TIAA-CREF Warns That Negative Interest Rates are Coming

In all seriousness, I propose that Congress modify the Fed’s mandate to include a monetary policy version of the Hippocratic oath: First Do No Harm. Just following that simple precept would lead to an immediate reversal of the ZIRP/NIRP policies that have plagued the global economy since the Greenspan-Bernanke-Yellen triumvirate unleashed their war on savers and retirees 35 years ago. (The next step is to permanently reduce our reliance on excessive debt, but first things first.)

This morning I received a message from TIAA-CREF informing me, and all plan participants, to begin taking negative yields into account as we consider our future asset allocations. The message is available to the public at the following URL: TIAA-CREF Interest Rate Message.

The main points are summarized in the following screenshots from the web page:

TIAA-CREF-Negative-YieldsTIAA-CREF-Negative-Yields-2Regular readers of this blog know that I have been predicting continuation of the Fed’s “all talk, no action” strategy for over a year now, with articles such as Deflation is the Main Reason the Fed Will Raise Rates Later Rather than Sooner (Mar. 27, 2015) and The Fed Won’t Raise Rates Until Deflationary Trends Reverse (Oct. 28, 2015). The main reason for the excess chatter and lack of actual rate increases was explained on Dec. 14, 2015: Leading Indicators Suggest U.S. Economic Activity Approaching Stall Speed. Today we received confirmation that the U.S. economic activity is trending toward the rest of the world with an unusually honest headline from CNBC.com:

US-Economy-Grew-0.8-PercentAlthough Bloomberg tried to spin this news as positive:

US-Economy-Grew-Morewhich is truly pathetic. Personally, I have never been able to solve a problem until I address the problem directly. I urge the highly-paid PhDs at the Fed to do the same. Combined with the imminent arrival of negative yields in the U.S. (joining Japan and much of Europe), the exhibit  below completes the story. It’s a graph of the Baltic Dry Index (an index of global shipping activity) over the past 5 years. The blue arrow shows the 2.5-year trend. For the directionally-challenged, it’s DOWN. For the aspiring chartists, the index has made 3 lower highs over the period, and has started to form a fourth.

Baltic-Dry-May-2016There’s a global recession and we can’t avoid it. Accept the reality of the situation. The one good thing that can come out of our economic slump is that it’s relatively easy to remove the main cause: central bankers around the world clumsily manipulating free markets and achieving ever-worse outcomes!

Categories: Market Commentary

The Great Central Bank Permabubble

A considerable amount of time has passed since the financial crisis of 2008 and the “great recession” that followed. March 2016 marks the seventh year since the economy began its long, slow recovery and the current bull market in stocks began.

The current economic recovery and stock price gains have been accompanied by a considerable degree of skepticism, however. Many have argued that we’re in the least-respected bull market in history, and discredited naysayers with nicknames like “permabear” and “Dr. Doom.” In this article I will take a long-term view of the pros and cons regarding the past and current state of the U.S. economy and financial markets, explain why such a wide range of opinions prevail among analysts, investors and the financial media, and identify the main force that propelled stock prices to record levels in 2015.

We’ll start by considering Figure 1, which shows the long-term growth rates of corporate profits, stock prices, gross domestic product (GDP, the value of all goods and services produced in the U.S. over time), and new orders for capital and durable goods (spending on big-ticket items by businesses and consumers). Following the 1991 recession, orders for capital and durable goods grew rapidly, with profits and stock prices following along until the late 1990s. Although spending by consumers and business continued at a brisk pace until 2000, it is now widely-recognized that the stock values had crossed over into “bubble” territory, which happens when stock prices rise without accompanying growth in fundamentals (such as corporate profits). Because the excess technology investments of the late 1990s did not lead to further increases in profits, stock prices retreated into bear market territory in 2000, with the events of 9/11 prolonging the decline all the way into early 2003.

Figure-1

Figure 1

The bull market of the early 2000s seemed poised to right the wrongs of the previous bull, as this time capital and durable goods orders grew proportionately with stock prices, and corporate profits grew even faster – what could go wrong? It turned out that markets had yet another lesson to teach, because profits and stock prices had received significant tailwinds from dual bubbles in real estate and credit. In 2008 the bear caught up with markets again, and the carnage in both the economy and financial markets was more severe than anything seen in the 2000-2003 bear market.

