Dow Jones Industrials Looking Distressed

I'm entering the fifth week of being contaminated by some kind of illness. This time, it's a nasty cold that developed last Thursday, and gave me a fever every day this past weekend, into Monday morning. That was accompanied by an incredibly sore throat, cough, and inordinate amounts of post-nasal drop. Not exactly the most fun way to spend a weekend, but thankfully it looks like things are turning a corner.
A handful of technical indicators on the Dow Jones Industrial Average are flashing warning signs that the market might be slightly distressed.

StockCharts.com

Attached above is a picture of the Dow Jones Industrials over the last six months, with the Average Directional Index (ADX) posted below. The +DI (Positive Directional Index) and -DI (Negative Directional Index) are superimposed on the ADX. In a nutshell, an ADX value over 20 generally indicates the presence of a trend in the market. Using the ADX alone, one can't determine the direction of the trend without looking at the values of the stock or index. The Directional Indexes help out by separating the ADX into positive and negative components. When the ADX exceeds 20 and the +DI is greater than the -DI, the trend of the security is generally positive/upward. Likewise, when the ADX exceeds 20 and the -DI value is greater than the +DI value, the trend of the security is generally negative/downward. This is by no means foolproof, but can be a guide to identifying trends and momentum, to some degree.
The ADX has been stuck in a pretty tight range since middle September, eyeballing it says it's hovering between roughly a 22-27 value window. Although the index has stagnated, it remains above 20, and therefore it is plausible that a trend still exists in the market. How can there be a trend if the Dow is stuck in a sideways pattern, you ask? Well, that's the gist of it. The trend is for the sideways pattern to continue, it would appear, as has been the case since last month. When taking into account the Directional indexes, we get a different story. Since mid/late August, the -DI line has consistently been above the +DI line, save for a brief come-together in late September. This was not a red flag back in August and early/mid September, because the ADX was below that key 20 threshold. However, it's been about a full month that the ADX has been above the 20 mark, and the -DI line has exceeded the +DI line. This has bearish implications for the Dow, and while there's nothing from this particular index screaming "correction" in the very near future, this indicator is raising the possibility that a correction cannot be ruled out down the road. A sideways trend with -DI exceeding +DI isn't something I'm fond of.

StockCharts.com

We now turn to another indicator, using the same 6-month timeframe as the ADX analysis. This time, we're looking at the Moving Average Convergence/Divergence Oscillator, or the MACD. This is a momentum oscillator, and will work in tandem with our ADX analysis above. The MACD, while a wonderful indicator, is also a rather complicated indicator to learn, given the number of crossover signals and such that can be learned. For this analysis, we will be focusing solely on the positivity or negativity of the MACD line itself (black line). In a nutshell, when the MACD value is positive, the momentum for a gain in the security is increasing. Taking this point further, a strongly positive MACD value can predict a strong upward breakout, whereas a weakly positive MACD value may anticipate weak gains or even stagnation. Similarly, when the MACD value is negative, the momentum for a loss in the security is increasing. A strongly negative MACD value may anticipate a large drop in the security's value, whereas a weakly negative MACD value may predict small losses or stagnation.
Something right off the bat that worries me is that the MACD has been negative since early September. This implies that there is more momentum for the index to lose value than to gain value. However, as we saw with the ADX, we are stuck in a rather small window, and in order for the MACD or ADX to succeed in anticipating this downward momentum, we need something to break out of the small window. Perhaps a series of worse-than-expected earnings, as we're in the thick of earnings season, or some other shock to the system. Those kinds of things can't really be anticipated, but when a breakout does occur, the MACD agrees that a downward movement is more likely than an upward movement.

Of course, we can't discuss stress in the market and not bring up everyone's favorite fear gauge.

StockCharts.com

The CBOE's Volatility Index, or VIX, is Wall Street's 'fear gauge', measuring volatility in the markets. When investors get jittery and uncertainty over the future increases, the VIX goes up. When markets are calm and the economy's looking good, the VIX goes down. As of the day this post was written (Tuesday), the VIX closed at 13.46, about where it's been since this past spring. That's something that I find a bit concerning.
As we described above, when volatility is low and investors are calm, the VIX is down. When you take into account that the 52-week range of the VIX currently stands at a high of 32.09 and a low of 11.02, you don't need a financial analyst to tell you that investors are pretty complacent with economic conditions right now. In some aspects, this is good; stock markets generally stay up during calm periods, enabling a prolonged, slow appreciation of capital if this calm period were to extend into the longer term. In other aspects, this is not good; investors are a little too complacent right now. The Federal Reserve is well on its way to boosting interest rates, either in its November or December meetings (likely the latter), and while experts are pricing this likelihood in, I don't believe the stock markets are doing the same. To some degree, this is warranted, as the FOMC has lost some credibility in the last few meetings after building up the case for a rate hike and then keeping rates steady. Despite this, I believe a correction will occur at some point if/when the markets realize that interest rates could very well rise in December. It shouldn't be a big correction, but at least a few days in the red ought to accurately price in a rate hike.

Another thing to discuss concerning the VIX is the Relative Strength Indicator, or RSI, placed above the VIX price chart. The RSI is an indicator of whether a security is overbought or underbought. Values above that dashed line at 70 indicate a security is overbought and a pullback in value can be expected soon. Similarly, values below the dashed line at 30 indicate the security is underbought, and a rise in value can be expected in the near future. The 'neutral' line is at 50, so anything between 50 and 70 generally is accurately priced but perhaps a bit too pricey, while anything between 30 and 50 is generally accurately priced but perhaps a bit too cheap for its real value. The VIX stands at about 46 at Tuesday's close, below the neutral line of 50 but not below the 'underbought' line of 30. In other words, volatility is about where it should be based on recent history, but might be just a bit too low. The RSI isn't perfect of course, but it's one of the more accurate technical indicators. Using the RSI, the VIX should be watched for a slight short-term boost.

