SPX Breakout

BREAKOUT FROM CLASSIC TEXTBOOK TRIANGLE FORMATION 

Check Out the Astonishing Balance Sheet Growth of Central Banks

Many are asking how inflation is on the rise while the Fed is technically "tightening."

The answer is that while the Fed is technically tightening, but only recently, other Central Banks, particularly the Bank of Japan (BoJ) and European Central Bank (ECB) have been printing their currencies by the hundreds of billions.

See for yourself… below is a chart showing the balance sheets for the Fed (blue line) the ECB (orange line) and the BoJ (black line) since 2Q13.

H/T Bill King

First and foremost, while the Fed is technically shrinking its balance sheet, the amount it has shrunk is negligible. Since the second quarter of 2013, the Fed's balance sheet is still UP 3%.

Over the same time period, the ECB grew its balance sheet by 63%. And the BoJ has grown its balance sheet by an astonishing 260%.

Mind you, throughout much of this time period, especially post 2016, NONE of these economies were shrinking. So these Central Banks were pumping all this money into GROWING economies!

Beware: These 3 Important Indicators Are Signaling Economic Problems Ahead

The consensus is that the economy is doing great – and will continue to do well.

Everything seems fine – right? Well, not exactly.

I have been looking at some important – but little used – indicators that are showing very troublesome economic data.

Here are three important indicators that will throw ice on the hot economy narrative the mainstream media is pushing. . .

 

Right now, the yield curve is dangerously close to flattening – then soon after will invert.

Looking at the 2 n' 10 Rule – the spread between the 2-year Treasury and the 10-year Bond – we see the spread is at the lowest it's been since The Great Recession of 2008.
 

 

43 basis points. . . That's it.

To put this in perspective, if the Fed hikes just two more times (which is 50 basis points) and the 10-year keeps sticking below 3%, then the yield curve will invert.

This is important because yield curve inversion –  when the spread turns negative –  has preceded the last seven straight recessions.

If we only look at more modern times – say the last 30 years – we can see the spread collapse negative before a recession strikes.

This 2 n' 10 Rule is still one of the most important indicators we can use to forecast recessions. And it's saying that the U.S. economy is more fragile than many like to admit.

There is also the cash hoarding problem going on – and that's a bad signal of economic health.

To summarize, when things are going good in the economy – people spend more money and save less. Because they feel confident they will be able to make that money back.

But when things are uncertain and become difficult – people save their money. They will put off dining out and buying things they wanted and instead keep money in their bank account for a 'rainy day'.

Today, Americans are saving at the highest levels since the 1991 recession. They are skittish about the future.

 

"The average checking account customer has more than $3,700 stashed away. The median amount in checking accounts since 1991 is $2,263… Anything lower than this signifies the economy is doing well… Anything above this indicates the economy is not doing well."

This problem coincides with soaring credit card debt. And what that means is Americans would rather go into debt and finance their consumption while paying some interest instead of spending all their money upfront.

They're opting to keep their checking accounts full incase they will need cash – not credit – immediately in the future.

That doesn't sound like confidence – does it?

 

Finally, and most importantly, another situation signaling trouble ahead is a little-followed indicator – but is eerily accurate. . .

The South-Korean Export Growth (SKEG) Indicator. . .

Many wouldn't have guessed that South Korean exports are a great leading indicator of global corporate earnings (EPS).

But historically – it is.

And right now, the SKEG indicator just turned negative.

That means so will global corporate earnings.

Just look at the 25-year correlation between the two. . .

I should also remind you that the last time the SKEG indicator dropped this steeply negative was around the time China devalued their currency – the Yuan – in January 2016. Sending global markets spiraling and causing the Fed to tone back their hawkish attitude.

Also, gold ended the multi-year bear market it was in and rallied over $300 during the next few months.

If the SKEG indicator continues its accuracy – as it always has if you study the chart above – then we can forget about the mainstream media's view of soaring earnings in the coming months.

Instead, I expect earnings to underperform over the next 12 months.

 So, even with the flattening yield curve, a cash hoarding problem, and South Korean Export Growth signaling problems ahead – the Fed continues to tighten credit.

These are some widening cracks in the global growth story.

One of these cracks isn't anything to shout "WATCH OUT" over – but three of them is worrying.

If history is any indicator – there is a high chance of big problems ahead.

Here’s When Everyone Should Have Known That Argentina Would Implode

About a year ago, Argentina – which has inflated away and/or defaulted on its currency every few decades for the past century – issued 100-year government bonds. And the issue was oversubscribed, with yield-crazed developed-world institutions throwing money at the prospect of a lifetime of 7% coupon payments.

