Not only did China stall out in mid-2009 but it has now surpassed the lows set in mid-2010.

Shanghai Index

 One of many indicators pointing to more troubles ahead, the port data out of LA and Long Beach is showing that trade has been slowing down for some time.  Usually traffic peaks in August-October but this year we hit a high in May that we were not able to break.

LA and Long Beach Port Traffic

The bottom line is that Europe may be getting all of the headlines but China has been slowing, is still slowing, and looks as if it will continue to slow.  With Europe and China basically in recession how much longer can the United States hold out?

Happy Trading,

Dave@TheMacroTrader.com

http://TheMacroTrader.com

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Right now we think it highly likely that going forward we see an increase in the rate of economic deterioration.  Europe is already in a mess but the economy in the United States is now showing signs of its last gasp of growth.  One indicator that we track is the Citi Economic Surprise Index.  In the chart below you can see that economic numbers have been coming in very strong for the past few months.  Based upon previous history it is safe to say that we have peaked or are very near peaking and that economic numbers going forward should start to turn lower.

Citi Economic Surprise Index USD and G-10

Not only are economic numbers expected to turn lower but we are also seeing several signs that inflation is dropping.  One relationship that we follow closely is that of the CRB Raw Industrials Index against the SP500.  As you can see in the chart below the two are usually very correlated.  When the industrials are moving higher stocks usually follow and when they turn down stocks tend to do the same.  Right now there is a disconnect, one that we expect to be resolved with the SP500 moving lower.

CRB Raw Industrials Index and SP500

This relationship matters because if inflation moves lower the stock market will as well.  We can see this very clearly in the next chart where we have overlaid the weekly SP500 with the 10-Yr TIPS breakeven rate.  As you can see these have a very tight relationship.  What you can’t see is that this relationship goes back long before the crisis.  When inflation expectations rise the stock market rises and when they fall the market falls.

SP500 and 10-Yr Breakeven Rate

Other signs that inflation is not upon are that government bond yields are hovering around historic lows.  As you can see in the next chart the 2-Year Treasury yield has been low and headed lower.  Despite all the hype regarding hyperinflation we have not seen any of it, and based upon the messages from the bond market we are not seeing it anytime soon.  In case you are wondering we are seeing the same thing farther out on the curve with 10 and 30 year yields also near their lows.

2-Yr US Treasury Yield

Another sign that we have been following is this chart of the Shanghai composite and the CRB index.  As you can see the two indexes peaked within two weeks of each other and have been steadily working their way lower for the past eight months.  As the nation of commodity stockpiling has slowed down so have their stockpiles.  As this huge underlying commodity bid has vanished it has allowed industrial commodities to drop.

Shanghai Composite and CRB Index

Whether it becomes an all out crash, ala 2008, or not is not known but we are confident that the global slowdown will continue.  So what have we done with this view?  In our model portfolio we are short the AUD/USD as we expect the Australian Dollar to move lower as commodity prices and Asian demand continues to falter.  We are short the EUR/USD via options in a trade we placed back in August.  Recently we bought the USD/CHF as we expect the Swiss Franc to weaken considerably from here.  We are also short the SP500 via options and long the Lehman/Barclays Aggregate index which is highly weighted with US Treasuries and investment grade credits.

Happy Trading,

Dave@TheMacroTrader.com

http://TheMacroTrader.com

Take a $1 trial of The Macro Trader to receive unbiased actionable research.

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Many new traders spend a lot of time looking for the holy grail of trading.  The secret Gann angle, the right wave count, the perfect valuation model, etc.  What we have found is that while a lot of new and even old traders spend countless hours searching for the holy grail very few, if any, successful traders have found it.  Instead they figure out at some time or another that instead of a magical tool they should spend their time looking for useful tools that do a reasonable job of either lowering risk, increasing return, or increasing their hit rate.

