US MARKET ANALYSIS (November 10th 2012): Prevailing Bearish Sentiment in Market Breadth

Just a quick post this weekend to highlight the technical weakness in US market breadth, which has deteriorated over the last month or so.

As we highlighted last week, leading economic indicators were broadly disappointing for the month of October. While encouraging signs were made in the recovery of US indicators, and there were some early signs of a "bottoming out" of Chinese leading indicators, the signs from Europe and Japan were cause for concern. Sure enough, this was highlighted by comments made by Mario Draghi this week, which put pressure on global equity markets.

We concluded our article last week with the following:

How does this month's data relate to our investment decisions in equity markets? While it is difficult to say where technical momentum will carry US indices, we may be more inclined to eventually buy oversold conditions in select industries, even after some disappointing PMIs this month.... There are greater apparent risks to the recovery trend than last month, especially emanating from Europe. As ever, it is worth being highly selective in entering positions, with a healthy appreciation of the risks - only adding to positions if it becomes clearer that there is positive momentum in the US economy.

I'd like to build on the statements made in that article. If we are selective with the markets and industries we wish to buy into, is now the right time to be buying on weakness before the end of the year?

While we might be inclined to eventually add risk, it is ultimately hard to decide how technical momentum will affect the entry-points we are offered as investors. One useful method is to judge the market's prevailing mood with analysis of market breadth.

For brevity, you can read more about the individual indicators and their calculation at www.stockcharts.com, where these charts are taken from.

BULLISH PERCENTAGE INDICATORS

We commented on our use of the Bullish Percentage indicators in early October:

This brings us to our crossroads point in October 2012. The BPNYA hasn't made a new high in a couple of weeks, and since mid-September has been consolidating. In 2011 and earlier this year, BPNYA spent 9-10 weeks consolidating in this way - making new Dow/S&P highs in the process - before diverging from the market and falling. We will continue to watch the market breadth indicators for developments as it remains in this consolidation phase. If it begins to fall violently, diverges from the market, or continuously fails to make new highs along with the market, we will begin to take profits on long exposure.

The chart above shows how BPNYA has developed since then. The period of consolidation has been followed by a loss of momentum and eventual declines. Failure to make new higher highs in the Bullish Percentage indicators can signal a change in mood of the market. While this indicator has no regard for levels the market could fall to, we know that these indicators are reflecting a bearish mood in the main US indices.

In other words, from mid-October onwards, the bullish percentage indicators have independently given us reason to worry about a significant market sell-off. In these kind of conditions, we want to be more patient in waiting for opportunities to buy oversold markets. Like August-October 2011, it can be highly risky to buy on slight pullbacks when the market's mood is bearish.

PERCENTAGE OF STOCKS ABOVE THEIR 50MA AND 200MA

This is a new indicator for us to discuss at Big Macro Picture. It is more volatile than the Bullish Percentage, which rely on Point & Figure analysis. It's a very simple measure - how many stocks in the S&P or the whole NYSE are above or below their 200MA? How about their 50MA? And how is that changing over time?

The trends in both charts, the % of stocks above their 200MA on the S&P and NYSE respectively, are quite clear. We can see the medium term trends in the market on a whole. From warning us out of the market in March 2011, to guiding us back in after October, the results last year were impressive. By helping us identify a weakening trend in April 2012, a difficult couple of months could have been avoided. Changing direction in June, and again in September, identifies two more turning points for the market this year.

The trend and direction of this indicator is fairly slow and deliberate, but certainly has leading qualities for the main US indices. An opportunity may eventually be afforded to the smart investor who pays attention to this indicator troughing, whenever that may be, and wherever the market is by then.

Below we have the 50MA version, which as you can imagine is far more sensitive.

  

 

As you can see, this measure looks far more erratic in candlestick form. Using the momentum indicator below can often be more useful than the 20 week MA in this case. We can see a clear early signal to re-enter the market in September 2011 - another early warning signal to reduce risk in March 2012, a re-entry signal after the weakness in June 2012, and an early signal to reduce risk again in early October.

The trends, peaks, troughs and cycles in all four charts are useful in determining underlying market sentiment. All four have deteriorated rapidly in recent weeks - we wait for signs of consolidation.

CUMULATIVE NYSE ADVANCE-DECLINE ISSUES

This indicator is unlike any other I tend to use, and is a cumulative calculation of advancers vs decliners over time on the NYSE. It can be a useful long term indicator, and tends to have very broad multi-year trends.

