THE WEEKLY TOP 10
Table of Contents:
1) Friday’s employment report should not keep the Fed from tapering.
2) 3 major economic powers are getting less stimulative. That’s all you need to know.
3) Inflation fears will remain even if commodities correct from overbought levels.
4) The repercussions of the debacle at Evergrande are far from over.
5) Weaker growth in China is spreading to other areas around the globe.
6) The housing stocks are very close to a key support level.
7) Sentiment is getting bearish…and that’s bullish.
8) Despite some new headwinds, Bitcoin’s chart looks quite good.
9) The energy stocks are getting ripe for a near-term pullback.
10) Summary of our current stance.
1) The weaker-than-expected employment data on Friday led a lot of pundits to say that it gave the Fed an excuse to delay the tapering back of their bond purchase program. Maybe it does, but it definitely should not. We are not longer in an emergency situation with the economy (or with employment), so the Fed should go ahead and taper back their emergency levels of stimulus.
When the weaker-than-expected employment number hit the news-tape on Friday, it immediately led many pundits to say that the Fed would likely push-off the beginning of their “taper” program into the future. This might indeed be the case, but we hope it is not.
The real discussion should about the Fed should be as follows: Do we still need emergency levels of stimulus…just because employment growth is a bit slower than expected…when we have moved well away from a state of emergency in the employment picture? In other words, do we really need emergency levels of stimulus…long after the emergency has passed?
Let’s face it, it’s not like the employment number was so bad that it put us back to anything close to something that would resemble an employment emergency (like we saw in the spring of 2020). Several members of the Federal Reserve have already told us that we don’t need to see the employment picture improve further in a significant way.
The employment picture…the economy…and the markets moved away from the emergency many, many months ago. Therefore, the Fed needs to stop providing emergency levels of stimulus. We believe that the Fed knows this and thus we believe they’ll stick with their tapering schedule.
In our opinion, the only thing that will keep the Fed from tapering in 2021 will be if, for some reason, the credit markets see some major stress develop in the credit markets. In other words, now that the emergency has passed, we believe the Fed has become much more “market dependent” than “data dependent.”
2) China, the Euro area, and the U.S. all have economies and markets that are very highly leveraged after the massive levels of stimulus that was injected into their financial systems during the pandemic (and beforehand). NOW, China has been engaged in a de-risking/de-leveraging program for almost a year now. The Fed & the ECB are about to do the same thing. That’s all you really need to know…when you think about the macro situation…as we move into the end of the year and into next year.
China began clamping down on leverage and risk-taking almost one year ago (when they went after Jack Ma and Alibaba). They have since expanded this de-risking/de-leveraging program in a major way…to include other tech companies, the video gaming industry, the education industry, casinos, and (especially) real estate.
Real estate has been responsible for huge part of their overall growth over the past decade (as real estate production and property services has risen to 29% of GDP according to Ken Rogoff). When a country’s economy and markets are as leveraged as China’s has become (in order to reach Xi’s economic growth goals that were unattainable without massive debt), hitting the breaks on that leverage HAS to have a negative impact on future growth at some point. In fact, we’re already seeing signs of a noticeable slowdown…as retail sales and industrial production have slowed in a serious way recently.
Another sign that China continues to clamp down is that the PBOC (Bank of China) drained the most cash in a year from the banking system late last week. Now, we don’t want to overstate this development. The PBOC had added a lot of support in order to keep things stabilized during their weeklong holiday season, so the move was more of an offset to the large amount of cash that has injected into the system very recently. So, we can see that the Chinese authorities have certainly not pulled the plug. In fact, most people have seen the recent actions by the PBOC as ones that tell them that they’re working hard to make sure the situation does not get out of hand. However, the fact that they did such a big drain after the holiday shows that they are not reversing their de-leveraging/de-risking program.
In the U.S. and Europe, we’re about to see a similar move…as the emergency levels of monetary stimulus that has been pouring into the system for 18 months will begin to shrink when the Fed & ECB begin to taper back on their bond buying programs soon). Needless to say, this is not the same as a direct “de-leveraging” or “de-risking” that China is engaging in, but it still shows that there is going to be less stimulus flowing into the system over the months ahead.