One tool that we have found useful in looking out towards the future is that of the ECRI Weekly Leading Index.  While by no means a holy grail it has historically done a fairly good job at forecasting stock market returns.  As you can see in the chart below it has been very accurate over the past few years as it has led the SP500 by several months at important turning points.  (Click on chart to enlarge)

SP500 Year Over Year % Change and ECRI WLI Growth Rate

So what is the WLI saying right now?  Going along with our long held deflation thesis the WLI is now pointing towards slower growth in both the economy and particularly in the so-called “risk markets”.  This of course matches what we are seeing in several other indicators and relationships that we follow.  We have covered a few indicators in previous posts such as how junk spreads point to higher unemployment claims and how the PMI is pointing towards slower growth.  In addition to these we are seeing many other signs such as the drop in commodities, take a look at the CRB Raw Materials Index, and in the rise of the US Dollar.  Of course none of these are holy grails, just signposts in the fog.

Happy Trading,

Dave@TheMacroTrader.com

http://TheMacroTrader.com

Take a $1 trial of The Macro Trader to receive unbiased actionable research.

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One group of indicators that we follow quite closely are yield spreads.  They work as great risk indicators as well as  economic indicators. In the case of junk spreads they tend to lead rather than coincide or lag the overall economy.  One area where they really shine is at the darker end of the economy.  As you can see in the chart below junk spreads tend to lead the initial unemployment claims by anywhere from two-five months.  For the past four months junk spreads have been inching higher and higher as the economy has noticeably weakened.  What does this mean?  Well if the correlation holds up then we would expect initial claims to move higher.  This would go along well with most of the indicators that we are seeing such as the various manufacturing indexes pointing lower, with the exception of the Chicago PMI, as most indicators whether economic or market are pointing to a weaker economy. (Click on chart to enlarge)

Junk Spreads and Initial Unemployment Claims

Happy Trading,

Dave@TheMacroTrader.com

http://TheMacroTrader.com

Disclaimer-We are long US Treasuries and Gold.

Take a $1 trial of The Macro Trader to receive unbiased actionable research.

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Remember the anti-drug commercials with the frying pan and the egg?  As of late it would appear as though investors have forgotten that you are supposed to say NO to drugs, especially during market hours.  In the chart below we have a rolling 21-Day Standard Deviation for the SP500 as well as the 50-Day moving average of that number.  On a one month basis we are at the second highest reading in over 10 years, second only to the crash of 2008.  Looking at the smoothed 50-day moving average we are actually at a new high. The close to close movement is running at an average of 2.34%. (Click on chart to enlarge)

SP500 Rolling 21-Day Standard Deviation

How can you use this information?  There are a few trading strategies you can investigate from this such as selling options or putting on some arbitrage positions betting the spreads will come back in.  For most investors however the more important thing to see here is that risk management is not only paramount to your investing/trading but it is a moving target.  As a general rule when volatility is high, or extremely high as the case may be, you would want to look at using relatively loose stops, scaling down your position sizes, lowering your leverage, raising cash, etc.  While most, maybe all, long time traders already use good risk management we have found that far to many new traders don’t adjust their trading when the market gets stoned.   Consequently they lose far more money then they have too.  Following tools like this can help you to smooth out your returns and stay in the game.

Happy Trading,

Dave@TheMacroTrader.com

http://TheMacroTrader.com

Disclaimer-We always use risk management and own the domain name riskfreak.com.

Take a $1 trial of The Macro Trader to receive unbiased actionable research.

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We follow several different types of indicators to include economic, valuation, sentiment, technical, etc. but one of the most important and powerful family of indicators would be monetary indicators.  Monetary indicators allow us to measure liquidity which of course affects all markets.  Historically some of the best gauges of liquidity have been interest rate trends, interest rates, margin debt, public offerings, money supply, etc.  One of the most powerful indicators is Fed policy and the tools it uses to put their policy into effect.  We have all heard the saying “dont fight the Fed” and while many market sayings are cliche this one carries weight.