Again we can use a simple moving average (in this case 13 week MA) or a momentum indicator to define the different modes and trends in the underlying indicator. We can compare the results from other indicators to 2011 and 2012 so far. June-October 2011 is identified as a time to avoid being over-exposed to the market. October 2011 - April 2012 is identified as a "risk on" period. May 2012 is identified as a period of market weakness, but very quickly rebounds throughout the summer.

Now we see the most recent cross-over in late October, for both the TSI (bottom) and the 13 week moving average. This indicator is broad and rarely the most sensitive to react to changes in market sentiment, but recent weakness in this indicator is a cause for concern.


Another indicator, the McClellan summation index for the NYSE, is similarly used to measure the net advancers vs decliners in US stocks, and reaches very similar conclusions.

We can see this in the recent declines below the 20 week moving average, and cross-over in the True Strength Index. You can read more about these indicators here.


 

NYSE HIGH-LOW INDEX

Finally we'll consider the NYSE Hi-Lo Index, a smoothed indicator showing trends in the number of NYSE stocks making new highs or lows. This is a particularly choppy indicator even after smoothing, so we use a slower form of TSI (40,20,10) settings, and rarely use the 20 week moving average for signals.

We can see how choppy this indicator can be - but also how market phases can be determined using the TSI. We can see how an early risk-off signal was given in April, and how the decline in NYHILO halted before the market lows in June. The TSI, having moved positive again in July, has crossed back to negative this week - inferring a very different mood in the overall market.

CONCLUSIONS

We have seen a variety of different market breadth indicators signalling a new prevailing mood within the stock market, beginning with the peaking of many measures of market breadth between September and October. With the advent of this week's sell off, the TSI momentum indicators have crossed over in each instance.

This shouldn't be taken as an outright signal to be net short in equities. Rather, it is an indication that we might be best served waiting before "buying weakness" in even the strongest sectors of the US market.

The analysis regarding leading indicators from last week still remains valid - the US remains the strongest main market, while Japan and Europe have particularly worrisome trends in PMI. While the US seems to be enjoying a sustained recovery from the summer's economic malaise, the above indicators show that we should be careful in our market timing.

Until we see a sustained improvement in these indicators, and with emphasis on the fragile nature of the recovery in the global economy, we'd wait before being too greedy amidst the fear prevalent in the market.

In short, "eventually buying oversold conditions" might still take a little longer. Hopefully we'll see more bullish evidence in the US economy before then.

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GLOBAL ECONOMY (November 4th 2012): Global PMI Round-up; How Strong Is the "Improving" Trend in Economic Data Worldwide?

Thursday and Friday this week saw the release of important economic reports from the United States and the rest of the world. ISM Manufacturing, Non Farm Payrolls, Unemployment Claims and PMI stats were released for October - with important implications for the imminent US Presidential Election, ongoing global monetary policy and overall trends in the global economy.

In this article, we'll build on last month's analysis and provide a review of the world's PMI Reports, courtesy of Markit, ISM, HSBC and JP Morgan. You can see most reports for yourself here.

LAST MONTH'S REPORTS

You may remember from last month's article here, that the last round of figures were broadly improving - China saw a modest improvement in operating conditions, Japan hit a three month high, Russian PMI made a four month high, Spain improved slightly, Italy saw a six month high, Germany saw a marked improvement despite still being in contractionary territory, and the Eurozone Composite hit a six month high.

The US saw mixed figures pointing to fairly mediocre growth, but an arrest in the decline seen over the summer, and a move away from contraction in ISM.

France and the UK meanwhile saw disappointing figures.

This left us waiting for more convincing confirmation of a recovery in leading indicators, but with a sense that we'd seen a definite stabilisation since the summer. We felt the market meanwhile had been "guessing" on QE3 improving the data from June onwards, and preached caution of chasing risk as the market hit multi-year highs. Purely in terms of data however, the September reports were positive. Would October build on that burgeoning trend of recovery, or would we still be left waiting for monetary policy to filter into business conditions? If so, how patient can the market be?

GLOBAL PMI ROUND-UP FOR THIS MONTH

Let's look at the same major economies we covered in the September reports.


China - posted 49.5 in October, up considerably to an eight month high from 47.9 in September, and 47.6 in August. To better explain the trend in Chinese PMI (both the more "official" and HSBC versions), I've provided the charts below.

