Wealth Intact

The US economy is in its 11^th quarter of “recovery”; and by all standards, this “recovery” is sub-par.  The reason the economy is in this recovery—rather than 11+ quarters of decline—is due of the combination of 2 factors: ultra-low interest rates and a federal reserve that is monetizing US debt.  In the short term, there are very few consequences to monetizing the debt, specifically because the US Dollar is world’s reserve currency.  Long-term consequences are another story.

From this perspective, there are four catalysts for the price of gold:  the actual short-term and long-term consequences as well as the current perceptions of each.  The Federal Reserve has committed to an accommodative monetary policy for a long time; I suspect it will be longer than most people think, but that is irrelevant to this discussion.

The actual consequences of low interest rates and a devaluation of the dollar are supportive of the price of gold in both the short-term and long-term—although for different reasons.  In the short-term, a devaluation of the US Dollar via monetary policy is a natural positive catalyst.  In the long-term, ineffective US fiscal policy and a realignment of global currencies (a.k.a. “The Currency Wars”) is also a strong case for a higher price in gold.

Evaluating the perceived consequences is a more difficult task; and I think this is where the recent weakness has come from.  I would list the negatives as follows:

• A move higher in the SPX
• A general complacency in equities as represented by the VIX
• The regime change in Japan
• Euro-area comments regarding currency devaluation

My view:  volatility will gradually pick up as uncertainty comes back into play as the intermittently transient Euro-Zone and US fiscal problems are once again in the purview of investors.  I’ve previously noted SPX price studies that suggest a slightly bullish movement to the SPX—to the tune of 1% to 2%.  Well, that was when the SPX was around 1515 and it just may have put that +1% move higher to 1530 on Tuesday.  The upside is limited in equities and they have become much riskier as time passes without a more significant sell off.  It is too early to tell whether February 20^th will mark the beginning of the correction in equities, but the smart strategy is to continue to reduce long equity exposure.

There is very little on the economic calendar over the course of the next two weeks.  Of note are the 10-Year and 30-Year Treasury Auctions this week (Wednesday and Thursday, respectively).  The FOMC Minutes will be released next Wednesday, February 20th.  Then we get to March 1 and the Spending Sequester, which several prominent politicians have recently come out stating that it is likely to take place.  The question is, are the expectations and implications of this “priced in”.

Today’s 10-Year auction came in rather mixed, with the highest yield since March 2012.  Much of the data and sentiment in 2013 feels eerily similar to the beginning of 2012.  This could be the start to the “great rotation” or it could be just another head fake.

And for your reality check, below is a clip from CNBC six years ago this week:

The NYSE experienced a low volume session today.  Among the factors responsible for this could be:

• Chinese New Year (China’s markets are closed all week)
• NEMO (effects of which still linger)
• State of the Union Address (Tuesday)
• VIX expiration (Wednesday)
• Less demand for equities at this level

What might be a more accurate phrasing for that last bullet point is:

• Hesitation and/or uncertainty about short-term direction

The SPX rose for six consecutive weeks (as of last Friday).  Going back to 1957, there have been 93 other occurrences in which the S&P 500 Index rose 6 consecutive weeks or more.  The results of which are slightly positive.

Over the course of the next two weeks (following six consecutive weeks of price gains), the SPX:

• Increased 60% of the time (56 occasions)
• Gained an average of 0.59%
• At worst, returned -2.91%
• At best, returned 4.74%

Over the course of the next four weeks (following six consecutive weeks of price gains), the SPX:

• Increased 68% of the time (62 occasions)
• Gained an average of 0.96%
• At worst, returned -6.99%
• At best, returned 6.87%

Over the course of the next 13 weeks (following six consecutive weeks of price gains), the SPX:

• Increased 71% of the time (66 occasions)
• Gained an average of 2.64%
• At worst, returned -9.84%
• At best, returned 12.68%

In relation to those 93 prior occurrences, the return over the past six weeks has been slightly more positive than average; 8.24% compared with an average 6.96%.  While the possibility of outcomes is, as always, wide and every situation unique, history suggests (on average) a limited upside from here in the near term–one to two percent.  I expressed this likelihood last week.

I’m not suggesting equities are extremely overbought at this point; mainly because this sort of sustained momentum tends to feed on itself.  However, I also don’t think there are strong enough catalysts to propel equities to the high ends of historical ranges (i.e. the price study described above) without a minor correction (read:  better buying opportunity) first.

Much of the YTD gains (4.65%) came in the first 14 trading sessions of the year.  Over the last 14 trading sessions, gains are much more modest at 1.64%.  Whether this is a sign that equities are rolling over or just proceeding at a more realistic pace, what is apparent is that the rest of 2013 will not proceed with the same velocity and consistent upside as January.

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After much of the day in Oversold territory, the SPX finished yesterday nearly flat.  Internally, the last two days of trading have not looked healthy.  Futures are lower this morning.  Today’s levels:  Overbought at 1359, Oversold at 1339.  The SPX will once again trade into Oversold territory today.  We’ll need to see an early buying in order for the SPX not to get caught in the low 1300′s range.

Today’s Quantitative levels:  1373 (Overbought) / 1340 (Oversold).  Yesterday’s price action was more foundation building in this mid-1300s (1330 – 1370) range.  The SPX was severely Oversold on a short-term basis intraday and I added equities to certain portfolios.

Futures are rather flat this morning after coming off some gains earlier this morning.  I thought that the momentum was behind equities and with European news somewhat behind us, equities would naturally move higher.  The SPX is struggling to follow through.  The opposite thesis may be the case; rather than equities falling on negative news, they were rising on the potential for unexpected, positive intervention.  I’m not sold on the latter case and the SPX still has some time to prove the first scenario true.  And it will have to do so in the face of a weak earnings season.

Quantitatively, the SPX is at a better entry point than it was yesterday, but Treasury yields fell materially and the price action is becoming less bullish.

Treasuries rallied yesterday, but that was only good for a slight decline in equities.  The SPX closed just below the Oversold level of 1353.  Today’s Oversold level comes in just one point lower at 1352.  Today’s Overbought level is 1373.  Equity futures are slightly higher.  I noted that equities were a bit overextended last Tuesday and Thursday and the 25+ point retracement in the SPX from last Tuesday is a healthy one at this point.  This 1350 level is becoming more of a solid support area as time passes.

The SPX is not quite as oversold as it was several times in June and Treasuries are still bid with the 10 Year Note yielding 1.51%.  I’m slightly bullish here, but the risk/reward ratio is only modestly favorable at this point.