September 29, 2014

Technical divergences and breadth reductions

As previously noted, I am a (short) seller on any strength. As a measure of my conviction, in "Batten Down the Hatches," I reported that I even sold off a portion of some core investment holdings over the last two days, including Radian Group (RDN), Monitise (MONIF), Potash (POT) and Citigroup (C). (These stocks remain on my Best Ideas List, however, because of their intermediate-term reward vs. risk).

I was amused that several commentators in the business media this week couldn't find specific reasons for the recent market drops. By contrast, I see not only weighty technical divergences and narrowing breadth but also a host of fundamental concerns: 

  -  Away from the U.S., economic activity is weakening. Italy, France, Spain, Russia and Japan are in recession. European real gross domestic product growth is perilously close to zero and a Japanese-style deflation is threatening the region. Based on recent data, the rate of growth in China's economy is decelerating. (I recently sold my iShares FTSE/Xinhua China 25 Index (FXI) long at around $42.50 for a near 25% gain over a three-month period.)
  
 -  The European Central Bank faces the challenge of structural issues. The ECB may be running out of gimmicks to spur growth in the quarters ahead. Moreover, the region's leveraged banking complex represents systemic economic risk for Europe and the world. Should the European Union fall back into recession, global economic activity will slow and will not only serve as a headwind to the U.S. and European profit growth, but it will also make it hard for peripheral EU countries to access capital markets and to finance deficits.
  
 -  Geopolitical pressures are rising outside of the U.S. and, unfortunately, there are plenty of reasons to believe that the world will be a powder keg for years. The Russian-Ukraine military confrontation is pressuring trade and economic growth -- that conflict, too, will likely be with us for some time.

-   Housing activity continues to pause, and its foundation is fragile. Increased bank-capital requirements -- above those demanded under international banking regulations -- will further pressure the U.S. housing market and could tighten lending standards. (Mortgage purchase applications are down by 16% year to date)

-   The automobile industry is exhibiting signs of peaking, and so are other durables, such as tractors and other heavy equipment, as posted in Caterpillar's (CAT) recent dealer statistics. Automobile inventory supplies are high and increasing, and aggressive incentives are being offered by car dealers and manufactures.

 -   A strengthening U.S. dollar is dulling our economy's prospects by hobbling U.S. export growth.
    Domestic growth remains sub-par and at "escape velocity," and sustainable growth still seems in question. With the 2014 results, the Federal Reserve itself has missed its U.S. economic growth forecasts for the fifth consecutive year.

-    Inflation continues to run below the Fed's projections and, with the U.S. dollar strengthening and commodities collapsing in recent months, measured inflation is likely to continue lower.

-    Personal consumption expenditures, in particular, look to be weakening. Payroll growth has fallen for the past three months, spending fell in July and August, and the screwflation of the middle class has persisted. The "exclusive prosperity" of trickle up economic policy since the Great Recession holds economic and social risks. None of these effects are likely to be value inflating for stocks.


Originally published Sep 25, 2014
VIA http://www.thestreet.com/story/12892450/1/real-money-pros-doug-kass-on-the-market-sell-any-strength.html 

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