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Posts tagged Current Market Trends

MV Weekly Market Flash: Magic Numbers, Catalysts and Pullbacks

August 29, 2014

By Masood Vojdani & Katrina Lamb, CFA

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On Tuesday this week the S&P 500 closed above 2000 for the first time ever. When we say “above”, we mean “right on top of”: the actual closing price was 2000.02. On Wednesday the index inched slightly upwards to a close of 2000.12. Of course, there is nothing inherently special or magic about a round number like 2000 versus any other kind of number. But perception creates its own reality. Along with moving price averages, signpost numbers like 1900 and 2000 often act as important support and resistance levels for short-intermediate term asset price trends. We call these “event numbers”. 

The Event Number Corridor

The following chart provides a snapshot of pullbacks in the S&P 500 in the current year to date. They have been fairly short, shallow and infrequent (only three with a magnitude of 3% or more). Interestingly, all three have occurred around an event number: 1850, 1900 and 2000 (there was a pullback of a smaller magnitude at 1950).

What seems to happen here is that the event numbers act as a sort of catalyst for investors to trade on whatever risk factors may be prevailing at the time. Consider the three 2014 pullbacks shown above. At the beginning of this year the S&P 500 had just come off one of its best years ever, leading to general chatter about whether the market was overbought. The market was trading in a corridor just below 1850. The release of a surprisingly negative jobs report early in the year gave traders the excuse to pull money off the table. A -5.8% pullback ensued taking the index to 1750, where it found support and sharply rebounded.

In April the market stalled for a few days just below 1900, then growing concerns about the situation in Russia and Ukraine helped fence-sitting investors to hop off. Again the fear period was brief, and this time support was found at the 100 day moving average level. In July, the risk factors swirling around in the market were for the most part the same as in April: Ukraine, Middle East, Eurozone…and an event number corridor just below 2000 broke in the last week of the month.  That too found support around the 100 day average and rebounded sharply…right back up to 2000, where another corridor is playing out.

What Next?

The current event number corridor is particularly interesting because we are heading into to the final months of the year, a time when a strong positive or negative trend formation can propel the market right through to the end of the year. Which way do the tea leaves point?

The short term, of course, is unknowable with any kind of surety: every rally and every pullback is different. Given how long it has been since the market last experienced a real correction, in 2011, each new pullback heightens fears of a slide from mere pullback to secular reversal. But we are still seeing daily volatility levels more typical of a middle-stage than a late stage bull market.

In both of the last two secular bulls, from 1994-2000 and 2003-07, volatility started to head higher some time before the market reached its respective high water marks. Late-stage bulls tend to be frenetic, with hold-outs piling in to belatedly grab some of the upside. It is only after those net inflows subside that the reversal tends to gather steam. Even in the immediate wake of the late-July pullback, though, we still appear to be in one of the calmer risk valleys, with the CBOE VIX index not far away from its ten year low.

Still, anything can happen. Summer is over. We expect trading volumes to pick up and, sooner or later, a late-year trend to emerge and test more event number support and resistance levels. We head into the new school year vigilant and focused.

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MV Weekly Market Flash: Summer of Noise

August 8, 2014

By Masood Vojdani & Katrina Lamb, CFA

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It’s summertime, but the living has been anything but easy for the past couple weeks. A news cycle full of geopolitical flare-ups, health crises and dissension at the Fed has brought volatility and wild intraday price swings back onto center stage. Yet there appears to be less to the daily drama than meets the eye. For all the lead stories spilling out of the world’s trouble spots, the real force driving volatility is the low levels of activity typical of summer. Since the beginning of July, daily volume on the S&P 500 has been below its 200 day moving average 82% of the time. Low volume amplifies price swings. We think this environment is less about news, more about noise.

