By Frank Barbera, CMT | 27 May 2008
Amid the endless gasoline headlines crossing the news this past weekend came the headline from Germany that billionaire investment guru Warren Buffett sees the USA already in recession. According to Buffett, "the US is already in a recession, which will be deeper and longer than many think".
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Of course, the good folks at the BLS have managed to make sure that the ‘official data’ have been massaged enough to the upside in this election year so that, despite two consecutive quarters of negative real GDP growth, have been postponing the ‘official’ recession signal so far. In today’s update, we review some of the economic data released today from a bigger picture point of view to illustrate just how ‘spot on’ Mr. Buffett's comments in fact are. The primary focus of the last 12 months has been, and remains, the sinking housing market, where this month's action produced a technical bounce.
Earlier today, the Commerce Department reported that New Homes sales rose by 3.3% in April to a seasonally adjusted annual rate of 526,000 units. At the same time, the government also revised March activity lower to show an even bigger drop of 11 percent to an annual rate of 509,000, which was the weakest pace for sales since April 1991, a 17 year low. Viewed through the lens of a smoothed Rate of Change, we see that New Home Sales are still very close to the lowest levels of the last 40 years, sinking to the depths of the 1980 Carter ‘Stagflationary Recession.’ Appropriate, since today’s unreported inflation rate is running close to 12%.
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Above: Annual Rate of Change on New Home Sales in Deep Recession territory
In addition to the data on Housing Sales, today’s report also reported that inventories of unsold new homes edged down slightly to 10.6 months' supply at the April sales pace, compared with 11.1 months in March. According to CBS Marketwatch and AP, the April level was still about double the inventory level that was normal during the five-year housing boom. In our work, we follow the Ratio of Houses For Sale versus Houses Sold, which remains well above the 8 month upper benchmark that in the past has defined US recessions.
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Above: the Ratio of Houses FOR SALE versus Houses Sold— still in deep recession territory
With inventories still at near record levels of supply, it was also no big surprise that Housing prices remained under heavy downside pressure. According to CBS Marketwatch, the pace of home price declines accelerated in March with home prices in 20 major U.S. cities now down 14.40% over the past 12 months, a record breaking decline. According to the 20 City Case-Shiller Home Price Index, prices fell 2.2% from February to March marking the 16th consecutive monthly decline. Within the 10 largest US cities, prices fell by 2.4% in March, and by 15.3% over the last 12 months.
The combination of falling home prices and rising food and energy prices, stagflation (no growth and rising prices) continued to put a major damper on Consumer Confidence with the Conference Board Index plunging to 57.20 in May, down from 62.80 in April. At this point, there is simply no longer any argument remaining about whether or not the US is in recession, as the Conference Board Index has only declined below the lower +70 benchmark during recessions and is now closing in on some of the worst readings seen in prior recessions.
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Above: Consumer Confidence Survey fell to a 16 year low in May, now well below the +70.00 recession benchmark with a reading of 5.720 in May, down from 62.80 in April.
In fact, if one looks closely at the components which comprise the Conference Board Composite Index, the outlook going forward is bleak. To begin with, we note that the Forward Expectations Index which looks out six months from today, plunged this month to a reading of 50.00 to a value of 45.70. For proper context, that is an ALL TIME LOW since record keeping was started in the 1970’s. Talk about huge, this makes a strong case that the current economy is nowhere close to an important bottom as the Expectations component tends to usually lead bottoms by a year or more. What’s more, the overall Consumer Confidence Composite has actually been benefiting to this point by the Present Situation Component, which has been trending down in consistent fashion, but not falling out of bed.
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Above: Conference Board Index of Forward Expectations (6 months out)
If we look at the Present Situation Component in May the indicator fell to a reading of 74.4, down from 81.90 in April. Historically, this gauge is very likely to dip under the +50 mark, and could even— given today’s circumstances— be expected to fall into the +40 to +30 range. From where it stands at the current time near +75, we are still a long way from the zone where an important bottom could be seen. In our view, this implies that the current recession is simply just beginning to pick up downside momentum, and that the current bout of economic weakness will remain right through 2009.