All charts courtesy of the superb ForexFactory

The HSBC version more accurately depicts the malaise since the "China slowdown" theme became apparent. The "China Federation of Logistics and Purchasing" version meanwhile seems to be more sensitive to the month-to-month swings in global business conditions. While we're keen to applaud the trend of improvement in the last couple of months in both versions, as both charts show, there is far from a clear sign that China has "bottomed" in the data. Especially while the HSBC version remains in this multi-year contraction.

What do the report internals say, to maybe give us more hope for this little recovery? Encouragingly, for the first time in 12 months New Orders moved into positive territory, citing a growth in new clients. This offset a sixth month of decline in New Export Orders, as demand remains weak in the US and Europe. The commentary suggests that the deterioration may finally be over in China, and that easing measures are finally filtering through into business conditions, at a pivotal time in Chinese politics.

At Big Macro Picture, we'll believe it when the trend in data improves more convincingly, but this is definitely a positive month for Chinese PMI.




Japan - sank to eighteen month low of 46.9 in October, down from 48.0 in September. While last month's report was a moderate improvement, the chart below shows the generally depressed nature of Japanese PMI since the summer.

We're not big fans of Japanese PMI as a global indicator, but it is worth taking their report into consideration for the big global picture, even if Japanese PMI rarely acts as a useful bellwether. The internals of the report suggest sluggish international demand, excess capacity, and a reduced purchasing appetite amongst managers. Like our analysis of the UK, a healthy appreciation of currency-related issues has to factor into our thinking - for instance, how much weaker has the Euro or Dollar become in relation to the Yen? And how has that affected, as cited in the report, weak car exports? The report overall is disappointing and even forgiving currency-related weakness, detracts from the argument that PMIs are in recovery.


Russia - extended its impressive run to a five-month high of 52.9 in October. As mentioned last month, we do not often draw global conclusions from Russian PMI - however, the internal commentary of the report is interesting. While new export orders suffer from weak global demand, the resilience of the domestic Russian economy is cited, along with private consumption growth to fuel the production of consumer goods. Like last month, Russia is serving to contribute to the "positive" argument for PMI recovery since the summer.


Spain - declined from 44.5 to 43.5. As we mentioned last month, and as we can also see on the chart below, Spanish PMI is a very smooth and relevant leading indicator. It captures the marginal month-to-month changes in the peripheral European economy, and as it stands at the epicentre of the "European debt crisis", garners much attention from the market itself.

When such a smooth indicator stops recovering and posts a three month low, it is worth taking note - especially when it formed one of the most compelling bullish PMI arguments from August onwards. While the Spanish PMI has been in heavy contraction since 2011, as we saw in 2009, there is a large difference between a "recovering PMI" below 50 and a stagnating one, where markets are concerned. Analysts will hope that this decline is a blip in the recovery from August onwards. Internally, based on falling new orders and output components, as well as reductions in "prices charged", we might worry that there could be more weakness to come. This is certainly an indicator worth following as we go into 2013.


Italy - declined marginally from a six month high of 45.7 in September, to 45.5. While this may sound bad, and is far from good news, we are still far from the lows of the summer in Italian PMI, after it jumped higher last month.

As we said last month, there isn't much of a "recovery trend" to speak of in Italian PMI, but such a marginal decline probably does not invalidate the improvement since August. Interestingly, something that was also reflected in the Spanish report, New Export Orders saw an improvement in trend - turning positive in Italy. However, domestic demand was cited as a major drag on both economies, as margins continued to be squeezed for Italian producers. In terms of our big picture, the "recovery trend" or lack thereof in Italian PMI is neutral to any bullish or bearish arguments this month, and really continues to stagnate around the 2012 average.



France - recorded 43.7, only a slight rebound from 42.7 in September, which was the worst reading since April 2009. French producers continue to eat into outstanding business, and excess capacity is growing noticeably. Low demand and low business investment/confidence are cited as significant drags within the domestic market. New Orders were barely improved from the three-year lows seen in September, and new export orders were the worst since mid-2009. The report concludes by suggesting a return to recession in France is a major risk before 2013. This is a significant concern for France, as leading indicators for the last two months have pointed towards severe contraction in the manufacturing sector. Despite rebounding slightly this month, the negative trend in French PMI remains one of the most bearish factors in our analysis of European leading indicators.


Germany - 46.0, a sharp fall in PMI from 47.4 last month, but still some way off the 2012 lows. Subdued business confidence was considered a major factor in the ongoing contraction, while backlogs of work were eaten into at a sharp pace as new business and demand remained depressed. In terms of analysing the trend in German PMI, it is disappointing that this indicator did not continue to build on the improvement seen last month. However, as it is some way off the lows for 2012, it cannot be considered part of a convincing trend as a result of this disappointing report. Simply, we note that it is not alone this month in failing to post a "higher high" within any supposed recovery.


