The US election results are in and the US stock market is enjoying a sharp rally over the shock news of Donald Trump winning the election and becoming the new President elect.

On the back of the big rally in US stocks there has also been another big shift occurring in another very important asset class, US Government bonds.

US Government Bond Yields Surging

Since the news of the results of the US election were released US Government bonds have experienced a huge sell off in prices causing the yields to surge on Government bonds ranging from the 2 year bond all the way to the long end with 30 year Government bonds. (Note: Bond yields move inversely to bond prices.)

Specifically the US 10 yr Govt bond has seen the yield jump from around 1.80% before the election results to the current price of around 2.13%. (See chart below)

In the chart below you can see the magnitude of the rise in US 10 yr bond yield reaching the same level of the S&P 500 dividend yield.

Traditionally bond yields help to price the relative value of stocks. If bond yields rise the dividend yield on stocks would also have to rise. Usually stock dividend yields are above bond yields to entice investors to own riskier stocks over more conservative bonds. For the yield to rise on stocks either  dividends would need to rise and or stocks would have to fall in price to lift the dividend yields.

So the fact that the 10 year bond yield has reached the same level of the S&P 500 dividend yield means that a bond investor can receive the same yield as stocks without the perceived risk.

Normally when Government bond yields rises considerably it indicates that either inflation is also rising and / or the economy is accelerating it's growth prospects. When the economy start to accelerate its growth prospects investors traditionally buy stocks in anticipation of higher profits and dividends from a stronger economy and sell bonds which are considered defensive assets.

Many analysts and financial commenters have already come out and suggested that growth is now back on the agenda for the US economy since the electing of Trump as the new president. Because of the Trump factor these commentators have suggested this is the reason why bond yields are rising and suggest it's a positive.  

Why Surging Bond Yields Signals Pain Ahead

However we are not in normal times and there is a very big reason why the FED has spend the majority its balance sheet trying to keep US Government bond yields low, by buying them through the various QE programs and artificially forcing the bond prices higher lowering the yield.

It's also the same reason why the FED has only increased the interest rates once back in December 2015 and has been terrified to rise them further since then. The reason is because the US has a major debt problem from a Government , corporate America and consumer level.

So if the FED has tried all this time to keep rates lows, how is it all of a sudden a good thing for the Government, corporate America, the consumer and the economy that interest rates are now rising. Especially when the debt levels in the US are higher now than before the 2008 GFC event that shook the US and Global economy.

Increased Government Spending

Back in August this year Trump gave a short interview  with CNBC, discussing some of the problems in the US and how he was going to fix them.

In the video below he specifically discusses increasing spending on the military as well contributing over $500 billion to the ailing infrastructure in the US.

How Will It Be Paid For?

When asked by the CNBC host how will he pay for all the new additional spending he planned for the US economy. Trump said that he was willing to increase Government debt to fund it as one of the possible strategies. He further added that since interest rates are so low it would be wise to take advantage of the current low rate environment and borrow.

Bond Yields Reacting To Trump Plan

Now Trump will be the new US president I believe Government bond yields are surging not because growth will skyrocket in the US, but because they know that US debt under Trump will rise even faster than under Obama.

If Trump does plan to massively increase Government debt to pay for military and infrastructure spending, he is going to find out quickly that interest rates will not stay low for long.

Bond yields will continue to rise simply because bond investors will reprice US Government debt and the subsequent yield they will demand, to reflect the anticipated surge in debt coming over the next few years. The repricing of US Government bonds will occur to reflect the higher perceived risk of a potential default from considerably higher debt levels.

China Reacts To Trump Presidency

The Chinese Yuan / US dollar pair has been depreciating for while now, however the depreciation against the US dollar has accelerated recently. The currency pair is following closely with the US 10yr Govt bond yield since news of Trump's win was released to the world. (See chart below).

Since China is a large trading partner with the US and China holds a large portion of US Government bonds this is important, as the devaluation of the Yuan and its correlation to the 10 yr yield could indicate that China has accelerated its dumping of US Government bonds in reaction to Trump become President and the potential shift in Trump's trade policies effecting China.

China A Seller Of US Government Bonds

The chart below shows that China has been slowly selling US bonds since August 2015 reducing its holding from over $3 trillion to just below $2.8 trillion with the latest data.

If China decides to dump their holdings of US bonds rather than a gradual selling as has been the case, you could see US bond yields surging significantly higher due to the large amount China currently holds.

Once again given the high debt levels in the US this would create a lot of pain for the US, as US Government bond yields are used to price consumer, corporate, auto and housing loans. If the bond yields continue to rise it will squeeze the cash flow of debtors in the US and the economy will quickly feel the impact as the economy will buckle with higher interest rates. 

US Debt Obligations Impossible To Repay

A number that has been raised a few times recently during the lead up to the election results was the total US Government debt of around $20 trillion. However what vary rarely gets mentioned is all of the total obligations or promises that the US Government has made. These include the pension obligations, medicare, social security to name a few.

Ray Dalio from Bridgewater has put together a brilliant chart that encompasses all the Government IOU's as well private debt. (See chart below)

What you will notice is that on the right hand side of the chart that total US debt to GDP stands at over 1000% to GDP. This means that debt is over 10 times to the yearly GDP of the US economy and is too high for the economy to be able to effectively grow out of it. This explains why the US recovery has been so sluggish despite zero interest rates.

