July 9, 2016, Weekly Summary: Is There Fundamental Support for Equities?

First, we are going to look under the hood of the economy to see if the rally in equities has a fundamental underpinning; starting with the velocity of money in the economy.  According to the FED’s definition:

“The velocity of money is the frequency at which one unit of currency is used to purchase domestically-produced goods and services within a given time period. In other words, it is the number of times one dollar is spent to buy goods and services per unit of time. If the velocity of money is increasing, then more transactions are occurring between individuals in an economy.”

The narrowest definition of money supply is the M1, with the M2 and MZM consisting of increasingly broader definitions.  The following charts show the velocity of the
three money supply definitions.

M1

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Total industrial production is illustrated in the chart below.

Total Industrial Production

Notice the recent drop in industrial production and how the two previous recessions were preceded by similar drops in production.

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Wages have increased 2.6% year-over-year, but only 40% of workers have received increases (see chart below).  This implies an uneven-distribution of wage increases.

Percent Reporting Wage Increases

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The chart below shows the increase in the percentage of college educated individuals working for minimum wage, or less.  These individuals, one could argue, are representative of the “middle class”, without whom there can be no sustained economic growth.

College Graduates Paid at or Below Minimum Wage

With 10.6% of this cohort working for minimum wage (or less), we can assume that they are not able to fully participate in the economy.

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The strong NFP (nonfarm payroll) number (287k) for June excited the market because it made-up for the downwardly revised (11k from 38K) May jobs report.  The market rallied because, even though the NFP number demonstrates growth in the labor force, the market continues to price-in a zero chance of a rate hike at the end of the month, and only a 24% chance of a hike by the end of 2016.

We think this is a mispricing of the rate-hike probability.  These relatively strong job numbers could cause the FED to telegraph their intentions of raising rates AT LEAST once before the end of the year.  This could happen as early as this coming week which would result in an immediate “risk-off” for the market.

Turning to the historical patterns that we are currently following,

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The sentiment indicators increased to 31.1% bullish, 42.3% neutral, and decreased to 26.7% bearish.  The CNN Fear and Greed index has shot up from 52% (neutral), to 78% (extreme greed).  This supports the patterns we are following above.

The charts below, however, show a possibility of ‘risk-on’ taking hold in the market, but this has not been verified by the other patterns so we are simply keeping an eye on this.

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The following chart shows the various asset bubbles that have occurred since Nixon completely decoupled gold from the dollar in the 1970s.

Notice how the bubbles have increased in frequency; the gold/oil bubble (~1980) and the NASDAQ tech bubble were separated by 18-years; the housing bubble came 7-years later; the oil bubble came 3-years later; the gold bubble followed 4-years later; and now, 5-years later, the NASDAQ (equities) could be forming the next bubble.

It is also interesting to note that the NASDAQ is well ahead of gold in the formation of a bubble.

Gold

Gold continues elevated, but is displaying an inability to cross the $1400 level.  Until (if) that happens, gold is vulnerable to a serious correction.  This is especially so if the FED starts to make hawkish noises.

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The commitments of traders continues to push its way further into uncharted historical levels.  This is setting-up to be a monumental fail for one side, or the other.

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The commercial traders continue to increase their short-selling, while the hedge funds (large speculators) buy deeper into the long side.

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Considering how difficult the markets have been since March 2015 when we started our Trade Alert subscriber service, we are pleased that we have managed to book a 32% profit (non-compounded), and that 80% of our trades have been winners since inception.  We continue to work toward calculating probabilities that will profit both ourselves and our subscribers.

We wish everyone a profitable week ahead.  Please monitor emails for trade alerts.

Regards,

ANG Traders