The reason we believe that this is SO INCREDIBLY important is that we strongly believe that a large part of the rally over this year has been fueled by the outsized levels of stimulus that has been pushed into the system. No, we’re NOT saying that it is the ONLY catalyst that has fueled the rally. The economy has continued to improve. More importantly, earnings have been absolutely fabulous! HOWEVER, even though earnings have improved dramatically, the stock market has remained extremely expensive. (It’s still trading at more than 20x forward earnings…and 3x sales…which is an all-time record.) Since the massive rise in earnings growth this year has not been enough bring valuations down much at all, it shows that something else has been helping this rally in a material way. In our opinion, that “other source” of fuel has been monetary stimulus.
Pretty much everybody would admit that the MASSIVE monetary and fiscal stimulus that was provided in 2020 kept the stock market at an artificially high level for much of last year. The economy had slowed to an almost completely halt, so if the market was trading on fundamentals only, the stock market would have fallen MUCH more than it did. Instead, the market stayed elevated…and far above ANYTHING that could be justified by the underlying fundamentals.
THEN, once we got the vaccines, the economy started to improve. This helped earnings improve significantly…and they’ve been playing catch-up all year. However, given that the extreme levels of valuation that still exist today, it shows that the fundamentals have not been strong enough to fully catch-up with asset price levels. Therefore, EVEN THOUGH those fundamentals (especially earnings) have improved in a tremendous way…the markets are well ahead of the fundamentals. Therefore, as stimulus around the globe shrinks further, asset prices will have to come down. The best we can hope for is for the fundamentals and the stock market meet somewhere in the middle.
3) Most economist/strategists acknowledge that inflation is going to be with us for quite a while. (They might argue about how long it will last, but most believe it will stick with us for quite some time. Our belief is that we WILL get some relief in the months (just like when lumber did earlier this year), but that does not mean that inflation will drop to a comfortable level.
Since you’ve almost certainly been inundated with opinions about how long inflation will remain a problem…and given that we’ve harped on this issue many times…we’re going to talk about the issue of inflation from a different angle this weekend.
Late last week, the price of containers for the shipping industry fell slightly…as the cost of 40-foot containers fell by 0.2%. That might not sound like much, but it’s the first decline after a sharp increase over the previous 22 weeks. We also saw an 11% decline in natural gas prices over the last three days of last week as well…after it had reached a very overbought level. We’d also note that commodities like WTI crude oil are getting quite overbought on a short-term basis, so they could see some declines before too long as well.
If these commodities start to experience multi-week declines, it will likely give investors the belief that the worst of inflation is behind us. However, we’d note that lumber crashed by over 70% this summer…and it did not give us any relief on the inflation front. Part of the reason for this is that lumber had seen a parabolic rally before the crash took place. More importantly, lumber leveled off at a level that was/is twice the level of the average price of the last 10 years.
In other words, the rally in many of the other commodities has been SO strong that a significant decline…and still leave them well above their average levels of the past decade (or two). For instance, natural gas could crash 30% down to $4.50…and that would still leave it above the level it has been for all but 5 months of the last 120 months (the last 10 years)! What we’re saying is that even though commodity prices will likely fall at some point, they’re still going to remain well above anything they’ve seen in the last decade. (The last several decades for that matter.)
When you combine this…with the supply chain issues that are causing higher prices for everything…and the wage pressures that all business leaders (large and small) have been talking about all year…and it’s hard to think that a decline in some commodity prices will give us a lot of relief on the inflation front.
Long-term interest rates have been moving higher for over two months now (just like they did this time last year). The yield on the 10yr note has signaled a significant change in trend. (After making a nice “double-bottom” in July and August, it has broken above its trend-line from May and made a key “higher-high” above the 1.4% level.) It now stands at 1.605% (the highest level of this move. With the supply chain issues still with us (if anything, they’re getting worse)…we don’t think a pullback in the price of a few commodities will be enough to keep long-term yields from rising further. This is especially true given that the Fed is about to taper back on their massive bond buying program…down to zero by mid-year next year.
4) With the fiasco in Washington DC and concerns about inflation rising, the problems surrounding Evergrande have moved to the back pages. However, this situation is definitely starting to spread anddeteriorate, so it should still be a big concern. As we said a couple of weeks ago, just because Evergrande was not a “Lehman moment,” it does not mean that it’s not important…or that it is not a sign of deeper problems to come.
A few weeks ago…when some pundits were comparing what was going on with the China Evergrande Group to the collapse of Lehman Brothers…we said that it actually reminded us of Bear Sterns. No, we were not talking about the failure of Bear Sterns in 2008. We were talking about the collapse of two Bear Sterns hedge funds in the summer of 2007 (six months or so before “the Bear” collapsed). That incident was a big warning signal for what was to come…and that’s what we’re worried about with Evergrande. (We’re not saying that we’re about to see a repeat of 2008, but we do think it we’ll see much more fallout before this issue completely plays-out.)
