Market Rally & Global Economic Growth Recovery Remain Alive
By Chris Puplava, March 3, 2010
Co-Manager of PFS Group's Precious Metals Managed Account, Energy Managed Account, and Aggressive Growth Managed Account
News today that Greece will seriously work on cutting their budget deficit sent the global markets rallying today. Details from Greece’s proposed measures are provided below from a Bloomberg article:
Greek Prime Minister George Papandreou announced 4.8 billion euros ($6.6 billion) of additional deficit cuts as he tries to convince European allies and investors he can tame the region’s biggest budget gap.
Greek bonds rose to their highest in three weeks on the measures, including higher fuel, tobacco and sales taxes. The plan will also cut by 30 percent three bonus-salary payments to civil servants. Public workers already had their wages frozen and benefits cuts, and unions have called for new strikes over today’s plan.
The premier is risking a backlash at home to meet European Union demands for more deficit cuts before allies would come to Greece’s aid. The announcement comes as Papandreou prepares to meet Germany’s Angela Merkel on March 5 and French President Nicolas Sarkozy on March 7 to discuss Greece’s financing needs and ways to limit the fallout from the weakening euro.
“Today’s announcement is as much about giving other EU governments more political capital in the event that they do eventually need to provide liquidity to Greece,” said Gary Jenkins, head of credit research at Evolution Securities Ltd. in London. “They can make the claim to their own taxpayers that Greece has taken further measures as suggested by the EU.”
Accompanied with today’s release was a significant drop in the credit default swaps (CDS) on the PIGS (Portugal, Italy, Greece, Spain), which peaked in February as the S&P 500 bottomed. Another improvement is a decline in the CDS index I created for the CINN states (California, Illinois, New Jersey, New York), which shows overall credit stress in various markets has subsided from the peaks seen last month, with the market rallying.
With at least a temporary respite from the daily focus on Greece the markets are able to focus on the underlining trends across the globe, which is that of an expanding global economy that continues to improve. The combined auto sales coming from China and Brazil reached a record recently as the U.S. has been eclipsed in auto sales as U.S. auto sales remain stagnant.
Industrial production growth rates for the BRIC (Brazil, Russia, India, China) economies continue to accelerate northwards with Brazil showing the greatest recent improvement. Confirming the pickup in global economic activity as evidenced by rising BRIC industrial production numbers is overall freight traffic as more and more goods are being shipped across the globe with the pickup in economic activity. This is made abundantly clear in the second figure below which shows the year-over-year (YOY) growth rates in air freight traffic by region, with growth coming from Latin America showing the highest growth rate, with Europe showing the weakest growth rate, though still positive. Not only has air freight traffic picked up but so too has actual passenger travel, another sign that the global economy is expanding after the 2008 deluge.
While there are major headwinds still facing the U.S. economy, and that it is still uncertain whether the U.S. will be able to stand on its own two feet once the monetary and fiscal steroids are removed, U.S. economic activity continues to improve. Perhaps one of the most important improvements to the economy ahead will be an improved labor picture. Leading employment indicators such as the ISM manufacturing and non-manufacturing employment composite, which leads the YOY growth rate in nonfarm payrolls by six months, as well as the temporary employment YOY growth rate suggests that the monthly loss in jobs is set to moderate over the next several months. While the employment leading indicators are not suggesting actual robust GROWTH in employment, the simple event of not shedding hundreds of thousands of jobs each and every month would be a welcome development to say the least.
Source: ISM, BLS
Also confirming a moderation in actual job losses is that the U.S. employment diffusion index is nearly almost in neutral territory. Like the ISM indexes, readings below 50 indicates that more than half of the polled industries are laying off workers while readings over 50 indicate more than half of the industries are expanding payrolls. The U.S. employment diffusion index is a great read on economic breadth and typically turns down ahead of the stock market (S&P 500), and the fact that it continues to improve is supportive of equities going forward.
Of the four indicators that make up the Conference Board’s Coincident Economic Index (CEI), employment is by far the weakest component and improvement ahead, as forecasted by the leading employment indicators, should propel the CEI upwards. While a pickup in the leading economic indicators typically coincides with outperformance coming from the early cyclicals such as technology and consumer discretionary, a pickup in the coincident index is likely to lead to outperformance coming from the mid to late-stage sectors, such as industrials and energy. This was an actual theme suggested heading into the year in a former article, “Sector Rotation: Mid & late-stage cyclicals positioned for the next phase of this cyclical bull market.”
So far the industrial sector has been the top performer for the year, though energy remains in the middle of the pack, performing roughly in-line with the S&P 500. However, while energy hasn’t quite had the outperformance I would expect a continued increase in the U.S. CEI should be supportive of energy’s outperformance of the broad market ahead as seen in the second figure below.
