Late-Stage Market Behavior Has Arrived

Nobody hits a bell at the top of the market but you can identify symptoms of a top from how stock prices are behaving from their charts. One variable to consider is time as markets are cyclical which means their uptrends only last for so many years before a sizable correction occurs. There is no doubt that the Fed with its ultra-low interest rates and $4T balance sheet have added to the strength of the uptrend since the 2009 low. The sunset of this policy is on the 2017 horizon as the Fed begins to raise interest rates and withdraw the liquidity from the financial system. We will know more at the Fed’s next meeting in mid September. Until then, Janet Yellen will be giving a speech later this month at a conference (Jackson Hole) which may hint at the Fed’s next steps.


Higher Beta Cap's Weaker than Lower Beta Cap's

So what are the prices of the major indices telling us now? This chart from Elliott Wave International demonstrates investors are leaving speculative stocks and buying large-cap blue chip stocks. In the chart, the more speculative Russell 2000/1000 ratio made a high in December of last year while while the Dow has continued to rise – a “divergent” state as noted by technical analysts. A healthy stock market is one where all four major indices
trend higher at the same time and growth companies outperform their sleepier cousins that comprise the DOW and S&P 500. In other words, investors want “safe” stocks and not speculative stocks – a sign that we are in the very late stages of a stock market rally that began in 2009. Does this indicate a recession is around the corner? Maybe, time will tell but it does mean something really good needs to happen in the next few months to synch up all the indices to the upside and make this a “healthy” stock market again.

Let’s take a closer look at the NASDAQ which is largely viewed as a basket of 100 growth stocks. The chart below tells us that we are beginning to break a trend channel and that the upward momentum is showing signs of an upcoming reversal. See below.




Now, let’s take a closer look at the Russell 2000 and you can see a distinct
technical pattern that implies lower prices. See commentary below:

Russell 2000

Earnings Update

We are still in the midst of earnings season and although earnings have been good the price action has been less desirable. Remember, stock prices are forward looking and reflect what the market will do prospectively (6 months).
So, a good earnings announcement may be met with a lower stock price if the market thinks business may decline in the coming months. On average, shares of companies reporting earnings are falling by 0.78% on announcement day.
Companies that beat earnings estimates are rising by an average of 0.38%, while shares of those reporting negative surprises are dropping by an average of 3.43%. (Bespoke/WSJ)


One More Chart for the Bears

US stock market capitalization as a percentage of disposable personal income is approaching the dot-com peak. Notice that we are above the 2007 peak but not quite as high as the 1999 peak. (WSJ)

U.S. Stock Market Capitalization to Disposable Personal Income


Economic & Central Banking Snippets

  • Sales for major U.S. auto makers sharply declined in July, continuing an industry slowdown that has led to a glut of inventory on dealer lots and a spate of discounts. Here are the results as compared to July of 2016: General Motors Co -15.4%; Ford -7.4%; Fiat Chrysler -10%. Car makers are also facing a new problem: lenders are backing away from offering the cut-rate lease deals that kept monthly payments low. Clearly, a benefit to the industry as a by-product of ultra-low interest rates. (WSJ)
  • The Labor Department released new hiring and unemployment figures on Friday morning. This is the latest official snapshot of the state of the American economy as 209,000 jobs were added in July, somewhat above Wall Street economists’ expectations. The unemployment rate was 4.3% as the labor force participation rate ticked up to 62.9% from 62.8% so it was a healthy drop in the unemployment rate. Average hourly earnings also increased 0.3% with some upward revisions to the history, pushing the YOY rate to 2.5%.
  • The ISM manufacturing report pointed to robust manufacturing growth continuing last month with a reading of 56.3. The 56.3 level has historically been associated with 4.1% GDP growth. The economy is nowhere near this level of growth but it is a sign of a manufacturing revival in the USA. (MS)
  • US disposable income growth has been terrible over the past decade – near the lowest level in recent history. See the chart below. (WSJ)

Change in personal disposable income


  • The European economy has grown at its fastest pace since the eruption of the debt crisis six years ago. Figures from a business survey showed the eurozone’s manufacturing sector was in the grip of a jobs boom and eurozone gross domestic product accelerated in the second quarter, outpacing the UK. (FT, Reuters)
  • The Bank of England (BOE) cuts it’s growth forecasts this week as uncertainty over the UK’s future relationship with the EU is holding back business investment and household spending. (FT)
  • Canada’s unemployment rate fell to 6.3% – its lowest level since October 2008, driven by a rise in jobs in the retail and wholesale industries.