During this cycle the Fed, in addition to its zero interest rate policy ZIRP, has been using quantitative easing to inject money into the economy in an effort to “prime the pump” and get people spending.  Unfortunately there is little if any evidence that any of this money has been finding its way to main street. Instead it has been going into financial markets and in the process has helped fuel some bubbles.  While the term bubble has been overused as of late we are using it in the sense that without QE1 and QE2 most financial markets would be a lot lower then they are today or a few weeks ago.

All of this brings us to the current situation.  As you can see in the chart below whenever the Fed is actively buying or selling securities the market goes up or down.  From mid 2005-2007 the Fed was buying small quantities and the market, already in an uptrend, continued higher with muted volatility.  Later during the early stages of the crisis, and after the Bear Stearns breakdown, the Fed decided in all its wisdom to sell some of its securities taking liquidity out of the market at the exact time that they should have been adding it.  While not the cause of the crash it did further enable it.  In early 2009 the Fed began QE1 at the same time that the government passed TARP.  Between these two massive stimuli the market was able to shoot higher.  While the argument can be made that the pump was primed and brought investors back into the market it is hard not to notice what happened once the Fed stopped buying.  As you can see the correction in mid 2010 coincided with the end of QE1.  As this correction got going and with the backdrop of high unemployment and a still sluggish economy the Fed embarked on QE2.  As you can see the market once again started to move higher.  Well guess what?  Since the Fed stopped buying the market has consolidated and as you have likely noticed over the past few weeks has started to crash moving down 18% in just two weeks.  (Click on chart to enlarge)

POMO and SP500

While it is true that there are other factors at work it is obvious to everyone except maybe the Fed that they have been the buyer and until the economy really does improve the risk markets will fall anytime that they back away.  With the statement earlier this week that the Fed is going to maintain a ZIRP until at least 2013 we are also led to expect an eventual announcement of QE3.  While we don’t think that it will help the economy and might actually hurt it, we do think that in the framework of Helicopter Ben’s mind this is the only course of action.  If we break lower by 5-10% expect the Fed to come out and announce another round of purchasing.  Oh and one more thing, don’t fight the Fed.

Happy Trading,

Dave@TheMacroTrader.com

http://TheMacroTrader.com

Disclaimer-We are long US Treasuries via TLT  and gold via GLD.

Take a $1 trial of The Macro Trader to receive unbiased actionable research.

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Despite the countless hours spent by the media talking up the debt ceiling debates and its effects on financial markets the real concern amongst actual investors has been the prospects of actual economic growth.  As we have stated in the newsletter as well as in previous posts on the blog we do not think, and bond yields have agreed, that anyone is actually scared of a default.  So despite the misguided hand of the media bonds and other financial markets are moving based upon future growth potential or the lack thereof.

On Monday we got a PMI number that came in not just low but drastically lower than expected and very near the negative growth line.  The PMI index is a diffusion index meaning that if it is above 50 then the manufacturing sector is growing and if it is below 50 then the manufacturing sector is contracting.  So how bad was the number?  Well last month PMI came in at 55.3 and this month it came in at 50.9 which means that manufacturing is barely above the zero line.  You can see the drop more clearly by looking at the chart below. (Click on chart to enlarge)

ISM PMI

As you can see the drop from the February peak reading of 61.4 has been fairly steady and swift as the manufacturing sector has been slowing down despite many economists expecting strength in the economy and a continued recovery.  Of course as long time readers know we have been less than impressed with the economy ever since the bottom back in March 2009.  The market rebound was impressive but the real economy has been very mediocre.   All this has weighed heavily on the markets as of late and since February bonds have been moving higher.  At the same time and with the help of he sideshow in Washington the stock market has taken a hard and swift hit as of late and is starting to get more in line with the actual economy.

One chart that we like to follow is that of the SP500 year over year growth rate overlaid with the PMI data.  As you can see the PMI is a good rough business cycle indicator.  While not perfect by any means it does a great job of tracking what the market is expecting in the medium term.  As you can see right now the PMI is pointing lower and it seems as though stocks are following its lead. (Click on chart to enlarge)

PMI and SP500 YoY % Change

Right now many of our economic indicators are saying to lighten up if not exit equities all together.  While this has been the case for a while the market via trend, breadth, and sentiment is coming around to the same conclusion, and that is that the economy is weak and prospects are not good for a favorable risk to reward environment.  Do you really want to sit in a market hoping to eek out meager gains of maybe 5% over the next year but with potential and relatively likely downside of 15-20%?  We don’t and instead have been going into assets that do well in times of slow economic growth.