Geopolitics Priced In (For Now)

Of all the current flashpoints, arguably the escalating tension between Russia and the West is cause for greatest concern. This tension certainly has not helped Europe, which depends on Russia for the majority of its energy imports. Shares in broad Eurozone market indices are down nearly 10% from where they were at the beginning of July. But Russia’s role in the global economy is less impactful than China’s or Brazil’s. Even if economic sanctions between Russia and its main trading partners worsen, the effect is likely to more localized to companies with significant interests in Russia (major international energy companies come to mind) than widespread.

Events in the Middle East are likewise unsettling, but contained in terms of practical economic impact. Crude oil prices – often a barometer for tensions in the Gulf – are at their lowest levels for the year to date. Questions remain about the level of U.S. engagement as the crisis in Iraq creeps towards the oil-rich Kurdish state, but for now any potential use of ground troops is fully off the table.

Support, Resistance and Round Numbers

There is nothing particularly magical about round numbers or 100 day moving averages, but in the capital markets perception creates its own reality. The S&P 500 broke through the 1900 resistance level back in May, and was closing in on 2000 before gravity kicked in late last month. The Dow Jones Industrial Average topped 17,000 before the latest tumble. On the other side, though, the major indexes are all finding support around intermediate-term moving averages: the S&P 500 is currently trading right around the 100-day average.

Bear in mind that over 60% of the daily trading volume on U.S. equity exchanges is machine-driven, reacting to algorithms rather than human decision makers. Many of these algorithms are programmed to react specifically to things like round numbers and moving averages, and that is why they figure so prominently in observed trading patterns. Given the pace of the rally that started in mid-May, it is scarcely surprising that we see a brief pullback and perhaps an extended period of trading in a narrow support-resistance corridor. Whether it turns into something more remains to be seen, but for now the noise factor appears to predominate.

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MV Weekly Market Flash: Yellen’s Dilemma

August 1, 2014

By Masood Vojdani & Katrina Lamb, CFA

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Major U.S. equities indexes gave up all their July gains and more on Thursday, the final trading day of the month. The Dow Jones Industrial Average, which has lagged the S&P 500 and the Nasdaq Composite for many months, finished the day in negative territory for the year to date. Tellingly the pullback was sandwiched in between two events: the Fed Open Market Committee deliberations which ended Wednesday, and the July jobs numbers, released earlier this morning. Was this 2% reversal a brief event, a virtual particle popping into and out of existence within the blink of an eye? Or does it portend a double portion of toil and trouble in the weeks ahead?

Cruel Summer

One has to feel sympathy for Fed Chairwoman Janet Yellen as she and her Fed colleagues deal with a full complement of X-factors, good and bad, bubbling up in their policy cauldron. It is an unusually eventful summer. In addition to trying to sort out the U.S. macroeconomic picture and communicate clear forward guidance on interest rates to the market, there are the crises in Ukraine, Gaza and Iraq trading places as any given day’s front page headline. Europe’s economy is stuck in the doldrums and sits in the shadow of Russia, its principal energy supplier.

On the other hand, China seems to be back on track after concerns earlier this year about the sustainability of its growth trajectory in tandem with a major economic rebalancing. India’s outlook appears somewhat more promising in the wake of May’s elections bringing Narendra Modi and his business-oriented BJP to power. There are reasons for caution and reasons for optimism. That makes it difficult for the Fed to maintain tight consensus. We saw some cracks in the consensus with the holdout vote Wednesday of Philadelphia Fed president Charles Plosser. Tension over rate policy is likely to continue, and likely helped stoke the flames for Thursday’s pullback.

Good News, Bad News

The economic data continue to accumulate more in the good news column. GDP grew at an annualized rate of 4% in the second quarter. Inflation is over the Fed’s 2% threshold. But in the looking glass world of capital markets, good news for Main Street is often bad news for Wall Street. More jobs and higher wages mean tighter capacity, upward pressure on prices and, eventually, rate hikes. Breaking the six year zero-rate addiction will be hard.