Municipal Bond News – U.S. Virgin Islands (WSJ)

Trouble in neighboring Puerto Rico, which recently filed for a form of bankruptcy after a string of debt defaults, has investors worried that the U.S. Virgin Islands might be next. With just over 100,000 inhabitants, the protectorate now owes north of $2 billion to bondholders and creditors. That’s the biggest per capita debt load of any U.S. territory or state. The territory is on the hook for billions more in unfunded pension and healthcare obligations.

Ratings agencies have downgraded the islands’ credit ratings deep into junk territory. With the U.S. Virgin Islands shut out of the credit markets after a failed January bond issue, officials are scrambling to stabilize its finances.

Gross domestic product has declined by almost one-third since 2008. At times this year the government was operating with just two days’ cash on hand. Locals live with pitted roads, crumbling schools, electricity outages and deteriorating medical care.

Governor Kenneth Mapp is quick to reassure bondholders that they get first crack at one of the territory’s largest funding sources: rum taxes. The money pays debt service before heading to government coffers, a protection called a lockbox. “There was an idea that because of the lockbox structure and the fact that the territories did not have a path to bankruptcy, they had to pay you,” said Curtis Erickson, San Francisco-based managing director of Preston Hollow Capital, a municipal specialty finance company. That all changed in 2016 when Congress passed legislation known as PROMESA giving Puerto Rico its first access to debt restructuring (bankruptcy). Investors have quickly surmised the U.S. Virgin Islands might pursue the same strategy prompting a downgrade of its credit from BBB+ to B by S&P Global Ratings.


Politics! Politics! Politics!

  • US imposes sanctions on Venezuela: The US on Monday imposed sanctions against Nicolás Maduro, a day after the Venezuelan president staged what world leaders condemned as a fraudulent vote to create an authoritarian “constituent assembly”. The US Treasury said all of Mr Maduro’s assets subject to US jurisdiction were frozen, and that Americans were prohibited from dealing with him. (FT)
  • The Trump administration is planning trade measures to force Beijing to
    crack down on intellectual-property theft and ease requirements that American companies share advanced technologies to gain entry to the Chinese market.
  • Major health insurers in some states are seeking increases as high as 30% or more for premiums on 2018 Affordable Care Act plans, according to new federal data that provide the broadest view so far of the turmoil across exchanges. (WSJ)


Market Snippets

  • Equity bears hunting for excess in the stock market might be better off worrying about bond prices, Alan Greenspan says. That’s where the actual bubble is, and when it pops, it’ll be bad for everyone. “By any measure, real long-term interest rates are much too low and therefore unsustainable,” the former Federal Reserve chairman, 91, said in an interview. “When they move higher they are likely to move reasonably fast. We are experiencing a bubble, not in stock prices but in bond prices. This is not discounted in the marketplace.” (Bloomberg)
  • The correlation between stocks and Treasury yields is now the lowest in about a decade. It means that Treasury securities are not as effective in hedging against declines in the stock market. (WSJ)

S&P 10-year Treasury Yield Correlation


  • The S&P 500 will start excluding companies that issue multiple classes of shares, managers of the index said on Monday, a move that effectively bars Snap Inc (SNAP) after its decision to offer stock with no voting rights.


International Snippets

  • Venezuela’s economy continues to fall apart as money printing has accelerated. The broad money supply has risen 400% over the past year. This is not sustainable for its economy and will rob their citizens of their wealth. (WSJ)

Venezuela money supply


  • British American Tobacco, the world’s second-largest listed cigarette company, is under formal investigation by the UK’s Serious Fraud Office over claims that it bribed officials in east Africa to undermine anti-smoking laws. (FT)
  • Bain Capital Credit has bought a €385m portfolio of loans from an Italian bank, in a further sign of growing investor appetite for the country’s stock of bad loans. The deal comes as regulators continue to push for a solution to Europe’s post-crisis non-performing loan problem, with Italy seen as the most severely affected country. US investment banks have also sought to increase their activity in funding purchases of debt. The portfolio, which was bought from Banca Mediocredito del Friuli Venezia Giulia, marks Bain Capital’s first standalone acquisition in the country since it bought a servicer, Aquileia Capital Services, in February this year. The loans are mostly secured by industrial, residential and commercial real estate assets, the company said. (FT)

Paul McCarthy

Mr. McCarthy is the President and founder of Kisco Capital.