Happy Trading,

Dave@TheMacroTrader.com

http://TheMacroTrader.com

Disclaimer-We are long US Treasuries via TLT and also hold some small long positions in US equities.

Take a $1 trial of The Macro Trader to receive unbiased actionable research.

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The following was sent to subscribers Tuesday night but is still entirely relevant to the current market.

In a paper entitled “An Exploration Of The Nature Of Bull Market Tops” by Lowrys Research written in 2006 we learned that in previous stock market tops the day of the top saw only a few stocks in the major indexes hitting new highs.  Most of the constituents were down and many were down more than 20% from their highs.  Contrast that to major bottom when almost all the stocks are at or near their lows.

That brings us to Tuesday the 26th when the NASDAQ 100 hit a new high.  How many stocks closed at new highs?  If you answered three you are right.  How many are at least -10% off their highs?  If you said 51 then you are once again a winner.  And what about stocks that are at least -20% off their highs?  That answer is 19.  So almost 20% of the index is at least -20% off their highs, 51% of the index is at least -10% off their highs, and only 3% of the index is at new highs.  The average stock in the NASDAQ 100 is off -12.76% from its 52-Week High.  Is that the sign of strength that you were looking for?

Lets look at another index that should be a harbinger of things to come in the economy the SP100.  Also known as the OEX the SP100 is the mega-cap index that looks at 100 of the largest companies in the SP500.

With the SP100 trading just -2.3% off its cycle highs how is the breadth here?  Is the NASDAQ 100 just experiencing a tech sell off or is it more widespread?  Well 39% of the SP100 is off at least -10% and 9% is off at least -20%.  A better showing than the NASDAQ 100 but not exactly New Highs R Us either.  How many of the stocks hit new highs Tuesday?  Only Apple.  The average stock of the SP100 is off   -9.35%  from its 52-Week High.

In the following table you can see the NASDAQ100 and the SP100 side by side.  In the 52 Wk High column you will see the 52 week high on a close basis as of Monday the 25th.  In the % From 52-High column you see how far off the 52-week high the stock is.  In the case of AAPL and a few others they are blue and have positive reading denoting a new 52-week high made on Tuesday the 26^th.  Finally at the bottom is simply the max and the min for each index.

SP100 and NASDAQ100 52-Week High Table

Happy Trading,

Dave@TheMacroTrader.com

http://TheMacroTrader.com

Disclaimer-We have very light long exposure to equity markets right now.

Take a $1 trial of The Macro Trader to receive unbiased actionable research.

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Yesterday in our post Myths Surrounding The US Dollar we discussed how contrary to the medias perception the US Dollar is not tanking.  Today we will look at another common misconception regarding the US Dollar.  That is that if the monetary base goes up the US Dollar goes down.  While this has definitely worked several times in the past it has also not worked several times in the past.  Right now the idea of researching before you speak is even more important than normal because the numbers are far larger than normal.  if you thought that an increase in the money supply drove the USD lower then you would think that an almost tripling of the monetary base inside of three years would force the USD to drop like rock.  In fact most people with whose experience with trading and economics is via their television set would say that the US Dollar would be worth less than their toilet paper.