Free markets are resilient, however, and starting in 2009 profits and stock prices rebounded once again. This time prosperity seemed to be on more solid footing until late 2012, when signs of a cooling economy began to surface (note the slowdown in spending on capital and durable goods). Profits and stock values continued surging ahead for two more years, but in 2015 volatility began spilling over from global markets. Since then profits and stock prices have declined, capital goods orders have stagnated, and durable goods orders have fallen sharply. This leads to our first question: after all the lessons that were supposedly learned in the previous two market bubbles, how is it possible for profits and stock prices to surge ahead to new highs without support from basic economic fundamentals like spending by businesses and consumers?

Figure-2

Figure 2

To answer this question, let’s examine Figure 2, which takes a closer look at long-term growth in key fundamentals such as consumer spending, personal income, retail sales and wages and salaries. Even a casual glance at the graph makes one thing clear – during the bull markets of the 1990s and early 2000s, these economic fundamentals all grew at nearly identical rates, as expected. During the 2008-2009 recession, however, the relationship among these fundamentals suffered a key interruption that has yet to be corrected. Although personal income and consumer spending declined before resuming their upward trend, retail sales and wages and salaries fell by much more, and have continued growing on a slower trajectory throughout the current economic expansion. The fastest-growing component of personal income since 2009 has been – drumroll, please – transfer payments – essentially checks from the government, which is not consistent with expanding prosperity. It’s clear that profits and stock prices are not getting any help from standard fundamentals.

This leads to our second question: can we identify the factor that enabled profits and stock prices to achieve new highs when basic economic fundamentals were growing much more slowly?

Figure-3

Figure 3

Figure 3 introduces the villain in our story: debt. Despite the poignant lessons of the 2000s credit bubble, and the apparent deleveraging in the Federal and corporate sectors from 2008-2010, debt levels remain excessive, and have given corporate profits and stock prices a considerable boost in their march to new all-time highs. Figure 3 depicts the obscene explosion in student debt since 2009, which shows how free markets are always ready to invite new borrowers to the party when old borrowers are tapped out. We’ll have more to say about the “apparent” deleveraging in a moment, but first let’s pose our third question: how has it been possible for debt levels to remain so high since 2009 – especially when we were supposed to be unwinding a credit bubble?

Figure-4

Figure 4

Figure 4 provides a long-term view of interest rates, inflation and commodity prices. First, half the answer to our previous question can be found by tracing the trajectory of interest rates. The U.S. Federal Reserve Bank, for reasons too obscure for the rest of us to understand, have persisted in their mistake of keeping interest rates too low for too long. The accompanying low cost of borrowing has led to yet another debt bubble – the U.S. and global economies have been drowning in excessive debt for years. Figure 4 also shows some of the unintended damage to another factor considered crucial for modern economies: inflation, or in this case, the lack of it. The global commodity index shown in the graph (based on everything from oil to aluminum to copper) has crashed and taken energy-dependent economies down with it. For now, bankruptcies have been manageable because, with interest rates still so low, it costs little to extend and restructure the terms of existing debt contracts.

Figure 4 also shows the “spread” of interest rates that markets are requiring from low-quality debt (rated BBB) vs. higher-quality Treasuries. Notice how the spreads have widened to levels associated with previous recessions, although still not close to the crisis levels of 2008. Why does this matter? Because credit and stock market bubbles don’t pop simply because asset prices are overvalued – they pop when investors suddenly become risk averse, sell out of risky assets and find safe havens in which to invest. The rise in credit spreads indicates that markets have been concerned with repricing risky debt since early 2015, and these concerns have spilled over into the prices of all risky assets, including stocks.

