There’s a difference between a tradeable rally and a fundamentally sound trend. The stock market has been exceptionally strong since Labor Day, turning positive for the year around the middle of September. During this period the two dominant news themes have been the Republican party’s campaign gaining momentum and the Federal Reserve Board’s verbalization of their willingness to do whatever it takes to keep the economy churning. Additionally, we are heading into the strongest seasonal period for the stock market on an annual basis. When these factors are combined with equity managers who have to put money to work on the long side to keep pace with the index, we see a stock market that defies logic by gaining momentum as it rallies.
The S&P has had three outside bars in the last five trading sessions. Typical market movement is just over one outside bar per month. Analysis of these three days shows that they all started lower based on overnight concerns and finished higher on the day’s trading here in the U.S. Whether the buying that came in was from fund managers trying to get capital into the market at a discount, traders covering their short positions or foreign money coming in to buy our equities at a dollar denominated discount is irrelevant. Buying is buying.
We’ve clearly identified the trend is higher. There are sectors with fundamental support like Potash, ADM, ConAgra, Freeport McMoran and so forth. These commodity based companies should rally in an economic environment dominated by a declining dollar. It’s good to own, “stuff.” In fact, the basic materials sector is up over 20% on the year, led by precious metals. An argument can also be made that the historically low interest rates have created a new type of carry trade, where borrowed money is being put to work owning, “stuff.”
The flip side of the stock market’s rally combines technical resistance, bearish commercial positions and a deteriorating labor market. Technically, resistance comes in another 2.5% higher around the April highs at 1200. Also, the market has lost about 15% of its open interest since making the August lows. Healthy trends are supposed to gain open interest as they progress.
Moving to the commercial positions, the open interest peak at the August lows coincided with the last commercial net long position. Over the last couple of weeks, the commercial traders have moved to a dead net short position. This includes a record short position in the Nasdaq. This type of behavior is a perfect illustration of why we follow the commercial traders. Small speculators and funds were accumulating short positions at the August lows while the commercial traders were buying the market against them. We are seeing the exact opposite play at the market’s top, right now. Small speculators and funds are putting money to work in the market as the commercial traders have gone from long position liquidation to outright short position initiation over the last two months.
Finally, the public unemployment rate held steady at 9.6% for the month of September. However, looking deeper into the data, we see that the economy has added only one month’s worth of new jobs over the last year and 90% of those jobs have gone to hiring workers over the age of 65. Employers are paying minimum wage for experience and reliability, not rebuilding long- term work forces. The data also shows that part time workers for, “economic reasons,” which means they can’t find full time employment is the highest ever recorded. The last piece of doom and gloom comes from Richmond Federal Economic Conditions Survey, which shows that companies are issuing a hiring freeze with the one of the largest single month declines that the Number of Employees Index recorded in the last decade. This is reinforced by the plunge in the Workweek index and the New Orders Index.
We may be approaching a climactic event in the stock market. The data spreads that went into crating this article have never been wider. The Federal Reserve Board is talking about a second round of quantitative easing. Their dialogue has created a rush into tangible assets like the commodity markets. It is supplying an artificial floor for the stock market and it has created a rush to buy short and medium treasuries. These moves are based on conjecture and hyperbole. What if the Fed sits tight? The markets have provided the Fed with the action they’ve been unable to create through their own actions. Inflation, low interest rates and a healthy stock market are exactly what they’ve been trying to construct. What happens when these bubbles burst?
This blog is published by Andy Waldock. Andy Waldock is a trader, analyst, broker and asset manager. Therefore, Andy Waldock may have positions for himself, his family, or, his clients in any market discussed. The blog is meant for educational purposes and to develop a dialogue among those with an interest in the commodity markets. The commodity markets employ a high degree of leverage and may not be suitable for all investors. There is substantial risk of loss in investing in futures.