With such a high proportion of IOU's relative to the size of the US economy, you can clearly understand why higher bond yields will cause a lot of pain in the future for the US.

The previous chart above on the US IOU's is actually a global trend with many countries having a similar looking chart with Government and Private debt rising rapidly over the years.

When you take a look at the chart below on the left, you can understand why Central Banks around the world have struggled to lift rates over the last 5 years. The reason they have not been able to normalize is that debt levels globally are too high to sustain in any interest rate rise.

In fact over the last 18 months or so many Central Banks have cuts rates to further spur economic growth without much success.

Central Banks Stuck In Interest Rate Limbo

In previous economic cycles after Central Banks cut interest rates to stimulate the economy they were able to lift them higher as the economies expanded. However in 2016 the debt levels have grown so high relative to GDP just like the US, the global economy is no longer able to handle higher rates without crashing the Global economy.

As an example on the global debt problem, I recently wrote an article about the huge ballooning debt in China  and how its negatively effect the economy. See: Chinas debt bubble threatens global growth.

The only solution to the debt problem for the Central Banks (CB's) is QE liquidity injections to keep the status quo going. The chart below on the right shows the global equities market addiction to CB's liquidity, with a strong correlation to movements in liquidity.  What this shows is that stock markets follow CB's liquidity above the actual strength or weakness of economies.

We Have Reached Our Debt Limits

In September Ray Dalio outlined very simply that we have reached the Debt limits globally, and low rates and lower interest payments no longer work because the debt is too high to have any additional stimulus effect on growth. (See video below)

If you have not seen this short video before take a look to hear Ray explain the current problem the world is facing.

Higher Bond Yields To Cause Economic Pain

Therefore on the flip side if the debt is too high that low rates no longer cause an stimulus boost or economic impact, higher rates will negatively impact the US economy. This is because as higher rates ultimately reduce demand as higher interest payments take a higher share of disposable income and reduce overall spending power.

If overall spending demand is reduced in the economy this will lead into another recession or deeper economic crisis.

Considering the US economy is already weakening as recent economic indicators is signalling a slowing economy or even recession see: US economy continues to weaken.

Higher bond yields will therefore only tip the US economy faster into economic contraction.


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Election uncertainty and fears of a rate rise by the FED in December rattle the US markets as the S&P 500 and Dow Jones Index breaks key support lines.

It seems a shift in sentiment towards Trump over Clinton in the US election, due to the reopening of the Clinton email scandal investigation by the FBI has spooked the markets. To make things worse it seems the market is also convinced that a rate rise in December is going to ahead as the market is pricing a 75% probability. 

Too Much Uncertainty Breaks S&P 500.

Overnight the S&P 500 finally broke a key support line of 2125 (see chart) on increased  volume. Mild panic has begun to take hold as the market attempts to digest all the recent news with regards to the election. The break of support also confirms the recent reversal of the long term uptrend for the index  which occurred a few weeks ago (Circled on chart).

The S&P 500 closed at 2,111 yesterday with a 70 - 75 point  or 3.5% gap between the current price and the next support level on the daily chart. With rate rise odds rising and the US election still 4 trading days away, we could see the index under more pressure over the week.

Normally when stocks are under pressure and there is uncertainty in the markets, investors take refuge in bonds bidding the price up which brings rates down. Currently this is not the case as bond yields continue to rise in conjunction with the market probability of a rate rise in December moving higher (see chart below).

Will The FED Save The Market Again?

With the increased volatility in the markets it's very possible that Janet Yellen (FED chairperson) could deliver dovish comments in today's FED's committee meeting to try and soothe the market fears about a rate rise and spark a rally in the markets.

The Dow Jones index is showing a similar pattern to the S&P 500 index. You will notice before yesterday's price action to the downside the Dow Jones has been stuck within a tight sideways channel unsure which direction to go.

Considering that Dow Jones has made another attempt at breaking support on heavy volume after recently breaking it's long term uptrend (see boxed area in chart), could be the final confirmation of lower prices ahead for the index.

If break of support is to hold especially after today's FED committee meeting, expect the Dow's next support level to be around 17,130. Since the Dow Jones closed at 18,037 yesterday this is big gap to fill as there is 907 points gap between support levels. To be fair though there is a minor support level around 17,600 to first clear. However this is not a major support level for the index which is why I have not highlighted it within the chart.

The chart below show's simply what is probably causing the biggest grief for the US markets right now. The outcome of the election is now in jeopardy as the markets had previously priced in that Clinton was to win the election convincingly. Now the market isn't quite sure about the outcome.

The first of the red dotted lines was on last Friday when news was released to the market that James Comey the director of the FBI had reopened the investigation of Hillary Clinton and her emails scandal as fresh evidence was found compelling the FBI to take further action.

The news of the investigation caused panic in the markets on Friday (see chart), with further selling continued as new polls were released that Clinton was falling in the polls. While Trump has quickly jumped higher because of the latest scandal. Than more news was announced that additional evidence was found causing even more selling initially before recovering slightly.

The Nasdaq index below shows more resilience compared to the S&P 500 and the Dow with regards to its reaction to the uncertainty.

You can see that the Nasdaq is still holding support of 5125, after touching the support level during yesterday's trade, however recovered to close at 5153. If support is unable to be held over the next few days the next level of support is between 4965 - 4970.