First of all, Reuters is reporting that a default of $300bn of Evergrande’s offshore debt is imminent. Second, real estate developer, Fantasia, has defaulted on $205mm of their bonds that were due to mature last Monday. Third, major real estate developers in China have seen their sales plunge 36% in September from a year earlier. Fourth, concerns over more defaults have risen considerably…which can be seen by the jump in high yield rates in China. (They have jumped to almost 17%...it’s highest level in almost 10 years).
Much like it did in 2007/2008, it took many months for the debt debacle to unfold. (The same is true in Japan in very late 1989 and into 1990…when THEY engaged in de-leveraging move.) Therefore, even though we’ve only felt a few minor aftershocks after the initial earthquake that Evergrande provided a couple of weeks ago, there is a definite chance that we’ll get a bigger “quake” at some point down the road. Contagions are strange animals…they frequently subside for several weeks…only to raise their ugly heads in a more significant way before long.
5) When a highly leverage economy like China’s sees a reversal in policy from one that entices massive risk & leverage to one with much less risk and leverage, it has to have a negative impact on economic growth for at least a while. Given that China is the second largest economy in the world, that will have to have an impact on other countries (if not global growth in general). We’re starting to see signs that this is taking place in that part of the world.
There are some pundits who believe that China’s government is omnipotent…and that they can completely control their economy without any repercussions. Of course, history tells us that no government can control the natural forces forever, so there is little question in our minds that China’s economy will have to slow in response to their policy of de-risking and de-leveraging the markets/economy.
If you promote leverage and risk taking in a major way, it does provide outsized growth (like it has in China for years). However, when you start to take it away, you cannot keep that change in stance from having the opposite effect. Sure, they can work very hard to keep it from creating a major downturn, but you cannot prevent some sort of downturn from taking place. (We believe that China knows this…and are merely trying to mitigate the impacts…not prevent it. They’re not stupid.)
As we highlighted earlier, we’re already seeing signs of weakness in china…with falling retail sales and industrial production. If this continues, the odds are VERY high that it will spill over into the global economy. We’re already seeing some meaningful weakness in certain stock markets in that part of the world. Since a country’s stock markets tends to be a leading indicator for growth in that country, these recent sell-offs are likely signaling that a slowdown in growth throughout Asia is just over the horizon.
We’re talking about the decline in two key stock markets in that part of the world: South Korea and Japan. There is no question that we’re already seeing the South Korean KOSPI and Japan’s Nikkei Indexes break down in a meaningful way.
Before bouncing mildly late last week, the KOSPI had fallen 12% from its summer highs. It has broken well below its trend-line from March 2020 and it has now made a key “lower-low” below the 3,000 level……As for the Nikkei, it has fallen almost 10% and it has also broken below its trend-line from March 2020. It has not made a key “lower-low” yet, but if it breaks below the 2700 level, that will do the trick.
Again, a country’s stock market tends to decline several months before their economies show signs of slowing. If these markets fall further in the coming weeks, it should signal that the effects of China’s de-leveraging program is spreading outside their country…and could/should spread around the entire globe eventually.
The problem is that the supply chain problems mean that a slowdown in growth is not going to give us much relief on the inflation front. Therefore, there is no question that “stagflation” is a definite possibility in the months ahead.
6) If we get an extended period of inflation and/or stagflation, hard assets should do quite well. However, the housing stocks have not been acting well in recent months. Right now the ITB home construction ETF stands at a key technical juncture. If it falls much further from current levels, it’s going to raise a big warning flag on the near-term potential for this group.
During the stagflation years of the second half of the 1970s, hard assets did quite well. This included the price of homes and other real estate. We believe the same will be true going forwards, BUT we also know that no stock, group, or market moves in a straight line. Looking at the chart of the ITB home construction ETF, this group could see some noticeable (further) pressure in the coming weeks if it falls much more any time soon.
The housing stocks saw a momentous rally from the March 2020 lows to the late-spring highs. This rally took the ITB higher by 219%, so it outperformed the broad market by a wide margin. However, since that time, the group has faced some volatility. The early summer decline of 14% was followed by a nice bounce of over 10% in the last half of the summer. The problem is that the late-summer bounce in the ITB still gave it a “lower-high”…and it has rolled back over again since the beginning of September.