Lastly, we apply the ADX we discussed earlier to the VIX. I'll save you the trouble of re-explaining the ADX and +/-DI, as it's all explained at the beginning of this post, so we'll just analyze the chart. The +DI line has exceeded the -DI line ever since the first few days of September, up until the last couple of days before this writing. Over the last few days, we've seen the -DI and +DI switching back and forth, seemingly fighting over which is more dominant. In a situation like this, I would call it neutral. But it doesn't really matter too much because the ADX itself (black line) is below that key 20 threshold, indicating there isn't really a trend present for the -DI and +DI lines to anticipate momentum. The momentum recently has been negative, and while that momentum and the trend are currently neutral, it could very well return and place continued upward pressure on the VIX.

Lastly, adding on to this theme of losing momentum and being stuck in a sideways pattern, let's check out just how low volatility has been, using numbers.

TradingViews

Shown above is the Dow Jones Industrials over the last year, with two price change windows on the right side of the chart. The larger window is where I measured the range in index values from highest close/open to lowest close/open. Since mid-August, a period of about 2 months, the Dow has varied by 626 points, or 3.36%. That's not much of a move at all, when looking at other 2-month periods over the last year. Applying the same method to the last month and a half, we get the Dow varying by 320 points, or 1.74%. These two price changes, particularly the window over the last month and a half, show this pattern we've been stuck in. The Dow Jones has been moving sideways on this chart, hence the 'sideways pattern' references. While there is downward pressure on stocks as we described above, until we get out of this pattern there's really nothing that can be done. Thus, we're waiting for an event that triggers either an upward breakout, such as a slew of much better-than-expected earnings from big companies, or a downward breakout, such as a series of poor earnings and a decrease in economic conditions. Time will tell just when this breakout happens, but until then, it's a waiting game. Which direction will it go? What will be the trigger for the breakout? Those two questions are at the forefront of my mind for the medium term.

Andrew

Yellen's 'High-Pressure Economy' May Pressure Stocks

Janet Yellen laid out her take on current monetary policy in Boston on Friday at a luncheon, describing how a "high-pressure" economy may be necessary in order to boost growth. The speech comes at a time when the Federal Reserve is divided on whether to raise benchmark interest rates this year, or keep them steady at their historically-low levels. (More information on her speech can be found in this link from Reuters).

I have a few concerns about letting inflation run temporarily hot.

FRED - Federal Reserve Bank of St. Louis

Shown above is the civilian unemployment from January 1948 to the most recent data point, September 2016. Shaded gray areas indicate economic recessions. There are two main take aways from this graph:

1. When looking at past economic expansions, a common signal that the expansion is coming to an end is when we start to see the slope of the unemployment rate line go to zero. This was seen prior to the recessions of 1970, somewhat in 1973-1975, again in ~1979 and ~1981, and notably just before the early 1990s recession, the early 2000s recession, and a bit before the Great Recession back in 2008. While one could nitpick and say the slope never did get to zero, merely eyeballing it shows that before recessions, the unemployment curve generally becomes flat, if not close to flat, as the economy reaches full employment.
Taking a look at our current position on the curve, we're right around (if not at) that point where the unemployment line's slope hits zero-ish. The table below illustrates this quite well:

The attached table shows civilian unemployment data from FRED, compared year-over-year for September of each year during the current economic expansion. We began the economic expansion in September 2009 with a change of -0.3% from then until September 2010. The YoY change in the unemployment rate from September 2015 to September 2016 was the smallest change throughout the entire economic expansion when looking at September YoY changes. I haven't run the data for all the months' YoY change, but going through a few more data points, it appears this could very well be the smallest YoY change throughout the entire expansion, including all months' YoY changes.
What does that tell us? Right now, the only thing we can plausibly assert is that the labor market is near full employment, based on how the slope of the unemployment line is getting closer and closer to zero. I don't believe this shows that a recession is barreling our way, primarily because the Fed is keeping monetary policy extremely accommodative and investor sentiment remains more-or-less high, though we saw an unexpected drop on the Consumer Sentiment Index on Friday. However, given the Consumer Sentiment Index is a lagging indicator, and by most other measures the domestic economy is still chugging along, I don't believe a recession is pending in the short-term.

2. Despite claims that the labor market is not yet at full employment, recent recessions indicate it could be. Referring back to the FRED unemployment rate chart, note how the minimum unemployment rate, or at least the point when the slope of the curve begins to flatten to zero, has been creeping up ever since April 2000, when it hit an expansion-low of 3.8%. The expansion-low prior to the Great Recession was 4.4%, hit multiple times from Fall 2006 to Summer 2007. Our expansion-low in our current economic expansion is 4.7%, from May 2016. The gradual uptick in apparent minima with respect to the unemployment rate could be a signal that our labor market is at full employment, in addition to the signal from the flattening slope of the curve.

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My other main concern resides in the fact that the stock market is already near record highs, and broke record highs this past summer. Allowing inflation to run hot could create a bubble, if one hasn't already been formed.

Big Charts - Marketwatch

The chart above reflects the DJIA's history through early 1988 or so, on a weekly scale. Note how we are currently just below record highs reached earlier in the summer. Record stock prices generally come about around the peak of a bull market, and it's been my belief for some time that we are either at the peak or just past the peak of this current expansion's bull market. But that's not my primary point of discussion relating to the stock market.