The other interesting thing compared to the other index's reviewed is the fact that the Nasdaq is still within it's uptrend as the FANG (Facebook, Apple, Netflix, Google) stocks strong performance have kept the market strong relative to the other US indexes.

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Disclaimer: This post was for educational purposes only, and all the information contained within this post is not to be considered as advice or a recommendation of any kind. If you require advice or assistance please seek a licensed professional who can provide these services.

The US economy continues to show weakening conditions as new warning signs are flashing recession ahead. This is despite the best efforts of the FED and the US Government to ensure there is plenty of measures in place to continue to stimulate the economy.

Over the last few weeks we have received several economic announcements on the US economy, with a few positive or better than expected results. However the vast majority of announcements have been poor or woeful as the economic data continues to show further weakness within the economy.

US Q3 GDP - A Convenient Smokescreen

I know what your thinking, hang on a minute on Friday we had a first look at US Q3 GDP and the result was positive and even beat expectations. This is correct GDP came in at 2.9% beating expectations of 2.5% and smashing last quarter's result of 1.4%.

However I find the result convenient and timely considering there is an election in less than 2 weeks time. The second and third estimate for GDP could see considerable revisions lower after the election has ended.

The other interesting points about the GDP result was that a 1/3 of the GDP growth came from a one off exporting boost of Soybeans.  This is not a normal occurrence for the US however due to shortages in other countries due to crop damage, there was a surge in demand for soybeans  exports. The one off export surge contributed 0.61% of the GDP growth.

Another big factor for the surge in GDP was a large inventory buildup in the quarter contributing 1.17% of the GDP growth. The most likely reason for the surge in inventories is in anticipation of a big pickup in spending for Christmas. However as I'm about to show you below the US consumer is struggling to meet their living costs, as the consumer is no longer confident and struggling with price rises for everyday items.

In addition the majority of the job gains over the last 12 months have been in part time jobs and low paying services jobs like in restaurants and bars which typically bring in lower incomes. Therefore companies are going to find it difficult to clear all the inventory ordered in the Q3 for the coming quarter. This will lead itself to lower GDP result the following quarter as companies struggle to clear excess inventory over the holiday period.

Lastly GDP is measured after deducting inflation for the quarter. In the most recent quarter released last Friday the GDP price index / inflation was measured to be 1.4% compared to 2.3% last quarter. This means the Government is indicating that inflation has slowed considerably from the previous quarter. For everyday citizens in the US they know this doesn't make much sense as rent, food, fuel, electricity, healthcare and education continues to jump higher making it harder for average American's to pay for everyday items. If the GDP price index remained the same as the previous quarter at 2.3% the GDP would of been further reduced to reflect a more accurate measure of US economy.

Leading Indicator - Investment Swings To Contraction

Over the last 65 years you can see the steady decline in terms of investment as the US slowly began investing less into the economy with each economic cycle. More importantly each down turn in investment relative to GDP was a perfect leading indicator to a US recession, as corporate America cut back spending with each contraction within the economy.

The red marker's together with the red vertical lines on the chart represent  the start and ending of economic contractions (recessions) in US history since 1950.

Currently investment has again peaked within the new cycle and is now heading down indicating the US economy is about to head into a recession if the economy is not already in one unofficially. 

This short video below highlights the chances of a recession after an election is typically at 52%,  regardless of who wins the election. Over the alternative 2 year period of no election the chances of a recession drop to around 25%.

FED Chart Predicts Recession 71% Of The Time

This chart is one the FED monitors to determines the strength of the labor market. The vertical pink lines are previous recorded official recessions within the US since 1977. The circles are to illustrate each time the labor market conditions fall's below 0%. Since 1977 five out of the seven times or 71% of cases the index has fallen below zero the economy has fallen into a recession. Currently this Labor market conditions index has fallen below zero.

Consecutive Quarters Of Declining Earnings

Here is another chart showing US corporate profits going back to around 1950. The vertical red lines represents each time the US has had a recession since the 50's.

What you will notice is that each recession except one back in the late 80's resulted in corporate profits declining for consecutive quarters. Or the fact corporate profits fell consecutively leading to a recession most of the time.

Presently the US has had 5 consecutive quarters of corporate profits falling. The current quarter profit season is still in progress with high odds that we will make 6 consecutive quarters of declining profits. If this occurs this will the most quarters of profits declining without a recession officially occurring.

In this interesting video Wilbur Ross explains in a concise way the current state of the US economy. He describes the economy as weak and that market valuations are high. He also believes there  is no avenues for revenue growth for corporate America due to weakness currently in the economy, which most likely will lead to a recession. in the next 18 months.

No Revenue Growth = Business Cut Spending.

Last Thursday the US released durable goods spending which represents capital expenditure by companies. The chart below is the capital goods orders that excludes defense and Aircraft spending. This chart is important as it's a proxy for business spending in general and gives you an indication of the strength of corporate America.

If you look over to the right side of the chart below you can see that capital goods spending has basically been declining nearly every quarter since 2014. If the economy was strong companies would be investing in more capital goods to grow production and revenue. This would be from an increase in demand for the goods and services they provide. However the opposite is present as demand continues to fall leading to companies cutting back expenditure to counter weak demand.

