This morning in the WSJ’s Streetwise column, James McKintosh succinctly summed up the bi-polar behavior of investors in risk assets over the last last couple months (The Markets Have a Message: Don’t Believe This Rally):
Worries have changed, rather than gone away. In February, investors feared recession, deflation, Chinese devaluation, falling profits, excessive emerging-market debt and corporate defaults due to cheap oil. More expensive oil assuaged some of these concerns and prompted a repricing of commodity-linked assets and of inflation-linked assets. That boosted emerging markets, junk bonds and mining stocks, while prompting a flood of cash out of money-market funds.
While equity markets here in the U.S. have remained bid they seem to have lost a little steam into quarter end. That’s a quarter that saw a 13% decline and a 13% rally in the S&P 500 (SPX) placing it very near breakeven on the year. I would add that the SPX was rejected at the nice round number of 2050, and a break below its 200 day moving average (yellow) could yield a move back to its 50 day moving average (purple) at 1950 in the coming weeks:
Regular readers know that it’s my view that the SPX’s inability to make a new high (above the November high at 2105 or so) while putting in its 4th lower high since the all time highs last May with three lower lows may be signaling a rolling top. Most important is the fact that the February low near 1800 was the first lower low the SPX has made in its entire run from March of 2009.
It’s kind of early to call the demise of U.S. stocks at the moment as there seems to be a lack of immediate catalysts to incite the sort of fear that gripped the markets back in January and February. As a guess, aside from some sort of unforeseen global macro event, it would probably be a re-tracement in oil and other industrial commodities re-testing the earlier year lows. Crude oil is certainly doing its best to spook investors, having failed for the third time to rise above its 200 day moving average since mid 2015 after a huge counter-trend rally, each time yielding lower lows:
So back to the fears, you have the 1o year US Treasury yield at 1.85%, in a massive downtrend, with what looks like a date with the prior lows at 1.5% in the offing:
U.S. high yield index, measured by the etf HYG approaching a key support level at $80:
Gold having just bounced off of support at its 50 day moving average:
And US small caps massively underperforming large cap peers, defensive stocks and sectors like U.S. telcos AT&T and Verizon, Consumer Staples and Utilities trade near 52 week highs.
None of the above are a layup short, but with the backdrop of weak corporate profits and GDP prints below 2% here in the U.S. it would not take too much of an external shock to cause a re-test of the February lows in my opinion.
There is one that should keep stock market bears up at night, which could reverse the slide in oil, rally in gold and fear in credit markets, and that’s the U.S. Dollar. The DXY (US dollar index), despite its recent bounce is clearly in a downtrend from its 52 week highs made in early December, with its 50 day about to cross below its 200 day, which some call a death cross:
It’s been my view that this is nothing more than range bounce action between $94 and $100 and the death cross did occur in early October when the DXY was at the lower end of this trading range. It subsequently bounced and made a new high in a two months. But it’s worth keeping an eye on in case my range theory fails at the lower end. As my friend Brian Kelly likes to say, get the US dollar right and you get just about everything else right, which is why it makes sense to take a look at history.
Fundstrat’s Tom Lee did just that in the following chart of the U.S. dollar over the last 35 years showing what can be the severity of dollar corrections when they do occur:
— Dan Nathan (@RiskReversal) March 16, 2016
So you ask me what could change my cautious view on all of the risk assets listed above, and that would be the last two charts.