Extraordinarily-accomodative monetary policy in the U.S. for the last many years, and expectations of continued accommodative policy, has led to prolonged risk-on sentiment, as reflected in the record highs for all three major equity indices this past summer, and the near-record-high valuations at present date. Many financial analysts promote the idea that this accommodative policy has led to the 'Central Bankers' Bubble', named after central banks' continued enforcement of such monetary policy that some believe has blown a bubble in more than just one specific asset. To be sure, this is by no means a prevailing opinion, as far as I can tell, and the theory that we are mid-bubble does not stand for all financial analysts. However, I do personally believe that this is the case, at least to some degree, and this is where my concerns over a 'high-pressure economy' come to light again.

In a general sense, inflation is bearish for the stock market. When inflation begins to ramp up, typically the Federal Reserve will act to tighten monetary policy by hiking interest rates, thus placing a more risk-off sentiment across financial markets as investors leave stocks and seek safer investments, like bonds. However, if the Federal Reserve were to maintain low interest rates while allowing inflation to rise, the 'lower-for-longer' concept (the idea that interest rates will stay lower for a longer period of time) that has boosted stock prices over the last few years would persist. Inflation would begin to eat away at the stock market, and at that point the Fed would begin tightening monetary policy, but until then it would be a continuation of low interest rates and more-or-less tepid inflation, until the 'high-pressure economy' kicks in and inflation rises.
Why the worry? With inflation expectations so low, we could be talking about a number of years in a low interest rate, low inflation environment, which would almost certainly blow an equities bubble, if one hasn't already begun forming. Consequentially, if/when inflation reaches a point that the Fed deems as conducive to hiking interest rates, the pullback in stock markets would be far sharper than it would be if the Fed were to hike rates today.

In my eyes, the Fed has dug itself into a hole by maintaining interest rates for so low. To be fair, this was a good choice when you see how steadily the unemployment rate fell. However, good cases could have been made for a rate hike in the last few FOMC meetings, particularly after some FOMC members began taking far more hawkish viewpoints. Then, when they didn't hike, the Fed began losing credibility, but that topic is for another write-up. By allowing a low-inflation, low-interest rate environment to persist, possibly for a prolonged time period (longer than Ms. Yellen believes, as the FOMC is notorious in recent history for being too aggressive in their inflationary expectations), equities would almost certainly enter into a bubble, and if other assets also enter into bubbles as ultra-accommodative monetary policy continues, the pullback if/when tightening occurs could be nasty.

Lucky for us, all of this is hypothetical, and assuming the FOMC goes along with Yellen's ideals. While she posed the high-pressure economy as a 'question that needs more research', it's quite frank that she is looking for every excuse to not hike interest rates, and it's entirely plausible that the chairwoman is able to convince the FOMC to follow suit.

Andrew

Testing Technical Analysis

I’ve finally managed to recover from the worst of my illnesses, after getting a fresh round of antibiotics to take care of something called ‘hemophilus influenzae’ that was making things pretty unbearable for a while. As I type this on this Wednesday, the third week anniversary of when I first went in to the doctor for an illness, I’m still stuck with a cold, but I am feeling far better than before.
The same cannot be said for financial markets in the last couple of days. Between the GBP/USD flash crash and continued weakness and stocks taking a nasty hit on Tuesday, I imagine there’s an abundance of Advil circulating around trading floors. If technical analysis is to be believed, painkillers could soon be flying off the shelves.

Bloomberg

Let me first assert that, as a college student, I’m not going to pretend like I know what I’m saying is completely accurate. I’m more or less learning as I go, and there’s bound to be times where I say one thing and the complete opposite happens. Caveats aside, above is a screenshot of the Dow Jones Industrial Average from Monday with a bearish pennant formation. This pennant is bearish as per the 2.88% contraction (flagpole) around the early part of September, which kicked off the pennant formation. The Dow fell 200 points on Tuesday, and as of this typing, is up about 34 points on this Wednesday at 18,163 points. Needless to say, Tuesday’s big drop was the downward breakout point for the Dow we were looking for. The drop came on the heels of uncertainty over the OPEC “deal”, a surging Dollar, and general anxiety over market volatility, certainly not helped by the Cable flash crash earlier. While conditions today (10/12) are slightly better and major indices are showing modest gains, DJIA remains below the pennant’s line of support. I’ll be watching carefully in coming days to see if this line of support is treated as a new line of resistance, or if markets rally and the pennant formation was likely a false alarm. Only time can tell.

Bloomberg

I’m not too convinced that this is just a flash in the pan with respect to the pennant formation yet. The S&P 500 has been exhibiting the same kind of bearish pennant formation as the Dow, with a drop of ~60-70 points at the flagpole. As a result of Tuesday’s sell-off, this pennant too was broken, and again I’m watching carefully to see if this holds and the index remains at subdued levels relative to what we saw in the pennant.

Bloomberg

The ‘kicker’ to me is a strong bullish pennant formation we saw in the VIX. This formed at the same time as the S&P 500 and Dow pennants, though this flagpole was bullish with a 71.47% gain in early September. Tuesday’s sell-off saw this pennant broken, and the VIX stands at 15.71 as of this typing (Wednesday). With the VIX pennant broken in an upward movement as expected, the idea that the bearish pennants in DJIA and SPX were valid gains traction. Again, it’ll take a couple more days to see if this is actually true, but things are certainly looking that way.

Ideally, I’ll be over this cold in the next couple days and I can finally have a day where I’m not sick with anything. That day should come very soon, but if technical analysis is to be believed, the same cannot be said for stocks.

