LUMP OF COAL

From the HRA Journal: Issue 297

The major markets got a lot more uncomfortable since the last issue, and that's saying something. It's not a bear market on Wall Street but it keeps heading that way.

I'm less concerned about continued drawdowns on Wall St than I am about a crash. Crashes take everything down with them while more measured declines–even big ones–allow for some rotation to sectors that look "cheap". The gold sector still has cheap in spades. We may be setting up for another early 2016 scenario where gold stocks–explorers included–hugely outperform other sectors of the market.

I'm hoping for that outcome but not counting on it yet. Gold's got to get above $1300 first. And we hope that hedge funds in NY and all those passive retail and index funds don't need to do so much selling in the back half of December to square the books that the wheels come off everything. I don't really expect that, but there may be enough selling to keep the current S&P downtrend going for a while longer.

I expect very little news for the remainder of the year. I'm going to start on a yearend issue as soon as this is sent. I'll deal with base metals and other resource sectors in that issue.

In the meantime, I wish you all the happiest of holidays for you and your families and for a happy (and profitable) 2019!

Eric Coffin
December 21, 2018


Dude, where's my Santa Rally?

Nowhere to be seen, so far. Ok, technically, Santa rallies come after Christmas, so there is still a chance we get one. It will take one hell of a rally to materially change the market situation pictured in the chart below, though.

I'm still not convinced large market and passive index investors will have anything to look forward to in their stockings this year other than lumps of coal. Plenty of bulls are calling for a V shaped bounce, but there isn't an obvious fundamental catalyst for one yet.

You can see from the SPX chart below that we have now put in a series of lower highs and lower lows. Even more ominously, the index has now fallen below the February low. NY markets have now joined virtually all other major bourses in being down year to date.

It's pretty difficult to put any sort of positive spin on the chart below. The only "good" thing I see at the moment is that sentiment is truly awful in NY. It might be awful enough to generate an oversold bounce.

I would not count on a bounce on the S&P being anything other than the "dead cat" variety until something changes for the better on the macro side.

In the last issue I talked about some potential catalysts that could either help NY markets turn around or doom them to new 52-week lows. While I'm still in the "no crash yet" camp, I see more reasons to fear one will happen. Near bear market conditions in NY seem the most likely outcome now, and it doesn't take much to move a market from "near bear" to "full bear".

The first catalyst discussed in the last issue was the US-China trade war. There was a G20 meeting on the horizon and it was no secret there would be a side meeting between President Trump and Premier Xi at that event.

Trump tweeted on the success of the meeting and commented on "concessions" by China. It was reported that an impending tariff increase by the US would be on hold for three months.

That led to a very brief bounce before China said it had a different understanding of what it had agreed to. The situation worsened considerably when Canada, on behalf of the US, arrested the VP (and daughter of the chairman and founder) of China tech giant Huawei. The US State Department is accusing Huawei of violating Iran sanctions. The market did not react well to the news. Neither did Beijing. We haven't heard the last of this.

This action may have been news to Trump and his trade negotiators, who seemed to try to downplay it. The idea that the left hand doesn't know what the right hand is doing in the US government did not improve Wall St's mood.

To the good however, both sides are at least still talking, and more meetings are scheduled. As long as that is happening Washington may continue to push back the date for another step up in tariffs. On a slightly sourer note, Premier Xi's keynote address at a major communist party event didn't sound conciliatory at all. Granted, he was playing to his audience, but it didn't sound like he was in the mood to make a lot of concessions.

Next up on the list of catalysts from the last issue was the US non-farm payrolls and, here too, the market was disappointed. The payroll number came in light, as did the hourly wage gain which I watch closely. And the prior month numbers for both gain in payrolls and wages were revised downwards.

The US is at virtually full employment so I don't expect amazing gains but Wall St wasn't pleased. The wage gain number would have troubled them the most as its ultimately drives consumer spending which drives the whole US economy. When you add that to traders looking for a reason to sell already, it created yet another drawdown.

The third main catalyst I mentioned in the last issue was the Fed meeting this month. By and large, the meeting turned out as I expected. But there were a couple of missteps by Fed Chair Powell (he probably wouldn't see them as such) that ramped up the angst, and selling, on Wall St.

As expected by me, the Fed raised rates by 25 basis points this meeting. Also as expected, the FOMC released "dot plots" that indicate a slightly shallower rate trajectory going forward, with two 25 basis point increases in 2019 rather than the previously assumed three.

None of the above should have been that distressing for the market. It seemed to be Powell's prepared speech and answers to reporters' questions that set traders off. Powell made the comment that he wasn't concerned about the recent market drop and it wasn't his job to worry about it. That happens to be true but Wall St does have a high population of princesses that think everyone should worry about their problems.

Traders were even more troubled by the comment that the Fed considered its balance sheet reduction (quantitative tightening) program to be on "auto-pilot" and saw no reason to adjust it. Wall St was expecting more dovish comments, including something about reducing the $50 billion/month pace of balance sheet reduction. Traders were not happy when they didn't get it.

The two charts below show measures of financial conditions. The upper one is a private reading developed by Goldman Sachs while the bottom is one calculated by the Chicago Fed. The Fed reading shows tighter conditions, but nothing like the increase in the private measure. Wall St thinks the Fed is tightening too much and that its not going to end well.

Other surveys and market measures show a similar divergence between the market's views of the future and the Fed's. The Fed talks about forward inflation expectations that are broadly in line with its mandate while Wall St is selling down inflation swaps hard, lowering the inflation measure by 0.6% since the start of October.

The story is the same in the bond market, where traders have a much more negative and cynical view of future market conditions. The yield curve has continued to flatten, with some portions of it inverting. We haven't seen a full inversion of the yield curve–yet. Good to know, as inverted yield curves are one of the more dependable recession predictors.

Market implied forward yield measures tell the same story. Bond traders are far more negative than the Fed in their forward growth forecasts. The bond market expects just 12 basis points in yield increases next year–half a 25-point rate hike, rather than the two 25-point hikes implied by the Fed's dot plot this month. And the bond market expects yields to drop in 2020.

The Fed's latest estimate predicts US economic growth decreasing by 0.6% next year but the bond market clearly expects something a bit more dramatic.

The bottom line is that the basic character of the NY markets has changed in the past three months. FAANG stocks that saved the day on so many earlier pullbacks during this bull market are mostly trading worse than the indices now. "BTFD" seems like a quaint phrase from the distant past.

That is neatly captured by the chart above. This year, unlike the last 15, big weekly declines in the S&P have led to… more declines. The recent dive has been so deep, and the current sentiment on Wall St so negative, that many are expecting a large bounce now. Hopefully, but that chart above should temper our enthusiasm. So should the knowledge that earlier episodes of sentiment this negative often occurred in the midst of major index declines, not the end.

Has the recent market had any winners? I'm sure you know the answer to that already. Unlike just about everything else, gold's been in an uptrend through most of this quarter and just broke above its 200 DMA for the first time since May. Gold miner indices have also been outperforming just about everything else in the market. Both gold and gold miner stocks have a LONG way to go to regain respectability, but at least they're going in the right direction, unlike everything else.

It was a "near bear" experience for the S&P that helped kick off the rally in gold juniors in 2016. We may be setting up for a similar move in early 2019. The key word for NY is "near". We don't want to see a major crash on Wall St. That would take everything down with it. We can't discount that possibility with the way NY markets have traded lately. More measured declines though, could generate continued rallies in gold, gold stocks and gold explorers. We're certainly way overdue for a sector rotation in our direction. It may final be our turn.

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