Friday, October 29, 2010

Sitting on a Signal: Clear(?) Signal Expected on 11/3

The Federal Reserve Open Market Committee (FOMC) last met to discuss the condition of the economy on Sept 21. The U.S. central bankers said they were “prepared to provide additional accommodation if needed to support the economic recovery.” They also left the benchmark lending rate in a range of zero to 0.25 percent while noting that inflation measures were at levels “somewhat below” the central bank’s mandate to achieve stable prices and full employment. The Fed statement boosted speculation that the central bank will buy more Treasuries sometime later this year.

Fed observers are expecting that the FOMC will announce a new program of quantitative easing (QE) after they meet on November 2-3.

In a post on October 8, I asked myself "what are some signals to look for? A rally up to S&P 1170 might inspire some profit taking, with bargain hunters looking to test the water around 1130. Breaking through and closing below 1130 should alert investors to look for signs of a shifting mood." The thresholds were breached in stride and all in apparent anticipation of the expected new QE.

Now, look at the graphs used in that post, updated to the most recent info. There is also a new look with the US dollar index line added in these graphs to illustrate the level of correlation to the currency which has been strong since the end of May in many markets.

Here is a look at the condition of large US banks, looking at the non-performing loans in a couple of different ways through June 30. The blue line illustrates the percent of banks whose allowance for loan loss reserves
exceeds their non-performing loans, looking only at banks with assets greater than $20 billion. The red line shows the total of non-performing loans as a percent of assets at all banks. The message in this graph is that banks in general have not been in a worse condition to lend since this data collection series was started in 1988.

Here is a look at the bond market from several types of bond indexes. The primary view is of the Barclay's aggregate bond index. This index is about 60% treasury bonds, 20% agencies and 20% corporate credits. a The US dollar index line is in the primary view, and clipped in below is the ETF that tracks the Barclay's 1-3 Yr Treasury Bond. Below it is the ETF that tracks the Barclay's 1-3 Yr Credit Bond. This ETF also includes 25% exposure to foreign quasi-sovereign credit. Are bond prices turning lower in a sustainable move? Is the US Dollar the driver?

There are some stock market sectors that can be early indicators of the mood in the market. The horizontal bars show buy (gray) and sell (red) volume by price. Semi-conductors are one sector. Are they making a path to the moon without the US$? Emerging markets appear to be holding hands with the US$. And in its own world is the gold mining companies ETF. Adding to the data is the US Dollar index solid dark line.

After considering the condition of the major lenders, trends in the bond markets, several unique stock market sectors now look at currency from the US dollar perspective. The next graphs illustrate how much foreign currency the US$ will purchase. For a brief and helpful description of how currency rates are determined, read the article by John Hussman dated August 23, 2010.

Lastly, consider the number of stocks in the S&P 500 making a price that exceeds their 150 day moving average. Obviously, a sign of strength in those company prices. The clip on the bottom of this graph illustrates the S&P 500 price for a simple comparison.

Conclusion made from this analysis is that money is still moving into risk assets, especially those with a low correlation to the US$ such as the emerging market equities, semi-conductors, and the gold miners of the few sectors examined here. The bond market graph supports the idea of money leaving bonds. For one idea of where else this cash is coming from, consider the concept described here of the Fed's Plunge Protection Team. Scanner