The chart below coincides with the lack of capital spending for companies in the US. Because more companies are facing tougher conditions to grow their business falling to levels seen in 2014, companies have had to rely on cost cutting and stock buybacks to lift earnings per share (EPS) rather than on actual revenues increases.

With rates so low in the US at 0.25% it's not a good indication that business conditions are declining.

Poor Christmas Sales Foretasted

Consumer confidence continues to fall with the latest results on last Friday showing confidence dropping again to levels last seen in 2014.

Like I mentioned above regarding the huge inventory build of companies for the lead up to Christmas. Companies will realize in the coming months that this was not a good idea, as the consumer does not feel confident with rising prices and lower spending power from their paychecks, leading to lower spending than the previous holiday season.

Bad Debts Spiking In 0% Environment.

This particular chart shows the delinquency rate on company loans made by banks since the late 80's. The last 2 recessions the US had in 2001 and 2008, both show delinquency rates spiking before each recession occurred.

In the current business cycle delinquency rates / bad debts have spiked from below 1% to the current level of 1.6%. Keep in mind interest rates are currently at 0.25% having been at zero for about 6 years. Therefore rates are extremely low compared to previous business cycles yet companies are having trouble paying their loans.

The other troubling fact for the banks is that debt level for companies are much higher than the last recession. This is due to record low rates enticing companies to borrow to  start or increase stock buybacks and increase dividends. So any fallout from an accelerated delinquencies within corporate lending, will have a much  deeper negative impact to bank's solvency than the 08 recession.

Leading Indicator Small Cap Index  - Breaking Down

Small companies are traditionally a leading indicator of strength and weakness within an economy. When an economy is set to expand out of contraction you will notice that smaller companies tend to lead higher in price before large cap and blue chip companies do.

On Friday the Russell 2000 index which is the US small cap index broke a key support level on both a weekly and daily chart.  Even though the S&P 500 is still within record highs, the small cap index has broke away from the larger index as it has ended its long term uptrend as well key support levels.

If you would like to check out my chart review of the Russell 2000  breaking down click on the following link: Russell 2000 review

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The world has changed a great deal in the last 85 years in terms of how the markets and the economy functions as well as how we see them operating. Slowly over time we have added and implemented more and more policies, regulations, controls, mechanisms and various forms of stimulus in an attempt to smooth out business cycles booms and busts. Central Banks (CB's) and Governments have tried very hard to shorten the busts / recession cycle by lowering interest rates and extend the boom cycles in each and every business cycle over the last 85 years.

Now we fast forward to 2016 and the chief aim is to never experience a bust / recession / depression or deflation ever again. Central Banks (CB's) have taught us that they are all bad things and that we must avoid them at all costs.

These CB's have tried multiple policies and even some new experiments like negative interest rates in attempt to keep the global economy from experiencing a slow down or any amount of deflation. How bad is it really if the price of everyday items like food, rent and fuel becomes 1 or 2% cheaper each year. For the average income earner around the world their money will be allowed to go further if prices fall.

The more we have tried to control every aspect of the market, capitalism and the economy, the harder its becoming to not lose total control of these very things. However I believe we are already in the process of losing control of one of the most important things, the real economy. Presently all the Central Banks have done an excellent job at keeping the Financial assets Ie Stocks and Bonds markets up at or near record highs , while the actual economy has been unable to improve in real inflation adjusted terms over the last 10 years.

Real Assets At All Time Lows

If we take a look at the chart below, it illustrates perfectly the complete distortion of over 85+ years of controlling mechanisms, policies and Central Bank experiments have done to the relative value of real assets compared to financial assets.

This chart goes all the way back to 1925 and currently we are at an all time low, for real assets (Houses, commodities, fine art, jewellery etc) relative to financial assets of stocks and bonds. All the stimulus and attempts at controlling the markets and economy have only influenced the price of financial assets. Financial assets are more easily influenced and controlled through electronic exchanges, rather than real tangible assets which are much harder to manipulate on a global scale.

In the video below, Ray Dalio and company deliver a frank assessment on how we have reached the physically limits of the system. As we have artificially pushed markets and demand higher through debt accumulation, lowering interest rates to zero and by ballooning the derivatives market.

Increasing Volatility And Valuation Divergence

The chart below provides a good understanding on the ever increasing huge swings in volatility the financial markets have experienced. Central Banks began to introduce and try new stimulus and policy ideas in the early 2000's to reduce the busts / recessionary periods, causing large swings in the prices of the financial market as well as the valuations.

The most recent round of stimulus that began in 2009 with Zero Interest Rate Policy (ZIRP), followed by QE 1, 2, 3 and negative interest rates have stretched out the valuation of the S&P 500 relative to US productivity. Up to 1995 / 96 US productivity moved in sync with the S&P 500 stock market. This is clearly no longer the case as the chart indicates a strong divergence in valuation.

This week we received the latest monthly industrial production number in the US and showed that the year on year figure remains negative.

Since mid 2014 you will notice that industrial production data used to coincide with the value of the S&P 500 index very well. Now industrial production has been falling for 2 years and the stock market is near nominal all time record highs.

One of the policies that the Central Banks have utilized to try and control the economy, markets and financial assets values is to physically adjust interest rates up and down. Since the 1980's when Paul Volcker raised interest rate to around 18% to combat high inflation, we have been steadily lowering them all the way to zero.