UK - lower again this month, from 48.1 to 47.5. As the chart below shows, UK PMI can be a "messy" indicator to deal with nowadays, and is often difficult to use as a bellwether for global economic conditions. 

Like many other indicators, UK PMI seems to have peaked in February-April and troughed in August for 2012. While the last three months show a worrying continuation of the 2012 malaise, it is difficult to derive much of a declining trend from these reports. Internally, the report shows another sharp decline in New Export Orders - showing weak demand in Asia and mainland Europe, and probably not helped by the strength in Sterling. One interesting note, as was reflected in the German report, manufacturing in the consumer goods sector rebounded impressively this month, possibly reflecting an improvement in global retail sales and the international consumer.



Eurozone Composite - 45.4 in October, ticking down from September's six-month high of 46.1. As mentioned last month, this broad indicator tends to give us a smooth representation of the Eurozone as a whole, from the periphery to the core. Apart from economies we have already covered, this report mentions Greek PMI at a four month low, Austrian PMI at a 40 month low, the Netherlands at a three month low, and Ireland at a three month high. Every economy covered by the composite report, other than Ireland, is showing contraction in PMI.

Being a smooth, composite indicator, we tend to take notice when this indicator trends in one direction or the other, especially given its relevance in 2012. It is not immune to producing "off trend" reports which turn out to be anomalies in a wider trend - so we're not worried by one single bad report. However, it is probably indicative of how fragile this recovery in the data has been since the summer - if it will be remembered as a true recovery at all.

We can see on the same chart how much conviction there was behind the strong rebound in business conditions in 2009, with almost a straight year of month-by-month improvements in PMI. While not every trend can be as smooth or convincing as that, a step closer to expansion this month would've given us more confidence that business conditions were on the right track in the Eurozone - instead, one of our bullish arguments has become more doubtful.



United States of America - ISM Manufacturing PMI shows another month of improvement from 51.5 to 51.7 in October. Again, this is best shown on a chart, lest we forget that we are barely 1 percentage point off the 2012 lows in this indicator, and barely in "growth" territory.

However, one of the most encouraging signs this month has been another better than expected (and improving) ISM PMI, one of our favourite leading indicators. After dropping unexpectedly in mid-2010 and mid-2011, ISM stabilised over six months or so, and then began beating expectations and modestly recovering (periods of impressive returns for equities).

Naturally we're pleased that ISM has seemingly troughed for 2012 (if you believe this is a trend of recovery) and has made two month's worth of higher highs. However as we noted last month, equity markets began reflecting this kind of improvement all the way back in June, on the expectation that QE3 was imminent - so investors cannot really use this as "divergence" to justify adding equity market risk.

Another side of the story comes from the less established US Markit PMI. This version of US PMI edged slightly lower to 51.0 from 51.1, the lowest reading since October 2009. Both New Orders and New Export Orders components declined - and without seasonal adjustments, this version of PMI moved close to contraction for the first time since the bull market began.

Output on a whole increased at at a faster pace, but interestingly - a theme we've seen throughout these reports - the rise was solely down to the reported increase in consumer goods production. Output of investment and intermediate goods actually declined.


Both versions of PMI reflect a barely-growing US manufacturing sector, fraught with insecurity in the new orders component, perhaps due to fiscal uncertainty. While ISM shows a US economy stabilising and improving from the summer, the Markit version continues to reflect deteriorating conditions in 2012.

To muddy the waters further, as a "stronghold" of the global economy in 2012, US PMIs have held up remarkably well compared to the rest of the world. With peripheral Europe at the centre of ongoing concerns, it has sometimes taken three or four months to "drag the US down" when the European leading indicators have taken a downturn. This makes it more difficult to use the US economy as a leading "bellwether" for global conditions, even though the US economy is the single most influential factor in the global business environment.

Being such an influential component, we can take ISM's stabilisation and improvement as an important indicator that the world's largest economy is out of the summer doldrums - albeit in a very fragile state. This is also reflected in Non Farm Payrolls, something we'll discuss in an article later this week. Markit's version, meanwhile, continues to give us something to worry about. Questions such as "when will QE3 filter into the data more convincingly" and "what will be the effect of the devastating Hurricane Sandy on the US economy?" remain unanswered, something we'll need to look out for in next month's reports.