Figure-5

Figure 5

Figure 5 introduces our last perspective. When describing trends in corporate and consumer debt in Figure 3, I had referred to the slight deleveraging by business as “apparent” – now I’ll explain further. All of the debt in existence today doesn’t show up on the chart, because over $4 trillion of public and private debt now resides on our own Federal Reserve Bank’s balance sheet, conveniently out of sight – at least for awhile. Most readers have probably heard the term “QE,” short for “quantitative easing,” thrown around in the last few years. Figure 5 shows what QE means. In addition to its obsession with low interest rates, the Fed has used its powers to buy up a substantial amount of the excessive debt in financial markets. Notice how the Fed begins implementing this highly unconventional support for markets in late 2008, and how stock prices begin responding in March 2009. The rest of the story is told by the graph itself. When the Fed is buying debt and injecting more liquid assets back into the banking system, some of the excess liquidity may get loaned out, but most of it winds up chasing stocks and other risky assets. The size of the Fed’s balance sheet and U.S. stock prices have been rising in lockstep since 2009. Stock prices haven’t been rising because economic fundamentals are growing, they’ve been rising because global central banks have pumped over $20 trillion of liquidity into financial markets, and they all plan to accelerate these programs in 2016.

Only the U.S. Federal Reserve says it doesn’t like this game anymore, and to prove it, they raised interest rates a paltry 0.25% in December. The market’s extended tantrum over this rate increase should tell you all you need to know about markets in 2016. If the Fed keeps raising rates, as they’ve promised, expect the tantrums to continue all year. If, on the other hand, economic and financial conditions weaken precipitously, the Fed may very well find itself rejoining forces with all the other major central banks around the world, which continue depressing interest rates. In case you haven’t heard, Japan, Denmark, Sweden and Switzerland are all quite proud of their negative interest rate policies, yes, you read that right, and some are already forecasting that the U.S. Fed will be forced to follow along within another year or two.

So, if you’ve found the recent volatility in markets entertaining . . . you’re in luck. My prediction is that stock, bond and commodity prices, not to mention the grand wizards at the Federal Reserve Bank, have more surprises in store for us in 2016 and beyond. Buckle up.

Categories: Market Commentary

Leading Indicators Suggest U.S. Economic Activity Approaching Stall Speed

In this article I will assess the strength of U.S. economic activity by analyzing the components of The Conference Board’s (hereafter “the CB”) Leading Economic Index, along with a few additional indicators. Overall, the analysis indicates a significant slowdown in U.S. economic activity, and the possibility of a recession in 2016, based on: 1) lack of growth in consumer and capital goods orders, 2) a range-bound stock market and flattening yield curve, 3) a multi-year trend of slowing sales growth, 4) unsustainable increases in business and consumer borrowing, 5) an elevated inventory-to-sales ratio, 6) commodity price deflation and 7) the complete exhaustion of Federal Reserve monetary policy.

The analysis method is to individually rank each Conference Board indicator -1, 0, or +1 (negative, neutral or positive, respectively) and to average these rankings two ways. The first way treats each indicator equally, while the second uses the weighting system employed by the CB. The possible range of scores is from -100%, which would represent a severe recession, to +100%, which would represent robust expansion. The summary table below previews the results of the analysis. According to the equally-weighted method, past, present and future economic activity in the U.S. has been hovering close to stall speed — neither expanding nor contracting (0% diffusion index values). Using the CB’s weightings, which more heavily emphasize manufacturing activity, interest rates and consumer sentiment, the U.S. economy is expected to remain in a sluggish, slow-growth mode for the first half of 2016 (a 23% diffusion index value corresponds to slow growth). If business activity continues decelerating, however, the economy will most likely slip into recession sometime in 2016.

Unweighted-Diffusion-Index Weighted-Diffusion-Index

The most heavily-weighted component is the Average Length of the Manufacturing Workweek (weight = 27.8%), shown below with the Average Length of the Construction Workweek. The manufacturing workweek has averaged 41.8 hours — exactly — for the past 8 months (which raises questions about the validity of the reported data). The length of the construction workweek is also at multi-year highs.

LE-1-Workweek

In the chart below, I compare the manufacturing workweek to total manufacturing employment. Despite my doubts about the accuracy of the workweek data, the increase in manufacturing employment since 2010 convinces me to rank this indicator +1.