Andrew

Everything That Buys Bonds Isn't Gold

I’ve been under the weather for the last two weeks as of this writing, contracting things from strep throat, to a common cold, to a finger infection, to pink eye, and now something with my tonsils. It’s been the less fun part of the school year to date, especially seeing how none of my friends have come up with any of the symptoms I’ve dealt with. The grass is always greener on the other side, as they say. The same can’t be said for gold, however.

TradingView

The big story on the Street from Tuesday came from the battering of Gold, as the price of this commodity fell by about $40 amidst a storm of news that didn’t bode well for the metal. This drop, the biggest in three years, was fueled in large part by hawkish comments from two Federal Reserve regional bank presidents; Loretta Mester of the Cleveland branch, and Jeffery Lacker of the Richmond branch. These comments fall in line with what we’ve seen other higher-ranking Fed officials say in recent weeks, that the economy is more-or-less primed for an interest rate hike. Reports also surface during the day Tuesday that the European Central Bank will aim to back off from its aggressive quantitative easing program, as the world of QE-eligible bonds becomes ever more scarce. This scarcity is in part due to investors unwilling to let go of bonds they already have, and central banks already owning a significant chunk of the sovereign bond market.
The Bank of Japan announced a ‘refocus’ of its QE program at its last meeting, which seemed to adjust their primary goal to maintaining the yield curve, in a sign of surrender that the effectiveness of quantitative easing is on the decline.

The combination of hawkish Fed presidents and signals that central banks may be less willing and/or less able to effectively utilize QE sent the dollar on a tear, with the Dollar Index Spot (DXY) jumping from 95.695 on October 3rd at the close to 96.169 on October 4th at the close. DXY is currently down slightly as I type this around noontime Wednesday, but the effects on gold remain.

As a mere college student, trying to learn as much as I can as things unfold, looking back on gold’s drop reveals that there were signals and reasons to be short gold. In addition to the stream of hawkish comments from Fed members in the last several weeks, technical analysis presented a big signal that gold was due to drop.

TradingView

We saw a flag back in Q1 and Q2 as gold steadily marched upward, and this flag broke off in late May on a downward breakout point. Gold rapidly gained value yet again in late June after Britain’s Leave vote in the referendum concerning membership in the European Union, as investors sought haven assets amidst the shock to the system (you’ll recall JPY also dropped below 100 yen to the dollar immediately after the referendum’s results were announced). From there, gold entered a Descending Triangle, which came to an abrupt end when the metal dropped $40 in its breakout point on Tuesday. Should gold follow the ‘typical’ path in the wake of a Descending Triangle, suppressed prices should continue over the next few weeks.
From there, I see two possible routes for Gold:

1) The Federal Reserve opts to hike benchmark interest rates in its November 1-2 meeting, favoring a relatively strong economy against uncertainty surrounding the presidential election. Gold suffers another drop as USD strengthens. Equities may also take a hit, save for financials, as I don’t believe the markets have fully priced in the potential for a November rate hike.

2) The Federal Reserve does not hike interest rates in its November meeting, citing uncertainty over the election, but strongly suggesting a December rate hike if data continues to support it (of course…). Gold jumps on a combination of election uncertainty and a weaker dollar, but is subject to a correction downward after the election, particularly if Clinton wins, as the markets appear to be heavily pricing in right now.

To summarize, Gold’s pullback was to be expected from a number of viewpoints, including via technical analysis and the continuation of hawkish Federal Reserve members. Other factors could have been used to identify a pullback, but as a college student without regular access to a Bloomberg, those two will have to suffice. Suppressed gold prices compared to the last 4 months are anticipated to persist into November, when a fork in the road comes up as a consequence of the next Federal Reserve meeting.
I’m hoping each night I go to sleep that I’ll wake up and not be sick and/or not feel sick, because the grass is certainly greener when the body feels healthy. And while the grass may get greener for me when I get my full health back, gold’s shine looks to stay a little dulled for the short and medium terms.

Andrew

Deutsche Bank: TBTF Edition

Over this past summer, I had the pleasure of reading Andrew Ross Sorkin's book 'Too Big To Fail', a beautiful reconstruction of the financial crisis at its roots. The book claims to have been based off of many interviews & previously-secret pieces of knowledge, and the material inside confirms it; it really is a fascinating book about the crisis.
The other day, I received in the mail another book titled 'Too Big To Fail', this one penned by Gary Stern and Ron Feldman, published in 2004. This book was essentially the 'warning shot' for the 2008 financial crisis, as it spoke of the dangers of bank bailouts. I have yet to dive into the book, but I'm very eager to do so. Aside from all the literature, while we thought the era of TBTF was more-or-less over, if not heavily reduced, Deutsche Bank this week proved that this is not the case.

Yahoo Finance

Attached from Yahoo Finance is a chart of Deutsche Bank's stock price from somewhere early in the trading session Tuesday, to the end of the trading session Friday. The Dow Jones Industrial Average is superimposed in green. You don't have to have a paid subscription to fancy charts and graphs to tell that DB was under some intense pressure both Thursday and Friday.

Thursday was not a good day for the banking sector. Two prominent events contributed to this general malaise, the first stemming from Commerzbank and the second from Deutsche Bank. Commerzbank announced that it would be eliminating nearly 10,000 jobs and suspending dividends for its stock on Thursday, news that sent a chill throughout the financial markets. This news came about prior to the start of the trading day, if my phone alerts are to be believed, and more or less set the tone for the financial sector before the American trading had even begun.