If you are one of these people who only listen to pundits, politicians, and other putzes and you believe this then please stop reading, scroll down to the bottom of the page, find my e-mail, and let me know how many squares of toilet paper you need.  I am running a special of two triple ply Charmin squares for each dollar you send me.  Seriously I will trade toilet paper for US Dollars all day long.  Why you may ask?  Well if you look at the evidence you will see that while the monetary base has exploded to almost triple the size of three years ago and yet the US Dollar is essentially in the same place that is was three years ago.  Look at the chart below and you will see that while some rises in the monetary base led to a fall in the USD others led to a rise in the USD.  Over the past three years it has obviously let to nothing at all in the USD as the price is virtually unchanged.  With the runaway inflation, runaway deficit, and collossal rise in the monetary base the USD by conventional wisdom should be trading at 0, instead it is holding up quite well. (Click on chart to enlarge)

US Dollar Spot Index and US Monetary Base

Please don’t listen blindly to so called experts on TV.  Everyone is always talking their book and in the case of people that aren’t running money their “book” is called hype and they want as much as possible.  Instead of watching the TV, and that includes CNBC, or reading Newsweek to help guide your investment decisions try doing your own research.  If you want to save time, or just supplement your research then consider services such as The Macro Trader (I just talked my book) or others who market their goods not by ridiculous hype but by sharing their research backed by something other then an ill-informed sound bytes.   No one will ever be perfect but we can all at least live in reality and not in lala land where the USD is toilet paper, all bonds have defaulted, and Armageddon reigns on earth.

Happy Trading,

Dave@TheMacroTrader.com

http://TheMacroTrader.com

Disclaimer-In our model portfolio we are currently short the EUR/USD which means we are long the USD and at home we are long several bundles of toilet paper from Costco.

Take a $1 trial of The Macro Trader to receive unbiased actionable research.

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In our last post “Democrats and Republicans Don’t Care About You And The Bond Market Doesn’t Care About Them” we discussed how many pundits show their stupidity by sticking to their opinions without making sure that their view is grounded in reality.  In that post we showed how politicians and media hype be damned the bond market doesn’t care much about the potential “technical default”, instead it seems to think that US debts will continue to be paid.  So despite all the hullabaloo about how interest rates will skyrocket pushing up the cost of our debt the truth is that bonds are higher/yields are lower over the past five months or so which is coincidentally the same amount of time that the debt ceiling debate has been raging on.

Now it is time to look at the US Dollar.  If you ask the average 24 hour news watcher, and it doesn’t matter if it is MSNBC, FOX, or CNN, what the US Dollar has done over the past three years they will usually say it is down.  If you ask how much they all guess 10-30%.  Luckily for us there is a place called reality and reality doesn’t care what people think, it just is.  In this land called reality the US Dollar despite some large gyrations is actually up over the last three years.  Don’t believe us?  Well take a look at the following chart. (Click on chart to enlarge)

US Dollar Index

As you can see over the past few years it has effectively gone nowhere.  Why has this happened?  If the US has huge debt and the Fed is mismanaging the monetary base shouldn’t the USD be lower?  In a vacuum yes but since currencies do not trade in a vacuum the USD is holding its own.  As opposed to equities, fixed income, or commodities the currency market always trades against other currencies.  For instance while you could have every stock in the SP500 climb higher the same is not possible in currencies.  If the USD goes up then what did it go up against?  If the Swiss Franc is down then what did it go down against?  This is why currency quotes are always quoted EUR/USD or JPY/USD.  For one currency to go up at least one other currency has to go down.  So anytime you hear someone on the news say that the (name your currency) is going higher you need to ask against what.

When all currencies trade against each other the resilience of the US Dollar makes more sense.  After all the US may have a ton of debt but how are its competitors doing?  The Euro Zone is crumbling before our eyes, Japan has an even higher Debt to GDP ratio then the US, and the UK economy is in horrible shape.  So while the United States has a lot of issues our largest free floating trading partners do too and this goes a long ways towards leveling the playing field. So until the United States is the only major economy with a debt crisis we will not go into a free fall.  Remember to look at reality before you make trading and investment decisions.  Do not trade based upon what you want to happen but instead trade off what is actually happening.  Distancing yourself from empty opinions will improve your bottom line year in and year out.

Happy Trading,

Dave@TheMacroTrader.com

http://TheMacroTrader.com

Disclaimer-In our model portfolio we are currently short the USD/CHF and short the EUR/USD.

Take a $1 trial of The Macro Trader to receive unbiased actionable research.

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