Equity prices are slipping quickly this morning ahead of the FOMC announcement (2:15 Eastern). The dollar is up sharply, bonds are higher, and both oil and gold are lower. Unfortunately, this action will produce opening gaps on the charts, so be very careful if you are trading in front of the FOMC, and expect that the first reaction is very likely the wrong reaction.
Yesterday’s gains were very trepid, coming on falling and pathetically low volume. Below is a daily chart of the SPY showing how the volume has been falling ever since the Flash Crash low, and with each bounce volume falls further, while on each decline it rises. Volume confirms price, and the direction since the beginning of July is up, volume is saying that this rising wedge rally is getting very, very tired:
China’s Shanghai Index fell 2.9% overnight and that did help to get our futures rolling downhill. Note in the 3 year daily chart below (last night’s decline not depicted) that the gap between the SPX and Shanghai market has actually been growing. That condition typically will resolve with our markets playing catch-up as you can see that occurred during the ’08 timeframe with the Chinese markets leading:
There were some Chinese economic reports indicating potential slowing, but also China took action to have their banks pull some off-balance sheet paper back onto their books – holding debts off balance sheet can give the appearance of lower leverage than actually exists, thus this would be a step towards less leverage in their banking system:
Aug. 10 (Bloomberg) -- China’s banking regulator ordered banks to transfer off-balance sheet loans onto their books and make provisions for those that may default, three people with knowledge of the situation said.
The move may increase pressure for capital-raising at Chinese banks, which Fitch Ratings last month said had more than 2.3 trillion yuan ($339 billion) of off-balance sheet assets. It also underscores concerns about the health of the banking industry after a person with knowledge of the matter said regulators last month ordered lenders to conduct stress tests to gauge the impact of home prices falling as much as 60 percent.
Back in the U.S., Non-farm Productivity fell .9% in Quarter 2. Expectations were for a flat report, so this is worse than expected, however, quarter 1 was revised higher from the initially reported +2.8%. This is a rapid deceleration of productivity, one of the measurements that I believe has been vastly overstated. Unit Labor Costs rose .2% which is much less than the expected 1.5% rise that was forecast, showing once again that creating inflation is much more difficult in this environment than most economists believe - this is because they live and were trained in a linear world that does not exist, nor do they understand debt saturation. Here’s Econoday:
Highlights
A 3.6 percent increase in hours worked outpaced a 2.6 percent increase in output, making for a 0.9 percent quarter-to-quarter decline in second quarter productivity and ending five straight quarters of strong growth. In a partial offset, first-quarter productivity was revised 1.1 percentage points higher to plus 3.9 percent.
The reversal in second-quarter productivity made for a 0.2 percent rise in labor costs to end three straight quarters of sequential decline. The rise in labor costs doesn't mean that workers are making more. Hourly compensation fell 0.7 percent following a flat reading in the first quarter. Weakening productivity is not surprise given the slowdown in growth, but today's results are further evidence that the recovery may be in jeopardy.
An admission that the “recovery” might be in jeopardy? Oh my, it’s only been what, three straight months of horrific economic data? Congratulations, I think they might be coming around… naw, their pay is tied to selling never ending growth, just like the rest.
Of course the bond market has been recognizing reality for quite some time, and has not backed down from that pronouncement. You can see that clearly in the chart below that shows the U.S. Bond Fund (long duration bonds) versus the SPX (thin black line). Note that typically a rise in bond price portends lower prices in stocks as was the case up until July. Then in mid-July bond prices continued to rise while stocks rose with them. One of these is wrong, and it is almost a 100% guarantee that the bond market is right:
This is one of many divergences now in place, all indicating that equities are pushing the envelope. And speaking of envelope, here’s a close up of the VIX daily showing how yesterday’s action pinned both the upper and lower boundaries of the flag it has formed. I think a break is highly likely today, but expect wild swings on the FOMC announcement:
Below is a 60 minute chart of the SPX showing the rising wedge. Note the top of the wedge is now 1140, while the bottom is roughly 1115:
There were 5 distinct waves into yesterday’s high, which means that a pullback should be expected. McHugh seems to favor overthrowing the top of that wedge after a small decline first, but that definitely does not need to happen, nor is it important from my perspective. What’s more important is the bottom trendline and breaking decisively below 1115 – that would indicate to me that wave 2 is over, and it provides a demarcation line for entry/ stop positions.
Today is the Bradley Model turn date… the direction into the turn is obviously up, and all indications are that the rise is very tired. We are also heading into the unfavorable time of year for equities, it may finally be time…