Trading kicked off for Deutsche Bank on Thursday pretty stationary from where it had closed Wednesday, hovering right around $12.25 per share. However, at around 12:20 PM ET Thursday, word got out that a handful of hedge funds were either pondering, or already commencing a cut in exposure to Deutsche Bank. This, of course, is not what investors wanted to hear, after the news about Commerzbank was already promoting a little more Advil than normal on this trading day. In a span of 40 minutes, from 12:20 PM to 1:00 PM ET, Deutsche Bank's stock plummeted from $12.22 per share to $11.39 per share, a 5.37% drop. The Dow responded similarly, dropping from 18,315 points to 18,151 points in that same timeframe. It eventually scraped the 18,100 mark right before 2 PM, but bounced back to close down over a hundred points on the day.

There are a lot of editorials out there with far more knowledge and experience than I possess, and that's fine; ideal, actually, as it gives people like me an opportunity to keep learning. And something that's been made a point of in some of these articles is that Deutsche Bank may remain Too Big To Fail. The financial markets certainly believe that; the CBOE'S VIX index jumped over two points in that same 40-minute time span we looked at above.

The nice thing here, though, is that this isn't Lehman Brothers 2.0. You'll notice that DB is sitting on a large quantity of cash reserves, has bonds that can be converted into equity if needed, and after Lehman in 2008, as well as observing the current state of our global economy, it would be nonsense to even imply that a bank as significant as Deutsche Bank would be allowed to fail. Deutsche is not Lehman 2.0, and is far from it.

StockCharts.com

After Thursday's scare, Friday brought a heavy dose of optimism back to the overall market, and especially Deutsche Bank. Its stock ended the day just over $13, a jump of over 10% compared to its Thursday closing price. This jump came on the heels of reports that the US government's settlement with the bank may come in around $4-6 billion, a fraction of the ~$14 billion charge initially levied against Deutsche Bank. I'm practically hitting my head on the wall at how I didn't realize that the settlement would be lower than the initial charge, leading to a rally like this; the bears got trapped and the bulls are running free in Deutsche Bank's stock, for now.

Technical indicators like the MACD and Bollinger Bands as portrayed above indicate that another, certainly more modest drop could be in the cards over the next couple days until the MACD crosses above the signal line again. What might be a bit alarming is how even despite Deutsche Bank's stock hitting an all-time low Thursday, it still stayed within the Bollinger Bands, which delineate the +2 and -2 standard deviations. Friday's rally has brought the price back just below the middle of these Bollinger Bands, but when you put together the still-iffy MACD and now-very-wide Bollinger Bands, a non-zero chance for further selling remains. I don't see it anywhere as severe as Thursday's selloff, but similar to the gradual downward trend we've seen since about May, depicted in the chart above.


Deutsche Bank is a Too Big To Fail bank, but it's a strong TBTF bank compared to the position Lehman Brothers was in when they started taking big beatings from hedge funds cutting exposure. Even if, for whatever reason, DB ended up needing government assistance to survive, common sense all but guarantees the bank would not go under, unless the end goal here was another significant shock to the system, and we know no one wants that.

Andrew

Central Banks at Center Stage

I'm typing this post with a case of strep throat, so forgive me if my thoughts seem a bit disjointed or otherwise incomprehensible at times. It just so happens that this past weekend was the much-anticipated Oklahoma vs Ohio State football game, which I had the honor to attend. While the main show was indeed the football game, a number of other factors played an equally important role in the experience. This included nearly coming to blows with a very drunken fellow student, an intense storm just prior to the game's original start time, among other things. This week, while central bank decisions are taking center stage, there are a number of factors working on the exterior of the stage still playing a big role in our current economy.

Let's begin with the latest FOMC forecast for the long-term.

Federal Reserve

The infamous dot plot above shows many FOMC members wishing to hike the benchmark interest rate from 0.25-0.50 percentage points to an average 1.25-or-so percentage point interest rate in 2017, a rather ambitious goal given the global struggles to see stronger economic growth. By 2019, most FOMC members would prefer to see the benchmark interest rate somewhere around 2.50 percentage points, again a rather ambitious outlook and one I'm personally wary of, as we're already in/near year 8 of this economic expansion, making it one of the longest on record. A bull can't run forever.

The vote to maintain the current interest rate of 0.25 to 0.50 percentage points landed at 7-3, a pretty strong signal that some members inside the Fed are getting a little antsy with respect to keeping interest rates low, and I agree. The Fed almost seems scared these days, worried that even a minimal jolt to the economy could bring everything crashing down, and thus the best way to keep things steady is to keep interest rates steady. This mindset has created a whole other level of problems alone, but that's a post for another day.

Federal Reserve

Another interesting graph from the Fed's decision yesterday, and one of those exterior factors dancing around central banks, was the projected PCE inflation. I don't have my protractor on me at the moment, but that's nearly a 90-degree angle from observed PCE inflation through 2015 to projected PCE inflation through 2016. The FOMC is essentially expecting inflation to reverse course and start chugging its way back up at this very moment in time. Unfortunately, the FOMC is notorious for being too optimistic on the future of the economy, particularly in the current expansion. When accounting for this, it becomes difficult to see a 2% PCE inflation mark earlier than 2018.

The Federal Reserve isn't the only central bank that had their monetary policy meeting this week; the Bank of Japan also met up.

