The Economy Pauses But Stocks Make New Highs With Flagging Momentum
“October. This is one of the peculiarly dangerous months to speculate in stocks. The others are July, January, September, April, November, May, March, June, December, August, and February.” Mark Twain
History indicates that September is the weakest month of the year, and October has more crashes than any other month. Someone forgot to tell the stock market all that.
With continued mixed signals from the economy, stocks moved to a triple top and broke through to new highs. Strangely, though, there has not been much carry-through since the breakout.
As impressive as the upside action had been, the momentum was not as strong as in previous peaks, creating a technical divergence. In the bottom panel of the chart, you can see the rate of change has tailed off, and volume is contracting. In short, the market has moved to new highs but is not showing much power just yet. This has surprised some observers because the Federal Reserve did announce and follow through on the first in a series of interest rate cuts.
On the other hand, the market has been amazingly poised and resistant to decline despite the political unknowns in the US, the slump in China, military reverses in Ukraine, and the spreading of war in the Middle East. As we have noted before, as long as the market stays well above the linear and moving average trend, it is best to assume the market remains in the bull phase.
Generally, after Thanksgiving, through the end of the year, is a strong period for stocks.
Many global central banks have started to cut rates, and in China, they have fired multiple monetary bazookas to stimulate the economy and rescue the stock market. The result has been a massive upward move in Chinese stocks. However, critics note that if such stimulus was necessary, there is something wrong with the underlying Chinese economy. Real estate and banking woes continue to harry investors. China’s sharp move to the Left and demographic issues are also of concern. Nevertheless, the market initially soared on the news but now is giving some of those quick gains back.
Chinese stocks rose quickly, almost 30%, on the news of “stimulus.” It remains to be seen if such an overbought rally can continue.
Speaking of stimulus, the combination of many nations cutting rates and providing liquidity through their central banks has caused the global money supply to start rising. Many economists believe that inflation is primarily a monetary phenomenon. If true, such global money expansion will make battling inflation that much more difficult. If global inflation does not moderate, it will be hard to keep up with the promise by central banks to lower interest rates. That is unless said banks abandon any pretensions of fighting inflation. On that news, world gold prices also continue to rise to new highs, brushing $2,700 an ounce before backing off modestly.
The combined actions of many central banks are boosting world liquidity. Some of that may translate into increased economic activity, but much of it will likely flow into financial markets.
Did the Federal Reserve start to cut rates before inflation was slayed? It would seem so. If you believe the numbers, employment remains robust, although an incredible 86% of new jobs were government jobs! Persistent inflation and huge supply (massive deficits, as far as the eye can see) have caused the bond market to short-circuit. Below is a chart of the bellwether 10-year US Treasury Bond yield. Usually, when a central bank starts to cut interest rates, interest rates generally begin to fall. That is the whole point of the exercise, to make it easier and cheaper to borrow money.
Note that rates for the 10-year bond have been falling since May. The Fed made its announcement on September 19th. Since mid-September, rates have gone up by almost a half percentage point. Momentum indicators have turned upward, suggesting rates will continue to rise even further for a while.
Moreover, inflation numbers are not going in the right direction. As the ever-observant Kobeissi Letter notes, Core CPI inflation is now rising for the first time in 18 months. Headline PPI inflation has been rising for the first time since June. Last month’s PPI inflation number was revised to HIGHER. Core PPI inflation has now been up for two straight months. The previous month’s Core PPI inflation number was revised HIGHER as well. This has all occurred with oil prices falling. However, now that war is looming in the Middle East and China is stimulating, there is a good chance oil has found a bottom and will be strengthening in the months ahead.
Skepticism toward government economic numbers continues to grow. Not only are the revisions frequent and significant, they are almost always in the opposite direction. Furthermore, some of their calculations make no sense. For example, in creating inflation numbers, the government contends that healthcare insurance costs have declined 33% over the past two years. Does anyone in the real world believe that? How many other inputs to their final calculations are as flawed as this number?
Incidentally, skepticism towards modern hedonically adjusted (adjusted for changes in quality) inflation numbers is not a new problem. John Williams at Shadowstats.com has been keeping CPI data using older methods, and since 2000, there seems to have been a huge difference between how numbers were kept before and how they are kept today. This makes historical comparisons very difficult. It would be like comparing the length of trees over time by constantly changing the definition of a foot.
The red line is the CPI in use today, and the blue line is how Williams keeps it, based on the way the government calculated before hedonic adjustments. What began as a small spread around 2000 has become a canyon of difference.
So, interest rates are rising rather than falling, and inflation remains a problem. What could cause this misfire? Opinions vary, but we are concerned that the Fed (and other central banks) have given up too early in the inflation fight, and the oversupply of bonds (huge deficits to finance) may well be the cause of such abnormal action.
Central banks may also be basing policy off bogus government numbers or being overtly political. Whatever the facts, the outcomes seem strangely perverse.
As we have mentioned before, the financial markets and the economy are not the same thing. Over the years, massive liquidity injections have reduced the association between the real economy and securities prices. For example, earnings are up year over year, less than 5%, but the market is up 22%. Thus, if there is a connection between earnings and market performance, it seems to be a very loose one indeed. The financial markets march more to the tune of liquidity and sentiment, which remain undeniably positive.
Sentiment is high right now, which is rather odd for a seasonally weak period of the year. The CNN Fear and Greed Gauge is now well into the Greed zone and almost to the Extreme Greed zone. Markets tend to underperform in conditions of extreme sentiment because such emotion is already in the price structure.
Just one month ago, it was just 38, so it has doubled quickly. Jubilation over lower rates? Perhaps, but maybe the market may wish to look at what rates are doing on Treasury Bonds.
Finally, how is the economy doing? David Rosenberg provided this quick summary which tells the tale well.
Other than export volumes and average weekly earnings, it is hard to find any metric that is higher now than it was a year ago. Mind you, this slack performance is despite an incredibly large fiscal stimulus. Given how much adrenaline the patient has been injected with, the patient should be off the gurney and dancing in the operating room. Unfortunately, that is not what is happening.
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Security charts courtesy of Stockcharts.com created by the author.