A contemporaneous media account of the deal:

Argentina sees strong demand for surprise 100-year bond

(CNBC) – Argentina sold $2.75 billion of a hotly demanded 100-year bond in U.S. dollars on Monday, just over a year after emerging from its latest default, according to the government.

The South American country received $9.75 billion in orders for the bond, as investors eyed a yield of 7.9 percent in an otherwise low yielding fixed income market where pension funds need to lock in long-term returns.

Thanks to a stronger-than-expected peso currency, the government has increased its overall 2017 foreign currency bond issuance target to $12.75 billion from its previous plan of issuing $10 billion in international bonds, Finance Minister Luis Caputo told reporters in Buenos Aires.

Argentina is going to the international capital markets to help finance a fiscal deficit of 4.2 percent of gross domestic product this year. Caputo said Argentina has $2.6 billion in bonds left to be issued this year. The new paper could be denominated in euros, yen or Swiss francs.

The new bond had a coupon of 7.125 percent, the finance ministry said in a statement that hailed success of the sale as evidence that Argentina had regained "credibility and confidence."

That similar transactions between US and European "investors" and Latin American countries have happened with regularity and have nearly always blown up in the investors' faces once again didn't matter.

And once again it's blown up. This time with more than the usual shock and awe.

Now the question is, who's stuck with those 100-year bonds that are plunging in value and will – possibly soon – default? The above article noted that pension funds were especially interested.

The implication? Owning 7% bonds has allowed an unknown number of pension funds to pretend that they're capable of earning the 7.5% annual return that their political bosses demand. And now the possible default on those bonds has stripped those same pension funds of even the pretense of meeting their obligations. The already real pension crisis just got more real.

As for the hedge funds that bought these bonds with leverage – we're about to see even more reports of formerly solid funds underperforming, closing down and returning what's left of their clients' capital.

This is how a crisis at the periphery spreads to the core.

Here's an excerpt from an excellent overview of the emerging market situation:

Behold The Sudden Stop. Risk of Emerging Markets Collapse

(Daniel Lacalle) – The recent collapse of the Argentine Peso and other emerging currencies is more than a warning sign.

It could be the arrival of a "sudden stop". As I explain in Escape from the Central Bank Trap (BEP, 2017), a sudden stop happens when the extraordinary and excessive flow of cheap US dollars into emerging markets suddenly reverses and funds return to the U.S. looking for safer assets. The central bank "carry trade" of low interest rates and abundant liquidity was used to buy "growth" and "inflation-linked" assets in emerging markets. As the evidence of a global slowdown adds to the rising rates in the U.S. and the Fed's QT (quantitative tightening), emerging markets lose the tsunami of inflows and face massive outflows, because the bubble period was not used to strengthen those countries' economies, but to perpetuate their imbalances.

The Argentine Peso, at the close of this article, lost 17% annualized is one of the most devalued currencies in 2018. More than the Lira of Turkey or the Ruble of Russia.

What explains this drop?

For some time now, many of us have warned of the mistake of massively increasing money supply and using high liquidity to avoid much-needed structural reforms. In Argentina, the government of Cristina Fernández de Kirchner left a monetary hole close to 20% of GDP and massive inflation after years of trying to cover structural imbalances with increases in the money supply greater than 30-35% per year.

Unfortunately, as in other emerging markets, the urgent reforms were abandoned, and an alternative formula was tried. Issue great quantities of debt and continue financing a growing public spending with central bank money printing expecting economic growth and cheap debt would offset the growing fiscal and monetary hole.

This wrongly-called "soft adjustment" was justified because of the enormous liquidity in international markets and appetite for emerging markets' debt driven by consensus estimates of a continued weakening of the US dollar. Many Latin American and emerging market economies fell into the trap. Now, when it stops, and the US dollar recovers some of its weakness, it is devastating.

Stock Bull- & Bear-Traps Galore

The S&P500 could not hold the 50-day moving average today, setting, yet again, a nice bull trap to hang out the MoMo crowd.  Seeing a lot more traps, both bull and bear,  these days.  It is the result of the increasing dominance of machine trading.   They are above our human emotions.  Smug, don't you think?

We wrote in our recent Week In Review post,

• S&P500 generated a very rare back-to-back bear trap (broke and closed above 200-day) days on Thursday and Friday.  It has occured only 0.76% of the trading days since 1962

What a market.