Yellen caught a bit of a break with today’s job numbers, though. Nonfarm monthly payrolls came in over 200,000 but below consensus expectations, and the unemployment rate ticked up slightly. In other words: good enough but not too good. Equity futures rallied on the jobs news, though they have pulled back into negative territory (as of this writing) as yesterday’s selloff gets a second wind. It would certainly not be unheard of for a pullback of 5% or more to materialize. But at some point good news may just be good news, even on Wall Street. We’d be fine with a 10% correction if it were followed by a sustained, genuinely organic economic growth story.

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MV Weekly Market Flash: Stocks & Bonds: Everyone Gets a Trophy

June 27, 2014

By Masood Vojdani & Katrina Lamb, CFA

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One of the many unusual exhibits on display in today’s asset markets is the seemingly tandem performance of U.S. stocks and bonds through the first half of 2014. Consider the two side-by-side charts below, both showing the price performance of the S&P 500 and the 20+ year Treasury bond. The leftmost chart depicts the trend from January 2012 to December 2013; on the right we see the 2014 year to date pattern.

The left chart is what we normally expect from the relationship between stocks and bonds: one goes up, the other goes down. Treasury yields soared in the first half of 2012 as the world still fretted over the uncertain fate of the Eurozone. In 2013 U.S. large cap equities had their best year since 1997, while bond markets went into a panic over the prospect of the Fed’s winding down its QE program. By contrast, these two asset classes have both enjoyed the investment climes of 1H 2014, causing a great deal of chatter and head-scratching among market participants. Should we expect this trend to continue? If not, which asset is more likely to fall out of favor?

All Quiet on the Correlation Front

As is often the case with short term asset trends there is less here than meets the eye. For one thing, there is not much difference in the correlation between stocks and bonds this year versus long term patterns. The fact of both assets moving in the same general direction this year would imply positive correlation. In fact, the YTD correlation between the two assets shown above, measured by rolling one month returns, is -0.75. That is actually a higher negative correlation than the -0.45 level for the 2012-13 period.

A closer look at the rightmost chart above should explain why this is so. While both stocks and bonds have gained ground this year, they have not done so at the same time. There have been a few classic risk on / risk off trades in the year to date, notably at the end of January when stocks experienced a 5%-plus pullback. There really is not much of a mystery here: stocks and bonds have benefitted from some of the same tailwinds (accommodative Fed, temperate inflation), but also from many independent factors.

Treasuries: Unlikely Yield Oasis

One of the distinct factors driving the bond market is foreign purchases of U.S. Treasuries. According to the Financial Times, foreigners hold a record $5.96 trillion, or just about half of the total volume of outstanding Treasury bills, notes and bonds. This is important: bear in mind that the Fed is reducing its own purchases of long-dated government bonds by $10 billion after each Open Market Committee meeting, taking $50 billion off the table since tapering began last December. Increased bond purchases by non-U.S. investors have thus stabilized bond flows, especially at the longer end of the curve. That helps explain why the U.S. 10-year yield remains far below where it started the year, while shorter term yields like the 2-year note are at or near their YTD highs.

And why are Treasuries so attractive to the rest of the world, given that rates are still far below historic norms? Partly because rates are even lower elsewhere. The chart below shows the yield spread between the U.S. 10-year and the Eurozone 10-year benchmarks.

.5% looks like a good yield when compared to 1.3%. On a risk-adjusted basis Uncle Sam would look even more attractive, given that Eurozone credits share a mix of the stable (Germany) and the shaky (France, Italy et al). In Japan, which shares with China the status of top global Treasuries investor, yields are even lower, and U.S. bonds offer the additional sweetener of a strong currency. The yen is about 17% lower today than it was at the beginning of 2013, thanks to an orchestrated weak currency policy. The Financial Times article cited above notes that the Japanese have bought $33 billion in Treasuries since mid-April – that alone more than makes up for the QE taper.

What’s In the 2H Tea Leaves?

