Thursday, September 10, 2015

Sentiment Is So Bearish That Maybe It’s Bullish (excerpt)

The 9/8 Business Insider website included an article titled “I just got back from Burning Man and here’s what I saw.” The author recounts that this annual festival at Burning Man in the Black Rock Desert, a remote part of Nevada, attracted 70,000 people and “was as wild as ever.” The stock market also seems to have turned wild as ever over the past few weeks. However, it hasn’t been a festive development for many other than high-frequency traders.

The S&P 500 was listlessly trading in a very narrow 110-point range between 2020 and 2130 from the beginning of February through mid-August. Then the wildness started following the devaluation of the yuan. As I wrote on Tuesday, “Arguably, the stage was set for the Monday, August 24 flash crash on Tuesday, August 11, when the Chinese devalued the yuan. That heightened fears that China’s economy was in much worse shape than widely perceived. Those fears were confirmed on the morning of Friday, August 21 with the release of a very weak reading for the Caixin Flash M-PMI. The S&P 500 plunged 11.2% from August 10 through August 25.”

The range for the S&P 500 is now much wider, spanning 263 points between the record high of 2130 on May 21 and the August 25 low of 1861. The daily swings certainly have become wild.

The flash-crash correction and all the volatility have depressed the Investors Intelligence Bull/Bear Ratio, which fell to 0.92 this week. That’s the lowest since October 2011. It’s so bearish that it’s bullish, at least from a contrarian perspective. Readings below 1.00 have provided strong buy signals in the past.

From a fundamental perspective, investors are fretting over lots of known unknowns. China’s economy is slowing, but is it a bumpy, soft, or hard landing? Might it be hard enough to cause a global recession? The plunge in commodity prices might be good for consumers, but bonds issued by commodity producers are at risk of default, as evidenced by the rising yield spread between corporate high-yield debt and 10-year Treasury bonds. The currencies of emerging market economies (EMEs) have been in freefalls this year as a result of capital flight. Won’t that put them into recessions, and might there be some sort of EME crisis? If the Fed does start raising rates, might that cause a massive unraveling of global carry trades?

We all know what the issues are. We just don’t know how they will actually play out. No wonder that investors aren’t in a festive mood. Nevertheless, stocks may be set up for yet another relief rally if all the worst-case possibilities of the known unknowns don’t unfold. Just as important for the bull case is that no matter what happens, the US economy remains resilient and strong. So far, that seems to be a known known. I see plenty of evidence of that in the latest survey of small businesses and the JOLTS report.

Today's Morning Briefing: Big Jolt. (1) A wild festival in the desert. (2) Stock market has also gone wild, but without the festivities. (3) From tight range to wide-open range. (4) Buy signal: Bull/Bear Ratio drops under 1.00. (5) Lots of known unknowns could be setting stage for yet another relief rally. (6) Small businesses are big employers in the US. (7) Upbeat trends in NFIB survey data. (8) Buddy, can you spare a worker? (9) In the past, rising job openings tended to boost wages. (10) It has been and may continue to be different this time. (11) Known known: US economy doing just fine. (More for subscribers.)

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