With global economic activity continuing to improve and the U.S. on the verge of finally stopping to shed jobs each month (though not necessarily adding jobs), it’s hard to conceive of a major market peak, though a prolonged consolidation is always a possibility. The technical picture of the markets is one of resiliency and underlining strength, though momentum has waned over the last month or so. Market breadth continues to remain bullish as the cumulative advance-decline line for the S&P 500 and the NYSE have now breached their January 2010 highs. This is seen in the first and second panel below, though the cumulative advance-decline line for the AMEX has yet to breach its January highs, showing weakness relative to the S&P 500 and the NYSE.
Since the February lows the percentage of new highs on the NYSE and NASDAQ have recovered strongly which, along with the cumulative advance-decline lines above indicates broad participation in the current rally. Given that one year ago was roughly the market’s lows, the percentage of new lows is not likely to be instructive, though the percentage of new highs is and the percent new highs on the NASDAQ has now exceeded the level of the January highs, showing there is no negative divergences yet in this market indicator. The percentage of new highs on the NYSE remains below the January highs and if it continues to do so while the NYSE matches or exceeds its January highs we will then have a negative divergence which would be bearish. As this has yet to happen no conclusions can be made, just a suggested watch point.
There is perhaps more fuel for the rally given that sentiment has flip flopped from one extreme to the other. USD sentiment was extremely bearish while euro sentiment was extremely bullish heading into the January highs, which has now reversed as USD investor sentiment is at extremely bullish levels and the euro sentiment is at an extreme bearish sentiment level. This indicates that the USD may experience a short term decline while the oversold euro may rally, pushing reflationary assets higher.
Source: Ned Davis Research
Source: Ned Davis Research
Earlier in the year I penned an article entitled, “Market Tops are a Process, Not an Event.” In the article I commented on data from Lowry Research Corporation, who has decades of market experience and used their analysis of market tops in stating that market peaks are characterized by a widespread deterioration in breadth. As shown by the new highs in the cumulative advance-decline lines for the NYSE and NASDAQ, breadth is certainly not an issue in the present case and why I still think that, at least a retest of the January highs is likely.
While the Lowry market top study I referenced in the January article uses net new highs data for market top analysis, Lowry’s also uses basic economic principles to determine market price levels. Higher demand for stocks coupled with falling supply of stocks leads to higher prices and vice versa. What characterizes market peaks is that the supply for stocks overwhelms demand, and market bottoms are characterized when market demand overwhelms supply for stocks. Lowry’s has proprietary measures to determine the supply for and demand for stocks on the New York Stock Exchange (NYSE), which they use to gauge the markets health.
If the market was indeed in the process of peaking we should be seeing a dramatic surge of selling and a contraction in buying (demand) for stocks, such as was the case at the 2007 market top. However, this is far from the case as the commentary from Lowry’s weekly newsletter on February 19th states below.
“Over Lowry’s 77 year history, forewarnings of major market tops and subsequent declines have been signaled by sustained patterns of expanding Supply and contracting Demand. At present, though, there are numerous indications of exactly the opposite process—that is, one of expanding Demand and contracting Supply.”
Since their February 19th commentary, their buying power index (measure of stock demand) has exceeded its January 2010 high and their selling pressure index (measure of available stock supply) just reached a new low, not the kind of development associated with major market peaks. Confirming the data from Lowry’s is Ned Davis Research (NDR) which has its own measures of supply and demand for stocks. NDR volume demand is well above NDR volume supply, with annual gains of 15.4% seen when this occurs, while annual declines of 10.2% are seen when the NDR volume supply indicator rises above the NDR volume demand indicator. As shown below, there is still ample distance between the two measures, which is not indicative of an impending major market peak.
Source: Ned Davis Research
Continual monitoring of supply and demand for stocks will be useful ahead in determining when this cyclical bull will end. What has historically worked well in timing cyclical bull and bear markets is the 15/40 weekly exponentional moving average (EMA) system, as was highlighted earlier (“The Guy behind the Guy Is You and I”), and that signal system remains on a buy as the 15 EMA has picked up with the market's bounce.
Perhaps another canary in the coal mine may be the Chinese Shanghai Index, which bottomed before the U.S. markets did and also peaked earlier last year. The Shanghai Index went through a 38.2% Fibonacci retracement from its 2007-2008 decline before stalling. The index remains in bull market territory as its 14-week RSI remains above 50 (green box below), and we have yet to see a sustained break of its 200 day moving average (200d MA). If the Shanghai breaks down further with an associated break below 50 on the 14-week RSI, that would be a bearish signal that would likely mean a deeper correction is in the works for global stock markets. As it stands there is no clear direction in the Shanghai, with its next move likely providing key direction for global markets in general as China has replaced the U.S as the world’s economic engine.
© 2010 Chris Puplava