At their previous meeting, the Bank of Japan announced it would re-evaluate its current monetary policy, which set off concerns amongst investors if this was a warning shot, if the BoJ might stop pushing ahead with negative interest rates and QE. This week, the Bank of Japan came out and modified their policy slightly, now to a yield-curve based goal. The BoJ will now aim to keep 10-year Japanese government bonds around 0%, and while this is still very accommodative monetary policy, it's also a cessation that plunging further into negative interest rates right now, when the benefits are beginning to be questioned, is not the right move. It's part of a larger cessation that the Bank of Japan is running out of tools, something we've all known for a while, but no one really knew when the Bank would begin realizing that. One could effectively argue that this realization moment came at their last meeting, when the BoJ opted to re-evaluate its policy, but carrying through with that re-evaluation into this week's meeting reaffirms that more than incredibly accommodative monetary policy is needed to stimulate the economy.

Central banks will continue taking center stage, perhaps the Romeo and Juliet of this monetary policy opera. However, Mercutio, Tybalt, and Benvolio are also on stage, and while they aren't the main focus right now, you can bet that what they do will influence what the two main characters do. In our case, inflation, equity pricing, bonds, and more play our 'secondary characters', but their influence down the road will prove anything but.

Andrew

Monetary Easing Wells Running Dry?

As a former meteorology major, I found myself intrigued by how steadfast a drought can be. Case in point, the Southwest remains in a deep drought after several years without a good, prolonged rainfall weather set-up. There was even a rumor or two about some water wells running dry in the Northeast as western New York is experiencing a pretty notable drought at this point. It just so happens that the monetary easing wells across the world may be running dry, too: not for a lack of 'water', but a lack of confidence that pulling up more water will further benefit the global economy.

StockCharts.com

A look back at the last month of trading across the Dow Jones Industrial Average shows how large Friday's drop in stocks was. The index shed just under 400 points on the day, closing down just over 2.1%. Other American equities didn't fare any better, with the Nasdaq dropping 2.55% and the S&P 500 closing down 2.45%.

Global bonds took a significant hit worldwide after Friday's apparent broad turning-of-the-tide in central banks, and yields continue to rise as I type this at roughly 2:00 AM on this Monday. European peripherals are looking a bit shaky, too:

Investing.com

Italy's 3-year government bond yield has risen over 117% as of 0700 UTC Monday, but even as I type this sentence about a minute after that screenshot, the yield has jumped to 139% in the last day. Longer-term bonds are generally showing 2% to 10% gains, with bonds beyond 10 years hovering near 3%. 

Elsewhere, Ireland's 10-year government bond has jumped over 30%, Spain's 10-year and 30-year bonds are both up over 2% in the last day, with their 3-year bond up nearly 70% as of this typing at 0704 UTC. Emerging markets have been acknowledged as a substantial part of the bond rally, as the hunt for yield has bled from developed economies into these riskier, but profit-producing bonds. Now, as we see a global bond sell-off continuing on from Friday into this workweek, one can't help but entertain the thought of what the global economy will look like even a month from now if this kind of anxiety over potential central bank hawkishness persists.

Forgive me, I feel like a guest at a party who's been talking for far too long. Let me introduce how we got here. Back on Friday, global markets began to wake up and smell the reality that is the limits to central bank action. The last week or so has seen the European Central Bank, the Bank of Japan, and the Federal Reserve all display increased hawkish tones in their actions. From the ECB, we saw President Mario Draghi refrain from any further monetary easing. The Bank of Japan was found to be in a tough spot, with concerns that it is running out of debt to purchase as part of its monetary easing program. And, to put it all together, usually-dovish Boston Federal Reserve branch president Eric Rosengren indicated it is plausible that normalization in monetary policy is coming much sooner rather than later. Financial markets reacted quickly and in typical knee-jerk fashion.

StockCharts.com

The CBOE's volatility index (VIX) jumped nearly five points on Friday, up about 40% on the day. Given how low volatility has been since July, some form of rebound in volatility was expected. I like to think of this aggressive monetary easing as the equivalent of feeding the financial markets Xanax, in that it calms the markets, makes everything feel all fine and dandy. But now that there's signs central banks may be backing off, it's quite a sobering reminder and a signal that the 'Xanax effect' in the markets isn't invincible.

Already on this Monday morning, Asian markets took a hint from the American markets on Friday and continued the sell-off. The Nikkei 225 fell by nearly 300 points (1.73%), while Hong Kong's Hang Seng index is currently down about 685 points, or 2.85%. Using stock futures, American and European markets will see the slide continue Monday, and further drops are definitely still on the table, especially if the Fed's Lockhart, a typically-dovish member, turns hawkish. 

The fact of the matter is we're in the ~eighth year of this economic expansion, one of our longest in history. Every peak is followed by a valley, and whether or not the valley is coming sooner rather than later, the reluctance of central banks to continue propping up financial markets may hinder any further expansion, should a halt to easing come to fruition. It's time to start seeing how much central banks are willing to conserve the 'water' in their monetary policy wells, because the well's starting to look a bit dry.

Andrew

Technical Foreshocks

I had the pleasure of being woken up this past Saturday by what was yesterday revealed as the strongest earthquake in recorded history in Oklahoma, a magnitude 5.8 on the Richter scale. My door was going back and forth in the doorframe, some of my drawers were pulled out by an inch or two, but no damage.

It does, however, present yet another reminder of what could be coming if fracking, assumed to be the primary cause of increased tectonic activity in Oklahoma, continues. It's this kind of foreshock that we're starting to see in some technical indicators.

TeleTrader

One tool I took to playing around with is the Fibonacci retracements tool from teletrader.com . In a nutshell, there's a significant amount of mathematics behind the Fibonacci sequence and associated 'golden ratio', to the point where scientists generally agree the Fibonacci sequence is found commonly throughout nature in many forms. One of these forms just happens to be the stock market.