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Above: Conference Board— Present Situation, still a long, long way from a low
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Above: Ratio of Leading to Lagging Indicators— 12 Month Rate of Change
Paralleling the steep declines in all of these gauges in the last 12 months are a number of other gauges, including the Ratio of Leading to Lagging Economic Indicators, which for the balance of the last two years has been drifting its way steadily lower toward the full recession levels of— 5%.
Again, in very deep recessions this gauge has fallen to readings well below— 10 to— 12%, and thus, for anyone concluding that a bottom has been seen, we would argue that historically what is showing up right now in terms of falling Home Sales, Home prices, and diminished Forward Expectations makes a compelling case that the Ratio of Leading to Lagging Indicators has potentially a long way to go on the downside. To bring things full circle and close the loop, in the chart below we plot the annual rate of change on Home Sales (thin line) and overlay it against the Ratio of Leading to Lagging Indicators (thick line).
What we find is that over a long stretch of time, the directional change of Home Sales has led the Ratio of Leading to Lagging gauges by about 5 to 6 months. That means that from where things stand right now, we could be staring down the barrel of new record lows in the Leading to Lagging Gauge Ratio which would imply a very deep recession, possibly even a depression getting underway. The same time of implication is seen with an overlay of the Conference Board Confidence data versus the Leading to Lagging Indicators. The clear implication from the way some of these ultra leading indicators are pointing is that the downside risk in the US, and likely the global economy, is still very substantial and that at present, we are a long way from the bottom of this downside contractionary cycle.
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Above: Housing sales at Annual Rate of Change lead even the Leading Indicators (Thick line is Leading to Lagging Ratio at Annual Rate of Change)
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Above: Ratio of Leading to Lagging Indicators versus Conference Board Composite
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Above: top clip: S&P rate of change, middle clip: Payrolls rate of change, and bottom: Home Prices— rate of change.
Finally, we view the current decelerating economy through the lens of the stock market as a leading indicator for broader economic conditions. In the chart above, we plot a two year rate of change for the S&P in the top clip. Immediately below the S&P we show the 12 months rate of change on Non-Farm Payrolls, and below that, the 12 months Rate of Change for Real (Inflation Adjusted Home Prices). In both cases, we have lagged Employment and Home Prices by 12 months as the stock market has historically turned down in advance of economic weakness. In all three cases, the rate of change data is now negative with Housing leading the way on the downside over the last few months as the Credit Crisis has had a powerful negative impact on Housing Affordability.
In our view, given what is happening in Housing, it is a very logical outcome to suggest that the Employment Rate of Change will revisit prior lows and that the stock market rate of change may also have another big excursion below zero dead ahead. Again, the implications are powerful that this down cycle still could have a long way to go as neither the stock market rate of change or the Non-Farm Payroll Rate of Change has seen the kind of figures which typically mark major lows; we suspect before this is over, those readings will be seen.
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Above: the S&P 500 (top clip) and lower clip Relative Strength Ratio of Recession Retailers versus Discretionary Retailers
As far as the stock market is concerned, we believe that an extended recession from here will place more downside pressure on both cyclical stocks, and on retailers. In the chart above, we plot the relative strength ratio of defensive retailers, what I call ‘recession retailers’ versus ‘discretionary retailers.’ On the defensive side, we have names like Wal-Mart, Costco, Ross Stores, Big Lots, TJX Corp, and CVS all in rising configuration, while on the downside names like Radio Shack, Pacific Sunwear, Guess, Starbucks, Whole Foods, Urban Outfitters, and Nordstrom all look overbought and vulnerable.