LE-1A-Employment

The second leading indicator is the ISM’s New Manufacturing Orders Index, weight = 16.5% (notice that the first two indicators make up 44% of the weightings in the CB’s Leading Index). The ISM index has recently plunged below the contractionary level of 50, which earns it a ranking of -1. (The recent downtrend in this indicator casts further doubt on the accuracy of the manufacturing workweek numbers — declining activity should be accompanied by a declining average workweek).

LE-2-ISM

The University of Michigan’s Consumer Sentiment Index (weight = 15.5%) has also exhibited unusual behavior, spiking sharply higher despite 1) increased financial market volatility, 2) contradictory and confusing announcements by the Federal Reserve Bank, and 3) increased geopolitical tensions. Despite all that, I will give the indicator the benefit of the doubt and assign it a score of +1.

LE-3-Sentiment

Interest Rate Spread Between the 10-year T-Note and the Fed Funds Rate (weight = 10.7%). This indicator is really a proxy for the slope of the yield curve. A steeply-sloped yield curve indicates economic expansion, while a flat or inverted yield curve indicates slowdown or contraction. The curve has recently flattened as longer-term rates have slumped and short-term rates have risen slightly, in anticipation of the long-awaited Fed Funds increase. The 2% spread is typical for the middle of an economic expansion, but with the Fed’s central planners maniacally pinning the Fed Funds rate at zero for the past 7 years, the indicator cannot be rated higher than zero.

LE-4-Rate-Spread

Manufacturers’ New Orders for Consumer Goods (weight = 8.1%). Nominal and real Durable Goods Orders (deflated by the Personal Consumption Expenditure Index, or PCE) are shown below. After climbing sharply during the years following the last recession, the indicator has contracted sharply in 2014-2015. Moreover, the inflation-adjusted series shows zero growth over the past 15 years. The indicator therefore merits a score of -1.

LE-5-Durable-Goods

The Conference Board’s proprietary Leading Credit Index is replaced by The Chicago Fed’s National Financial Conditions Index (weight = 7.9%). Lower levels indicate “looser” borrowing conditions. Access to credit remains easy, especially for this stage of an economic expansion, so I’ll rate this indicator +1.

LE-6-Financial-Conditions

The +1 rating is on the generous side, however, as demonstrated by the following graph depicting total borrowing by U.S. businesses and consumers. Both have increased at historically high rates since 2010, a trend which is not sustainable. (Total business credit is an official CB lagging indicator.)

Comm-Loans-Consumer-Credit

The ratio of consumer credit to personal income, another CB lagging indicator, is at an all-time high of 22.5%, further confirming the unsustainability of the debt binge. It’s unpleasant to contemplate the effect on U.S. consumers’ spending power if the Fed raises rates, and payments on all adjustable-rate loans for consumers rise.

LA-2-Credit-to-Income

Level of the S&P 500 (weight = 3.8%). After rising dramatically since 2009, the S&P 500 has remained in a trading range for all of 2015, while volatility has increased sharply. I will generously assign this indicator a score of zero.

LE-7-SP500

Manufacturers’ New Orders for Capital Goods (weight = 3.6%). Capital Goods orders show a contraction similar to Durable Goods, and the inflation-adjusted Capital Goods Orders index has been in a 15-year downtrend. The indicator earns a score of -1.

LE-8-Capital-Goods

Initial Unemployment Claims (weight = 3.3%). Unemployment claims continue trending lower. What could be the problem? As the chart shows, consistent readings below 300,000 usually occur late in a business cycle expansion. This indicator therefore rates a score of zero.

LE-9-Unemployment-Claims

Building Permits for New Private Housing Units (weight = 2.7%). This indicator continues advancing, but remains far lower than the levels achieved in each of the two prior expansions. I will therefore rate the indicator zero.

LE-10-New-Building-Permits

A summary of the individual scores for each leading indicator and their weighted and unweighted averages are shown below. This marks the third year in a row that my ranking of the Leading Indicators has been in decline. Overall, the analysis implies that economic momentum will continue declining through at least the first half of 2016. For the first time since 2009, the U.S. economy is showing signs that it may slip into recession sometime in 2016.

Leading-Diffusion

Additional concerns. Despite all the excessive borrowing described above, U.S. GDP growth has barely averaged +2.0% during the current expansion.

