reversals of economic sentiment. The Westpac Positive Surprise Index measures the percentage of releases beating Bloomberg consensus estimates in the previous eight weeks, presented as a percentage and is bounded by 0% and 100%. The Westpac size of Surprise Index captures the size of economic data surprise from Bloomberg consensus forecasts, with the data bounded by z-scores of -1 and +1. The z-score reveals how many units of the standard deviation a result is above or below the mean.

So let's have a look at the data to see how relevant it has been in calling for turns in the markets using the S&P 500 to represent the market and what the data is currently hinting. As seen by Figures 1 and 2 below, peaks in the Westpac data, whether in terms of percent surprise (Figure 1) or size of the surprise (Figure 2) have been consistent in leading or coinciding with peaks in the S&P 500 over the past three years.

Figure 1

Figure 2

Source: Westpac Strategy Group, Bloomberg

Both indices turned sharply lower prior to last May's correction and have both recently rolled over hinting at another possible correction as economic data is turning more negative in terms of the size of the surprise and the number of positive economic surprises contracting. We have already seen some negative economic news from subprime mortgage lenders and higher energy prices as of late after January's fall. More fuel is coming from today's economic reports with a higher headline CPI number that came in above the consensus, and a negative year-over-year percent change in the Conference Board's Leading Indicator Index (discussed below) are possibly putting the breaks on investor enthusiasm.

Another development hinting at a possible market correction is the double bottom forming in the relative strength ratio of the S&P 500 consumer staples sector, as the sector is seen as a defensive sector due to its non-cyclical earnings. The relative strength ratio turned up sharply from September to October of 2005 during the market correction, and in April through September of last year as the market corrected again. The ratio bottomed in December and looks set to turn higher as it has put in a higher low, though a higher high or sharp upturn has yet to be seen.

Figure 3

Source: Stochcharts.com

Is the sky falling? No, but there may be rain clouds on the horizon as indicated by the above mentioned developments.

ADDICTED TO OIL: YOU BETTER BELIEVE IT!

On a side note, I wanted to share some insights of what I found while looking at the trade report last week. I took the cumulative value of petroleum imports, both real and nominal, since January of 2000 through December of 2006 and charted them below.

Figure 4

Source: Moody's Economy.com/BOC, BEA

Nominal: $1.2 Trillion dollars or $1,200,000,000,000
Real: $0.92 Trillion Dollars or $920,000,000,000

Since 2000, we have imported $1.2 trillion dollars worth of energy products -- quite a staggering number to say the least. I conducted the same analysis with the trade deficit, from January 2000 through 2006 with the data provided below.

Figure 5

Source: Moody's Economy.com/BOC, BEA

Nominal: -$4.2 Trillion dollars or -$4,193,000,000,000
Real: -$4.01 Trillion Dollars or -$4,010,000,000,000

Last year marked the fifth consecutive annual record and an all-time high for the trade gap with China. The gap between what America sells abroad and what it imports rose to a record $763.6 billion last year, a 6.5 percent increase from the previous record of $716.7 billion set in 2005. In December, the deficit rose 5.3% to $61.2 billion, larger than the consensus figure of -$59.5 billion.

What I want to comment on is that of the cumulative -$4.2 trillion trade deficit since 2000, $1.2 trillion of that deficit has come from oil imports. Oil imports represent 29% of the cumulative trade deficit since 2000!

Addicted to oil, you better believe it! We have shipped $1.2 trillion dollars to Mexico, Canada, the Middle East, and Venezuela to purchase a product that doesn't last, that returns no dividends, no income, no return on investment -- it’s completely consumed! In contrast to our country exporting our dollars overseas for a consumable product, the nations receiving our dollars invest them into their economies to improve productivity, quality of life, or they recycle them back into our country buy buying our treasuries where they receive interest on their investment.

We ship our dollars (wealth) overseas for oil and then to compound the wealth transfer, our government pays interest to foreigners on this exported wealth when they buy our treasuries, shipping even more of our wealth overseas. Who do you think is the loser and winner in this trade?

We have nothing to show for the money we ship overseas as our wealth is transferred to oil exporting nations and what we buy is consumed. These nations are building wealth while we consume it! By improving our alternative technology industries here in the United Sates and reducing our dependency on foreign nations exporting oil to us, we will be able to keep more and more of our dollars within our borders and recirculating within our economy instead of making other nations wealthy at the expense of our dependency.