I began this retracement from the valley of the Dow Jones Industrial Average during the 2008-2009 financial crisis. I didn't begin the retracement from the lowest point, as you can see, since there is some apparent support right around where I placed the 100.0% line, and that support stuck around from September 2008 until roughly April 2009. I then placed the 0.0% line around where we are now, again right around an area of resistance that the Dow appears to be encountering, and where we are meandering right now in the upper 18,000's.

The cool thing about TeleTrader is when you decide your bottom and top points, it outlines the Fibonacci retracement levels automatically, a nice bonus for those who may be somewhat math-inclined (I was formerly a meteorology major, after all) but don't have the time to calculate all of those levels, like myself. So, when the retracement levels are all drawn out, it becomes apparent that the Fibonacci retracement concept does actually work. I've annotated areas of resistance and support to show how the Dow stuck around areas between two retracement levels, and it's no coincidence how these areas of support and resistance line up incredibly well with the Fibonacci retracement levels. It's not a perfect correlation, as you can see by the 2013 period where support and resistance levels were a little bit away from the Fibonacci levels, but for the remainder of the graph, the shoe more or less fits.

If we're to trust this Fibonacci retracement set, we should be at or just past the peak of our bull market. I personally believe the peak came a handful of months ago, and we're starting to see a slowdown in momentum in equities, as well as remarkably low volatility signaling a level of investor complacency that could cause big trouble if/when a negative surprise shock hits the markets. But that's a whole other post to write about.

TradingView.com

This meat-and-potatoes graphic comes from tradingview.com , which has a cornucopia of technical analysis indicators and indexes and all that fun stuff. We're taking a look at the Dow Jones Industrial Average since around 2002-2003 until present day at the top, the Dow's Momentum index values in the middle, and the Relative Strength Index on the bottom.

As far as this graphic is concerned, at quick glance, things seem just fine and dandy. We're near record highs, the RSI is in a comfortable range (albeit gradually inching upward), and momentum remains positive. However, this is all a bit deceiving, and to illustrate this, we bring in volatility.

TradingView.com

 In the above image we see the Dow Jones Industrial Average from mid-2011 to present day, with the CBOE's Volatility Index superimposed in blue. The horizontal aqua line illustrates the lowest point that the VIX hit this past summer on a weekly scale, closing the week of August 15th at 11.34. For some perspective, that level was last breached in July 2014, and although the index frequently drops near this line, it's rather uncommon to see it go as low as it did this past August.

That tells us that the markets are complacent, as we briefly discussed earlier. This complacency makes for a significant problem in the RSI, which is defined by Investopedia as an index that "compares the magnitude of recent gains and losses over a specified time period to measure speed and change of price movements of a security."
The key phrase there is "recent gains and losses over a specified time period". You'll notice that American equities are trading in a pretty narrow slot right now, as confirmed by low volatility. Hence, recent gains and losses are going to be low, likely artificially lowering the RSI and making it appear that equities are not overbought, when in fact they very well may be.

This volatility issue also hurts the momentum indicator to some degree, as the same issue about recent gains and losses pops up. With minimal movements day-to-day in equities, it's no surprise that the momentum index in the last month or so is oscillating around the zero-line.
These oscillations can give some clues, however. Note how we've started to see lower highs and deeper lows in the momentum index from about 2015 onward, especially back in 2015. We've lately seemed to buck that trend, but I'll be darned if there's no concern over the momentum index hitting levels not seen since the financial crisis, back in 2015. That's a foreshock in a nutshell.

TradingView.com

But hope is not lost! We still have the ADX, the Average Directional Index. This index helps identify the strength of a trend. It doesn't identify if the trend is positive or negative, but shows how strong the trend is. While this index is subject to some of the same limitations imposed on the RSI and Momentum indicators, with how equities are overall not too active, the ADX raises a key point in that there really is no clear trend in the current market. ADX values below 25 are seen as the market either exhibiting a weak trend, or no trend at all, and we've been consistently below 20 in this index since late April! Now, since late April the Dow has gained a good 500-600 points, which is nothing to shake a stick at. But it took us close to 5 months to get there, a lot of dawdling, and a clear indication that there is no real trend. The best trend I can think of is stagnation now that we're likely at the peak or just past the peak of our bull market in equities.

To sum all of that up, while the RSI may be flawed due to a lack of movement, the overall picture of the ADX can provide some context. According to that index, we haven't had a clear trend since the first two months of 2016, when the Dow shed a couple thousand points. Since then, it's just been a meandering climb up to where we are now, the upper 18,000's.

This is a foreshock because the longer we continue without a clear trend, the more wary investors will grow, as more questions are asked about the state of the economy, whether we're peaking the bull market or just starting one. It's plausible that this uneasiness will lead to a climb in volatility, which could set off a chain reaction, but that's one of literally hundreds of possibilities in our current market state.

In sum, much like the increasing occurrence of Oklahoma's earthquakes culminating in a record-5.8 magnitude quake this past Saturday, technical indicators are also sending out foreshocks in the form of Fibonacci retracement red flags, the lack of a clear direction in the markets combined with concerningly-low volatility, and possible hints of less positive momentum in the markets, particularly in late 2015/early 2016. There are fundamentals that are also issuing foreshocks, and one day soon we'll discuss those as well, but for now I'll leave you with an all-too-real paraphrased-excerpt I came across while reading Didier Sornette's "Why Stock Markets Crash: Critical Events in Complex Financial Systems":

Much to the contrary of expectations, stock market crashes arise when economists and analysts are the most positive about the economy and the economy's future. That way, everyone's caught even more off-guard when things suddenly turn south.