Real-GDP-Growth

Another concern arises due to the behavior of the inventory-to-sales ratio, which will hamper GDP growth in future periods as businesses reduce production and liquidate excess inventory at reduced prices.

Inv-to-Sales

Global deflation is one of my most serious concerns. The chart below shows the 1-year price change for oil, coal, copper, aluminum, lead, zinc and nickel. All are negative, with declines ranging from -12% and -45%.

Physical-Commodities

Agricultural commodities are also in a deflationary spiral, as shown below. Although cotton and cocoa exhibit slight increases in price (after declining in 2014), the prices of corn, oats, wheat, soybeans and coffee are in a long-term decline, ranging from -7% to -30% year-over-year. Deflation is an unmistakable sign of global economic weakness.

Ag-Commodities

Finally, one of my new official concerns is the blatantly positive bias of the U.S. financial media, which has now been fully captured by corporate interests. The age of objective journalism is over. Consider this Bloomberg headline from December 11:

Bloomberg-Sales-Headline

The headline makes it sound as if sales are ripping higher. After considering the trend in retail sales growth depicted below, however (declining from 2012-2015), a more accurate headline might be “Retail Sales Growth Slows To Zero”:

Retail-Sales-YOY-Growth

Summary. The Conference Board’s Leading Economic Indicators have deteriorated significantly over the past year. Lack of growth in consumer and capital goods orders, a range-bound stock market and flattening yield curve, slowing sales growth, unsustainable increases in business and consumer borrowing, an upward-trending inventory-to-sales ratio, deflation in physical and agricultural commodities and the utter exhaustion of both conventional and unconventional Federal Reserve monetary policy all suggest that the 6-year economic expansion is running out of steam. A significant probability exists that the U.S. economy will slide into recession sometime in 2016.

Categories: Market Commentary

The Fed Won’t Raise Rates Until Deflationary Trends Reverse

We all love to say “I told you so,” but gloating is difficult when the news is this bad. Back in March 2015, I published an article entitled Deflation is the Main Reason the Fed Will Raise Rates Later Rather than Sooner. As the exhibits below will confirm, deflationary pressures persist, thus the Fed will most likely not be raising rates in December 2015, either. The mainstream media is high on hopium when it asserts that raising rates is the default decision for December. Unless there is a significant turnaround in the trends presented below, rates will remain at current levels until at least April 2016.

Agricultural-Commodities

Corn and cocoa are the only two major agricultural commodities to finish the trailing 12 month period at slightly higher average prices. Oats, wheat and cotton prices declined modestly, and soybeans and coffee are both down over 35% from a year ago.

Physical-Commodities

The story is worse for physical commodities. Aluminum, copper, nickel, zinc and lead have suffered price declines of -10% to -30% in the past year.

Bloomberg-Commodities-Index

A one-year history of Bloomberg’s commodities index confirms the trend. The global economy has been experiencing widespread declines in the prices of both agricultural and physical commodities for several years. These trends are not consistent with global growth and prosperity. Every central bank in the world is easing its monetary policy except the U.S. Federal Reserve. The Bank of China has recently announced new monetary stimulus efforts on consecutive days. The Bank of Japan openly admits it has extended quantitative easing to include the outright purchases of equity securities (which is more of a monetary madness than a policy). The European Central Bank also laid out plans for another massive round of quantitative easing recently (although Mario Draghi is fast becoming known as the boy who cried “QE”).

It is not plausible that the U.S. Fed will act against these trends. As reported by Bloomberg, Janet Yellen managed to obtain near unanimity (9-1, with only Lacker dissenting) from the FOMC to continue monitoring the situation and reconsider raising rates at its December meeting.

One last exhibit below — the Baltic Dry Index (also from Bloomberg), a measure of global shipping activity, managed to show some improvement from June-August. But the index has trended down for the past 2 months, as the global market selloff quickly dampened business confidence.

