Stock valuations change primarily upon future expectations. The US Stock market has traded sideways all year waiting for clarity on future trends with the US Central Bank (Fed) assumed to be the weather vain. Earnings and GDP growth have slowed, the US Dollar peaked in March, Oil prices have fallen to 6 year lows and Chinese weakness has put a shiver in anxious stock markets. Will the dark clouds cause stocks to fail signaling a scary global contraction or will prices break to new highs as sunny optimism returns?
Commodity prices led by Oil are falling for a reason: reduced expectations of global demand. China and the emerging markets are on the verge of stall speed. However, while the fundamentals are deteriorating the mixed technicals are improving short to medium term. There is technical risk in the current market valuations, but it would be unusual to have stock indices fall sharply (>10%) while sentiment has moved so decidedly into oversold territory. Analysts will be watching for this narrow trading range to be a trigger for the next trend change (2030’s to 2120’s basis SP 500 Index).
When measures of Fear reach the current extremes general stock market prices are typically near a bottom.
Looking at the speculative options component of this Fear gauge there is a strong correlation with negative sentiment extremes due to Put volumes and market Buy zones (chart below). Option traders at stock market lows exhaust their selling power with the purchase of more puts than calls as they bet on even lower prices. The current multi-year peak in negative option sentiment by traders (green line) signals that stocks should bottom soon and at least stage a strong short term rally. If valid we would expect that prices should rally before the end of September with a focus on the mid-September Federal Reserve (FOMC) meetings. If new highs in the SP and Dow are achieved then a breakout toward 2200 on the SP 500 Index becomes likely. Currently the vast majority of economists expect the new cycle of Fed rate hikes and credit tightening by the Central Bank to begin around September 16th while many investment analysts are certain there will be no hikes in 2015. The recent US jobs and retail spending data would appear to support the case for rate hikes soon unless new signs of domestic or global weakness arise very soon.
Falling Commodities Expose Failing Chinese Fundamentals
A year ago economists were certain that falling energy prices would send a huge tax cut to the US and Global consumer, eventually boosting rates of consumption and GDP growth. Never happened! Earlier this year when US 10 year interest rates fell to 1.6% and German 10 year rates fell to “0.17%” upon the launch of a new major asset repurchase plan, it was assumed that Europe would finally recover and trigger a global surge. Yet again the global economy has decelerated with falling commodities choking like like the “canary in the coal mine”.
Evidence that China is scared has been revealed in recent weeks as they have initiated massive Government intervention to support their falling stock market and now they have begun devaluing their currency in an effort to jump start exports. This devaluation of the renminbi (yuan) was relatively small in percentage terms, but symbolic of the growing economic fears they face.
When Exec Spec signaled a TOP in Oil a year ago we later forecasted a February 2015 low and a rally back into the $60’s per barrel that would ultimately be negated after a 2nd quarter top. Oil prices indeed bottomed in February and topped in the $60’s and have collapsed over $20 a barrel this summer toward new multi-year lows. Falling Chinese consumption rates have been a major factor as they have failed to keep up with production. Chinese freight traffic, exports and the manufacturing sector data have been flat to negative and confidence is falling. China went back to its old playbook by devaluing its currency and threatening investors seeking safety. Along with China, emerging markets have been moving into recessions around the world as commodities have fallen. This Chinese devaluation will hurt Brazil, Australia, SE Asia and commodity oriented countries even more, forcing these countries to lower their own currencies to support their exports.
Southeast Asia allows their currencies to float, unlike China. China’s autocracy was behind the curve and is merely playing catch up by forcing a devaluation of their currency to spur exports. Emerging markets and the China sensitive SE Asian markets have been devaluing for a few years as the global economic weakness has been harmful to these export driven economies. The Singapore $ has fallen to new 5+ year lows today.
The currency devaluation evident around the world vs the US Dollar reflects slowing demand vs supply globally in an era of debt overhangs and reduced demographic spending rates. Falling commodities are a reflection of the fundamental and structural weakness that should persist through the end of this decade. Eventually currency adjustments and producer price deflation will provide a new base to launch a stronger economic growth cycle, but for now investors will need to remain cognizant of the growing risk symbolized by sharply falling commodity prices that are reminding us of the panic down wave in 2008. Oil has already touched sub $40 a barrel today and our call for sub $2 gasoline at the pump in the 4th quarter is increasing in confidence.
Long term concerns for investors using the current 2015 lows as major support have to be balanced with the near term potential for technical gains later in the 3rd quarter as negative sentiment extremes signal an August/September low to buy oversold stocks.