This most recent decline has taken the ITB below its 200-DMA for the first time since May of last year. More importantly, it has taken it down to its lows from June and July. This action means that the ITB has formed a “descending triangle” pattern and it stands quite close to the bottom line of that pattern. In other words, a meaningful drop below the $66 level would not only take the ITB well below its 200-DMA, but it would also take it below that triangle pattern (below its summer lows)…and that would be quite negative on a technical basis. (This is especially true given that this ETF has already fallen below its trend-line from the March 2020 lows.”
Again, we like this group on a fundamental basis for the longer-term. However, if the ITB breaks below the $66 level in any significant way, it’s going to tell us that it’s headed lower…and that we should avoid “buying it on weakness” until the group becomes washed-out at some point in the coming weeks.
7) If there is one item that stands on the bullish side of the bull/bear ledger, it’s sentiment. Sentiment has been moving to the bearish side of things for may weeks. Whether it be some bearish comments from the bulge bracket firms or the bull/bear polls, sentiment has become much less bullish over the past several months.
On Wall Street, sentiment is a contrarian indicator. When sentiment becomes overly bullish, it is actually a bearish development. When it becomes overly bearish, it’s actually a bullish development. Recently, sentiment has become quite bearish. Bullishness in the Investors Intelligence poll shows that the bulls have fallen to 40.4%...the lowest since March 2020. Those looking for a correction has risen to 37.1%, which is the highest level since last March.
Similarly, the AAII Sentiment Survey of individual investors shows that bullishness has fallen to just 25.5%...near its lowest level since August of 2020. Also, the number of bearish stories in the media has reached the highest level since Q1 of this year…..On top of this, we have bulge bracket firms like Morgan Stanley warning about a decline of 20% or more in the stock market. (Bulge bracket firms don’t usually call for anything but an 8%-10% pullback.)
There numbers are not at extreme levels that we frequently see when the stock market gets completely washed out. However, they are much more bearish than they usually are when the stock market is in the early stages of a significant correction. Therefore, maybe the stock market can bounce back soon…and “climb the wall of worry.”
8) We had become much more cautious on Bitcoin on a near-term basisafter the news that China had made trading cryptos illegal and Gary Gensler signal that more regulation on this asset class is coming. However, the action in Bitcoin (and other cryptos) has been quite bullish sine then…and this has lowered some of our nervousness surrounding the asset class.
A couple of weeks ago, we said that we were quite worried that some renewed headwinds would cause some problems for cryptocurrencies of the near term (even though we remained bullish on a longer-term basis). The combination of China making crypto trading illegal…and SEC Chief Gensler’s warnings about future regulation on the asset class…led us to worry that Bitcoin could fall back below the $40,000 level (and other cryptos would fall along with it).
If you’ll remember, Bitcoin had traded between $30k and $40k for a few months in the spring and summer. However, it broke above the $40k level in early August and once it broke out of that range, it rallied strongly into September. However, concerns we highlighted above caused Bitcoin to drop as we moved through the rest of September.
HOWEVER, as it usually does, that “old resistance” level became “new support”…and this “new support” level held VERY well as we moved into October. Not only did that key $40k level hold, but the ensuing bounce took Bitcoin above its summer highs.
Another way to state this situation is to point out that the sideways range is saw this summer (between $30k-$40k) was something that allowed Bitcoin to build a nice “base.” After building that base, it broke out nicely…and then saw a successful “test” of its “new support” level of $40k….and then broke to another higher-high. When any asset builds a strong base over a multi-month period of time…and then follows that with a “higher-low/higher-high” sequence…it should be seen as a very bullish development on an intermediate and longer-term basis.!
Having said all this, we do need to point out that Bitcoin is getting overbought on a very-short-term basis (on its RSI chart). Therefore, it could/should take a “breather” soon…but it will take a break back below the $40k level to signal that Bitcoin is seeing any real headwinds.
9) We have been VERY bullish on the energy sector for a full year now…and that has turned out extremely well for us. However, we’ve also taken a “breather” on the bullish side of the ledger a couple of times over the last 12 months…and we’re going to do the same thing right now. (However, we remain very bullish on the sector on an intermediate/long-term basis).
You’re probably tired of hearing us pat ourselves on the back when it comes to the bullish call we made a year ago on the energy sector (when everybody else was wildly bearish). So we won’t review the details once again…except to say that the XLE and XOP energy stock ETF’s have outperformed the market is a substantial manner since then.
