Risks of a Confounding Market?

Ryan Vlastelica of MarketWatch reports, Stock-market gyrations cull bulls and bears alike:
Over the past month, the U.S. stock market has seen both its best weekly performance since 2013, and its worst week in two years. In other words, it’s been a confounding time to be an investor.

The resurgence of volatility on Wall Street, which has led to the Cboe Volatility Index (VIX) jumping more than 50% this week, and more than doubling over the course of 2018, has battered investors from both side, giving arguments both for and against bullish and bearish positions.

In a sign of how confused investors are about the market’s outlook, neutral sentiment spiked to a seven-month in the latest week, according to the AAII Sentiment Survey.

More than 39% of respondents were neutral on the market, up 6.7 percentage points from the previous week and hitting its highest level since July 27. The historical average for the reading, which indicates a belief that prices will remain essentially unchanged over the coming weeks, is 31%. At current levels, “neutral sentiment is now close to the upper end of its typical range,” AAII wrote in a news release, citing readings above 40% as “unusually high.”

Most of the rise in neutral prognostications came from investors who were formerly bullish. The number of respondents who expect the market to be higher in six months was 37.3%, down 7.4 percentage points from the previous week and back below its historical average of 38.5%.

The levels of bullish and bearish sentiment has been volatile of late, shifting around as big swings in both directions returned to Wall Street. Optimism hit a seven-year high in January as equities hit repeated records, then pessimism spiked as the Dow Jones Industrial Average DJIA, -0.21% and the S&P 500 both fell into correction territory for the first time in about two years last month. A partial recovery in stocks led to a rebound in positive sentiment.

That recovery in prices was recently shaken by a resurgence of weakness, including three straight sessions with a 1% drop, the longest such streak since January 2016. However, that didn’t coincide with a surge in pessimism in the latest week; bearish sentiment rose just 0.6 percentage points, hitting 23.4%, a level that is below its long-term average of 30.5%.
It's Friday, been watching these lackluster markets all week and I'm not surprised investors are less than enthusiastic on stocks.

A couple of things I'd like to get out of the way. In my opinion, there were two major overreactions this week. First, the market overreacted to the new Fed Chair Jerome Powell’s Senate testimony fearing he's going to hike rates aggressively, and more recently, the market overreacted to President Trump's threat of trade tariffs, wrongly assuming it's the beginning of a trade war.

Absolute and total rubbish. People need to cool down, breathe in from the nose and out from their mouth. I listened carefully to Jerome Powell and he actually impressed me. He's very much in tune with what is happening in markets and I strongly doubt he's going to rock the boat.

As for President Trump's silly tariff comments, give it a week, nobody is going to be talking about it any longer.

Nothing has really changed since I wrote my comment on the big correction a little less than a month ago. Stocks keep climbing the wall of worry, etching higher, but there is increasing uneasiness out there.

Some expert traders I talk to think we're going to revisit the pre-Trump rally low of 2120 on the S&P 500 this year. Others are more optimistic thinking the tax cuts will help sustain the rally into year-end.

I'm personally ratcheting down my expectations for the rest of the year, sticking to my thoughts which I outlined in my Outlook 2018: Return to Stability.

Importantly, the macro winds are shifting. A winter storm has hit Europe and it's a nasty one:

And it seems as if leading economic indicators are topping out there. Jonathan Cable of Reuters reports, Euro zone factory boom slowed again in February but stayed strong:
The euro zone’s manufacturing boom slowed a little further last month but factories across the bloc still appear to be enjoying their best growth spell in almost two decades, a survey showed on Thursday.

Evidence the recovery remains robust and widespread, alongside price pressures at a near seven-year high, will be welcomed by policymakers at the European Central Bank as they move closer to unwinding their ultra-easy monetary policy.

IHS Markit’s final manufacturing Purchasing Managers’ Index for the euro zone fell to 58.6 in February from 59.6, just pipping an earlier flash estimate of 58.5 and comfortably above the 50 mark that separates growth from contraction.

An index measuring output, which feeds into a composite PMI due on Monday fell to 59.6 from 61.1, but was also above its flash estimate.

“The average PMI for the first quarter so far is the second-highest since the spring of 2000, falling just short of the near-record peak seen in the fourth quarter of last year,” said Chris Williamson, chief business economist at IHS Markit.

“The broad-based nature of the upturn is especially welcome, with all surveyed countries reporting solid rates of expansion.”