Andrew

Trust and the Banking Sector

In my current semester, I have two communications-based classes. The other day, in one of these classes, the professor had us form a circle and take a few minutes to define exactly what trust is, and how trust can be gained or lost. There is no correct definition of trust, of course, as everyone interprets it differently. You may only trust someone after they lay down their life for you, or you may trust them as soon as you first shake hands.

Recounting that class period now, I can't help but think how ravaged the trust between investors and the banking sector has become, but also how ravaged the trust between big banks and the government has become.

Take, for instance, J.P. Morgan Chase (JPM).

Barchart.com

Over the last six months or so, JPM has been through its fair share of ridges and valleys. Perhaps the most pronounced of these oscillations was the Brexit-induced volatility in late June, when the value of J.P. Morgan's stock dropped to just over $57 in intraday trading. Today, we're back up to $67.49 a share as of Friday's close, over three dollars higher than the close immediately prior to the Brexit referendum.

Overall, this chart looks pretty okay to me, and the stats on paper concur. JPM is up nearly 13% in the last six months, and its price-to-earnings ratio is at a comfortable 12.07.
Technical analysis indicators aren't as warm to the idea of placing a Buy sticker on JPM, with the stock's Relative Strength Index at ~70 at Friday's close, right into Overbought territory. Bollinger Bands show JPM grinding along the top band in the last few days, even closing above the upper band three of the last five trading days. It's not insensitive to believe a correction is coming.

But, this is where things get tricky. J.P Morgan's stock could very plausibly stick around these higher levels. We could see repeated intraday breaches of that upper Bollinger Band down the road, and the RSI could easily inch higher. This is the land of broken trust between investors and big banks, big banks and the government, and the government and the investors.

This handy chart I drew up at 3:40 in the morning illustrates how the lack of trust between the three sectors is leading the banking sector to moves irrational moves.

The government, as well as the Federal Reserve, clearly has a problem with investors these days. Time and time again we've heard Fed chairwoman Yellen and other high-ranking officials comment on how the financial markets seem too complacent, purportedly setting the foundation for a benchmark interest rate hike later on in the year. This happened once before, in June, but rate hike chances were eliminated when the United Kingdom voted to leave the EU. Now it's September, and last month at Jackson Hole, Yellen again began painting some more hawkish tones onto her speech, with a handful of other Fed people being more direct and clearly indicating they are ready to raise the benchmark interest rate.
This was all fine and dandy until the ISM Manufacturing PMI number came out this past Thursday. Expectations were for a value somewhere around 52, so there was some egg on some face when the value was released as a 49.4, the lowest in seven months and now into Contraction territory. Almost immediately, the air became thick with the concern that this would be another case of the Fed building up the case for, but not actually being able to hike interest rates. However, calm prevailed until the August jobs report this past Friday, which missed by 29,000 (180k expected, 151k actual) and held the unemployment rate steady at 4.9%. Surprisingly, though, the three benchmark US equities indexes all ended in the black that day. Why? Who knows. All we know is that we're going back around the circle we were in back in June, but this time investors don't seem to be listening all too hard. Equities remain near 52-week, as well as all-time highs, something that will be interpreted by the Fed as complacency but what is really a lack of trust.

Investors aren't too keen on investing in the banking sector. If you managed to figure out the round-about that the Fed has been going around re: hiking interest rates since this past June, congratulations, you can appreciate why there's a general hesitancy to firmly invest in the banking sector.
Profits remain low across the board due to historically-low interest rates, and big-name banks like Deutsche Bank are cutting jobs to compensate for the fall in profits. This has led many banks' shares lower; our JPM example again plays in here, with the bank's share value up a measly 2.21% year-to-date.
For many investors, this is a solid buy sign. The economic recovery continues slowly chugging along, and the overall banking sector is valued pretty okay compared to pretty-overbought defensives. But we aren't seeing a massive rush to the banking sector, and the blame for that is placed squarely on the Fed for inconsistent messages (not solely to their fault), breaking the chain of trust between investors and banks in financial markets.

It's pretty accurate to say that the banking sector doesn't exactly look at the government and Fed with a wink and a smile. The inconsistent Fed messaging has poisoned the trust link here, too, with banks not entirely sure which directions to take internally as the Fed scrambles to find its direction. There's little help coming from hesitant investors, and the government doesn't appear to be about to lay down an Abe-level fiscal stimulus package, leaving it up to the Fed to stimulate the economy and make banks highly-valued again. Of course, the Fed isn't currently doing this, so the banking sector is more or less dead in the water until either investors start wading back into the waters again, or the Fed finally hikes rates like it says it will. Until the latter happens, however, you'll be hard-pressed to find a willingness to trust.



I almost invested in a bank ETF the other day. I started remembering the hawkish Fed speak, anticipated the Manufacturing PMI would be positive, and there weren't any signs to be remarkably pessimistic on non-farm payrolls. Fast-forward to today and we're in another world of uncertainty, albeit not as uncertain as we were immediately post-Brexit (i.e. the yen isn't in the double-digits again). I didn't invest in that ETF, and do not plan to before the FOMC's September meeting, because I have a low amount of trust that the Fed will be able to confidently carry through with their not-so-subtle indications of an impending benchmark rate increase. I also have a low amount of trust in that any rate hike would really help banks- the most recent economic data from last week likely bars any interest rate increases from the current level beyond 50 bps until 2017, and in order for banking sector profits to swell, we'll need more than that.

Trust is hard to gain but easy to lose, and we've got a lot of trust to gain back.

Andrew