However, we have picked a couple of times when we thought the group had gotten ahead of itself, so we pulled-back from these stocks. We told short-term traders to takes some profits (while still staying with their core positions in the sector) and told longer-term investors to step back and wait for lower prices before they added to their positions further. Those calls have also worked-out extremely well. We made that call in March…and then again in June. Both times, those calls were followed by correction in crude oil…and the energy sector as well.
We are going to make this same call this weekend. We do admit that WTI crude oil and the energy ETF’s are not as overbought on their RSI charts as they were in March and June, but the weekly RSI chart is getting pretty close. We want to make this call a little bit earlier this time because we’re concerned about the broad stock market. (If the broad market sees a full blown correction, all sectors will likely get hit.)
On top of the RSI charts on WTI and the XOP, we’ve also included a chart on one individual stock…Conoco Phillips (COP). This stock has seen an unbelievable run! It has rallied over 160% in the last year…including a 42% rally in just that past six weeks. However, the stock has become extremely overbought. Its RSI chart has moved above 83 (its most extreme reading in seven years), so we think it’s a name that should not be chased up at these levels. Of course, it did get more overbought in 2014 (when its RSI chart reached 90), so it could go higher from here on a very-short-term basis. However, we think you’ll be able to add to COP at lower levels between now and Thanksgiving, so we’re going to take a “breather” on this name as well. (We do want to point out that, like we are with the rest of the sector, we’re bullish on COP for the intermediate/long-term timeframe.)
10) Summary of our current stance…….The reason we remain quite cautious about the near-term prospects for the stock market is quite simple. We are moving from a situation where massive amounts of stimulus have been provided by many different sources from around the globe since the spring of 2020. That pushed asset price above levels that could be justified by the underlying fundamentals. That’s okay. In fact, that was the purpose of the stimulus! We had a once-in-a-lifetime emergency (at least we hope it’s once-in-a-lifetime) and we needed the kind of stimulus that would keep the financial system from imploding. (Those who don’t realize that the financial system was on the brink in March of last year, don’t understand what was really going on. The credit markets had completely frozen up, so the financial system was truly on the brink.)
The thing is, however, once the emergency had passed, the full level of emergency stimulus was maintained by the global central banks. Therefore, even though the underlying fundamentals improved dramatically…and that improvement continued well into 2021…asset prices continued to stay WELL above their fundamental values. In other words, the due to the continued emergency level of liquidity, the fundamentals have not been able to catch up enough……Don’t get us wrong, they’ve caught up significantly compared to where they were in the spring and summer of 2020, but that “significant” catch-up has still left asset prices well ahead of those underlying fundamentals.
If the stock market was trading at 15x forward earnings…or even 17x forward earnings…we’d be singing a much different tune. However, since the global authorities have kept their stimulus at emergency levels, even the fabulous earnings growth we’ve seen here in the U.S. this year has not been enough to be able to describe the stock market back to anything that could be considered fairly valued in our opinion.
NOW, we see the three major global powers…the U.S., China, and Europe…are beginning to take away the punch bowl. In fact, China began doing this almost a year ago (with Jack Ma & Alibaba). They then accelerated their de-risking/de-leveraging program as we moved through the year…which became even more evident over the summer. More recently, the U.S. and Europe have announced that they are going to be less plentiful with their own stimulus (through the Fed and the ECB’s upcoming taper programs).
On a longer-term basis, this is actually a very bullish development. The underlying fundamentals have been like a cat chasing its tail. Due to the massive levels of artificial stimulus, the fundamentals could never catch-up to those rising asset prices (just like the cat can never catch its tail). However, now that this stimulus is shrinking…and thus the level of risking taking and leverage will also shrink…asset prices will be able to come down and meet the fundamentals somewhere in the middle. Yes, that will be painful for a while, but it will allow markets to get back into sinc with their fundamentals…and THAT will allow growth to progress in a healthy way (instead of an unhealthy one that includes excessive risk taking and leverage).
Matthew J. Maley
Chief Market Strategist
Miller Tabak + Co., LLC
Founder, The Maley Report
275 Grove St. Suite 2-400
Newton, MA 02466
Although the information contained in this report (not including disclosures contained herein) has been obtained from sources we believe to be reliable, the accuracy and completeness of such information and the opinions expressed herein cannot be guaranteed. This report is for informational purposes only and under no circumstances is it to be construed as an offer to sell, or a solicitation to buy, any security. Any recommendation contained in this report may not be appropriate for all investors. Trading options is not suitable for all investors and may involve risk of loss. Additional information is available upon request or by contacting us at Miller Tabak + Co., LLC, 200 Park Ave. Suite 1700, New York, NY 10166.