Back-to-back bear traps followed by today's bull trap.  Three traps, three days in a row.

Bull Traps In This Correction  

Since the March 2009 low in the S&P500, there have only been 128 bull traps, as defined by the cash S&P piercing the 50-day moving average in an intraday move only to close back through it.  This example of a bull trap has occurred only 1.13 percent of the 11,309 trading days since the 2009 low.

During the correction that began on January 29th, there have already been 8 bull traps, or 11.59 percent of the the 69 trading days.

Pennant Forming

It looks like a pennant is forming here, which is bullish if you ignore rising interest rates and oil prices, tighter money, rising inflation, and geopolitics.   Macro traders cannot adhere solely to technical patterns but must consider them.  Just another arrow in the global quiver.

Upshot

We believe most of the positive earnings and macro news are pretty much priced, and the markets have not fully discounted the risk of a negative outcome in any one of the macro swans that are looming and flying around out there.  The economic locomotive is running near full speed and close to overheating, and unless policymakers create a new economic bullet train,  this seems to be "as good as it gets."

Moreover,  we find it ridiculous the market catapults 100 S&P points in a few days because the Oracle of Omaha is accumulating Apple shares.   Mr. Market does what Mr. Market does, listens to who it listens to.

Warren, Charlie, and Bill dropped a big duce on Bitcoin over the weekend, and though it did retreat from $10k,  the sell-off was tame for Bitcoin standards.

Warren, a Hall of Famer, in our book, but doesn't seem to fair so well when he and Charlie venture into large cap tech, however.

IBM was always a curiosity for Buffett followers. He'd spent years telling them that technology companies were outside his area of expertise then plowed more than $10 billion into the company in 2011.

Flawed Valuation

Back then, Buffett's investment was a huge vote of confidence for the aging computer-services firm and its leadership. But things soon went south. IBM struggled with declining sales, forcing Buffett to defend the pick. For awhile, he even added some to his holdings.

Last year, however, he'd had enough. Just before Berkshire's annual meeting in May, he acknowledged that his valuation had been flawed and that he'd begun to cut back on the investment.  – Bloomberg, February 2018

Fan Of AAPL Innovation,  Not APPL Financial Engineering 

We were Apple's biggest fan early in the decade.  See here.

Can't buy the stock here, however, because of the following chart and until the dark cloud of  our trade spat with China looks to be clearing.  May trade it but taking it down as a medium-term investment (1-12 months) is a big no no in our house.

The Oracle is probably going to be right long-term on Apple.

Sooner or later the company will come up with another world changing gadget.  Until then, financial engineering just doesn't tickle our fancy nor does it help Main Street or the economy.  Of course, we will always entertain a trading opportunity.

Moreover,  Apple has become just too large.   The company's annual revenues exceed the GDPs of Greece and Peru, and 75 percent of the world's country GDPs.

Senior management thus has a huge revenue nut to cover, and must wake up the first day of every year and begin their quest to sell enough electronic gadgets in size to surpass the GDP of Ireland.   That is a big, big, nut.

Apple is trying to increase recurring revenues.  Services now account for about 14 percent of total revenues, or $33 billion over the past four quarters.   Not there yet for an almost $1 trillion market cap, however, and, at the end of the day,  Apple is still an iPhone company with flat to negative unit sales growth over the past two years.

What The Stock Bulls Need Now, And Soon

Enough with Apple.

It is imperative the S&P bulls:  1)  hold the 20-day moving average at 2,663.04;  2) bust and close above the 50-day at 2,679.56.   The slope of the 50-day is now negative and in a downtrend, which, on its own, is bearish,  and 3) take out, close , and stay above the recent high at 2,717.49

Relentless Pounding Of The 200-day Moving Average

A lower swing high, that is below 2.717,  will almost seal the fate the bears will take out the 200-day sometime very soon.  They have been relentlessly pounding the 200-day during this correction.

In bull markets, the 200-day may be tested maybe once or twice over a short period then bounce big and continue the uptrend.  Not test it every third day as it seems to be doing recently.

Some believe what doesn't kill you makes you stronger.

Personal character?  Absolutely.

Technical support levels?  We don't think so.

Eventually,  the front line will crack, even if it is the robots defending it.  And, what if they decide to all retreat at the same time and go offer only, as they did in the flash crash?

When contemplating the constant hammering of the S&P500's 200-day moving average, think the financial equivalent of Chairman Mao's "human wave theory."

"overwhelm the defenders by the sheer weight of numbers" – Wikipedia

Stay frosty.