Miscellaneous - there are a number of economies we do not tend to cover in detail in our PMI analysis, either because of poor "leading" performance as an indicator, or to avoid even longer articles. Briefly then, Canadian PMI fell from 52.4 to 51.4, Brazil PMI moved back into expansion from 49.8 to 50.2, Indian PMI was broadly unchanged near the lows of 2012, Mexican PMI (seemingly a lagging indicator) moved from 54.4 to 55.5,  South Korean PMI rebounded from 43-month lows to 47.4 from 45.7 and Australian PMI edged higher to 45.2 from 44.1.


JPM Global PMI - rose for the second month, from 48.8 to 49.2. This is a very smooth, composite indicator for the whole world, with PMIs weighted by economic influence on global GDP. You can read this very useful report here.

This rise may seem surprising, considering the declines reported in Japan and the poor showings in the UK and Eurozone. Certainly the breadth of this month's report is questionable, with the likes of France and South Korea only rebounding from a very low base, and only the the US ISM showing much conviction in a recovery trend from the summer.

Nevertheless, it is useful to note that this indicator has moved off it's 2012 lows, even if it is too broad to capture ongoing conditions in the beleaguered Eurozone. Improvements in the US and China this month cannot be ignored given their influence on the global economy - and the rest of the world may find themselves relying on their strength as we enter 2013.

OUR CONCLUSIONS

With this latest round of data, our perception of the strength of the MEDIUM TERM "recovery" trend has changed somewhat, while we still wait for more convincing signs that global monetary policy is improving business conditions.

Despite the disappointments and setbacks this month, PMIs have mostly troughed and recovered from the summer lows, as we reported last month. The number of PMI reports issuing new multi-year lows are now few, while many are only one month from trend highs. However, the strength or "conviction" in that bullish recovery trend is more doubtful after so many key economies fell back from last month - namely in the Eurozone and Japan.

The recovery trend in ISM, and the eight month high in Chinese PMI, represent the highlights from this month's data, from perhaps the two most influential economies in the world. In both cases, easing measures are filtering into the wider economy, with momentum which we would hope to see continue into 2013. However, with political and fiscal uncertainty surrounding both countries - not to mention the tragic consequences of Hurricane Sandy in the States - the fragility of both recoveries remain in question.

Perhaps the most disappointing aspect of this month's data comes from Europe, particularly the setbacks in Italy, Spain and Germany, where previously the data had been recovering. The UK data saw another month of decline, while France rebounded from a low base, still far below its 2012 average. Greece, the Netherlands and Austria all moved lower. It would be wrong to suggest that this month's data is pointing to a new bearish trend, but it pours cold water on the idea of a strong recovery from the summer's lows. 

The strengthening of the Euro against the dollar in recent months has reduced the competitiveness of Eurozone producers, seen especially in the automobile manufacturing sector, something which may need to be addressed before Europe can recover. Similarly, in Japan, where 2012 lows were seen this month, competitiveness may struggle to improve until the Yen devalues.

AND THE IMPLICATIONS FOR INVESTORS?

How does this month's data relate to our investment decisions in equity markets? Unlike the previous month, when the mildly recovering data was coupled with an overheated equities market, this month the Dow sits closer to 13k, some 600 points from 2012 highs. While it is difficult to say where technical momentum will carry US indices, we may be more inclined to eventually buy oversold conditions in select industries, even after some disappointing PMIs this month.

Much of the current concerns in US equities relate to political and fiscal uncertainty, which are very real problems. However, it does provide stocks with a "wall of worry" to climb once we know the outcome of the election. Other weakness has related to earnings reports, and negative earnings guidance from key US companies. Much of this reflects the weakness in data we saw up until August, when ISM PMI for example was below 50.

If the leading indicators in the US recover into 2013, as we hope they will, stocks may surprise positively in the next round of earnings from a very low base of expectations - but of course, this relies on a more consistent improvement in business conditions. In short, we believe that based on current US leading indicators, we're more inclined to add risk on oversold conditions.

Despite this, as we've outlined in this article, there are greater apparent risks to the recovery trend than last month, especially emanating from Europe. As ever, it is worth being highly selective in entering positions, with a healthy appreciation of the risks - only adding to positions if it becomes clearer that there is positive momentum in the US economy.


That's quite a lot of analysis to consider from around the world. It is possible to derive different meanings from the trends in data over different timeframes, this is simply our take on the developing trends in PMI data.

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