Why Lower Interest Rates No Longer Work?

Presently the federal funds rate is at 0.25% as you can see from the chart, however lower interest rates are no longer having the desired effects to stimulate the real economy anymore. One of the reasons for this is the fact we have reached the limits of our debt bubble cycle. We can no longer leverage ourselves any higher despite having interest rates at close to zero .

Leveraging Corporate America

One of the many side effects of lowering the federal funds rate to close to zero, has been the leveraging of US companies to levels higher than the 2007 and 2008 peak before the GFC crisis. Debt to equity is approaching 60% for non-financial companies, as the incentive to load up on debt has never been so high. But is it really helping corporate America?

What Is The Debt Being Utilized For?

The accumulation of more debt relative to assets would be ideal in the short term if companies were utilizing the debt to fund new innovation, capital expenditure and additional capacity for future growth.

The reality is that a large majority of the debt accumulation has been utilized to fund buybacks of company stocks to artificially boost earnings per share (EPS) which in turn helps stock prices rise despite the company profit not actually growing from this strategy.

The chart below shows that share buybacks have more than doubled since 2012 to $161 Billion in the 1st quarter of 2016, as more companies engaged in artificial growth strategies rather than invest in their own business models.

IBM a large technology company that has been an consistent innovator issuing several thousand new patents each year. However even though IBM still continues to issue several thousand patents, the company has been steadily increasing its debt levels (See chart below) to allow it to participate in stock buybacks.

IBM Increasing Debt & No Growth

These higher debt levels has allowed IBM to engaged in stock buybacks with the additional funds at their disposal. Unfortunately for IBM the stock buybacks have not helped the actual company as  it has struggled to grow over the last few years.

The chart below is a perfect example how a large company has tried to control its EPS through artificial boosting its profits with stock purchases funded through debt. However the actual result is that IBM's revenue (which can't be artificially adjusted through stock buybacks) has been falling since 2012 as the company continues to struggle to grow its top line and bottom line numbers.

Netflix, which is relatively young technology company that provide online streaming of TV content, is a company that has been investing large amounts of money into the companyto deliver new and original TV content, as it differentiates itself and reduces its reliance on licensing content from other media companies.

On the 18th October Netflix announced its latest quarterly result, which was above estimates for EPS and subscriber growth. However the interesting thing that investors didn't seem care about is that Netflix free cash flow is going the wrong way and accelerating. It burned through $506 million in a single quarter and just over $1 billion over 3 quarters. (See chart below) The stock ended up jumping around 19% after reporting its results.

Because of the huge drain of cash despite reporting a profit, Netflix did mention it will be tapping the markets for an increase in debt soon. Because interest rates are so low the market does not care that Netflix is essentially, borrowing more money to make new TV shows to attract more members. The current business model is simply not sustainable, especially when the company spends $142 to add one new subscriber.

If Interest rates were set by the market and were not manipulated by Central Banks the actual interest rate would be significantly higher to encourage savers to part with the capital. In this scenario Netflix business model would not survive in its current form.

The last chart summaries very simply, how "we have lost control of the real economy by trying to control everything". Global GDP estimates continues to decline as global stocks continue to increase, as Central Bank balance sheets fund global stocks higher.

Lastly this MUST WATCH video Rick Santelli makes a simple request to Central Banks.

Sources:

Forbes.com
Fred.stlouisfed.org
Zerohedge.com
Wsj.com

The S&P 500 broke its 8 month uptrend yesterday, as US 10 year Government bond yields have continued to move higher, signalling potentially more pain ahead for the S&P 500 stock index.

For the calendar year the S&P 500 is still up after falling in January and February this year, as the S&P 500  has not looked back since touching the lows for the year around the 1820 level. However the index has closed below its long term uptrend where it's current resting on a support level. (See chart below)

Moving forward the key to the direction of the S&P 500 is whether the break in trend is confirmed and it closes on a daily chart within or below the rectangle box shown in the chart below.

Break In Trend - Head Fake

An important note to make is that earlier this year on June 27th the index broke its uptrend after the Brexit vote shocked the international markets. However it quickly rallied back within the uptrend as coordinated efforts by the Central Banks, to artificially lift the stock markets with more stimulus worked. This allowed the index to move significantly higher over the next few months. Therefore it can't be ruled out that the break in trend is only a head fake by the markets and the Central Banks once again panic and step in to save the markets.

If the break of the uptrend is confirmed and is able to close below 2128 level on a daily basis the next level of support is around 2035 / 45 level.

Catalyst For The Break In Trend

Since making the highs in August this year the S&P 500 has been going sideways to slightly sloping down. One of the main catalysts for this is the rise in US 10 year Government bond yields, which have been steadily rising since making lows in July this year. (See chart below)

The chart below of the US 10 year Government bond yields is of a weekly chart, which allows you to see a better indication of the bigger longer term trend that is taking place.

From the chart you will notice that the weekly downtrend broke in the first week of September, where I have circled the chart. After it closed above its downtrend it fell briefly to the 1.59% level, which is now its new support level. After resting on support it started climbing again in the first week of October.

The fact that weekly downtrend that has been in place since 2015 broke last month, indicates a big shift is taking place for the S&P 500 index as well as global stocks in general.

Why Higher Rates Are Not Good For Stocks?