Baltic-Dry-Index-Oct-2015

And before you get too excited about that November 2014 “high” in the Baltic Dry, examine the chart below. Global shipping activity has been in a downtrend for at least the past 5 years:

Baltic-Dry-5-Years

The world is not only a long way from “normalized” interest rates, we are a long way from the kind of robust business environment under which any central banker would seriously consider so much as starting the normalization process. Here is the question we should be asking: How weak can the domestic and global economy be if most major central banks are easing further, and a 0.25% increase in the Federal Funds rate is unthinkable?

Categories: Market Commentary

Sector Analysis Reveals Investors’ Waning Appetite for Risk

Analyzing returns to stocks by sector can reveal information about investors’ desire to either take on or avoid additional risk exposure. The chart below shows that the top-performing S&P 500 sectors since May 2015 include defensive sectors such as Utilities, Consumer Staples and Health Care. Investors typically rotate into these safer sectors when they anticipate increased market volatility and sluggish economic conditions, which turned out to be a good call. It’s definitely been a “sell in May and go away” summer thus far.

Top-Sectors-May-Aug-2015

The worst-performing S&P 500 sectors include Industrials, Information Technology, Materials and Energy stocks. Investors typically rotate into these stocks when they anticipate lower market volatility and brisk economic activity. The continued decline in Materials and Energy raises the possibility that these sectors are now somewhat oversold, with the chance for a potential “relief rally” later in the year.

Low-Sectors-May-Aug-2015

The chart below shows the CBOE’s implied volatility index (VIX), sometimes called the “fear index,” although when volatility languishes as it has for most of the past 4-year rally in stocks, it can also be thought of as a “complacency index.” The spike in volatility from August 24 rivals those from early 2010 and late 2011, but is still much lower than the volatility observed in late 2008 and early 2009, during the heart of the financial crisis. If the VIX quickly returns to a sub-20% reading, it would signal a return to more of a “risk-on” mentality in Q3. On the other hand, stocks are unlikely to begin a significant uptrend if the VIX remains elevated.

VIX-Long-Term

Overall, sector activity shows that investors had been positioning themselves for a steep correction since May. Whether or not the selling continues into bear territory or remains confined to a quick correction likely depends on the Federal Reserve’s September interest rate decision. If the Fed hesitates and postpones their long-telegraphed rate increase, expect stocks to rally sharply this fall — especially the most beaten-down sectors. If the Fed proceeds and raises rates in September, however, the recent increase in volatility is likely to continue, and a sustained market rally is much more unlikely.

Data from S&P’s Capital IQ.

 

Categories: Market Commentary

Deflation is the Main Reason the Fed Will Raise Rates Later Rather Than Sooner

Like many, I have been perplexed by what can only be described as the complete cluelessness of the U.S. Federal Reserve. Chairwoman Yellen may speak more plainly than Greenspan or Bernanke, but like her obscure-talking predecessors, her statements are circular and contradictory. In her most recent statement last week, in virtually the same breath Ms. Yellen told us that 1.) “economic conditions have moderated” — which any objective observer can confirm — but also that 2.) “the economy continues growing above-trend.” With 2014 Q4 GDP coming in at another disappointing reading of +2.2%, Ms. Yellen must be referring to imaginary, rather than historical, trends. Neutral outsiders can clearly see that the Fed a.) is biased toward interpreting macro data in a way that conforms to their oversimplified academic theories, and even worse b.) reflexively parrots propaganda to markets that serves the interests of the financial services sector. The main problem, of course, is that the Fed stubbornly insists on implementing policies that increasingly diverge from basic common sense. Their recent “threats” to raise interest rates are, I believe, nothing more than a subterfuge being perpetrated on financial markets. They are merely flicking a few jabs to see how markets would react to actual action on interest rates later this year.

I offer two charts to illustrate why I believe the Fed is merely jawboning about imminent hikes in interest rates. The first chart shows the cumulative percentage change in the price of key agricultural commodities over the past year: Corn, wheat, soybeans, oats, cotton, coffee and cocoa. The average 1-year price decline is -25%. Every single commodity in the chart has declined in price. This is known as deflation, pure and simple, which results from economic weakness. When we look at direct measures of changes in price in this manner, instead of the hedonically- and seasonally-manipulated CPI, PPI, PCE, etc., one simple, common-sense truth is clear — the U.S. is being affected by the global deflationary episode that has persisted for at least the past year. The U.S. economy may be stronger than Japan’s or the Eurozone, but it is still so weak that the prices of key agricultural commodities can decline for an extended period of time. And such price behavior is in no way consistent with “an economy growing above trend.”

