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Monday, December 18, 2017

Daily update 12/18 Tell-Tale Spreads Confirm Slowdown Ahead

More tax cut fever.

Unfortunately most of the excitement happened overnight.  There was very little upside after the open.  Maybe we are getting close to tax cuts being priced in.  Breadth was +68%.  New highs spiked up to 259.  New lows dropped to 19.  SPX is the furthest away from the 200 SMA as it has been since March 1 (that high was not exceeded until 5/8).  The last time before that was early in 2014.  SPY had a doji bar today.  Upside progress from here might be slow.

The futures extended their gains after breaking out of the channel on Friday.  They are getting extremely extended from the 200 SMA here as well. 

The green count finally crossed 50 today.  I am not real sure what to make of this.  While the green count is short of overbought the price is way extended and extremely overbought. 

The market is clearly very overbought.  It is hard to say if that matters when in runaway mode.  Investors were not interested in buying the gap up today, but that does not preclude the futures from gapping up again tomorrow and/or the next day.  When the market is running on emotion technical analysis does not help much.  How far she goes nobody knows.  I would be remiss if I did not mention it is possible today was an exhaustion gap.  A close below today's low would greatly increase the odds of that.  We could see some consolidation now that everybody has piled in.

In Daily update 10/30 ERCI video on profits growth slowdown I wrote

"Interesting video of ECRI chief talking about global economic growth peaking and about to slow down based on their long lead indexes.  I remember ECRI saying in the summer of 2016 their long lead indexes pointed to a global economic upturn and they were dead right.  They might be correct again.  Notice in the video he mentions this might be as good as it is going to get."

Fast forward to today and ECRI is saying spreads are suggesting the slowdown may be starting.  Tell-Tale Spreads Confirm Slowdown Ahead

Of course, there’s no Holy Grail in the world of forecasting, which is why we look at a wide array of leading indexes that each includes many inputs. From that vantage point, the yield curve flattening actually makes a lot of sense. Growth in ECRI’s U.S. Short Leading Index, which doesn’t include the yield curve, has been falling since early this year (top line in chart), pointing to a U.S. growth rate cycle downturn that should become evident in coming months.
Next, please note the separate slowdown signal coming from the difference between the yields on junk bonds and investment-grade corporate bonds -- also known as the quality spread (middle line, shown inverted). It has widened in recent months because the rising default risk for junk bonds during economic slowdowns makes their yields climb faster than those of investment grade bonds, which are less likely to default.

That the quality spread has little to do with the term spread is telling. Please note how closely the (inverted) quality spread has followed the Short Leading Index growth rate, not only this year, but also in past cycles.

Finally, we turn to the term spread between 10-year and two-year Treasury yields, which has been falling all year (bottom line), flattening the yield curve. Again, this is being dismissed by some analysts who attribute the phenomenon to foreign central banks' suppression of their bond yields, even though this is nothing new. And while declining longer-term inflation expectations and trend growth expectations help explain the long-term downtrend in the term spread, they don't explain its cyclical fluctuations.

Of course, the quality spread doesn’t exhibit a similar long-term downtrend. That’s because it’s unaffected by both foreign monetary policy and the years-long downgrading of long-term growth and inflation expectations.

Nevertheless, the chart shows that the cyclical ups and downs of both the quality spread and the term spread have followed those of the Short Leading Index's growth rate. In other words, our leading indexes, as well as two very different bond market spreads, are telegraphing an economic slowdown that nobody sees coming. It certainly threatens to blindside the Fed, which -- fixated on the Phillips curve -- keeps projecting multiple rate hikes over the next year. 

It is too soon to have any idea how much of a slowdown we might be in for.  It is something to watch as 2018 progresses just in case.


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