Stocks traditionally move in opposite direction to bond rates / yields, as stock indexes are priced / valued according bond yields. If bond yields move higher stock dividend yields need to move higher as well, to compete with higher returns from bonds. To get higher dividend yields stocks need to either, generate higher dividends or the price of stocks falls or both.

The other reason higher bond yields are not good for stocks is that the higher the yields go the more expensive it is to take on debt for consumers and companies.

Higher debt payments for consumers reduces demand for products and services effecting companies revenues and profits, which ultimately ends with stocks falling.

Since corporations in the US have record debt levels to fund massive buybacks and dividend payments. Rates climbing and breaking its downtrend is also bad news for stocks.

To see a recent article where I discuss the shifts in bond yields and the negative impact on global stocks you can click Is the bull market in stocks ending?

Disclaimer: This post was for educational purposes only, and all the information contained within this post is not to be considered as advice or a recommendation of any kind. If you require advice or assistance please seek a licensed professional who can provide these services.

One by one real estate markets across the globe have begun to pop as the record real estate bubble has turned to a slow down in prices and growth. Multiple regions and real estate markets have begun to cool despite record low interest rates and Quantitative Easing (QE) stimulus.

Until recently the global real estate markets had been one of the best performing asset classes over the last 7 years, as Central Banks coordinated efforts to stimulate the economy in 2009 and further in 2012 - 2016 brought interest rates around the globe to record lows. Some countries even went negative with the objective to ensure GDP growth continues.

The Tipping Point Of Stimulus - Too Much Of A Good Thing

Eventually though any market will reach the limits of what artificial stimulus can do to prices and demand. Whether its auto / car market, think of the cash for clunkers stimulus and the more recent auto subprime loans bubble in the US, or  whats happening right now with real estate prices in different countries. Eventually demand begins to wane even when stimulus remains or increases. This happens when too much of a good things begins to take hold and stimulus actually becomes a negative to demand.

Pizza Eating Example:

If your hungry and you love pizza you decide go to a pizza restaurant. The demand for eating pizza is high, however eventually the demand or desire for more pizza will start to fall until you reach the point of when you don't want no more pizza. Your desire or demand will not change even if the pizza price falls by 50% making it easier to buy more. Why because you reach the limits of your own consumption and demand eventually disappears.

This simplified example works in a similar way to economic stimulus in asset markets as it does for the rise and fall in demand for pizza. Everything has a limit where extra stimulus stops being effective.

Luxury Manhattan Real Estate - Latest Market To Correct

The luxury real estate market in Manhattan is one of the latest markets to cool as it pop its real estate bubble. In the chart below you can see the declining trend in growth in prices in Manhattan. Since January 2015 where growth was around 8% pa, the level of growth has continued to fall each month to February 2016. Where the data shows that it has gone negative to close to a 1% fall in prices.

San Francisco area has been another hot real estate market that has started to cool down, despite being a trendy place to live and close to employment opportunities. With several big Technology companies headquarters located in the area.

In this short video below its give you a good understanding how the bullishness of the real estate market has tapered off, as the real estate sales and prices have soften and the time taken to sell has increased compared to a year ago.

One of the reasons why the San Francisco real estate market has started to cool despite low interest rates and stimulus is due to the fact the employment levels in the area has peaked, and has been stagnating since September last year with no growth recorded in employment in the area. This has effected rental demand and rental prices have begin to come down also weighing on the San Francisco real estate market.

Based on the indicators and the employment data the trend for this real estate market is not looking good going forward.

Across over to Vancouver real estate market in Canada, has experienced a spectacular fall in prices in a very short period of time. (See chart below)

Similar to San Francisco real estate market, Vancouver had experienced sharp rises in prices over the last few years as foreign buyers and local demand drove up prices. This was due to record low interest rates forcing investors to find a destination to earn a return on their capital, as cash and bonds income continued to fall. However recent tax increases for foreign buyers in Canada has effected demand dramatically in the area, with prices falling sharply since July this year.

The video below gives you a snapshot of the current Vancouver real estate market and the fallout from a sharp drop in home sales in the region. On a bright note they expect the market to remain relatively stable moving forward. Given the global backdrop in real estate trends this assumption may change.

In the UK commercial real estate has been experiencing a slowdown since the beginning of the year and was in the process of cooling before the Brexit vote dampened confidence for this asset class further causing further pain for the sector.

The graph below shows the trend in property deals value falling compared to the same month year ago. The trend is clearly falling faster as February through to May show steeper falls than January.

The falls in property deal values is most likely the consequence of income and capital growth returns continuing to fall each month since reaching the peak in October 2014 of 12.95% return, to the current return of 5.91% in March 2016. (See chart below)

Australia's real estate bubble has continued to remain red hot in bubble territory despite warnings from BIS and other groups on debt levels. To see the article click here Australia's debt addiction fuels bubble.

Despite the residential real estate market continuing to perform strongly in Australia, the Australian real estate investment trust (REIT) sector which predominately focuses on commercial real estate, has experienced sharp falls in prices since August. The REIT sector current price has fallen back to the levels set in April this year despite setting a yearly high back in July this year.

Why It Feels Like Everything Is OK

This chart below shows exactly why it appear that everything seems to be OK even though each month another real estate market across the globe starts to cool as their bubble pops and deflates.