Equities look expensive by historical standards; for example, the price-to-sales (P/S) ratio for the S&P 500 is currently at a ten year high. And credit market watchers are still waiting for what they see as the inevitable rise in rates as the Fed’s likely decision window of late 2015 to early 2016 approaches. It is possible that both asset classes could follow each other on a downward trajectory in the coming months – a reversal of the 1H pattern.

But don’t count on that as a given. For as much as stocks have risen virtually uninterrupted in the past two years, for as many days have gone by without large cap indexes being anywhere near their 200-day moving averages, the market is not yet exhibiting much in the way of final-stage bull rally characteristics. Volatility is tepid, intraday spreads are miniscule, and volume is consistently light. There may yet be another buying wave or two before the end of the year – though another 5%-plus pullback along the way would be far from surprising in our opinion.

On the bond side, we see headline macro data points as the most telling tea leaves. The Personal Consumption Indicator, the Fed’s preferred inflation gauge, clocked in at 1.8% for May. That’s nearing the central bank’s 2% target, and (as we noted in last week’s Market Flash) the Consumer Price Index is already above the 2% watermark. June unemployment numbers will be out in a couple weeks, and as earnings season gets into full swing we’ll see how companies are rebounding from the weather and other headwinds experienced earlier in the year. Stocks up, bonds down? No-one knows for sure, of course, but it may be a reasonable base case.

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MV Weekly Market Flash: Let the Dog Days Begin

June 13, 2014

By Masood Vojdani & Katrina Lamb, CFA

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Summer weather has returned in full. For those of us who call the Mid-Atlantic region home, that means lots of humidity and the intermittent torrential downpour showing up just in time for the evening commute. It’s summertime in the markets as well. Average daily trading volume on the New York Stock Exchange for the month of June to date is about 17% lower than the average volume for the month of April. By the looks of things, not many people sold in May but they did go away, taking their algorithms and server platforms with them.

Light trading volumes are characteristic of many summers, though by no means all. Average NYSE trading volume in June 2011 was about 40% higher than the month-to-date figure for this year. Investors in 2011 were focused on the possible collapse of the Eurozone, and as the summer unfolded the debt ceiling debacle and S&P downgrade of U.S. Treasuries also conspired to keep money professionals from getting away to their favorite vacation destinations. In 2012 June was another busy month, but in early July that year ECB Chairman Mario Draghi uttered his famous “anything it takes” pronouncement to shore up support for still-beleaguered Europe. Average daily trading volume subsided from around 870 million shares in June to 740 million in July, and a listless 615 million in August (which is close to the 2014 June month-to-date figure of 605 million). Resort owners cheered Draghi.

While markets this summer are off to a calm start, there is no shortage of news stories with the potential to cause some near-term mayhem. The recurring 2014 theme of geopolitical flashpoints is back front and center today with Iraq seemingly on the verge of disintegration. The extremist Islamic State of Iraq and Syria is in the process of seizing control of large swaths of the country and converging on Baghdad, while in the north Kurdish forces have taken over the oil-rich city of Kirkuk. Oil prices predictably have shot up. Equities are down, though losses in most major markets are fairly contained. “X-factor” events like this have the potential to move index price returns well above or below 1% from the previous day’s close. That watermark is not being breached today; in fact, the S&P 500 has not experienced a daily gain or loss of 1% or more since mid-April.

Even a worsening of the Iraq situation, though, or a re-intensifying of other geopolitical problem spots such as Ukraine or the Senkaku Islands, is unlikely to keep traders from their beach houses or fly fishing meccas. At this point it would appear that the only thing with the potential to really shake up the current state of complacency would be a fundamental re-think of the baseline economic story. This story rests on several pillars: moderate growth in the U.S., avoidance of deflation in Europe, positive signs of a rebalancing Chinese economy, and healthy price trends in Japan (where headline inflation is now actually higher than either the U.S. or Europe). All with central banks at the ready where and whenever additional stimulus is needed.

It’s a strange calm, to be sure. Sometimes, looming clouds on a calm summer afternoon ominously portend a night of wild and devastating storms. But sometimes the clouds just sit there, and the calm continues.

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