TODAY'S MARKET - Economic Reports

Consumer Price Index (CPI) - January 2007

The headline CPI rose 0.2% in January over December, above the consensus expectation of a 0.0% rise, despite a 1.5% decrease in energy prices. The core CPI (headline CPI less food & energy) also came in above the consensus of 0.2% by rising 0.3% last month.

Headline CPI has risen 2.1% on a year-over-year (YOY) basis, which is lower than its peak of 4.3% in June and lower than the 2.5% reading seen in December. The core CPI's YOY rate came in at 2.7%, higher than the 2.6% YOY rate seen in December, though below November's 2.8% reading.

Source: Moody's Economy.com/BLS

MBA Mortgage Applications Survey

Mortgage demand fell 5.2% last week, the result of a 5.4% decline in refinance applications and a drop in purchase applications of 4.8%, pushing the purchase index near a 12-month low. The contract rate on the 30-year FRM decreased 5 basis points to 6.19% while the 1-yr ARM increased 1 basis point to 5.81%.

Source: Moody's Dismal Scientist
Data: Mortgage Bankers Association of America

The Conference Board Leading Indicator Index - January

The Conference Board's leading index rose 0.1% in January over December's level. There was four positive and six negative contributors to January's level. Positives were a decline in jobless claims, an increase in the money supply, and an increase in consumer expectations. Two of the biggest negative contributing factors were a shorter manufacturing workweek, hinting at manufacturing weakness, and a drop in residential building permits, indicating housing is still a drag on the economy.

The YOY rate in the index tends to lead or coincide with movements in the YOY rate of GDP. The leading indicator index turned sharply lower in 2004 while overall GDP remained flat. The index's YOY rate turned negative in January at -0.14%, the first negative reading since the index turned positive in January 2002. Evidence of a "Bad Moon Rising?" Maybe.

Since 1960 there has only been one exception where the index's YOY rate turned negative that did not lead to a recession, and that was in 1967. This might have resulted from the corporate sector picking up the slack in consumer debt contraction as corporate debt continued to grow (see Figure 21 and commentary from last week's WrapUp).

Source: Moody's Economy.com/BEA, TCB

The Markets

The markets fell in early morning trading after the release of the CPI data that came in above expectations, stoking inflation fears and weighing on sentiment. The NASDAQ managed to finish in the green as it was up 5.38 points to close at 2518.42. The Dow and the S&P 500 both fell with the Dow posting a decline of 48.23 points to close at 12738.41 and the S&P 500 fell 2.05 points to close at 1457.63. Investors sold Treasuries today with the 10-year note yield rising to 4.692%, declining 1.2 basis points. The dollar index was also up on the day, rising 0.04 points to close at 84.22. Advancing issues represented 44% and 48% for the NYSE and NASDAQ respectively, with up volume representing 46% and 49% of total volume on the NYSE and NASDAQ.

Energy commodities were up ahead of the inventory data coming out tomorrow with WTIC oil rising 2.41%. Precious metals had a big day with gold benefiting from the CPI report, rising $21.20/oz to $678.45/oz (+3.23%) and silver rising $0.40/oz to close at $14.235/oz (+2.89%). Base metals were mixed on the day despite falling LME inventories for most metals, with tin leading the pack up (+3.26%) and aluminum posting the biggest decline (-4.73%).

Overseas markets were mixed with the Taiwan and Latin markets putting in the best performances. Taiwan's Taiex index was up 0.94% and Brazil's Bovespa and Mexico's Bolsa indices were up 0.53% and 0.44% respectively. European markets were down the most with London's FTSE 100 index leading the decliners, down 0.86%, followed by Germany's DAX and France's CAC-40 indices, down 0.59% and 0.33%.

The decline in the markets today was broad as eight out of the ten S&P sectors were down. The materials (+1.06%) and energy (0.71%) sectors put in the only positive performances on the day, likely lifted by inflation data coming from the CPI report. The weakest sectors of the day were utilities and health care, down 0.51% and 0.43% respectively.

Chris Puplava

Contact Information

Christopher M. Puplava
PFS Group
PO Box 503147
San Diego, CA 92150-3147
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