The chart below shows global GDP expectations for 2016 overlapping the global stock market and global central bank balance sheet levels.

The chart shows the blue line which represents global central bank balance sheet continuing to increase, and the global stock market following this trend up with it since the start of this year.

What this indicates is that the global stock market is being held up by artificial stimulus as the stock market no longer reflects global GDP movements to the downside.

I'm aware that not every real estate market around the globe has started to pop. In fact some markets like China and Australia residential market are continuing to go higher.

The signs however are getting stronger as more and more real estate bubbles popping are emerging each month. Eventually more real estate markets will be effected, as the stimulus effect on demand starts to fade. Coupled with the fact global GDP continues to fall and the effect it will have on employment levels will cause real estate markets to fall in more regions.

Sources:

bloomberg.com - 1
bloomberg.com - 2
zerohedge.com - 1
zerohedge.com - 2
zerohedge.com - 3
theaustralian.com.au

Gold fell heavily overnight as it fell over $40 and broke its $1,309 support level and its 10 month uptrend in the process. So its fitting to take a look at where Gold will be heading next.

I recently discussed Gold Click here where I talked about the jump higher on Yellen's hold decision on rates 2 weeks ago. In the article I highlighted the imminent breakout potential higher, as its strong uptrend and bullish indicators pointed to higher prices in the future.

So to see a sudden plunge in price and reversal of its 10 month uptrend in such a short period is interesting.

Starting with the monthly chart below, I have circled in black the break of trend which you can notice has fallen considerably even though its only a few days into the new month.

Based on the monthly chart the first level of support to reach is around $1,205 an ounce or another $62 away from the current price (shown on the chart). Failure to hold that support level there is another initial support level at $1,170.

If the break of the uptrend to the downside is a false breakout, Gold would have to close above $1,350 resistance level to resume its uptrend. So we will have to wait for another 3 weeks or so to confirm the uptrend is broken on monthly chart.

Looking at the daily chart below the magnitude of the fall is relatively large compared to the average daily moves in price.

On the daily chart I have highlighted the first support level at $1,250 an ounce. If Gold is unable to hold the next support level the following support level is around $1,206.

Since Gold fell over $40 in one day it broke below 2 support levels of $1,309 and $1,293 closing at $1,267. So the previous support level of $1,293 is now its first resistance level. Based on the large fall in price, Gold would most likely test its resistance level of $1,293 over the next few trading days.

For Gold to resume its uptrend on daily basis, it would need to close above the $1,340/45 level to signal it a false breakout to the downside. Given the fact that the probability of a rate rise in the US for November and December is rising, Gold will most likely confirm the reversal of its uptrend and head lower.

Finally I have a video from Peter Schiff, who believes the drop in Gold due to the probability of rates rising isn't warranted. He believes rates wont be going higher and if the FED was to raise rates it would be bullish for Gold, just like the rate rise in December 15 was for the precious metal.

Rounding up the video Peter also outlines the end game for the markets from the FED's actions going forward.

Feel free to leave comments on this post if you enjoyed it.

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Disclaimer: This post was for educational purposes only, and all the information contained within this post is not to be considered as advice or a recommendation of any kind. If you require advice or assistance please seek a licensed professional who can provide these services.

Is The FED's Assessment Of The Economy Correct?

Yesterday Janet Yellen gave her press conference after releasing the decision to hold rates. In this press conference  (see video below) Janet mentioned "due to the recent pickup in economic growth' and "continued progress in the labour market, have strengthened the case for an increase in the federal funds rate."

Janet also mentions that " our decision does not reflect lack of confidence in the economy".

If Janet Yellen and her committee within the FED believe the comments about the economy to be correct and timely, why are there are a number of US economic indicators that show that economic growth is in fact not picking up, but rather its heading in the opposite direction towards a new recession for the US economy.

Motor vehicles sales had until recently been booming for several years since the 2008 crisis lows. Consumers have been flooded with easy access to cheap loan rates up to 7 years in some cases, to purchase new cars. This has allowed the car industry to record consecutive years of sales growth in the US. This trend has now ended and has reversed with a drop in units sold falling now since 2015. (See chart below) 

Industrial Production is another indicator that is giving a strong warning signal that the economy is in trouble. After topping out to close to 9% growth back in 2011, industrial production growth has been slowing down for several years and has been recording negative growth since 2015. (See chart below)

The Chicago Fed National activity index also points to a weakening economy, with the index in negative territory since the end of 2014, which happens to be the longest period without recording an official recession in 49 years.

There are many other economic indicators I could of showed you that highlight the economy is actually in contraction like retail sales, ISM Non manufacturing, corporate earnings and durable goods. However I think you get the idea what I'm saying.

Whats Going To Happen Next?

So if the real economy is declining and heading for a recession if its not already in a recession, whats the next course of action for the FED?

Bill Fleckenstein who is a professional money manager with over 30 years of experience said on CNBC yesterday, that when the  train wreck shows up, the FED will be introducing QE 4.

As he believes the FED will introduce QE 4, he see's limited opportunity to short the market initially. Because the FED will rescue the market as things get worse. Rather Fleckenstein suggests waiting until the FED steps in again and the markets jump higher, to determine what to short next.

Sources:
fred.stlouisfed.org
zerohedge.com
advisorperspectives.com

Overnight the price of Gold and Silver rallied higher as the Federal Open Market Committee (FOMC), decided to keep rates on hold again.