Commodities-03.27.15

The second chart shows the cumulative 1-year percentage price change in gold, crude oil, coal, heating oil, natural gas and copper. Every single physical commodity in the chart has declined in price, with an average 1-year price decline of -27%. Once again, we call this phenomenon deflation — a sign of profound economic weakness.

Physical-Commodities-03.27.15
The Fed is jawboning the market the may Floyd Mayweather uses his jab. They are feeling out markets, which they have never seemed to fully understand in the first place. The Fed is observing the effect of merely talking about higher rates, in case they continue losing their collective mind and would be so stupid as to actually raise rates any time in 2015. The relatively minor volatility we’ve seen in reaction to their jawboning would be many times worse, probably resulting in a “correction” in equities that would approach the -20% threshold for an official bear market. And I don’t think they have the nerve to pull the trigger.

It increasingly appears that Janet Yellen and crew are playing with their monetary policy levers like teenagers addicted to a video game. In a market suffering from numerous unpriced risks, the Fed’s utter cluelessness may be the biggest unpriced risk of all.

Categories: Market Commentary

Sector Performance Mixed as Stocks Search For a Catalyst

U.S. stocks were in the negative for January, a signal that often predicts how the rest of the year will go. Analyzing the performance of stock market sectors, known as “sector rotation,” can provide additional clues about the market’s next move. For example, when “risk-on” sectors such as Consumer Discretionary, Energy and Information Technology lead the market on the way up, it often signals the beginning of a broader, sustained rally. When “risk-off” sectors such as Utilities and Consumer Staples lead the market, however, it often signals a period of sideways consolidation or correction.

The 4th quarter of 2014 was characterized by the largest correction in equities in 3 years (-9% in October), after which stocks soared into a period of high-volatility consolidation that has lasted almost 2 months.

SP500-Volatility

Despite the October 2014 mini-correction, 8 out of 10 S&P 500 sectors finished higher in Q4, and did so in an unusually tight range of performance. There are two risk-on sectors among the top performers (Industrials and Consumer Discretionary, suggesting investor bullishness) as well as two risk-off sectors (Utilities and Consumer Staples, suggesting caution and a possible flight-to-safety as investors reached for higher yields while interest rates fell). Utilities declined by the least amount during the October correction, and Staples stocks benefitted from falling energy prices.

Top-Sectors-Q4-2014

The mid-performing sectors in Q4 were also mixed, with a defensive sector (Health Care) leading risk-on sectors like Financials and Information Technology.

Mid-Sectors-Q4-2014

The worst performers in Q4 were Energy (decimated by the decline in oil and gas prices) and Materials stocks, reeling from declines in commodity prices and a slowdown in global construction.

Low-Sectors-Q4-2014

Equities remained in the negative overall in early 2015, although 2 defensive sectors (Health Care and Consumer Discretionary) posted modest gains, along with 2 risk-on sectors (Materials and Consumer Staples). Continuing the theme from 2014, there is no clear signal from this type of sector performance.

Top-Sectors-Jan-2015

Sectors earning approximately zero returns in early 2015 include Energy, which recovered from additional losses in mid-January, along with Information Technology and Industrials. If the market was mounting a serious advance, we would expect more leadership from these sectors.

Mid-Sectors-Jan-2015

Rounding out the back of the pack in early 2015 were Utilities (risk-off) and Financials (risk-on). Financial stocks seem particularly affected by news that regulators might actually regulate banks a bit in 2015 — shocking.

Low-Sectors-Jan-2015

Despite Q4’s gains, the market’s overall lack of direction is reflected in this type of mixed sector performance. It will be important to continue watching stocks’ reaction to geopolitical and macro news (and the implications of the news narrative) to determine if 2015 is shaping up to be a positive or negative year.

Data from S&P’s Capital IQ. Disclosures: None.

Categories: Market Commentary
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