In the chart above, we plot the R/S Ratio of the recession retailers versus discretionary retailers, which is just now breaking out of a multi-week consolidation phase. The vertical dashed line on the chart shows that this ratio bottomed the same week that Sub-Prime Mortgages became headline news in February 2007. Clearly, the defensive tone remains intact within the stock market, a trend which should continue to favor the most basic industries with a special emphasis on commodities, sectors such as Energy and Precious Metals.
We end with the most discretionary of all items, New Cars, where last week Ford Motor guided lower, reversing its prior upbeat forecasts. We continue to maintain that neither GM nor Ford are likely to survive this downturn (in present form) as both companies have severe financial problems unlikely to withstand the Category 4 or 5 storm just now making landfall. On Friday, GM (which owns Rescap/Green Light Financial), Ambac, MBIA, Lehman Brothers, Indymac Bank and Bank America all closed near historic lows, and all are on the high alert watch list for potentially major pieces of bad news.
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That’s all for now,
Battlestations! S&P In Topping Mode.
By Frank Barbera, CMT | 20 May 2008
In reviewing the action in various markets over the last few days, it appears as though another juncture is rapidly approaching. Call it the start of "The Great Credit Bubble Phase II." In Phase I, Sub-prime and Alt-A mortgage paper collapsed, Bear Stearns slid beneath the waves, and Gold soared above $1,000 per ounce. The Stock Market tumbled nearly 20% (18.48%) and the Dollar plunged to record lows. For the last few weeks, markets have enjoyed a pleasant hiatus with stock indices recovering and the Dollar strengthening. That is until the last few days, as Gold has revived, stocks have reversed lower as has the US Dollar. While we still believe there is a good chance that equities may not actually break down to new multi-month lows until the fall, there is nevertheless a high risk that prices are at present very close to a major interim peak.
Back on April 22nd in our piece entitled "Oreo Cookies and the Stock Market," we opined:
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Since then, the indices have surpassed 1,400 and have managed to stagger their way higher with the S&P hitting a peak of 1440.24 just yesterday. In that same article, we placed a lot of emphasis on one of our favorite indicators, the Medium Term ARMS Index. At the time, the ARMS Index had NOT seen an overbought reading of any material sort, and as a result we concluded that the stock market advance probably had further to run. We stated:
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In that same update, we also included a chart of the ARMS Index which is shown below.
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Above: "THEN"— a snapshot of the ARMS Index from April 22nd, "Oreo Cookies and the Stock Market"
Importantly, as stock prices have moved sequentially higher, the ARMS Index has "done its thing" and moved sequentially lower. Remember, this indicator is plotted on an inverse scale, where high ARMS Index values reflect great fear, while low Index values reflect a swing toward optimism. Over the last few days, the Medium Term ARMS Index has plunged to values of 0.864 on Monday the 19th, 0.8730 on Friday the 16th, 0.874 on Thursday the 15th and a recent low last Wednesday at 0.846. We have now not only recorded a value below 0.90, but we have very closely approached the 0.85 to 0.80 window which is usually a very big warning.
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Above: "NOW"— the ARMS Index updated to present, with very low values signaling high risk of a market peak.
So what kind of warning could be at hand? In our view, it seems as though there is a good chance that a medium term peak for the S&P could be cemented into place over the course of the next 10 days within the range of 1405 to 1440. At the moment, today’s sharp S&P decline has not convincingly violated the rising uptrend of the last few weeks, and to that end, a retest of the highs for the S&P is probably still ahead over the next few days. That said, in the larger scheme of things, we have been leaning toward the idea that a large (a,b,c,d,e) triangle B-Wave is unfolding in the stock market, with the recent advance of the last few weeks comprising Wave C, an upward trending portion of the pattern. We outlined this in general terms back on April 22nd in the "Oreo Cookies and the Stock Market" discussion. In our view, much of that same process remains in place, even though the "C-Wave" has pushed a bit higher toward the 1440 zone. In Elliott parlance, this is known as an irregular "C-Wave" and this is fairly common within triangles.