Janet Yellen chairperson of the FOMC said "economic activity picked up from the modest pace seen in the first half of this year." This is despite the FOMC lowering the long run growth rate for the US economy to below 2%. As a consequence the FOMC decided to wait ‘for the time being for more evidence'.

They tried to balance their statements by also saying that the 'case for an increase in Federal funds rate has strengthened'

From the reaction of Gold overnight, jumping $20 to $1,334 after falling all of last week, shows the market has no confidence at all in Yellen's statement, that the case for raising rates has strengthened.

Taking a closer look at the Gold chart below, you will notice that since making new 2016 highs back in early July of $1,374. Gold has struggled to make new highs and instead has been forming lower highs (see chart), which is a bearish signal. On the bullish side Gold has continued to hold the support level of $1,310, and is still within its existing uptrend.

The key for Gold moving forward, is whether it is able to break out and close above the wedge pattern. If it breaks above this wedge formation this would be a very bullish signal for Gold.

Failure to close above the wedge pattern would lead to testing the $1,310 support level and its uptrend.

Silver which has similar characteristics to Gold also rallied higher by 56c to $19.78 after the FOMC decision to remain on hold.

Silver has been displaying a similar trend to Gold with lower highs as well. However as Silver is in an existing uptrend the most likely breakout direction from this wedge pattern would be to the upside.

If it breaks to the upside its first level of resistance is $20.60. Otherwise a close below its wedge pattern its support level is around the $17.80 (see chart below).

The market is currently pricing a 65.9% chance that the FOMC will raise rates at the December meeting, up from 58.8% before the FOMC announcement (see picture below).

If the FOMC had the courage to raise rates in December and this is a big if. The current uptrend of Gold and Silver would be in jeopardy, especially if the market believed more hikes would be followed up by the FOMC.

Right now though the only thing that matters is what the market thinks, and market price for Gold and Silver is indicating that a hike in rates is not likely.

Disclaimer: This post was for educational purposes only, and all the information contained within this post is not to be considered as advice or a recommendation of any kind. If you require advice or assistance please seek a licensed professional who can provide these services.

Source:
zerohedge.com

The 7 Year Experiment

Central Banks around the globe have experimented with a myriad of different policy tools over the last 7 years, with the explicit goal of reigniting global growth to prior 2007 levels. Central Banks figured if they could reverse falling asset prices and deflation, by creating inflation via Quantitative Easing (QE) they would be able to re inflate asset prices and kick start growth.

However since the global economy slowed down in 2007 and reversed course, crashing in 2008 and 2009, growth hasn't been quite the same. In fact the recovery from the 2008 recession has been the weakest in history.

By flooding the world with trillions of dollars in liquidity and creating money out of thin air, by printing digital money or QE and dispersing it through the banking system, the Central Banks have been able to create the illusion that the global economy is growing and things are back on track.

Yes the S&P 500 is just off all time record highs in price, and yes real estate prices around the globe have either recovered most, or all of the losses prior to the 2008 crash. Better still real estate markets in some  countries like in Canada and Australia have surpassed their previous highs . Wages have also been rising steadily for the last 5 years after falling from 2008 to 2011. Yet for the average person it doesn't feel like we are better off with higher levels of standard of living. More importantly we cant seem to pin point the exact reason why.

The Hidden Tax

The actual reason why the recovery from 2008 crisis has been so sluggish, with the weakest on record is because real household incomes adjusted for inflation have gone nowhere. In fact real household wages are down 1.1% in the last 16 years. This is evident even though nominal wages have actually grown by just over 40% since the year 2000. (See chart below Titled: Median Household Income in the 21st Century)

Inflation is sometimes referred to as a hidden tax, because you don't seem to notice it as much on a day to day, quarterly or annual basis. Yet inflation over a 5 or 10 year period or longer can be really easy to spot when you take a look and compares prices over longer periods for goods, services and assets like food, rent, education and real estate.

Since real wages adjusted for inflation has not increased in 16 years, yet the level of private debt has grown dramatically over the same period, the share of wealth by the bottom 90% of US households has actually been declining. (See chart Titled: Distribution of wealth in the US since 1917)

The reason for the decline is because the bottom 90% have used debt to fund increasing consumption on their home and living expenses, since their real wages have stagnated. In comparison the top 0.1% have steadily been increasing household wealth as they have been able to utilize debt and higher equity / capital levels to take further advantage of rising asset prices over time.

Lastly to further illustrate the real cost of inflation, and how it can be subtly hidden from most people. Take a look at the chart below of the S&P 500 which has been adjusted for inflation.

If you take a look at the current level on the right hand side of the chart you will notice its only just above the price level from the year 1999 / 2000 level.

The second interesting point is that the last bull market that occurred between 2001 - 2007 did not reach the prior 1999 - 2000 level when adjusted for inflation, even though the nominal price chart for the S&P 500 recovered to the same level as 1999 - 2000.

Some Things Cant Be Manufactured

So after experimenting with so many different policies and trillions of dollars in QE, Central Banks have achieved the outcome they have desperately tried to create, inflation and an artificial type of manufactured growth. Artificial because when you factor or adjust for inflation, you realize that there isn't a whole lot of real growth to be shared around.

Sources:
macrotrends.net
zerohedge.com