That robust growth came despite a sub-index measuring output prices rising to 58.4 from 58.0, its highest reading since April 2011.

“Widespread cases of demand exceeding supply highlight the ongoing presence of solid underlying core inflationary pressures,” Williamson said.

However, euro zone inflation slowed to a 14-month low in February, official data showed on Wednesday, underlining the ECB’s caution in removing stimulus despite growth exceeding expectations.

Prices across the bloc rose 1.2 percent last month, a long way below the ECB’s 2.0 percent target ceiling.
I keep coming back to the rise in the euro over the last year and it's only a matter of time before manufacturing gets hit there. It's also because of the rise of the euro that inflation pressures keep slowing there as the appreciating currency has put downward pressure on import prices.

Manufacturing activity in the UK is even worse but still signals expansion. The rise in the British pound over the last year is the main factor explaining the slowdown in manufacturing activity there.

China's manufacturing activity is at a six-month high but here too, it feels toppish and there are worrying signs that China's economy will be weaker than expected this year. If growth stalls in China, it will weigh on emerging market stocks (EEM) in the year ahead.

In Japan, the jobless rate hit a 25-year low and inflation ticked up but factory output fell in January for the first time in four months. Still, the Bank of Japan surprised everyone hinting at a monetary stimulus exit around 2019 (I need to see it to believe it).

In the US, there are clear signs of a monetary slowdown:

All this makes you wonder why are people so bullish on stocks and so bearish on bonds?

Again this week, I read Paul Tudor Jones, who called the October 1987 crash, is predicting an inflation surge and bond prices will plunge. He's not the only hedge fund guru to warn of inflation pressures and a possible shock to the financial system.

Earlier this month, Ken Griffin, founder of the $27 billion Citadel, said he’s concerned about quickening inflation globally amid “general complacency” around the risks of such a shock.

Let me assure these two titans of finance and the rest of you beating the inflation drums that there are no sustained inflation pressures in the US or anywhere else, only cyclical blips due to a depreciating currency which raises import prices.

The only inflation I see is in asset prices, especially private equity which is at frothy levels but since 2009, asset price inflation has not translated into real, sustained economic inflation.

That's why I keep telling you to pay attention to high-yield bonds (HYG), the canary in the coal mine, because any signigcant sell-off in this market doesn't bode well for stocks or private equity (click on image):

So far, I'm not concerned and I believe the Fed is also paying very close attention to this market which is why I find it hard to believe it will start raising rates more aggressively than what the market anticipates.

Others, like Jesse Colombo, think junk bond spreads are revealing a complacency, masking the "bubble in everything" (see the clip below). He may be right and I've already warned my readers of the danger of irrational complacency but so far, the market doesn't seem too concerned.

Another person worried about the rise of systemic risk, not just volatility, is Charles Hugh Smith of the Of Two Minds blog. Watch him discuss his views on the game of risk transfer with Gordon Long below, a very interesting discussion.

I'm not as bearish as either of these two gentlemen but think it's important to shift your portfolio into more defensive, stable sectors, which is why I continue to recommend a portfolio made up of 50% US long bonds (TLT) and 50% low vol US stocks (SPLV) if you want to sleep well at night.

Of course, if you want to gamble on stocks, you can try your hand at stocks that took a beating this week, like Valeant Pharmaceuticals (VRX) which broke below its 50-week moving average and might retest its 52-week low of US $8.31 (click on image):

I took a small position in this stock earlier today but trust me, this isn't a sleep well at night buy and hold stock (it swings very hard both ways and lately, it's only swinging down!). All the technicians were telling you to buy the weekly breakout on Valeant shares at $24 but they got clobbered once again and are now reeling after the latest dismal earnings report.

And if you think the sell-off in Valeant's shares is bad, check out recent action in Macquarie Infrastructure Corporation (MIC):

Holy smokes! And this is an infrastructure giant in the world, not some fly-by-night tech stock.

This is why I can't stress enough how hard it is to pick the right stocks in this crazy environment and if the macro winds shift even more, which is what I'm preparing for, the big beta stocks are going to get killed (and if it's really bad, all stocks will get clobbered, low or high beta!).

Hope you enjoyed this brief market comment. I'll be back on Monday, March 12th and just wanted to thank all of you who take the time to donate to this blog and help support my efforts. If you haven't done so, please take the time to donate on the top right-hand side, under my picture. I thank all of you who support this blog, it's greatly appreciated.