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The bottom line for the stock market as we see it, from a late May high, the S&P could be vulnerable to a trip all the way back down toward the area of the March lows, in the low 1300’s. This type of decline may not be a full on resumption of the bear market, as there could still be a final "E-Wave" advance later this year which would ultimately complete the larger five wave triangle pattern and Wave [B]. Thus, thinking "trading range" is probably a wise approach, and to that end, prices right now may be in the act of defining the ‘high’ end of the range.
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Above: the 20 day Average of Advances less Declines, and Below: the McClellan Oscillator
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Other short-term oriented technical gauges also reflect the market swing back toward overbought territory. In the case of the 20 day Advance-Decline Oscillator, with a close of +93.52 last night, we are now back up to the area where each of the last three peak readings, +91.52 on 2/27/08, +82.88 on 12/26/07 and +108.00 on 10.05.07, were highly problematic for the stock market. Likewise, the McClellan Oscillator has also moved back to overbought territory with a close of +297.63 last night. Importantly, the oscillator has essentially continued to trace out a series of sequentially lower highs throughout the rally, indicating that internally this advance is not robust and most likely of the bear market stripe.
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Above: Operating Company Only Put To Call Ratio
In addition to the recent set of overbought values on key daily oscillators, we also note that sentiment has swung widely in the last few weeks moving from high levels of fear to a now cautious optimism. 'The Worst is Behind Us’ mind set now rules the roost, with the Dollar Weighted Put-Call Ratio for Operating Companies swinging down toward its lower band. Again, this does not mean the market cannot move back up and retest the highs, or even record a token new high in the days just ahead. What it does mean is that traders operating on the long side of the market should be advised that perhaps the lion's share of the rally is now over, and that from a risk-reward point of view, downside risk seems high in the weeks just ahead.
So where are the risks if things get rough? In our view, when we survey the financial world, we still see a dismal road ahead with a lot more problems in front of us rather than behind us. In fact, instead of the "worst being already over," we lean heavily toward the idea that the "worst is still ahead." The price action in stocks like Fannie Mae, Lehman Brothers, and Citicorp is enough to cause us bad indigestion following lunch, if you know what I mean. None of these holds any hint that the worst is over, not fundamentally, and certainly not from the positively wretched price action seen on the charts. In each case, huge degrees of financial leverage are in play, and in each case the ‘light at the end of the tunnel’ is most likely a 100-car freight train on a head on collision rolling down the tracks at 100mph. 'Run, don’t walk for the exits' would be our best advice.
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Above: Fannie Mae— an odds on favorite for leading the parade of Phase Two major problems, way too much balance sheet leverage at work… ultra bearish chart configuration.
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Above: very likely still nowhere close to being "out of the woods," no bargain to be had here. Company survivability potentially still in serious doubt.
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Above: Long term view of Lehman Brothers (LEH) looks ripe for a renewed major decline; many big questions as to whether LEH will have the financial muscle needed to survive this down cycle…potentially another great example of too much leverage in reverse.
Finally, another indication of a trend reversal now rapidly approaching is the Goldman Sachs to Gold Ratio which measures relative confidence. If confidence is high in the financial system, money flows into Goldman Sachs (GS), the bluest of the blue chips, and shuns Gold, and the ratio falls. Alternatively, if confidence is frayed and frightened by the financial system, money flees Goldman and heads for Gold. We note that the ratio has recently undergone a hefty correction as the stock market rallied, but now in recent days, we see the ratio breaking out top side above its declining trend. Gold is regaining the upper footing, and as a barometer of faltering confidence, the rising ratio warns that a more challenging period may be just ahead. For those willing to listen, this breakout is the sounding of an alarm, a call to general quarters, and a warning to review portfolios on the spot. From here forward, odds are high that rallies should be viewed as opportunities to sell and that portfolios should be reverting back to a fully defensive posture.
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Above: the Goldman Sachs to Gold Ratio with 9 day RSI. Upside breakout signals "Battle-Stations" to all who will listen.
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Normxxx
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